The following selected financial data should be read in connection with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and notes that are included in this Form 10-K. Financial information in the table reflects the results of operations and financial position of OdysseyRe.
The following GAAP statement of operations and balance sheet data relating to each of the years 2000 through 2004 has been derived from our annual consolidated financial statements, audited by PricewaterhouseCoopers LLP, our independent registered public accounting firm. Consolidated balance sheets as of December 31, 2004 and 2003, and the related consolidated statements of operations and comprehensive income, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2004, and related notes, are included in this Form 10-K.
We encourage you to read the consolidated financial statements included in this Form 10-K because they contain our complete financial statements for the years ended December 31, 2004, 2003 and 2002. The results of operations for the year ended December 31, 2004 are not necessarily indicative of future results.
The Emerging Issues Task Force (“EITF”) Issue 4-08 “The Effect of Contingently Convertible Instruments on Diluted Earnings Per Share,” which is effective for periods ending after December 15, 2004, requires that the dilutive effect of contingently convertible debt securities, with a market price threshold, should be included in diluted earnings per share. The terms of our convertible senior debentures, which were issued in June 2002, (see note 17 of our consolidated financial statements) meet the criteria defined in EITF Issue 4-08, and accordingly, the effect of conversion of our senior debentures to common stock has been assumed when calculating our diluted earnings per share. The diluted earnings per share for the years ended December 31, 2003 and 2002 have been restated to conform to the requirements of EITF Issue 4-08. See notes 2(k) and 8 of our consolidated financial statements included in this Form 10-K.
Based on our common stock outstanding of: 64,754,978 shares as of December 31, 2004; 64,996,166 shares as of December 31, 2003; 65,003,963 shares as of December 31, 2002; 65,142,857 shares as of December 31, 2001; and 48,000,000 shares as of December 31, 2000.
The following table displays, by division, the estimates included in the years ended December 31, 2004, 2003 and 2002 financial statements related to gross premiums written, acquisition costs, accounts receivable and unearned premium reserves (in millions):
Premium estimates, the corresponding acquisition costs and unearned premium reserves are established on a contract level for any significant accounts due but not rendered by the ceding company at the end of each accounting period. The estimated ultimate premium for the contract, actual accounts rendered by the ceding company, and our own experience on the contract are considered in establishing the estimate at the end of each accounting period. Subsequent adjustments, based on actual results, are recorded in the period in which they become known. The estimated accounts receivable balances are considered fully collectable. The estimates primarily represent the most current two underwriting years of accounts for which all corresponding reported accounts have been settled within contract terms. These estimates are considered “critical accounting estimates” because changes in these estimates can materially affect net income.
addition, the allocation of changes in reserve estimates between underwriting year and accident year require allocations, both qualitative and quantitative. All of these processes, methods and practices appropriately balance actuarial science, business experience, and management judgment in a manner intended to assure the accuracy and consistency of our reserving practice.
Included in the estimate of ultimate losses and loss expense liabilities is our exposure to asbestos and environmental claims, which are considered to have a long reporting tail. Our reserve for gross unpaid losses and loss expenses for asbestos claims as of December 31, 2004 was $242.2 million. Our provision for gross unpaid losses and loss adjustment expenses for environmental claims as of December 31, 2004 was $29.9 million. Net of reinsurance and indemnifications, unpaid losses and loss adjustment expenses for asbestos and environmental claims were $50.7 million and $10.9 million, respectively, as of December 31, 2004 (see note 16 to the consolidated financial statements).
As of December 31, 2004, we had gross reserves for unpaid losses and loss adjustment expenses of $4.2 billion, comprised of reported case loss reserves (“case reserves”) of $2.2 billion and incurred but not reported reserves (“IBNR”) of $2.0 billion. We had ceded reserves for unpaid losses and loss adjustment expenses of $1.1 billion, of which $469.8 million was IBNR. Net reserves for unpaid losses and loss adjustment expenses as of December 31, 2004 were $3.1 billion, of which $1.5 billion was case reserves and $1.6 billion was IBNR.
The EuroAsia division accounted for $375.4 million of our gross reserves for unpaid losses and loss adjustment expenses, comprised of case reserves of $177.4 million and IBNR of $198.0 million as of December 31, 2004. The EuroAsia division ceded reserves for losses and loss adjustment expenses of $6.2 million, of which $1.7 million is IBNR as of December 31, 2004. EuroAsia division net reserves for unpaid losses and loss adjustment expenses as of December 31, 2004 were $369.2 million, of which $172.9 million was case reserves and $196.3 million was IBNR.
The London Market division accounted for $778.1 million of our gross reserves for unpaid losses and loss adjustment expenses, comprised of case reserves of $239.6 million and IBNR of $538.5 million as of December 31, 2004. The London Market division ceded reserves for losses and loss adjustment expenses of $188.9 million, of which $132.8 million is IBNR as of December 31, 2004. London Market division net reserves for unpaid losses and loss adjustment expenses as of December 31, 2004 were $589.1 million of which $183.4 million was case reserves and $405.7 million was IBNR.
Gross Premiums Written. Gross premiums written for the year ended December 31, 2004 increased by $0.1 billion, or 3.8%, to $2.7 billion from $2.6 billion for the year ended December 31, 2003. The increase in premium volume is attributable to increases in the EuroAsia division of $145.6 million, or 35.7%, the London Market division of $9.8 million, or 2.2%, and the U.S. Insurance division of $78.2 million, or 23.5%. These increases are offset by a decrease in the Americas division of $158.2 million, or 11.1%.
The increase in the EuroAsia division gross premiums written for the year ended December 31, 2004, compared to 2003, is comprised of increases in treaty property business of $68.7 million (27.5%), treaty casualty business of $43.6 million (70.3%) and all other treaty lines, principally marine, aerospace and credit, of $30.0 million (42.7%). Property facultative business decreased to $4.5 million for the year ended December 31, 2004 from $8.6 million for the year ended December 31, 2003 as we continue to reduce our exposure on this line of business.
Ceded Premiums Written. Ceded premiums written for the year ended December 31, 2004 decreased by $110.7 million, or 27.4%, to $293.9 million from $404.6 million for the year ended December 31, 2003. The decrease in ceded premiums written relates to decreases in cessions to Odyssey America’s whole account aggregate excess of loss cover of $71.6 million; the cancellation of certain affiliated business of $36.7 million; decreases in the Latin America facultative cessions of $14.3 million, as well as reductions in the cessions of our Newline Syndicate of $15.8 million. These reductions were offset by increased cessions in our catastrophe program for reinstatement premiums of $20.8 million primarily associated with the four hurricanes and an increase in the U.S. Insurance division cessions due to increases in the gross premium volume.
Net Premiums Earned. Net premiums earned for the year ended December 31, 2004 increased by $366.0 million, or 18.6%, to $2.3 billion from $2.0 billion for the year ended December 31, 2003. The earned premium increased in each of the Company’s divisions. The America’s division increased by $58.7 million, or 5%, reflecting the growth in volume over the past two years, offset by a slight decline in net premiums written in the current year. The EuroAsia division increased by $117.6 million, or 32.2%, reflecting the continued premium
Net Realized Investment Gains. Net realized investment gains for the year ended December 31, 2004 decreased by $89.2 million to $113.5 million from a gain of $202.7 million for the year ended December 31, 2003. The decrease in net realized gains is comprised of increases in net gains related to equity securities of $57.3 million and an increase in net gains related to other investments of $3.5 million, offset by decreases in net gains related to fixed income securities, short-term investments, cash and cash equivalents of $100.6 million. Additionally, during 2004, we entered into short sale transactions and Standard & Poor’s index call options, and Standard & Poor’s total return swaps, in each case to provide an economic hedge against a decline in the equity markets. Our derivative and short sale investments resulted in an increase in net realized investment losses for the year ended December 31, 2004 of $49.6 million, principally resulting from a decrease in the fair value of these investments, which is recorded as a net realized investment gain or loss. During 2004, we did not recognize any other than temporary impairment losses on our investment portfolio. Included in net realized investment gains, discussed above, for the year ended December 31, 2003 are $58.8 million of realized losses on the other than temporary write-down of certain fixed income and equity securities.
Our operating strategy is a total return basis including a value-oriented investment strategy, which results in the periodic recognition of realized capital gains, which can fluctuate significantly from period to period. The net realized investment gains in 2003 were principally related to gains on fixed income securities when interest rates declined to historically low levels.
For the Americas division, incurred losses and loss adjustment expenses increased 13.1% to $906.1 million for the year ended December 31, 2004 from $801.3 million for the year ended December 31, 2003. The increase in incurred losses and loss adjustment expenses was principally related to a $58.7 million increase in net premiums earned and $68.0 million of property catastrophe losses related to the four hurricanes occurring in the third quarter of 2004. In the Americas division, net losses and loss adjustment expense reserve adjustments related to accident years 2003 and prior for the year ended December 31, 2004 were $176.0 million, principally related to casualty classes of business. Casualty lines net reserve adjustments for accident years prior to 2001 increased $242.4 million, partially offset by net reserve reductions of $66.4 million on accident years 2001
Other Underwriting Expenses. Other underwriting expenses for the year ended December 31, 2004 were $125.7 million, compared to $101.3 million for the year ended December 31, 2003. The other underwriting expense ratio, expressed as a percentage of net premiums earned, was 5.4% for the year ended December 31, 2004, compared to 5.2% for the year ended December 31, 2003. This increase in other underwriting expenses is attributable to an increase in headcount, personnel related costs and other expenses generated by our substantial growth and global and product line diversification over the last three years.
Gross Premiums Written. Gross premiums written for the year ended December 31, 2003 increased by $663.7 million, or 35.0%, to $2.6 billion from $1.9 billion for the year ended December 31, 2002. Insurance and reinsurance market conditions improved substantially on a global basis the past two years, providing the key factor for growth. The increase in premium volume is attributable to increases in the Americas division of $232.4 million, or 19.5%, the EuroAsia division of $149.5 million, or 57.8%, the London Market division of $122.6 million, or 38.9%, and the U.S. Insurance division of $165.2 million, or 98.0%.
The increase in the EuroAsia division gross premiums written for the year ended December 31, 2003, compared to 2002, is comprised of increases in treaty property business of $89.0 million (55.4%), treaty casualty business of $19.5 million (45.9%) and all other treaty lines, principally marine, aerospace and credit, of $42.6 million (153.8%). Property facultative business decreased to $8.6 million for the year ended December 31, 2003 from $24.6 million for the year ended December 31, 2002 as we discontinued this line of business in Europe in 2003.
The London Market division generated $437.9 million, or 16.8%, of our gross premiums written for the year ended December 31, 2003 as compared to $315.3 million, or 16.3%, of our gross premiums written for the year
ended December 31, 2002. Gross premiums written by the London branch for the year ended December 31, 2003 were $154.4 million, an increase of $36.9 million, or 31.4%, compared to $117.5 million for the year ended December 31, 2002. Our Lloyd’s syndicate had gross premiums written of $283.5 million for the year ended December 31, 2003, an increase of $85.7 million, or 43.3%, compared to $197.8 million for the year ended December 31, 2002.
The U.S. Insurance division accounted for $333.8 million, or 12.8%, of our gross premiums written for the year ended December 31, 2003, an increase of $165.2 million, compared to $168.6 million, or 8.7%, of our gross premiums written for the year ended December 31, 2002. For the year ended December 31, 2003, Hudson had gross premiums written of $223.2 million, an increase of $54.6 million, or 32.4%, compared to $168.6 million for the year ended December 31, 2002. The new Healthcare unit established on January 1, 2003 contributed $110.6 million of premiums written for the year ended December 31, 2003.
Included in net realized investment gains for the years ended December 31, 2003 and 2002, respectively, are $58.8 million and $13.0 million of realized losses on the other than temporary write-down of certain fixed income and equity securities.
Losses and Loss Adjustment Expenses. Losses and loss adjustment expenses for the year ended December 31, 2003 increased by $338.6 million, or 34.6%, to $1,325.8 million from $987.2 million for the year ended December 31, 2002. The increase in losses is a direct result of the increase in net premiums earned and increases in net loss reserves of $116.9 million primarily associated with accident years 1997 to 2000 for U.S. casualty business. The losses and loss adjustment expense ratio for the year ended December 31, 2003 was 67.5%
Other Underwriting Expenses. Other underwriting expenses for the year ended December 31, 2003 were $101.3 million, compared to $70.3 million for the year ended December 31, 2002. The other underwriting expense ratio, expressed as a percent of premiums earned, was 5.2% for the year ended December 31, 2003, compared to 4.9% for the year ended December 31, 2002. This increase in other underwriting expenses and the related expense ratio is principally attributable to increased headcount from domestic and international expansion, increased premium taxes resulting from an increase in primary insurance premiums, and expenses associated with our Healthcare business and First Capital.
Our stockholders’ equity increased by $195.3 million, or 14.0%, to $1.6 billion as of December 31, 2004, from $1.4 billion as of December 31, 2003. The net increase was mainly attributable to net income of $186.9 million, accumulated other comprehensive income, net of deferred taxes, of $24.4 million, offset by a decrease in treasury stock of $6.9 million and dividends paid to stockholders of $8.1 million for the year ended December 31, 2004. We have flexibility with respect to capitalization as a result of our access to the debt and equity markets. We filed a shelf registration statement on Form S-3 with the Securities and Exchange Commission on February 23, 2004, which we amended on October 5, 2004 and January 26, 2005. This registration statement provides for the offer and sale by OdysseyRe of securities, including equity and debt securities, having a total offering price of up to $400.0 million.
As a holding company, our assets are principally comprised of the stock of Odyssey America and our principal sources of funds are cash dividends and other permitted payments from our operating subsidiaries, principally Odyssey America. If our subsidiaries are unable to make payments to us, or are able to pay only limited amounts, we may be unable to pay dividends or make payments on our indebtedness. The payment of dividends by our operating subsidiaries is subject to restrictions set forth in the insurance laws and regulations of Connecticut, Delaware, New York and the United Kingdom. During 2005, Odyssey America can pay dividends to us of $167.6 million without prior regulatory approval. Odyssey America’s liquidity requirements are principally met on a short-term and long-term basis by cash flows from operating activities, which principally result from
Total cash used in investing activities for the year ended December 31, 2004 was $1.0 billion compared to total cash provided by investing activities of $359.1 million for the year ended December 31, 2003. Cash and cash equivalents were $1,156.4 million and $1,588.7 million, as of December 31, 2004 and December 31, 2003, respectively. The decrease in cash and cash equivalents mainly resulted from purchases of fixed income securities. It is anticipated that our cash and cash equivalents will continue to be reinvested on a basis consistent with our long-term value oriented investment philosophy. Cash and short-term investments are maintained for liquidity purposes and represented 26.2% and 42.6% as of December 31, 2004 and December 31, 2003, respectively, of total financial statement investments and cash on such dates. Total fixed income securities were $2.5 billion as of December 31, 2004. Total investments and cash amounted to $5.2 billion as of December 31, 2004, an increase of $1.0 billion compared to December 31, 2003. The fixed income securities portfolio has a weighted average security rating of AA, as measured by Standard and Poor’s. The duration of our investment portfolio exceeds the duration of our liabilities. We believe this difference is mitigated by the significant amount of cash and cash equivalents maintained, our substantial cash provided by operations and our overall capital position.
In June 2002, we issued $110.0 million aggregate principal amount of 4.375% convertible senior debentures (“Convertible Debt”) due 2022. The Convertible Debt is redeemable at our option beginning on June 22, 2005. Each holder of Convertible Debt may, at its option, require us to repurchase all or a portion of its Convertible Debt on June 22, 2005, 2007, 2009, 2012 and 2017. Under certain circumstances specified in the indenture under which the Convertible Debt was issued, each Convertible Debt holder has the right to convert its Convertible Debt into 46.9925 shares of our common stock for every $1,000 principal amount of the Convertible Debt held by such holder; however, as of December 31, 2004, such circumstances had not occurred and therefore the Convertible Debt was not convertible as of such date. Upon conversion of the Convertible Debt, we may choose to deliver, in lieu of our common stock, cash or a combination of cash and common stock. It is our intent to settle any debt conversion in cash. During the fourth quarter of 2004, we retired $0.1 million of the Convertible Debt. The Convertible Debt is reflected on our balance sheet at a value of $109.9 million, the aggregate principal amount of Convertible Debt outstanding.
During the second quarter of 2004, Odyssey America pledged and placed on deposit at Lloyd’s the equivalent of £110 million of U.S. Treasury Notes on behalf of Advent Capital (Holdings) PLC (“Advent”). Advent is 46.8% owned by Fairfax and its affiliates, including 15.0% by the Company. nSpire Re Limited (“nSpire Re”), a wholly-owned subsidiary of Fairfax, had previously pledged assets at Lloyd’s on behalf of Advent pursuant to a November 2000 Funding Agreement with Advent whereby the funds are used to support Advent’s underwriting activities for the 2001 to 2005 underwriting years of account. Advent is responsible for the payment of any losses resulting from the use of these funds to support its underwriting activities.
On September 27, 2004, the Company and its subsidiaries Odyssey America, Clearwater, Hudson and Hudson Specialty entered into a Credit Agreement with Bank of America, as administrative agent, lender and letter of credit issuer, and JPMorgan Chase Bank, Citizens National Bank and PNC Bank, as lenders. The Credit Agreement provides for a 364-day revolving credit facility of $90.0 million, which is available for direct, unsecured borrowings by us. The credit facility includes a $65.0 million sub-limit for the issuance of standby letters of credit for our account or one or more of our insurance and reinsurance company subsidiaries. The credit facility will be used for working capital and other corporate purposes, and for the issuance of letters of credit to support reinsurance liabilities. Loans under the credit facility will bear interest at a fluctuating rate per annum equal to the higher of (a) the federal funds rate plus 0.5% and (b) Bank of America’s publicly announced prime rate. Alternatively, at our option, loans will bear interest at the “Eurodollar Rate,” which is the offered rate that appears on the page of the Telerate screen that displays an average British Bankers Association Interest Settlement Rate for deposits in dollars, plus 1.250%.
On February 18, 2005, our Board of Directors declared a quarterly cash dividend of $0.03125 per share to be paid on or before March 31, 2005 to all stockholders of record as of March 17, 2005. During each of the four quarters of 2004, our Board of Directors declared quarterly cash dividends of $0.03125 per share, resulting in an aggregate dividend of approximately $2.0 million paid in each quarter. The fourth quarter 2004 dividend of approximately $2.0 million was declared on November 18, 2004 and paid on December 31, 2004 to all stockholders of record as of December 15, 2004. During each of the first three quarters of 2003, dividends of $0.025 per common share were declared, resulting in an aggregate dividend of approximately $1.6 million in each quarter. On November 18, 2003, our Board of Directors declared a cash dividend of $0.03125 per common share. The total dividend of approximately $2.0 million was paid on December 31, 2003.
The Company and its subsidiaries are assigned financial strength (insurance) and credit ratings from internationally recognized rating agencies such as A.M. Best, Standard & Poor’s and Moody’s.
These ratings are used by insurers and reinsurance and insurance intermediaries as an important means of assessing the financial strength and quality of reinsurers. In addition, the rating of a company purchasing reinsurance may be adversely affected by an unfavorable rating of its reinsurer. A reduction in our financial strength ratings could limit or prevent us from writing new reinsurance or insurance policies. Our financial strength ratings as of December 31, 2004 were: A.M. Best: “A” (Excellent), Standard & Poor’s: “A-” (Strong) and Moody’s: “A3” (Good Financial Security). These ratings are based upon factors relevant to policyholders, agents and intermediaries and are not directed toward the protection of investors. Such ratings are not recommendations to buy, sell or hold securities.
In December 2004, the FASB issued FASB Staff Position No. 109-2, “Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004” (“FSP 109-2”). The American Jobs Creation Act of 2004 (“AJCA”) introduces a special one-time dividends received deduction on the repatriation of certain foreign earnings to a U.S. taxpayer (repatriation provision), provided certain criteria are met. The primary criteria to be met is that the repatriated funds must be reinvested in the United States and we are evaluating whether we can meet that criteria given our current U.S. and foreign capital structure. The FSP 109-2 provides accounting and disclosure guidance for the repatriation provision.
The FSP 109-2 grants an enterprise additional time beyond the year ended December 31, 2004, in which the AJCA was enacted, to evaluate the effects of the AJCA on its plan for reinvestment or repatriation of unremitted earnings. The FSP 109-2 calls for enhanced disclosures of, among other items, the status of a company’s evaluations, the effects of completed evaluations, and the potential range of income tax effects of repatriations.
All market sensitive instruments discussed in this section relate to our investment assets that are classified as available for sale. As of December 31, 2004, our $5.3 billion investment portfolio includes $2.4 billion of fixed income securities that are subject primarily to interest rate risk and credit risk.
The table below displays the potential impact of market value fluctuations on our fixed income securities portfolio as of December 31, 2004 and December 31, 2003, based on parallel 200 basis point shifts in interest rates up and down in 100 basis point increments. This analysis was performed on each security individually.
As of December 31, 2004, we had gross unrealized appreciation on our entire investment portfolio of $293.9 million, which is offset by gross unrealized depreciation of $164.1 million.
In the third quarter of 2004 the Company sold short SPDRs and XLF as an economic hedge against a decline in its equity portfolio. In order to reduce the margin maintenance requirements for these short positions, the Company replaced the short positions with the total return swaps described above. The margin maintenance requirement related to the total return swaps was $99.2 million as of December 31, 2004.
As of December 31, 2004 and 2003, 19.8% and 13.3%, respectively, of our investment and cash portfolio, was in common stocks (unaffiliated and affiliated). Marketable equity securities, which represented approximately 18.9% and 12.2% as of December 31, 2004 and 2003, respectively, of our investment and cash portfolio, are exposed to equity price risk, defined as the potential for loss in market value owing to a decline in equity prices. A 10% decline in the price of each of these marketable equity securities would result in a decline of $98.8 million and $51.5 million as of December 31, 2004 and 2003, respectively, in the fair market value of the total investment portfolio.
The following table reflects our investments’ fair value and gross unrealized depreciation, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, as of December 31, 2004 (in thousands):
In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Odyssey Re Holdings Corp. and its subsidiaries at December 31, 2004 and December 31, 2003, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2004 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedules listed in the accompanying index present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit of financial statements includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
Also, in our opinion, management’s assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting, that the Company maintained effective internal control over financial reporting as of December 31, 2004 based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), is fairly stated, in all material respects, based on those criteria. Furthermore, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express opinions on management’s assessment and on the effectiveness of the Company’s internal control over financial reporting based on our audit. We conducted our audit of internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. An audit of internal control over financial reporting includes obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.
Odyssey Re Holdings Corp. (the “Company” or “OdysseyRe”) is a holding company, incorporated in the state of Delaware, which owns all of the common stock of Odyssey America Reinsurance Corporation (“Odyssey America”). Odyssey America directly or indirectly owns all of the common stock of Clearwater Insurance Company (“Clearwater”); Clearwater Select Insurance Company (“Clearwater Select”) (see note 3); Odyssey UK Holdings Corporation (“UK Holdings”); Newline Underwriting Management Ltd., which owns and manages a syndicate at Lloyd’s, Newline Syndicate 1218 (collectively, “Newline”); Hudson Insurance Company (“Hudson”); and Hudson Specialty Insurance Company (“Hudson Specialty”). As of December 31, 2004, Fairfax Financial Holdings Limited (“Fairfax”), a Canadian financial services holding company, owned 80.8% of OdysseyRe.
OdysseyRe, through its operating subsidiaries, is a leading United States based underwriter of reinsurance, providing a full range of property and casualty products on a worldwide basis. The Company also underwrites specialty program insurance, as well as physicians medical malpractice and hospital professional liability insurance.
(a) The consolidated financial statements include the accounts of the Company and its subsidiaries. Intercompany transactions have been eliminated.
(b) All of the Company’s investments in fixed income securities, which include bonds and notes, and common stocks not accounted for under the equity method, are categorized as “available for sale,” and are recorded at their fair value based on quoted market prices. Common stocks of affiliates are accounted for under the equity method. Short-term investments are carried at cost, which approximates fair value. Other invested assets include limited partnerships and investment funds which are accounted for under the equity method. Other invested assets also include benefit plan trust accounts which are carried at fair value. The Company considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents.
(c) Premiums are earned (net of reinsurance ceded) over the terms of the related insurance policies and reinsurance contracts or certificates. Unearned premium reserves are established for the unexpired portion of insurance policies and reinsurance contracts or certificates. Such unearned premium reserves are computed by pro rata methods based on statistical data or reports received from ceding companies or program administrators. Premiums written and earned and related costs for which data has not been reported by the ceding company are estimated based on historical patterns and statistical and other relevant data. Subsequent adjustments, based on actual results, are recorded in the period they become known. Premium adjustments on deposit contracts and audit premiums are accrued on an estimated basis throughout the contract or policy
term. Premiums written and earned and the change in unearned premiums are reported net of reinsurance ceded in the consolidated statements of operations. Prepaid reinsurance premiums are reported as assets. A reserve for uncollectible premiums is established based on historical experience.
(d) Acquisition costs, which are reported net of acquisition costs ceded, consist principally of commissions and brokerage expenses incurred on business written under insurance policies and reinsurance contracts or certificates, and are deferred and amortized over the period in which the related premiums are earned. Commission adjustments are accrued based on premiums and losses recorded by the Company. Deferred acquisition costs are limited to their estimated realized value, which considers anticipated losses and loss adjustment expenses and estimated remaining costs of servicing the contracts or certificates, all based on historical experience. Realization is determined without consideration of investment income.
(f) The reserve for unpaid losses and loss adjustment expenses is based on evaluations by the Company’s in-house claims department of the reports and individual case estimates received from ceding companies for reinsurance business or the estimates advised by the Company’s outside claims adjusters for insurance business. The Company’s in-house actuaries utilize generally accepted actuarial methodologies to determine a reserve for losses incurred but not reported on the basis of historical experience and other estimates. The reserves are reviewed continually during the year and changes in estimates are reflected in losses and loss adjustment expenses in the consolidated statements of operations currently. Accordingly, losses and loss adjustment expenses, net of reinsurance recoverables, are charged to income as incurred. Reinsurance recoverables on unpaid losses and loss adjustment expenses are reported as assets. A reserve for uncollectible reinsurance recoverables is established based on an evaluation of each retrocessionaire and historical experience. The Company uses tabular reserving for workers’ compensation liabilities that are considered fixed and determinable and discounts such reserves using an interest rate of 3.5% and standard mortality assumptions.
no assurance that the ultimate liability will not exceed amounts reserved with a resulting adverse effect on the Company.
(g) During 2002 and through March 3, 2003, the Company and its United States subsidiaries filed a separate consolidated tax return. On March 4, 2003, Fairfax increased its ownership interest in the Company to approximately 81%. As a result, the Company and its United States subsidiaries are included in the United States tax group of Fairfax Inc., an affiliate that is wholly owned by Fairfax. Inclusion of the Company into Fairfax Inc.’s tax group did not have an effect on the Company’s tax position. The federal income tax provision is allocated to each of the companies in the consolidated group pursuant to a written agreement, on the basis of each company’s separate return taxable income.
(j) The Company translates the financial statements of its foreign subsidiaries to United States dollars by translating balance sheet accounts at the balance sheet date exchange rate and income statement accounts at the average exchange rate for the year. Translation gains or losses are recorded, net of deferred income taxes, as a component of comprehensive income. Foreign currency transaction gains or losses are reflected in the statement of operations in the period they are realized.
The Emerging Issues Task Force (“EITF”) Issue 4-08 “The Effect of Contingently Convertible Instruments on Diluted Earnings Per Share,” which is effective for periods ending after December 15, 2004, requires that the dilutive effect of contingently convertible debt securities, with a market price threshold, should be included in diluted earnings per share. The terms of OdysseyRe’s convertible senior debentures (see note 17) meet the criteria defined in EITF Issue 4-08, and accordingly, the effect of conversion of OdysseyRe’s senior debentures to common stock has been assumed when calculating its diluted earnings per share. The diluted earnings per share for the years ended December 31, 2003 and 2002 have been restated to conform to the requirements of EITF Issue 4-08.
(l) In April 2002, the Company’s stockholders approved the Odyssey Re Holdings Corp. 2002 Stock Incentive Plan (the “2002 Plan”). Effective January 1, 2003, the Company adopted the expense recognition provisions of Statement of Financial Accounting Standards (“SFAS”) 123, “Accounting for Stock-Based Compensation,” on a prospective basis, in accordance with SFAS 148, “Accounting for Stock-Based Compensation-Transaction and Disclosure” with respect to the 2002 Plan. The prospective method requires
The Company is evaluating the two methods of adoption allowed by SFAS No. 123R: the modified-prospective transition method and the modified-retrospective transition method, and the related financial statement impact.
(m) Payments of claims by the Company, as reinsurer, to a broker on behalf of a reinsured company, are recorded on the Company’s books as a paid loss at the time the cash is disbursed. The payment is treated as a paid claim to the reinsured. Premiums due the Company from the reinsured are recorded as receivables from the reinsured until the cash is received by the Company, either directly from the reinsured or from the broker.
On October 28, 2003, Odyssey America purchased General Security Indemnity Company (“General Security”), an excess and surplus lines shell company domiciled in New York. The purchase price was comprised of investment assets of $33.7 million held by General Security at the purchase date and intangible assets of $3.9 million, which as of December 31, 2004 and 2003 were not impaired and have an indefinite life. General Security’s name has been changed to Hudson Specialty Insurance Company. During 2003, Odyssey America also purchased the rights to new and renewal physicians medical malpractice and hospital professional liability business (“Healthcare business”) underwritten by TIG Insurance Company, a subsidiary of Fairfax. Hudson Specialty serves as the main platform for the Healthcare business. The purchase price of the Healthcare business was $7.5 million ($6.6 million unamortized value as of December 31, 2004) and was recorded as an intangible asset that will be amortized over a ten year life. For the year ended December 31, 2004, $0.9 million has been amortized. On December 18, 2003, Hudson Specialty and the Healthcare business were contributed to Clearwater. Clearwater subsequently contributed $18.0 million to Hudson Specialty.
The composition of the fixed income securities, common stocks carried at fair value and short-term investments as of December 31, 2004 follows (in thousands):
The gross unrealized appreciation of $119.5 million and the gross unrealized depreciation of $55.7 million resulted principally from the change in value of U.S. and non-U.S. equities, the credit quality of fixed income securities and the then current interest rate environment.
The fair value of fixed income securities and common stocks are based on the quoted market prices of the investments as of the close of business on December 31 of the respective years.
represent approximately 4% of the total fair value. In the case of securities containing put features, the actual maturity will be the same as the contractual maturity if the investor elects not to exercise its put feature. Total securities containing the put feature represent approximately 4% of the total fair value.
The following table sets forth the components of net investment income for the years ended December 31, 2004, 2003 and 2002 (in thousands):
The proceeds from the sales of investments were $1.8 billion, $4.9 billion and $2.5 billion for the years ended December 31, 2004, 2003 and 2002.
The following table sets forth the components of gross and net realized investment gains and losses for the years ended December 31, 2004, 2003 and 2002 (in thousands):
Included in gross losses for the years ended December 31, 2003 and 2002 are $58.8 million and $13.0 million, respectively, related to realized losses on the other than temporary write-down of certain fixed income and equity securities. The Company did not recognize any other than temporary write-down of investments for the year ended December 31, 2004.
The following table sets forth the changes in unrealized net appreciation (depreciation) of investments, and the related tax effect, reflected in accumulated other comprehensive income for the years ended December 31, 2004, 2003 and 2002 (in thousands):
The Company frequently reviews its investment portfolio for declines in value, and focuses its attention on securities which have a market value of less than 80% of their amortized cost at the time of review. Generally, a change in the market or interest rate environment does not constitute an impairment of an investment but rather a temporary decline. Temporary declines in investments will be recorded as unrealized losses in accumulated other comprehensive income. If the Company determines that a decline is “other than temporary,” the carrying value of the investment will be written down to the fair value and a realized loss will be recorded in the Company’s consolidated statements of operations. The Company’s assessments are based on current evaluations of the financial position and future projections of the entity that issued the investment security. Prior assessments can change, depending upon current pertinent information.
In determining possible impairment of debt securities held as investments, the Company reviews market and industry shifts, debt payment schedules that report how current and timely the issuer is with interest and principal payments, the issuer’s current financial position, the effect of foreign exchange rates and relevant analysis by rating agencies, investment advisors and analysts. In determining the possible impairment of equity securities, the Company reviews market and industry shifts, historical price to earnings ratios, recent financial statements, independent auditor’s reports on the issuer’s financial statements and any significant recommendations by investment advisors or rating agencies. Additional relevant information is also considered in determining the valuation of an investment.
The following table reflects the Company’s investments’ fair value and gross unrealized depreciation, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, as of December 31, 2004 (in thousands):
In connection with the short sales described above, the Company purchased a Standard & Poor’s 500 index call option at a cost of $1.5 million with a strike price of 120% of the price at which the borrowed securities were sold short. The call option is recorded at fair value in other invested assets in the consolidated balance sheet and changes in the fair value are recorded as a realized gain or loss in the consolidated statement of operations. As of December 31, 2004, the net change in the fair market value of the call option resulted in a net realized gain of $0.4 million.
The Company has investments in warrants, which replicate the investment characteristics of investment grade bonds. Warrants are contracts that grant the holder the right to purchase an underlying financial instrument at a given price and time or at a series of prices and times. Warrants, which are included in other invested assets, are recorded at fair value with the related changes in fair value recognized as a realized gain or loss. As of December 31, 2004, the net change in fair value of the warrants resulted in a net realized gain of $6.1 million. The total cost of the warrants was $7.9 million and $3.6 million and the fair value was $12.8 million and $5.3 million as of December 31, 2004 and 2003, respectively. The notional amount of the warrants was $270.8 million and $180.6 million as of December 31, 2004 and 2003, respectively.
As of December 31, 2004 and 2003, “non-traded” investments were $291.2 million and $358.3 million, respectively, and include common stock of affiliates, limited partnerships and investment funds which are recorded under the equity method of accounting based on the underlying financial statements of the investee. Dividends received by the Company from these entities were $11.8 million, $6.9 million and $7.5 million for the years ended December 31, 2004, 2003 and 2002, respectively. Collateral loans are recorded at the unpaid principal balance.
The Company utilizes retrocessional agreements principally to increase aggregate premium capacity, to reduce and spread the risk of loss on insurance and reinsurance underwritten and to limit its exposure with respect to multiple claims arising from a single occurrence. There is a contingent liability with respect to reinsurance, which would become an ultimate liability of the Company in the event that such reinsuring companies are unable, at some later date, to meet their obligations under the reinsurance agreements in force. Reinsurance recoverables are recorded as assets, based on the Company’s evaluation of the retrocessionaires’ ability to meet their obligations under the retrocession agreements. Premiums written and earned are stated net of reinsurance ceded
in the consolidated statements of operations. Direct, reinsurance assumed, reinsurance ceded and net amounts (in thousands and inclusive of amounts in note 6) for these items follow:
The total amount of reinsurance recoverable on paid and unpaid losses as of December 31, 2004 was $1,182.0 million and $1,142.1 million as of December 31, 2003. The Company is the beneficiary of letters of credit and trust agreements, and the Company withholds funds from certain reinsurers to secure these balances. The amount of this security as of December 31, 2004 was $619.5 million, and was $599.3 million as of December 31, 2003. The Company has established a reserve for potentially uncollectible reinsurance recoverables. The reserve is based upon an evaluation of each retrocessionaire and the Company’s assessment as to the collectibility of individual balances. The reserve as of December 31, 2004 and 2003 was $33.0 million and $28.5 million, respectively, and has been netted against reinsurance recoverables on loss payments. The Company has also established a reserve for potentially uncollectible assumed reinsurance balances of $5.9 million and $5.8 million as of December 31, 2004 and 2003, respectively, which has been netted against reinsurance balances receivable.
The Company markets its reinsurance products worldwide primarily through reinsurance brokers as well as directly to its customers. The Company’s five largest reinsurance brokerage firms accounted for an aggregate of approximately 56% of reinsurance gross premiums written for the year ended December 31, 2004. Loss of all or a substantial portion of the business provided by these brokers could have a material adverse effect on the Company.
statutory composite ratio, or in some agreements a loss ratio, in excess of the attachment point. The attachment point is net of other inuring third party reinsurance. The premium paid, net of commission, by Odyssey America is calculated based on a contractual fixed rate that is applied to the total premiums, subject to the retrocession agreements. Each agreement includes a provision for additional premium, subject to a maximum, based on the loss activity under the agreement. Reinsurance recoverables on paid and unpaid losses are fully secured by letters of credit or funds held by Odyssey America. The principal reinsurers of this business are London Life and Casualty Reinsurance Corporation and Underwriters Reinsurance Company (Barbados) Inc.
As of December 31, 2004, the 1994, 1998, 2000, 2001, 2003 and 2004 agreements have remaining limits of approximately $61.1 million, $9.5 million, $3.3 million, $101.8 million, $241.2 million and $291.0 million, respectively. The limits for the other retrocessional agreements have been fully utilized or commuted.
affiliates of $1.1 million and $1.3 million as of December 31, 2004 and 2003 respectively. In addition to the amounts in the table above, the Company has a receivable from nSpire Re of $8.2 million and $17.0 million as of December 31, 2004 and 2003, respectively, which represents transactions for certain reinsurance agreements.
The following tables set forth the Plan’s funded status, which uses a measurement date of October 1, and amounts recognized in the Company’s consolidated financial statements as of December 31, 2004 and 2003.
The accumulated benefit obligation for the Plan is $33,725 and $29,038 as of December 31, 2004 and 2003, respectively.
Plan, which has a measurement date of December 31, in the Company’s consolidated financial statements as of December 31, 2004 and 2003 (in thousands):
The weighted average assumptions to calculate the benefit obligation are as follows:
The Company expects to contribute $943,000 to the Excess Plans during the year ended December 31, 2005, which represents the amount necessary to fund the 2005 expected benefit payments.
The Company maintains a qualified deferred compensation plan pursuant to Section 401(k) of the Internal Revenue Code of 1986, as amended. Employees may contribute up to 10% of base salary on a pre-tax basis. The Company contributes an amount equal to two-thirds of each employee’s pre-tax contribution up to the first 6% of annual base salary. The maximum matching contribution is 4% of annual base salary, with certain government mandated restrictions on contributions to highly compensated employees. The Company also maintains a non-qualified deferred compensation plan to allow for contributions in excess of qualified plan limitations. The Company contributed $1.3 million, $1.1 million and $1.5 million to these plans in 2004, 2003 and 2002, respectively.
measurement date of January 1, in the Company’s consolidated financial statements as of December 31, 2004 and 2003 (in thousands):
The plan change of $1.3 million and the unrecognized prior service cost of $0.7 million as of December 31, 2004 result from a change in eligibility for postretirement medical benefits, which previously had no age limitation, to age 45 and 10 years of service and the adoption of the Medicare Reform Act. The curtailment credit of $0.6 million is the result of the eligibility change.
The weighted average fair value of each option granted is estimated on the date of grant using the Black Scholes Price Model with the following weighted average assumptions used for grants: expected volatility of 31.0%; risk-free interest rates ranging from 2.7% to 5.1%; annual dividend yield of 0.6%; and expected lives of five years for each grant.
The following table summarizes the options outstanding and options exercisable as of December 31, 2004 that relate to the 2002 Plan:
The Company provides a compensatory employee stock purchase plan through which all employees who meet the eligibility requirements of the plan have the option to purchase OdysseyRe common stock in an amount
up to 10% of their annual base salary. The Company purchases, on the employee’s behalf, OdysseyRe common stock equal to 30% of each employee’s contribution. In the event that the Company meets certain financial objectives, additional shares are purchased for the employee’s benefit. The expense related to this plan for the years ended December 31, 2004, 2003 and 2002 was $0.5 million, $0.3 million and $0.2 million, respectively.
During 2002 and through March 3, 2003, the Company and its United States subsidiaries filed a separate consolidated tax return. On March 4, 2003, Fairfax increased its ownership interest in the Company to approximately 81%. As a result, the Company and its United States subsidiaries are included in the United States tax group of Fairfax Inc. Inclusion of the Company into Fairfax Inc.’s tax group did not have an effect on the Company’s tax position. The federal income tax provision is allocated to each of the companies in the consolidated group pursuant to a written agreement, on the basis of each company’s separate return taxable income. As of December 31, 2001, the Company had a net operating loss carry forward of $186.3 million, which was fully utilized during 2002.
Pre-tax income, before cumulative effects of a change in accounting principle, from domestic companies, was $150.1 million, $286.1 million and $252.9 million for the years ended December 31, 2004, 2003 and 2002, respectively. Pre-tax income from foreign operations was $128.7 million, $92.2 million and $5.2 million for the years ended December 31, 2004, 2003 and 2002, respectively.
Clearwater agreed to allow Ranger Insurance Company (“Ranger”), a subsidiary of Fairfax, to attach an assumption of liability endorsement to certain Ranger policies issued from July 1, 1999 to April 30, 2004. Clearwater has terminated the agreement, effective April 30, 2004. Clearwater remains liable for any losses occurring prior to the effective date of the termination, pursuant to the terms of the endorsements. Clearwater’s
potential exposure in connection with these endorsements is estimated at approximately $6.7 million, based on the subject policies’ case outstanding loss reserves. We deem the potential exposure to be immaterial, as Fairfax has agreed to indemnify Clearwater for any obligation under this agreement. The Company anticipates that Ranger will meet all of its obligations in the normal course of business, and Clearwater does not anticipate making any payments under this guarantee that would require Clearwater to utilize the indemnification from Fairfax.
As of July 14, 2000, Odyssey America agreed to guarantee the performance of all the insurance and reinsurance contract obligations, whether incurred before or after the agreement, of Compagnie Transcontinentale de Réassurance (“CTR”), an affiliate, in the event CTR became insolvent and CTR was not otherwise indemnified under its guarantee agreement with a Fairfax affiliate. The Odyssey America guarantee was entered into as part of the redeployment of CTR’s business to Odyssey America, and was terminated effective December 31, 2001. As part of a Fairfax initiative, CTR was dissolved and its assets and liabilities were assumed by other Fairfax affiliates, which have the responsibility for the run-off of its liabilities. Due to the existence of the affiliate guarantee of CTR’s liabilities, the assumption of CTR’s liabilities by other affiliates, and a Fairfax agreement to indemnify Odyssey America for all obligations under its guarantee, we deem the likelihood of loss related to this exposure to be remote.
Through UK Holdings, Odyssey America became a limited liability participant in the Lloyd’s market in 1997. In order to continue underwriting at Lloyd’s, Odyssey America has established a clean irrevocable letter of credit and a deposit trust account in favor of the Society and Council of Lloyd’s. As of December 31, 2004, Odyssey America had pledged U.S. treasuries in the amount of $164.7 million in support of the letter of credit and had placed $170.9 million in a deposit trust account in London. The letter of credit and deposit trust account effectively secure the future contingent obligations of UK Holdings should the Lloyd’s underwriting syndicate in which Odyssey America participates incur net losses. Odyssey America’s contingent liability to the Society and Council of Lloyd’s is limited to the aggregate amount of the letter of credit and the assets in the deposit trust account.
Odyssey America provided quota share reinsurance to Gulf Insurance Company (“Gulf”) from January 1, 1996 to December 31, 2002 on a book of automobile residual value business. In March 2003, Gulf requested a payment of approximately $30.0 million, including a “special payment” of $26.0 million, due on April 28, 2003, representing Odyssey America’s purported share of a settlement (“Settlement”) between Gulf and one of the insureds whose policies, Gulf contends, were reinsured under the Residual Value Quota Share Reinsurance Agreements (the “Treaties”). In May 2003, Gulf initiated litigation against two other reinsurers that participated with Odyssey America on the Treaties, demanding payment relating to the Settlement. In late July 2003, Gulf added Odyssey America to its complaint against the other reinsurers. Odyssey America and the other reinsurers have answered the complaint and discovery has commenced. Among other things, Odyssey America contends that, (i) Gulf breached its duty to Odyssey America of utmost good faith when it placed the Treaties by failing to disclose material information concerning the policy it issued to the insured; and (ii) alternatively, the Settlement is not covered under the terms of the Treaties. Among the remedies Odyssey America seeks is rescission of the Treaties. Odyssey America intends to vigorously assert its claims and defend itself against any claims asserted by Gulf. At this early stage, it is not possible to make any determination regarding the likely outcome of this matter.
In consideration of Odyssey America making the deposit, nSpire Re agreed to pay Odyssey America a fee equal to 2% per annum on the assets placed on deposit by Odyssey America. The pledged assets continue to be owned by Odyssey America, and Odyssey America will receive any investment income thereon. As additional consideration for, and further protection of, Odyssey America’s pledge of assets, nSpire Re provided Odyssey America with indemnification in the event of a draw down on the pledged assets. Odyssey America retains the right to withdraw the funds at Lloyd’s at any time upon 180 days advance written notice to nSpire Re. nSpire Re retains the obligation to pledge assets on behalf of Advent. In any event, the placement of funds at Lloyd’s will automatically terminate effective December 31, 2008 and any remaining funds at Lloyd’s will revert to Odyssey America at that time.
Odyssey America organized O.R.E. Holdings Limited (“ORE”), a corporation domiciled in Mauritius, on December 30, 2003 to act as a holding company for various investments in Asia. On January 29, 2004, ORE was capitalized by Odyssey America in the amount of $16.7 million. ORE is consolidated in the Company’s consolidated financial statements. During 2004, ORE entered into a joint venture agreement relating to the investment by ORE of $16.6 million to purchase 45% of the issued and outstanding shares of Cheran Enterprises Private Limited (“CEPL”). CEPL is a corporation domiciled in India, engaged in the purchase, development and sale of commercial real estate properties and other investments. In conjunction with this investment, Odyssey America agreed to provide a guarantee of a credit facility to be established by CEPL in an amount up to
$65 million. The guarantee is conditioned upon a pledge in favor of Odyssey America by the other shareholders of CEPL of assets with an aggregate value of 150% of the guarantee. As of this date, the credit facility has not been established; it is expected that this transaction will be completed during the first half of 2005.
Odyssey America is subject to state regulatory restrictions that limit the maximum amount of dividends payable. Odyssey America must obtain approval of the Insurance Commissioner of the State of Connecticut (the “Connecticut Commissioner”) in order to pay during any 12-month period “extraordinary” dividends, which are defined as the greater of 10% of statutory capital and surplus as of the prior year end or net income for such prior year. Connecticut law further provides that (i) Odyssey America must report to the Connecticut Commissioner, for informational purposes, all dividends and other distributions within five business days after the declaration thereof and at least ten days prior to payment and (ii) Odyssey America may not pay any dividend or distribution in excess of its earned surplus, as reflected in its most recent statutory annual statement on file with the Connecticut Commissioner, without the Connecticut Commissioner’s approval.
The following is the consolidated statutory basis net income and policyholders’ surplus of Odyssey America and its subsidiaries, for each of the years ended and as of December 31, 2004, 2003 and 2002 (in thousands):
As of December 31, 2004 and 2003, $7.3 million of funds held under reinsurance contracts related to cash collateral has been provided in regard to the above mentioned indemnification agreements. The Company has also provided a $20.5 million LOC to Clearwater and a $0.5 million LOC to Hudson as of December 31, 2004, which has been used as collateral in regard to the indemnification agreements. The indemnification agreements do not affect the reinsurance recoverable balances as reported in the accompanying consolidated financial statements.
As of December 31, 2004, such reinsurance in force had a remaining maturity term of one (1) to 25 years. The approximate distribution of the estimated debt service (principal and interest) of bonds, by type and unearned premiums, for 2004 and 2003 follows (in millions):
The following table sets forth the activity in the liability for unpaid losses and loss adjustment expenses for the years ended December 31, 2004, 2003 and 2002 (in thousands):
Losses and loss adjustment expenses related to prior accident years were $181.2 million, $116.9 million and $66.0 million, for the years ended December 31, 2004, 2003 and 2002, respectively. Predominantly casualty classes of business in the Americas division, for the years ended December 31, 2004, 2003 and 2002 accounted for $176.0 million, $87.0 million and $44.4 million, respectively, of this increase.
Estimation of ultimate liabilities is unusually difficult due to several significant issues surrounding asbestos and environmental exposures. Among the issues are: (a) the long period between exposure and manifestation of an injury; (b) difficulty in identifying the sources of asbestos or environmental contamination; (c) difficulty in allocating responsibility or liability for asbestos or environmental damage; (d) changes in underlying laws and judicial interpretation of those laws; and (e) uncertainty regarding the identity and number of insureds with potential asbestos or environmental exposure.
Regarding asbestos exposure in particular, several additional factors have emerged in recent years that further compound the difficulty in estimating ultimate losses for this exposure. These factors include: (a) continued growth in the number of claims filed due to a more aggressive plaintiff’s bar; (b) increase in claims involving defendants formerly regarded as peripheral; (c) growth in the use of bankruptcy filings by companies as a result of asbestos, which in some cases attempt to resolve asbestos liabilities in a manner that is prejudicial to insurers; (d) concentration of claims in states particularly favorable to plaintiffs; and (e) the potential that states or the U.S. Congress may adopt legislation on asbestos legislation.
Our survival ratio for environmental and asbestos related liabilities as of December 31, 2004 is ten years, reflecting full utilization of remaining indemnifications. Our underlying survival ratio for environmental related liabilities is four years and for asbestos related liabilities is fourteen years. The survival ratio represents the environmental impairment and asbestos related illness reserves, net of reinsurance, on December 31, 2004, plus indemnifications, divided by the average paid environmental and asbestos claims, net of reinsurance, for the last three years. Our survival ratio is nine years for environmental and asbestos related liabilities as of December 31, 2004, prior to the reflection of indemnifications. Our survival ratio compares favorably with the United States Property and Casualty Industry average survival ratio of nine years as published by A.M. Best Company in its special report on Asbestos and Environmental claims dated December 6, 2004.
Environmental net losses and loss adjustment expenses declined $21.2 million for the year ended December 31, 2004.
In December 2001, the Company issued $100.0 million aggregate principal amount of senior notes, due November 30, 2006, pursuant to a private placement. Interest accrues on the senior notes at a fixed interest rate of 7.49%, which is due semi-annually on May 31st and November 30th. The senior notes are redeemable at a premium, prior to maturity, at the Company’s option. In November 2003 and June 2002, the Company prepaid $50.0 million and $10.0 million, respectively, aggregate principal amount of the senior notes. Immediately following the issuance of the senior notes, the Company entered into an interest rate swap agreement with Bank of America N.A. (“Bank of America”) that effectively converted the fixed 7.49% interest rate into a variable interest rate of London Interbank Offered Rate (“LIBOR”) plus 263 basis points. In May 2003, the Company sold the variable interest rate instrument for a gain of $6.4 million. The gain has been deferred and is being amortized over the remaining life of the senior notes. In conjunction with the prepayment of the senior notes, a portion of the deferred gain was immediately realized. As of December 31, 2004, the aggregate principal amount of senior notes outstanding is $40.0 million and the remaining deferred gain is $1.5 million.
The Company’s 7.49% senior notes are subject to certain covenants, none of which significantly restrict the Company’s operating activities or dividend-paying ability. As of December 31, 2004, the Company was in compliance with all covenants.
The Company’s operations are managed through four distinct divisions: Americas, EuroAsia, London Market and U.S. Insurance. The Americas division is comprised of the Company’s United States reinsurance operations and its Canadian and Latin American offices. The United States operations write treaty property, general casualty, specialty casualty, surety, and facultative casualty reinsurance business primarily through professional reinsurance brokers. Treaty business is written through its Canadian branch, while Latin America writes both treaty and facultative business. The EuroAsia division is comprised of offices in Paris, Stockholm, Singapore and Tokyo. The EuroAsia division writes primarily treaty and facultative property business. The Company’s London Market division operates through two distribution channels, Newline at Lloyd’s, where the business focus is casualty insurance, and the Company’s London branch, where the business focus is worldwide property and casualty reinsurance. The U.S. Insurance division is comprised of Hudson, Hudson Specialty and Clearwater. The U.S. Insurance division writes specialty program insurance business, physicians medical malpractice and hospital professional liability business.
A portion of the gross premiums written by the U.S. Insurance division has been ceded to, and is also included in, the Americas division’s gross premiums written. Accordingly, the total gross premiums written as shown in the tables above do not agree to the gross premiums written of $2,656.5 million, $2,558.2 million
and $1,894.5 million for the years ended December 31, 2004, 2003 and 2002, respectively, reflected in the consolidated statements of operations.
Due to changes in the number of weighted average common shares outstanding during 2004 and 2003, quarterly earnings per common share amounts do not add to the total for the year.
Diluted net income per common share for the first three quarters of 2004 and each quarter in 2003 has been restated for the effect of EITF Issue 4-08, “The Effect of Contingently Convertible Debt on Diluted Earnings Per Share” (see note 2(k)).
The condensed financial statements should be read in conjunction with the consolidated financial statements and notes thereto and the accompanying notes.
(2) OdysseyRe’s investment in Odyssey America is accounted for under the equity method of accounting.