Our corporate offices are located in 101,420 total square feet of leased space in Stamford, Connecticut. Our other locations occupy a total of 137,408 square feet, all of which are leased. The Americas division principally operates out of offices in New York, Stamford, Mexico City, Miami, and Toronto; the EuroAsia division operates out of offices in Paris, Singapore, Stockholm and Tokyo; the London Market division operates out of offices in London; and the U.S. Insurance division operates principally out of offices in New York, Chicago, Napa, California and Overland Park, Kansas.
The following selected financial data is derived from our audited consolidated financial statements and should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and notes thereto that are included in this Annual Report on Form 10-K. Financial information in the table reflects the results of operations and financial position of OdysseyRe.
Inclusion of restricted common shares, stock options and the effect of the conversion of our convertible senior debentures to common shares would have an anti-dilutive effect on the 2005 diluted loss per common share (i.e., the diluted loss per common share would be less than the basic loss per common share). Accordingly, such common shares were excluded from the calculations of the 2005 diluted loss per common share.
Odyssey Re Holdings Corp. (together with its subsidiaries, “OdysseyRe”) is a holding company, incorporated in the state of Delaware, which owns all of the common shares of Odyssey America Reinsurance Corporation (“Odyssey America”), its principal operating subsidiary. Odyssey America directly or indirectly owns all of the capital stock of the following companies: Clearwater Insurance Company (“Clearwater”); Clearwater Select Insurance Company; Newline Holdings U.K. Limited, Newline Underwriting Management Ltd., which manages Newline Syndicate (1218), a member of Lloyd’s of London, and Newline Insurance Company Limited (“NICL”) (collectively “Newline”); Hudson Insurance Company (“Hudson”); Hudson Specialty Insurance Company (“Hudson Specialty”); and Napa River Insurance Services, Inc. As of December 31, 2009, 100% of the common stock of OdysseyRe is owned by Fairfax Financial Holdings Limited (“Fairfax”) and its subsidiaries (see Note 1 to the consolidated financial statements included in this Annual Report on Form 10-K).
OdysseyRe is a leading underwriter of reinsurance, providing a full range of property and casualty products on a worldwide basis. We offer a broad range of both treaty and facultative reinsurance to property and casualty insurers and reinsurers. We also write insurance in the United States and through Newline.
Our gross premiums written for the year ended December 31, 2009 were $2,195.0 million, a decrease of $99.5 million, or 4.3%, compared to gross premiums written of $2,294.5 million for the year ended December 31, 2008. Our United States business accounted for 50.5% of our gross premiums written for the year ended December 31, 2009, compared to 48.8% for the year ended December 31, 2008. For the years ended December 31, 2009 and 2008, our net premiums written were $1,893.8 million and $2,030.8 million, respectively. For the years ended December 31, 2009 and 2008, we had net income available to common shareholders of $375.1 million and $543.1 million, respectively. As of December 31, 2009, we had total assets of $10.8 billion and total shareholders’ equity of $3.6 billion.
The property and casualty reinsurance and insurance industries use the combined ratio as a measure of underwriting profitability. The combined ratio, computed when using amounts reported in financial statements prepared under United States generally accepted accounting principles (“GAAP”), is the sum of losses and loss adjustment expenses (“LAE”) incurred as a percentage of net premiums earned, plus underwriting expenses, which include acquisition costs and other underwriting expenses, as a percentage of net premiums earned. The combined ratio reflects only underwriting results and does not include investment results. Underwriting profitability is subject to significant fluctuations due to catastrophic events, competition, economic and social conditions, foreign currency fluctuations and other factors. Our combined ratio was 96.7% for the year ended December 31, 2009, compared to 101.2% for the year ended December 31, 2008.
The Americas division is our largest division and writes casualty, surety and property treaty reinsurance, and facultative casualty reinsurance, in the United States and Canada, and primarily treaty and facultative property reinsurance in Latin America.
The EuroAsia division consists of our international reinsurance business, which is geographically dispersed, mainly throughout Europe, and includes business in Asia, the Middle East, Africa and the Americas.
We review our critical accounting estimates and assumptions on a quarterly basis. These reviews include the estimate of reinsurance premiums and premium related amounts, establishing deferred acquisition costs, an evaluation of the adequacy of reserves for unpaid losses and LAE, review of our reinsurance and retrocession agreements, an analysis of the recoverability of deferred income tax assets and an evaluation of our investment portfolio, including a review for other-than-temporary declines in estimated fair value. Actual results may differ materially from the estimates and assumptions used in preparing the consolidated financial statements.
The following table displays, by division, the estimates included in our consolidated financial statements as of and for the years ended December 31, 2009, 2008 and 2007 related to gross premiums written, acquisition costs, premiums receivable and unearned premium reserves (in millions):
The difference between estimates and the actual accounts received may be material as a result of different reporting practices by ceding companies across geographic locations. Estimates may be subject to material fluctuations on an individual contract level compared to the actual information received, and any differences are recorded in the respective financial period in which they become known. Since the assumptions used to determine the estimates are reviewed quarterly and compared to the information received during the quarter, the variance in the aggregate estimates compared to the actual information when received is minimized. In addition, during the quarter’s review of these contracts, any change in original estimate compared to the new estimate is reflected in the appropriate financial period. In any specific financial period, the original estimated premium for a specific contract may vary from actual premium reported through the life of the contract due to the reporting patterns of the ceding companies and, in some cases, movements in foreign exchange rates over the period.
We must make judgments about the ultimate premiums written and earned by us. Reported premiums written and earned are based upon reports received from ceding companies, supplemented by our internal estimates of premiums written for which ceding company reports have not been received. We establish our own estimates based on discussions and correspondence with our ceding companies and brokers during the contract negotiation process and over the contract risk period. The determination of premium estimates requires a review of our experience with the ceding companies, familiarity with each market, an analysis and understanding of the characteristics of each line of business, and the ability to project the impact of current economic indicators on the volume of business written and ceded by our cedants. Premium estimates are updated when new information is received. Differences between such estimates and actual amounts are recorded in the period in which estimates are changed or the actual amounts are determined.
We rely on initial and subsequent claim reports received from ceding companies for reinsurance business, and the estimates advised by our claims adjusters for insurance business, to establish our estimates of unpaid losses and LAE. The type of information that we receive from ceding companies generally varies by the type of
The reserve methodologies employed by us are dependent on the nature and quality of the data that we collect from ceding companies for reinsurance business and claims adjusters for insurance business. This data primarily consists of loss amounts reported by ceding companies and claims adjusters, loss payments made by ceding companies and claims adjusters and premiums, written and earned, reported by ceding companies or estimated by us. Underwriting and claim information provided by our ceding companies and claims adjusters is aggregated by the year in which each treaty or policy is written into groups of business by geographic region and type of business to facilitate analysis, generally referred to as “reserve cells.” These reserve cells are reviewed annually and change over time as our business mix changes. We supplement this information with claims and underwriting audits of specific contracts and internally developed pricing trends, as well as loss trend data developed from industry sources. This information is used to develop point estimates of carried reserves for each business segment. These individual point estimates, when aggregated, represent the total carried losses and LAE reserves carried in our consolidated financial statements. Due to the uncertainty involving estimates of ultimate loss exposures, we do not attempt to produce a range around our point estimate of loss. The actuarial techniques for projecting losses and LAE reserves by reserve cell rely on historical paid and case reserve loss emergence patterns and insurance and reinsurance pricing trends to establish the claims emergence of future periods with respect to all reported and unreported insured events that have occurred on or before the balance sheet date.
Our estimate of ultimate loss is determined based on a review of the results of several commonly accepted actuarial projection methodologies incorporating the quantitative and qualitative information described above. The specific methodologies we utilize in our loss reserve review process include, but may not be limited to (i) incurred and paid loss development methods, (ii) incurred and paid Bornhuetter Ferguson (“BF”) methods and (iii) loss ratio methods. The incurred and paid loss development methods utilize loss development patterns derived from historical loss emergence trends usually based on cedant supplied claim information to determine ultimate loss. These methods assume that the ratio of losses in one period to losses in an earlier period will remain constant in the future. Loss ratio methods multiply expected loss ratios, derived from aggregated analyses of internally developed pricing trends, by earned premium to determine ultimate loss. The incurred and paid BF methods are a blend of the loss development and loss ratio methods. These methods utilize both loss development patterns, as well as expected loss ratios, to determine ultimate loss. When using the BF methods, the initial treaty year ultimate loss is based predominantly on expected loss ratios. As loss experience matures, the estimate of ultimate loss using this methodology is based predominantly on loss development patterns. We generally do not utilize methodologies that are dependent on claim counts reported, claim counts settled or claim counts open. Due to the nature of our business, this information is not routinely provided by ceding companies for every treaty. Consequently, actuarial methods utilizing this information generally cannot be relied upon by us in our loss reserve estimation process. As a result, for much of our business, the separate analysis of frequency
We complete comprehensive loss reserve reviews, which include a reassessment of loss development and expected loss ratio assumptions, on an annual basis. We completed this year’s annual review in the fourth quarter of 2009. The results of these reviews are reflected in the period they are completed. Quarterly, we compare actual loss emergence to expectations established by the comprehensive loss reserve review process. In the event that loss trends diverge from expected trends, we may have to adjust our reserves for losses and LAE accordingly. Any adjustments will be reflected in the periods in which they become known, potentially resulting in adverse or favorable effects to our financial results. We believe that the recorded estimate represents the best estimate of unpaid losses and LAE based on the information available at December 31, 2009.
competitive conditions in the industry at that time. These competitive conditions resulted in price pressure and relatively broader coverage terms, thereby affecting the ability of standard actuarial techniques to generate reliable estimates of ultimate loss. Similarly, directors’ and officers’ professional liability lines were impacted by the increase in frequency and severity of claims resulting from an increase in shareholder lawsuits against corporations and their officers and directors, corporate bankruptcies and other financial and management improprieties in the late 1990s and early 2000s.
The London Market division reported net decreases in prior period loss estimates of $23.3 million, $40.0 million and $57.0 million for the years ended December 31, 2009, 2008 and 2007, respectively. The decrease in prior period loss estimates for the year ended December 31, 2009 was principally attributable to loss emergence lower than expectations in the period on liability business. The reduction in prior period loss estimates for the year ended December 31, 2008 was principally attributable to loss emergence lower than expectations in the period on professional liability and miscellaneous property lines of business. The reduction in prior period loss estimates for the year ended December 31, 2007 was principally attributable to favorable loss emergence on liability, property catastrophe and other miscellaneous property lines of business in the period.
Estimates of reserves for unpaid losses and LAE are contingent upon legislative, regulatory, social, economic and legal events and trends that may or may not occur or develop in the future, thereby affecting assumptions of claim frequency and severity. Examples of emerging claim and coverage issues and trends in recent years that could affect reserve estimates include developments in tort liability law, legislative attempts at asbestos liability reform, an increase in shareholder derivative suits against corporations and their officers and
The provision for IBNR in unpaid losses and LAE as of December 31, 2009 was $2,424.9 million. For illustration purposes, a change in the expected loss ratio that increases the year ended December 31, 2009 calendar year loss ratio by 2.5 loss ratio points would increase IBNR by $48.2 million. A change in loss
emergence trends that increases unpaid losses and LAE at December 31, 2009 by 2.5% would increase IBNR by $116.7 million.
We have exposure to asbestos, environmental pollution and other latent injury damage claims resulting from contracts written by Clearwater prior to 1986. Exposure arises from reinsurance contracts under which we assumed liabilities from ceding companies, on an indemnity or assumption basis, primarily in connection with general liability insurance policies issued by such ceding companies. Our estimate of the ultimate liability for these exposures includes case basis reserves and a provision for IBNR claims. The provision for asbestos loss liabilities is established based on an annual review of Company and external trends in reported loss and claim payments, with monitoring of emerging experience on a quarterly basis.
The following table provides gross asbestos and environmental outstanding claim information with respect to business written prior to 1986, as of December 31, 2009 and 2008 (in millions):
The number of asbestos claims, with case reserves, as of December 31, 2009 was 1,744, amounting to $211.3 million in gross case losses and LAE reserves. The largest 10 reported claims accounted for 10.1% of the gross case reserves, with an average reserve of $2.1 million. The number of asbestos claims, with case reserves, as of December 31, 2008 was 1,672, amounting to $204.8 million in gross case losses and LAE reserves. The largest 10 reported claims accounted for 11.6% of the gross case reserves, with an average reserve of $2.4 million. Gross case reserves increased in 2009, as newly reported claims and additional reported reserves on existing claims were greater than claim payments in the year. The asbestos open claim count increased by 72, or 4.3%, during calendar year 2009. Based on an aggregation of claims by insured, our 10 largest insured involvements accounted for 38.0% of our gross case reserves as of December 31, 2009, compared to 36.9% as of December 31, 2008. Net losses and LAE incurred for the year ended December 31, 2009 for asbestos claims were increased by $40.0 million, principally attributable to the annual review of this exposure.
The number of environmental claims, with case reserves, as of December 31, 2009 was 529, amounting to $18.4 million in gross case losses and LAE reserves. The largest 10 reported claims accounted for 29.3% of the gross case reserves, with an average case reserve of $0.5 million. The number of environmental claims, with case reserves, as of December 31, 2008 was 556, amounting to $20.9 million in gross case losses and LAE reserves. The largest 10 reported claims accounted for 30.6% of the gross case reserves, with an average case reserve of $0.6 million. Overall gross case reserves decreased in 2009, as newly reported claims and additional reported reserves on existing claims were less than claim payments in the year. The environmental open claim count decreased by 27, or 4.9%, during calendar year 2009. Based on an aggregation of claims by insured, our 10 largest insured involvements accounted for 51.1% of our gross case reserves as of December 31, 2009, compared to 45.9% as of December 31, 2008. Net losses and LAE incurred for the year ended December 31, 2009 for environmental claims were increased by $0.6 million, principally attributable to the annual review of this exposure.
We seek to limit our net after-tax probable maximum loss for a severe catastrophic event, defined as an occurrence with a return period of 250 years, to no more than 20% of our statutory surplus. Prior to 2009, this limit was 15% of statutory surplus. There can be no assurances that we will not incur losses greater than 20% of our statutory surplus from one or more catastrophic events due to the inherent uncertainties in (i) estimating the frequency and severity of such events, (ii) the margin of error in making such determinations resulting from potential inaccuracies and inadequacies in the data provided by clients and brokers, (iii) the modeling techniques and the application of such techniques and (iv) the values of securities in our investment portfolio, which may lead to volatility in our statutory surplus from period to period.
We record deferred income taxes as net assets or liabilities on our consolidated balance sheets to reflect the net tax effect of the temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and their respective tax bases. As of December 31, 2009 and 2008, a net deferred tax asset of $76.8 million and $290.2 million, respectively, was recorded. In recording this deferred tax asset, we have made estimates and judgments that future taxable income will be sufficient to realize the value of the net deferred tax asset. Accordingly, deferred tax assets have not been reduced by a valuation allowance, as management believes it is more likely than not that the deferred tax assets will be realized.
We are responsible for determining the fair value of our investment portfolio by utilizing market-driven fair value measurements obtained from active markets, where available, by considering other observable and unobservable inputs and by employing valuation techniques that make use of current market data. For the majority of our investment portfolio, we use quoted prices and other information from independent pricing sources in determining fair values.
impairment of an investment, but rather a temporary decline in value. In addition, we consider our ability and intent to hold the security to recovery when evaluating possible impairments.
Risks and uncertainties are inherent in our other-than-temporary decline in value assessment methodology. Risks and uncertainties include, but are not limited to, incorrect or overly optimistic assumptions about financial condition or liquidity, incorrect or overly optimistic assumptions about future prospects, inadequacy of any underlying collateral, unfavorable changes in economic or social conditions and unfavorable changes in interest rates.
Americas. Gross premiums written in the Americas division for the year ended December 31, 2009 were $745.9 million, a decrease of $30.5 million, or 3.9%, compared to $776.4 million for the year ended December 31, 2008. These amounts represented 34.0% of our gross premiums written for the year ended December 31, 2009 and 33.8% in 2008. Gross premiums written across each geographic region of the Americas division were as follows (in millions):
Canada - The decrease in gross premiums written was primarily due to the movement in the Canadian dollar exchange rate between 2009 and 2008.
U.S. Insurance. Gross premiums written in the U.S. Insurance division for the year ended December 31, 2009 were $547.0 million, an increase of $7.3 million, or 1.4%, compared to $539.7 million for the year ended December 31, 2008. These amounts represented 24.9% of our gross premiums written for the year ended December 31, 2009 and 23.5% in 2008. Gross premiums written by line of business were as follows (in millions):
Ceded Premiums Written. Ceded premiums written for the year ended December 31, 2009 increased by $37.5 million, or 14.2%, to $301.2 million (13.7% of gross premiums written), from $263.7 million (11.5% of gross premiums written) for the year ended December 31, 2008. The increase in ceded premiums written was primarily related to an increase in reinsurance purchased for our professional and medical professional liability business in the U.S. Insurance division.
Net Premiums Written. Net premiums written for the year ended December 31, 2009 decreased by $137.0 million, or 6.7%, to $1,893.8 million, compared to $2,030.8 million for the year ended December 31, 2008. Net premiums written represent gross premiums written less ceded premiums written. Net premiums written decreased over 2008 at a higher rate than gross premiums written, reflecting an increase in ceded premiums written during 2009.
Americas. Net premiums written in the Americas division for the year ended December 31, 2009 were $731.2 million, compared to $760.7 million for the 2008 period, a decrease of 3.9%. These amounts represented 38.6% of our net premiums written for the year ended December 31, 2009 and 37.5% for the year ended December 31, 2008. The net retention ratio, which represents net premiums written as a percentage of gross premiums written, was 98.0% for each of the years ended December 31, 2009 and 2008.
The decrease in net premiums written was consistent with the decrease in gross premiums written, which was primarily due to movements in foreign exchange rates and a modification to our estimation method during 2008, offset by an increase in reinstatement premiums.
The decrease in net losses and LAE incurred was principally related to a decrease in current year property catastrophe losses of $133.6 million, to $131.1 million for the year ended December 31, 2009, from $264.7 million for the year ended December 31, 2008. Losses and LAE for the year ended December 31, 2009 included a decrease in prior period losses of $11.3 million, attributable to reduced loss estimates due to loss emergence lower than expectations in the period on business written in the EuroAsia, London Market and U.S. Insurance divisions. Losses and LAE for the year ended December 31, 2008 included a decrease in prior period losses of $10.1 million.
Ceded losses and LAE incurred increased $74.6 million, or 32.8%, to $301.9 million for the year ended December 31, 2009, from $227.3 million for the year ended December 31, 2008. This increase was principally attributable to increased loss cessions related to business in the London Market division.
Americas Division - Losses and LAE decreased $96.8 million, or 15.0%, to $548.7 million for the year ended December 31, 2009, from $645.5 million for the year ended December 31, 2008. This resulted in a loss and LAE ratio of 70.8% for the year ended December 31, 2009, compared to 82.8% for the year ended December 31, 2008. This decrease in losses and LAE was principally attributable to a decrease in current year property catastrophe losses of $107.7 million, to $21.6 million for the year ended December 31, 2009, from $129.3 million for the year ended December 31, 2008. Losses and LAE for the year ended December 31, 2009 included an increase in prior period losses of $70.1 million, principally due to loss emergence greater than expectations in the period on asbestos. Losses and LAE for the year ended December 31, 2008 included current year property catastrophe losses of $129.3 million, with $93.9 million for Hurricane Ike, $9.3 million for Hurricane Gustav, $8.2 million for the Australia floods, and an increase in prior period losses of $66.6 million, principally attributable to loss emergence greater than expectations in the period on asbestos.
U.S. Insurance Division - Losses and LAE decreased $57.6 million, or 20.8%, to $219.8 million for the year ended December 31, 2009, from $277.4 million for the year ended December 31, 2008. This resulted in a loss and LAE ratio of 61.4% for the year ended December 31, 2009, compared to 66.8% for the year ended December 31, 2008. This decrease in losses and LAE was principally due to a decrease in current year property catastrophe losses and a decline in loss exposure associated with a decline in net premiums earned of $57.2 million, to $358.0 million for the year ended December 31, 2009, from $415.2 million for the year ended December 31, 2008. Losses and LAE for the year ended December 31, 2009 included a decrease in prior period losses of $35.3 million, principally attributable to loss emergence lower than expectations in the period on professional liability business. Losses and LAE for the year ended December 31, 2008 included current year property catastrophe losses of $27.6 million, with $26.1 million for Hurricane Ike and a reduction in prior period losses of $34.3 million, principally due to loss emergence lower than expectations in the period on professional liability business.
Acquisition Costs. Acquisition costs for the year ended December 31, 2009 were $375.3 million, a decrease of $42.7 million or 10.2%, compared to $418.0 million for the year ended December 31, 2008. The resulting acquisition expense ratio, expressed as a percentage of net premiums earned, was 19.5% for the year ended December 31, 2009, compared to 20.1% for the year ended December 31, 2008, a decrease of 0.6 points. The Americas, EuroAsia and U.S. Insurance divisions’ acquisition expense ratios decreased by 0.7 points, 0.9 points and 2.0 points, respectively, for the year ended December 31, 2009 compared to the corresponding period in 2008. The London Market division’s acquisition expense ratio increased by 0.5 point compared to the corresponding period in 2008. The reduction of 2.0 points in the U.S. Insurance division’s net acquisition expense ratio is principally related to writing more direct business from internal sources at lower commission rates, and the additional ceded commission received from reinsurers who participate in our medical professional liability reinsurance program.
an increase in net investment income from other invested assets of $11.3 million for the year ended December 31, 2009 compared to the year ended December 31, 2008;
Our total effective annualized yield on average invested assets, net of expense but before the impact of interest expense from funds held balances, was 4.0% and 3.3% for the years ended December 31, 2009 and 2008, respectively. The total effective annualized yield on average invested assets is calculated by dividing annual income by the annual average invested assets (computed using average amortized cost for fixed income securities and average carrying value for all other securities).
Net Realized Investment Gains. Net realized investment gains of $186.0 million for the year ended December 31, 2009 decreased by $506.3 million, from net realized investment gains of $692.3 million for the year ended December 31, 2008. The decrease in net realized investment gains was principally due to the following:
a decrease in net realized investment gains on derivative securities of $1,070.3 million, primarily attributable to a decrease of $567.0 million on total return swaps, a decrease of $379.4 million on credit default swaps, with decreased holdings in the current period, and a decrease of $126.6 million on forward currency contracts;
an increase in net realized investment gains on fixed income securities of $64.4 million;
increased realized investment gains on other invested assets of $14.0 million;
increased realized investment gains on preferred stock of $7.9 million; and
Other Expenses, Net. Other expense, net, for the year ended December 31, 2009 was $44.4 million as compared to $60.4 million for the year ended December 31, 2008. The other expense is principally comprised of foreign currency exchange gains and losses and the operating expenses of our holding company, including audit related fees, corporate-related legal fees, consulting fees and compensation expense. The $16.0 million decrease for the year ended December 31, 2009 compared to 2008 was primarily related to $41.6 million of foreign exchange related adjustments, offset by (i) $15.9 million of stock-based compensation and restricted equity value rights and (ii) $5.8 million related to the tender offer by Fairfax.
Interest Expense. We incurred interest expense related to our debt obligations of $31.0 million and $34.2 million for the years ended December 31, 2009 and 2008, respectively. The lower amount of interest expense in 2009 primarily resulted from the decrease in interest rates on our Series A, B and C floating rate Senior Notes.
Federal and Foreign Income Tax Provision. Our federal and foreign income tax provision for the year ended December 31, 2009 decreased by $158.0 million, to $120.5 million, compared to $278.5 million for the year ended December 31, 2008, resulting from a combination of (i) decreased pre-tax income and (ii) a shift in our fixed income portfolio to tax-exempt municipal securities and equity securities eligible for dividends-received deductions. Our effective tax rates were 24.5% and 33.7% for the years ended December 31, 2009 and 2008, respectively.
Americas. Gross premiums written in the Americas division for the year ended December 31, 2008 were $776.4 million, a decrease of $58.5 million, or 7.0%, compared to $834.9 million for the year ended December 31, 2007. These amounts represent 33.8% of our gross premiums written for the year ended December 31, 2008 and 36.6% for the year ended December 31, 2007. Gross premiums written across each geographic region of the Americas were as follows (in millions):
United States -Property business increased by $24.4 million, or 16.4%, to $172.4 million in 2008 from $148.1 million in 2007. Treaty and facultative casualty business decreased by $93.5 million, or 20.7%, to $358.5 million in 2008 from $452.0 million in 2007 due to an increase in competitive market conditions and the non-renewal of certain business that did not meet our underwriting criteria.
London Market. Gross premiums written in the London Market division for the year ended December 31, 2008 were $381.7 million, an increase of $31.8 million, or 9.1%, compared to $349.9 million for the year ended December 31, 2007. These amounts represent 16.7% of our gross premiums written for the year ended December 31, 2008 and 15.3% in 2007. Gross premiums written across each unit of the London Market division were as follows (in millions):
The decrease in gross premiums written by the London branch was primarily attributable to decreases in marine and aviation business of $7.9 million, casualty business of $4.4 million and property business of $3.9 million.
The increase in gross premiums written by Newline was primarily attributable to medical professional liability and motor business.
U.S. Insurance. Gross premiums written in the U.S. Insurance division for the year ended December 31, 2008 were $539.7 million, an increase of $7.4 million, or 1.4%, compared to $532.3 million for the year ended December 31, 2007. These amounts represent 23.5% of our gross premiums written for the year ended December 31, 2008 and 23.3% for the year ended December 31, 2007. Lines of business that experienced the greatest change in gross premiums written or were significant to the U.S. Insurance division for the year ended December 31, 2008 were as follows (in millions):
The increase in net premiums written is consistent with the increase in gross premiums written, which was impacted by the foreign exchange rate movement and the modification to the estimating process discussed in the gross premiums written analysis.
Losses and Loss Adjustment Expenses. Net losses and LAE increased $100.3 million, or 7.1%, to $1,508.7 million for the year ended December 31, 2008, from $1,408.4 million for the year ended December 31, 2007, as follows (in millions):
The increase in net losses and LAE incurred of $100.3 million was principally related to an increase in current year catastrophe events of $158.8 million, to $264.7 million for the year ended December 31, 2008, from $105.9 million for the year ended December 31, 2007. This increase was partially offset by a decrease in prior period losses of $50.6 million, to a decrease of $10.1 million for the year ended December 31, 2008, from an increase of $40.5 million for the year ended December 31, 2007. Losses and LAE for the year ended December 31, 2008 included $143.8 million attributable to Hurricane Ike, $45.9 million related to the China winter storm, $19.1 million related to Windstorm Emma, $11.3 million related to Hurricane Gustav and a decrease in prior period losses of $10.1 million, principally attributable to decreased loss estimates due to loss emergence lower than expectations in the period in the EuroAsia, London Market and U.S. Insurance divisions, partially offset by increased loss estimates due to loss emergence greater than expectations in the period in the Americas division. Losses and LAE for the year ended December 31, 2007 included $38.5 million for Windstorm Kyrill, $12.3 million for Cyclone Gonu, $10.0 million for the Mexico flood in Tabasco and an increase in prior period losses of $40.5 million, predominantly attributable to increased loss estimates due to loss emergence greater than expectations in the period in the Americas division, partially offset by reduced loss estimates due to loss emergence lower than expectations in the period in the EuroAsia, London Market and U.S. Insurance divisions.
The following tables reflect total losses and LAE as reported for each division and include the impact of catastrophe losses and prior period reserve development, expressed as a percentage of net premiums earned (“NPE”), for the years ended December 31, 2008 and 2007 (in millions):
EuroAsia Division - Losses and LAE increased $48.6 million, or 13.9%, to $397.2 million for the year ended December 31, 2008, from $348.6 million for the year ended December 31, 2007. This resulted in a loss and LAE ratio of 70.1% for the year ended December 31, 2008, compared to 64.2% for the year ended December 31, 2007. This increase in losses and LAE was principally due to an increase in current year catastrophe events of $27.9 million, to $81.3 million for the year ended December 31, 2008, from $53.4 million for the year ended December 31, 2007, and an increase in loss exposure associated with an increase in net premiums earned of $23.4 million. Losses and LAE for the year ended December 31, 2008 included current year property catastrophe losses of $81.3 million, with $45.9 million for the China winter storm, $19.1 million for Windstorm Emma, $5.1 million for the China earthquake and a decrease in prior period losses of $2.4 million, principally attributable to loss emergence lower than expectations in the period on credit business, partially offset by loss emergence greater than expectations in the period on miscellaneous property lines of business.
London Market Division - Losses and LAE increased $38.2 million, or 25.4%, to $188.6 million for the year ended December 31, 2008, from $150.4 million for the year ended December 31, 2007. This resulted in a loss and LAE ratio of 59.9% for the year ended December 31, 2008, compared to 49.0% for the year ended December 31, 2007. This increase in losses and LAE was principally due to an increase in prior period losses of $17.0 million, to a decrease of $40.0 million for the year ended December 31, 2008, from a decrease of $57.0 million for the year ended December 31, 2007, and an increase in current year property catastrophe events. Current year property catastrophe events increased $6.0 million, to $26.5 million for the year ended December 31, 2008, from $20.5 million for the year ended December 31, 2007. Losses and LAE for the year ended December 31, 2008 included current year property catastrophe losses of $26.5 million, with $23.1 million attributable to Hurricane Ike and reflected a decrease in prior period losses of $40.0 million, principally due to loss emergence lower than expectations in the period on professional liability and miscellaneous property lines of business. Losses and LAE for the year ended December 31, 2007 included current year property catastrophe losses of $20.5 million, with $11.7 million for Windstorm Kyrill, $5.1 million for floods in the United Kingdom and reflected a reduction in prior period losses of $57.0 million, principally due to favorable loss emergence on liability, property catastrophe and other miscellaneous property lines of business in the period.
U.S. Insurance Division - Losses and LAE increased $29.5 million, or 11.9%, to $277.4 million for the year ended December 31, 2008, from $247.9 million for the year ended December 31, 2007. This resulted in a loss and LAE ratio of 66.8% for the year ended December 31, 2008, compared to 57.8% for the year ended December 31, 2007. This increase in losses and LAE for the year ended December 31, 2008 was related to current year catastrophe losses of $27.6 million, with $26.1 million attributable to Hurricane Ike. For the years ended December 31, 2008 and 2007, prior period losses decreased by $34.3 million and $38.7 million, respectively, principally due to loss emergence lower than expectations on professional liability business in each period.
The following table reflects the acquisition and other underwriting expenses, expressed as a percentage of net premiums earned, for the years ended December 31, 2008 and 2007, for each of our divisions:
Interest expense on funds held, which is included in investment expenses, of $5.3 million for the year ended December 31, 2008, represents a decrease of $2.7 million, or 33.8%, from $8.0 million for the year ended December 31, 2007. The decrease was primarily attributable to ceded paid losses reducing the funds held balance.
During the year ended December 31, 2008, net realized investment gains were reduced by other-than-temporary impairment losses of $358.7 million, comprised of fixed income securities of $18.9 million, equity securities of $339.0 million and preferred stock of $0.8 million. During the year ended December 31, 2007, net realized investment gains were reduced by other-than-temporary impairment losses in the amount of $59.8 million, comprised of fixed income securities, common and preferred stock. Other-than-temporary impairments reflect situations where the fair value was below the cost of the securities, and the ability of the security to recover its value could not be reasonably assured.
Our shareholders’ equity increased by $727.5 million, or 25.7%, to $3,555.2 million as of December 31, 2009, from $2,827.7 million as of December 31, 2008, due to net income of $372.3 million, a gain on purchase of our Series B preferred shares of $8.0 million, and an increase in net unrealized appreciation on securities of $463.2 million (a component of accumulated other comprehensive income). Offsetting these increases were the repurchase of $73.8 million of our common shares, the purchase of $17.2 million of our Series B preferred shares, and dividends to our preferred and common shareholders of $18.6 million.
Odyssey America’s liquidity requirements are principally met by cash flows from operating activities, which primarily result from collections of premiums, reinsurance recoverables and investment income, net of paid losses, acquisition costs, income taxes and underwriting and investment expenses. We seek to maintain sufficient liquidity to satisfy the timing of projected claim payments and operating expenses. The estimate, timing and ultimate amount of actual claim payments is inherently uncertain and will vary based on many factors including the frequency and severity of losses across various lines of business. Claim payments can accelerate or increase due to a variety of factors, including losses stemming from catastrophic events, which are typically paid out in a short period of time, legal settlements or emerging claim issues. We estimate claim payments, on obligations existing as of December 31, 2009 and net of associated reinsurance recoveries, of approximately $1.1 billion during 2010. The timing and certainty of associated reinsurance collections that may be due to us can add uncertainty to our liquidity position to the extent amounts are not received on a timely basis. As of December 31, 2009, our operating subsidiaries maintained cash and cash equivalents of $0.9 billion and short-term investments of $363.5 million, which is readily available for expected claim payments. In addition, our liquidity is enhanced through the collection of premiums on new business written through the year. We believe our cash resources, together with readily marketable securities, are sufficient to satisfy expected payment obligations, including any unexpected acceleration or increase in claim payments, or timing differences in collecting reinsurance recoverables.
Cash used in operations was $3.1 million for the year ended December 31, 2009, compared to cash provided by operations of $112.1 million for the year ended December 31, 2008. The decrease in cash provided by operations of $115.2 million, or 102.7%, over the corresponding period of 2008, primarily relates to a $179.4 million extension payment made in March of 2009 for the 2008 tax year.
Total investments and cash exclude amounts receivable for securities sold and amounts payable for securities purchased, representing the timing between the trade date and settlement date of securities sold and purchased. As of December 31, 2009 and 2008, we had receivables for securities sold of $77.9 million and $6.3 million, respectively, which are included in other assets, and payables for securities purchased of $45.6 million and $126.6 million, respectively, which are included in other liabilities.
During the second quarter of 2005, we issued $125.0 million aggregate principal amount of senior notes due May 1, 2015. The issue was sold at a discount of $0.8 million, which is being amortized over the life of the notes. Interest accrues on the senior notes at a fixed rate of 6.875% per annum, which is due semi-annually on May 1 and November 1.
During March 2009, we filed a shelf registration statement on Form S-3ASR with the SEC, which became effective automatically upon filing. The registration statement provided for the offer and sale by us, from time to time, of debt and equity securities. On February 9, 2010, we filed a post-effective amendment to the Form S-3ASR to remove from registration the securities that remained unsold as of such date.
We participate in Lloyd’s through our 100% ownership of Newline Syndicate (1218), for which we provide 100% of the capacity. The results of Newline Syndicate (1218) are consolidated in our financial statements. In support of Newline Syndicate (1218)’s capacity at Lloyd’s, NCNL and Odyssey America have pledged securities and cash with a fair value of $139.1 million and $123.5 million, respectively, as of December 31, 2009 in a deposit trust account in favor of the Society and Council of Lloyd’s. These securities may be substituted with other securities at our discretion, subject to approval by Lloyd’s. The securities are carried at fair value and are included in investments and cash in our consolidated balance sheets. Interest earned on the securities is included in investment income. The pledge of assets in support of Newline Syndicate (1218) provides us with the ability to participate in writing business through Lloyd’s, which remains an important part of our business. The pledged assets effectively secure the contingent obligations of Newline Syndicate (1218) should it not meet its obligations. NCNL and Odyssey America’s contingent liability to the Society and Council of Lloyd’s is limited to the aggregate amount of the pledged assets. We have the ability to remove funds at Lloyd’s annually, subject to certain minimum amounts required to support outstanding liabilities as determined under risk-based capital models and approved by Lloyd’s. The funds used to support outstanding liabilities are adjusted annually and our obligations to support these liabilities will continue until they are settled or the liabilities are reinsured by a third party approved by Lloyd’s. We expect to continue to actively operate Newline Syndicate (1218) and support its requirements at Lloyd’s. We believe that Newline Syndicate 1218 maintains sufficient liquidity and financial resources to support its ultimate liabilities and we do not anticipate that the pledged assets will be utilized.
On December 16, 2009, our Board of Directors declared quarterly dividends of $0.5078125 per share on our 8.125% Series A preferred shares and $0.2208788 per share on our floating rate Series B preferred shares. The total dividends of $1.5 million were paid on January 20, 2010 to Series A and Series B preferred shareholders of record on December 31, 2009.
As described in Note 6 to our consolidated financial statements included in this Annual Report on Form 10-K, as of December 31, 2009, we held $47.5 million of investments, or approximately 0.6% of net assets and
liabilities measured at fair value, that are classified as Level 3 (which are financial instruments for which the values are based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement and that reflect our own assumptions about the methodology and valuation techniques that a market participant would use in pricing the asset or liability). These Level 3 investments are valued using a discounted cash flow model, including unobservable inputs that are supported by limited market-based activity. During the year ended December 31, 2009, we purchased $19.9 million of investments classified as Level 3, and transferred our investment in Advent (which, at the time, had a value of $32.6 million as compared to $32.9 million as of December 31, 2009), which is classified in other invested assets, from Level 2 to Level 3. In addition, Level 3 investments with a value of $24.3 million were sold during the year ended December 31, 2009. During the year ended December 31, 2009, we transferred $47.8 million of Level 3 investments to Level 2 after determining that broker-dealer quotes were available to determine the fair value of the instruments.
A description of recently adopted accounting pronouncements is provided in Note 3 to our consolidated financial statements included in this Annual Report on Form 10-K.
We have off-balance sheet arrangements, including certain arrangements with affiliated companies that have financial implications. A description of these arrangements is provided in Note 16 to our consolidated financial statements included in this Annual Report on Form 10-K.
The following table displays the potential impact of fair value fluctuations on our fixed income securities portfolio as of December 31, 2009 and 2008, 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, 2009, we had net unrealized gains of $828.2 million, before taxes, related to our total investments and cash. This net amount was comprised of gross unrealized appreciation of $876.0 million, offset by gross unrealized depreciation of $47.8 million, all of which are related to fixed income securities and common stocks.
As of December 31, 2009, we were party to floating to fixed interest rate swap contracts with a notional amount of $140.0 million. As of December 31, 2009, the fair value of these contracts is reported in other liabilities at $43 thousand. Net realized investment losses on interest rate swaps totaled $2.0 million for the year ended December 31, 2009.
Credit risk is the risk that one party to a financial instrument fails to discharge an obligation and thereby causes financial loss to another party. Our exposure to credit risk is concentrated in investments and underwriting balances.
The composition of the fair value of our fixed income securities portfolio as of the dates indicated, classified according to the higher of each security’s respective Standard & Poor’s and Moody’s issuer credit ratings, is presented below (in millions):
As of December 31, 2009, 89.5% of our fixed income portfolio at fair value was rated investment grade (as compared to 91.6% as of December 31, 2008), with 69.9% (primarily consisting of government obligations) being rated AA/Aa2 or better (as compared to 89.6% as of December 31, 2008). As of December 31, 2009, holdings of fixed income securities in the ten issuers (excluding federal governments) to which we had the greatest exposure was $1.6 billion, which was approximately 18.2% of our total invested assets. The exposure to the largest single issuer of corporate bonds held as of December 31, 2009 was $146.3 million, which was approximately 1.7% of our total investment portfolio, or 4.1% of our total shareholders’ equity.
Under a credit default swap, as the buyer, we agree to pay to a specific counterparty, at specified periods, fixed premium amounts based on an agreed notional principal amount in exchange for protection against default by the issuers of specified referenced debt securities. The credit events, as defined by the respective credit default swap contracts, establishing the rights to recover amounts from the counterparties are comprised of ISDA-standard credit events, which are: bankruptcy, obligation acceleration, obligation default, failure to pay, repudiation/moratorium and restructuring. As of December 31, 2009, all credit default swap contracts held by us have been purchased from and entered into with either Citibank, N.A., Deutsche Bank AG or Barclays Bank PLC as the counterparty, with positions on certain covered risks with more than one of these counterparties.
We obtain market derived fair values for our credit default swaps from third party providers, principally broker-dealers. To validate broker-dealer credit default swap fair value quotations, two reasonability tests are performed. First, we obtain credit default swap bid-spreads from independent broker-dealers (non-counterparty broker-dealers). These spreads are entered as inputs into a discounted cash flow model, which calculates a fair value that is compared for reasonability to the counterparty broker-dealer provided fair values. The discounted cash flow model uses the independently obtained credit default swap bid-spreads to calculate the present value of the remaining protection payments using the appropriate currency-denominated swap curve, with consideration given to various other parameters including single name bid-spread in basis points and the remaining term to maturity of the credit default swap contract. Secondly, a comparison is performed against recently transacted credit default swap values as provided by independent broker-dealers, and to prices reflected in recent trades of identical financial instruments where available.
The initial premium paid for each credit default swap contract was recorded as a derivative asset and was subsequently adjusted for changes in the unrealized fair value of the contract at each balance sheet date. As these contracts do not qualify for hedge accounting, changes in the unrealized fair value of the contract were recorded as net realized investment gains (losses) on investments in our consolidated statements of operations and comprehensive income. Sales of credit default swap contracts require us to reverse through net gains (losses) on investments any previously recorded unrealized fair value changes since the inception of the contract, and to record the actual amount of the final cash settlement. Derivative assets were reported gross, on a contract-by-contract basis, and are recorded at fair value in other invested assets in the consolidated balance sheet. The sale, expiration or early settlement of a credit default swap will not result in a cash payment owed by us; rather, such an event can only result in a cash payment by a third party purchaser of the contract, or the counterparty, to us. Accordingly, there is no opportunity for netting of amounts owed in settlement. Cash receipts at the date of sale of the credit default swaps were recorded as cash flows from investing activities arising from net sales of assets and liabilities classified as held for trading.
In the normal course of effecting our economic hedging strategy with respect to credit risk, we expect that there may be periods where the notional value of the hedging instrument may exceed or be less than the exposure item being hedged. This situation may arise when management compensates for imperfect correlations between the hedging item and the hedge, due to the timing of opportunities related to our ability to exit and enter hedged or hedging items at attractive prices or when management desires to only partially hedge an exposure.
Our holdings of credit default swap contracts have declined significantly in 2009 relative to prior years, largely as a result of significant sales in 2008. In the latter part of 2008, we revised the financial objectives of our hedging program by determining not to replace our credit default swap hedge position as sales or expiries occurred, primarily based upon our judgment that our exposure to elevated levels of credit risk had moderated, but also due to (i) the significant increase in the cost of purchasing credit protection (reducing the attractiveness of the credit default swap contract as a hedging instrument), (ii) improvement in our capital and liquidity (having benefited significantly from, among other things, $568.9 million in gains from sales of credit default swaps realized since the beginning of 2007), and (iii) our judgment that managing credit risk through means other than the use of derivatives was, given the market environment, once again appropriate for mitigating our credit exposure arising from financial assets. As a result, the effects that credit default swaps as hedging instruments may be expected to have on our future financial position, liquidity and operating results may be expected to diminish relative to the effects in recent years. We continue to evaluate the potential impact of the volatility in the U.S. credit markets on our financial statements and may, if conditions warrant, initiate new credit default swap contracts as a hedging mechanism in the future, although there can be no assurance that we will do so, in an effort to achieve our continuing objective to minimize the potential for loss of value of held assets where, in our view, an unusual or excessive exposure exists.
For the year ended December 31, 2009, we sold a portion of our credit default swaps, contributing to a decrease in the fair value of the portfolio to $10.0 million as of December 31, 2009, from $82.8 million as of December 31, 2008. The credit default swap portfolio had an average term to expiration of 1.5 years as of December 31, 2009, a decrease from 2.5 years as of December 31, 2008.
As of December 31, 2009, our holdings of financial instruments without quoted prices, or “non-traded investments,” included a collateral loan, which was fully impaired during 2005. We periodically evaluate the carrying value of non-traded investments by reviewing the borrowers’ current financial positions and the timeliness of their interest and principal payments.
The following tables summarize the effect of equity risk hedging instruments and related hedged items on our historical financial position, results of operations and cash flows as of and for the years ended December 31, 2009 and 2008 (in millions):
In the normal course of effecting our economic hedging strategy with respect to equity risk, we expect that there may be periods where the notional value of the hedging instrument may exceed or be less than the exposure item being hedged. This situation may arise when management compensates for imperfect correlations between the hedging item and the hedge, due to the timing of opportunities related to our ability to exit and enter hedged or hedging items at attractive prices or when management desires to only partially hedge an exposure.
The following table summarizes the potential impact of a 10% change in our equity and equity-related holdings (including equity hedges where appropriate) on pre-tax other comprehensive income (loss) and pre-tax net income for the years ended December 31, 2009, 2008 and 2007. Certain shortcomings are inherent in the method of analysis presented, as it is based on the assumptions that the equity and equity-related holdings had increased/decreased by 10%, with all other variables held constant, and that all the equity and equity-related instruments move according to a one-to-one correlation with global equity markets.
As of December 31, 2009, our equity related holdings in the ten issuers to which we had the greatest exposure totaled $1.6 billion, which was approximately 18.1% of our total invested assets. The exposure to the largest single issuer of equity related holdings held as of December 31, 2009 was $257.0 million, which was approximately 2.9% of our total invested assets, or 7.2% of our total shareholders’ equity.
Through investment in securities denominated in foreign currencies, we are exposed to foreign (i.e., non-U.S.) currency risk. Foreign currency exchange risk exists because changes in the exchange rates of the underlying foreign currencies in which our investments are denominated affect the fair values of these investments when they are converted to the U.S. dollar. As of December 31, 2009 and 2008, our total exposure to foreign-denominated securities in U.S. dollar terms was approximately $2.0 billion and $1.9 billion, or 22.6% and 23.8%, respectively, of our total investments and cash. The primary foreign currency exposures were from securities denominated in Euros, which represented 8.1% and 9.7% of our total investments and cash as of December 31, 2009 and 2008, respectively, the British pound, which represented 4.9% and 6.0% of our total investments and cash as of December 31, 2009 and 2008, respectively, and the Canadian dollar, which represented 4.0% and 3.5%, of our total investments and cash as of December 31, 2009 and 2008, respectively. As of December 31, 2009, the potential impact of a 10% decline in each of the foreign exchange rates on the
Through our international operations, we conduct our business in a variety of foreign (non-U.S.) currencies, with the primary exposures being Euros, British pounds, and Canadian dollars. Assets and liabilities denominated in foreign currencies are exposed to changes in currency exchange rates to the extent that they do not offset each other resulting in a natural hedge. Our reporting currency is the U.S. dollar, and exchange rate fluctuations relative to the U.S. dollar may materially impact our results and financial condition. We manage this risk on a macro basis by entering into forward currency contracts. As of December 31, 2009 and 2008, we were party to forward currency contracts with notional amounts of $416.3 million and $533.9 million, respectively. As of December 31, 2009 and 2008, the fair value of these contracts is reported in other liabilities and other invested assets at $39.3 million and $28.2 million, respectively. Forward currency contracts had net realized investment losses of $59.9 million and net realized investment gains of $66.7 million for the years ended December 31, 2009 and 2008, respectively.
Decisions regarding other-than-temporary impairments require an evaluation of facts and circumstances at a specific time to determine if an other-than-temporary impairment exists. For our available-for-sale fixed income securities, additional facts are evaluated to determine if the other-than-temporary impairment is related to credit or other factors. For our available-for-sale fixed income securities, should the facts and circumstances change, such that an other-than-temporary impairment is considered appropriate, and additional factors determine that the other-than-temporary impairment is related to credit, we will recognize the impairment by reducing the cost or amortized cost of the investment to its fair value and recording the loss in our consolidated statements of operations. When it is determined that an other-than-temporary impairment for our available-for-sale fixed income securities exists that is related to other factors (e.g., interest rates and market conditions), we will recognize the impairment in other comprehensive income. For our redeemable preferred stock at fair value, should the facts and circumstances change such that an other-than-temporary impairment is considered appropriate, we will recognize the impairment by reducing the cost of the investment to its fair value and recording the loss in our consolidated statements of operations. Upon the disposition of a security where an other-than-temporary impairment has been taken, we will record a gain or loss based on the adjusted cost or carrying value of the investment.
The following tables reflect the fair value and gross unrealized depreciation of our fixed income securities and common stock investments, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, as of December 31, 2009 and 2008 (in millions):
The following table provides a payment schedule of present and future obligations as of December 31, 2009 (in millions):
Consolidated Statements of Operations and Comprehensive Income for the years ended December 31, 2009, 2008 and 2007
I. Summary of Investments - Other than Investments in Related Parties as of December 31, 2009
II. Condensed Financial Information of Registrant as of December 31, 2009 and 2008 and for the years ended December 31, 2009, 2008 and 2007
To The Board of Directors and Shareholders of Odyssey Re Holdings Corp.:
On September 18, 2009, Fairfax and OdysseyRe announced that they had entered into an agreement and plan of merger (the “Merger Agreement”) pursuant to which Fairfax would promptly commence a tender offer to acquire all of the outstanding shares of common stock of OdysseyRe that Fairfax and its subsidiaries did not currently own, for $65.00 in cash per share, representing total cash consideration of approximately $1.1 billion. Pursuant to the Merger Agreement, on September 23, 2009, Fairfax commenced a tender offer for all of the outstanding shares of common stock of OdysseyRe (the “Offer”) other than shares owned by Fairfax and its subsidiaries for $65.00 in cash per share. The Board of Directors of OdysseyRe, following the unanimous recommendation of a special committee comprised solely of independent directors which had been formed to review and consider any Fairfax proposal, recommended that OdysseyRe’s minority stockholders tender their shares to the Fairfax offer and vote or consent to approve and adopt the Merger Agreement if it were to be submitted for their approval and adoption.
Investment income, which is reported net of applicable investment expenses, is recorded as earned. Realized investment gains or losses are determined on the basis of average cost. The Company records, in investment income, its proportionate share of income or loss, including realized gains or losses, for those securities for which the equity method of accounting is utilized, which include most common stocks of affiliates, limited partnerships and investment funds. Due to the timing of when financial information is reported by equity investees and received by the Company, including limited partnerships and investment funds, results attributable to these investments are generally reported by the Company on a one month or one quarter lag. Unrealized appreciation and depreciation related to trading securities is recorded as realized investment gains or losses in the consolidated statements of operations.
The net amount of unrealized appreciation or depreciation on the Company’s available for sale investments, net of applicable deferred income taxes, is reflected in shareholders’ equity in accumulated other comprehensive income. A decline in the fair value of an available for sale investment below its cost or amortized cost that is deemed other-than-temporary is recorded as a realized investment loss in the consolidated statements of operations, resulting in a new cost or amortized cost basis for the investment. Other-than-temporary declines in the carrying values of investments recorded in accordance with the equity method of accounting are recorded in net investment income in the consolidated statements of operations.
(e) Goodwill and Intangible Assets. The Company accounts for goodwill and intangible assets as permitted or required by GAAP. A purchase price paid that is in excess of net assets arising from a business combination is recorded as an asset (“goodwill”) and is not amortized. Intangible assets with a finite life are amortized over the estimated useful life of the asset. Intangible assets with an indefinite useful life are not amortized. Goodwill and intangible assets are tested for impairment on an annual basis or more frequently if events or changes in circumstances indicate that the carrying amount may not be recoverable. If the goodwill or intangible asset is impaired, it is written down to its realizable value with a corresponding expense reflected in the consolidated statements of operations. The Company has determined that its goodwill and intangible assets are not impaired as of December 31, 2009 and 2008.
The Company amortized $0.8 million for the year ended December 31, 2007, related to its intangible assets with a finite life. The Company did not incur any impairment of its intangible assets during 2009, 2008 or 2007.
The following table provides the estimated amortization expense related to intangible assets for the succeeding five years (in thousands):
For such contracts, the Company initially records the amount of consideration paid as a deposit asset or received as a deposit liability. Revenue or expense is recognized over the term of the contract, with any deferred amount recorded as a component of assets or liabilities until such time it is earned. The ultimate asset or liability under these contracts is estimated, and the asset or liability initially established, which represents consideration received, is increased or decreased over the term of the contract. The change during the period is recorded in the Company’s consolidated statements of operations, with increases and decreases in the ultimate asset or liability shown in other expense, net. As of December 31, 2009 and 2008, the Company had reflected in other assets $7.8 million and $8.0 million, respectively, and in other liabilities $1.6 million and $1.1 million, respectively, related to deposit contracts. In cases where cedants retain the consideration on a funds held basis, the Company records those assets in other assets, and records the related investment income on the assets in the Company’s consolidated statements of operations as investment income.
(h) Income Taxes. The Company records deferred income taxes to provide for the net tax effect of temporary differences between the carrying values of assets and liabilities in the Company’s consolidated financial statements and their tax bases. Such differences relate principally to deferred acquisition costs, unearned premiums, unpaid losses and loss adjustment expenses, investments and tax credits. Deferred tax assets are reduced by a valuation allowance when the Company believes it is more likely than not that all or a portion of deferred taxes will not be realized. As of December 31, 2009 and 2008, a valuation allowance was not required. During the third quarter of 2006, Fairfax reduced its ownership of the Company to below 80%, and as a result, the Company was deconsolidated from the United States tax group of Fairfax. Accordingly, the Company filed or will file separate company tax returns for the period August 2, 2006 to October 20, 2009. As a result of the Merger, effective October 28, 2009, the Company rejoined the United States tax group of Fairfax. The Merger had no effect on the Company’s tax position (see Note 15). The Company has elected to recognize accrued interest and penalties associated with uncertain tax positions as part of the income tax provision. As of December 31, 2009 and 2008, the Company has not recorded any interest or penalties.
(k) Foreign Currency. Foreign currency transaction gains or losses resulting from a change in exchange rates between the currency in which a transaction is denominated, or the original currency, and the functional currency are reflected in the consolidated statements of operations in the period in which they occur. The Company translates the financial statements of its foreign subsidiaries and branches, which have functional currencies other than the U.S. dollar, into U.S. dollars by translating balance sheet accounts at the balance sheet
The following table presents the foreign exchange effect, net of tax, on certain line items in the Company’s financial statements for the years ended December 31, 2009, 2008 and 2007 (in thousands):
(l) Earnings Per Share. Prior to the Merger, the Company calculated earnings per share using the two-class method. The Company treated unvested share-based payment awards that had non-forfeitable rights to dividends or dividend equivalents as a separate class of securities in the calculation. Under the Company’s former restricted share plan, the grantees had non-forfeitable rights to dividends before the vesting date and, accordingly, the restricted shares were considered participating securities. During the fourth quarter of 2009, Fairfax attained 100% ownership of the Company; accordingly, the Company has not presented earnings per share for the year ended December 31, 2009.
reinsured is an account used to record an asset resulting from the ceding company, in accordance with the contractual terms, withholding a portion of the premium due the Company as a guarantee that the Company will meet its loss and other obligations.
Depreciation and amortization expense for the years ended December 31, 2009, 2008 and 2007 was $4.6 million, $5.1 million and $9.5 million, respectively.
In April 2009, the FASB issued an accounting standard to provide additional guidance in estimating the fair value of assets and liabilities when the volume of activity has significantly decreased. The new accounting standard requires additional disclosures to discuss interim and annual significant assumptions and valuation techniques used to determine the fair value of the assets and liabilities. The accounting standard does not change the principles of fair value measurement but instead enhances it to provide further guidance on inactive markets. The Company adopted the accounting standard as of April 1, 2009. The adoption of this accounting standard did not have an impact on the Company’s consolidated financial statements.
In April 2009, the FASB issued an accounting standard that provides additional guidance for the measurement of other-than-temporary impairments on debt securities classified as available-for-sale and held-to-maturity. This accounting standard requires entities to separate their other-than-temporary impairment charges on available-for-sale or held-to-maturity debt securities into credit and other components. An other-than-temporary impairment charge resulting from credit-related losses associated with an impaired debt security should be recorded to earnings, while an other-than-temporary impairment resulting from other factors (i.e., interest rates and market conditions) should be recognized in other comprehensive income. In addition, if an other-than-temporary impairment exists that is related to factors other than credit, and it is more likely than not that the Company will have to sell the security prior to recovery, the other-than-temporary impairment should be recorded in earnings. Also, this accounting standard provides additional presentation and disclosure guidance for debt and equity securities. The adoption of this accounting standard as of April 1, 2009, did not have an impact on consolidated shareholders’ equity or net income.
In June 2008, the FASB issued an accounting standard that addresses the calculation of earnings per share for entities with instruments granted in share-based payment transactions that are participating securities prior to vesting and therefore should be included in the earnings allocation in calculating earnings per share under the two-class method. This accounting standard requires entities to treat unvested share-based payment awards that have non-forfeitable rights to dividends or dividend equivalents as a separate class of securities in calculating earnings per share. Under the Company’s restricted share plan, the grantees have non-forfeitable rights to dividends before the vesting date and, accordingly, the restricted shares are participating securities. On January 1, 2009, the Company adopted the accounting standard on a retrospective basis. The adoption of this accounting standard resulted in a reduction of diluted earnings per share to common shareholders of $0.07 and $0.04 for the years ended December 31, 2008 and 2007, respectively.
In May 2008, the FASB issued an accounting standard to clarify the guidance related to convertible debt with options to settle partially or fully in cash. This accounting standard does not change the accounting for convertible debt that does not offer a cash settlement feature, nor does it apply if the conversion feature is accounted for as an embedded derivative or for convertible preferred stock. On January 1, 2009, the Company adopted the accounting standard and applied it on a retrospective basis to the Company’s convertible senior debentures issued in June 2002 (see Note 13). As of May 1, 2007, all of the convertible senior debentures had been either repurchased by the Company or converted into shares of the Company’s common stock. The adoption of this accounting standard resulted in a cumulative increase, as of May 1, 2007, to additional paid-in capital and a corresponding decrease to retained earnings of $11.5 million.
As discussed in Note 3 to the consolidated financial statements, on January 1, 2009 the Company adopted, on a retrospective basis, an accounting standard that resulted in the Company treating its unvested share-based payment awards as a separate class of securities for the purpose of calculating earnings per share. As a result of the Merger (see Note 1), Fairfax attained 100% ownership of the Company; accordingly, the Company has not presented earnings per common share for the year ended December 31, 2009. The following table shows the allocation of net income as calculated in accordance with the accounting standard for the years ended December 31, 2008 and 2007 (in thousands):
Net income per common share for the years ended December 31, 2008 and 2007 as presented in the following table has been computed based upon weighted average common shares outstanding (in thousands, except share and per share amounts):
In calculating diluted earnings per share, the Company is required to evaluate each stock option and restricted stock grant to determine if it is dilutive or anti-dilutive in nature. For the years ended December 31, 2008 and 2007, respectively, 110,537, and 31,926 existing stock options and restricted stock awards outstanding were excluded from the computation of weighted average common shares for diluted earnings per common
Net income per participating security for the years ended December 31, 2008 and 2007, as presented in the following table, has been computed based upon weighted average restricted shares outstanding (in thousands, except share and per share amounts):
Level 1: Level 1 financial instruments are financial assets and liabilities for which the values are based on unadjusted quoted prices for identical assets or liabilities in an active market that the Company has the ability to access.
Level 2: Level 2 financial instruments are financial assets and liabilities for which the values are based on quoted prices in markets that are not active, or model inputs that are observable either directly or indirectly for substantially the full term of the asset or liability. Level 2 inputs include the following:
Level 3: Level 3 financial instruments are financial assets and liabilities for which the values are based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement. These inputs reflect the Company’s own assumptions about the methodology and valuation techniques that a market participant would use in pricing the asset or liability.
A review of fair value hierarchy classifications is conducted on a quarterly basis. Changes in the observability of valuation inputs may result in a reclassification for certain financial assets or liabilities. Reclassifications impacting Level 3 of the fair value hierarchy are generally reported as transfers in or out of the Level 3 category as of the beginning of the period in which the reclassifications occur. The Company has determined, after carefully considering the impact of recent economic conditions and liquidity in the credit markets on the Company’s portfolio, that it should not re-classify any of its investments from Level 1 or Level 2 to Level 3. However, during the third quarter of 2009, the Company transferred its investment in Advent Capital (Holdings) PLC (“Advent”) from Level 2 to Level 3, following Advent’s delisting from the London Stock Exchange.
The following tables present the fair value hierarchy for those assets and liabilities measured at fair value on a recurring basis as of December 31, 2009 and 2008 (in thousands):
As of December 31, 2009, the Company has not elected the FVO for any of its liabilities.
Common stocks accounted for under the equity method of accounting were carried at $158.5 million as of December 31, 2009, reflecting gross unrealized appreciation of $34.1 million and no gross unrealized depreciation. Other invested assets were carried at $146.7 million as of December 31, 2009, reflecting no gross unrealized appreciation or depreciation. Fixed income securities held as trading securities were carried at fair value of $532.7 million as of December 31, 2009, with changes in fair value reflected as realized investment gains or losses in the consolidated statements of operations. Fixed income securities held as trading securities include corporate, foreign government and mortgage-related securities, with fair values of $363.0 million, $99.4 million and $70.3 million, respectively, as of December 31, 2009. Convertible preferred stock and short-term investments held as trading securities were carried at fair value of $82.5 million and $238.4 million, respectively, as of December 31, 2009, with changes in fair value reflected in realized investment gains or losses in the consolidated statement of operations.
Actual maturities may differ from the contractual maturities shown in the table above due to the existence of call or put options. In the case of securities containing call options, the actual maturity will be the same as the contractual maturity if the issuer elects not to exercise its call option. Total securities subject to a call option represent approximately 53.0% of the total fair value. In the case of securities containing put options, the actual maturity will be the same as the contractual maturity if the Company elects not to exercise its put option. Total securities containing the put option represent approximately 3.2% of the total fair value.
The following table sets forth the components of net realized investment gains and losses for the year ended December 31, 2009, 2008 and 2007 (in thousands):
Included in net realized investment gains for the year ended December 31, 2009, is a net decrease in fair value of $15.5 million, as compared to a net decrease for the year ended December 31, 2008 of $290.7 million and a net increase for the year ended December 31, 2007 of $259.0 million, principally related to derivatives and investments designated as trading securities.
In assessing the value of the Company’s debt and equity securities held as investments, and possible impairments of such securities, the Company reviews (i) the issuer’s current financial position and disclosures related thereto, (ii) general and specific market and industry developments, (iii) the timely payment by the issuer of its principal, interest and other obligations, (iv) the outlook and expected financial performance of the issuer, (v) current and historical valuation parameters for the issuer and similar companies, (vi) relevant forecasts, analyses and recommendations by research analysts, rating agencies and investment advisors, and (vii) other information the Company may consider relevant. Generally, a change in the market or interest rate environment would not, of itself, result in an impairment of an investment. In addition, the Company considers its ability and intent to hold the security to recovery when evaluating possible impairments.
The facts and circumstances involved in making a decision regarding an other-than-temporary-impairment are those that exist at that time. Should the facts and circumstances change such that an other-than-temporary impairment is considered appropriate, the Company will recognize the impairment, by reducing the cost, amortized cost or carrying value of the investment to its fair value, and recording the loss in its consolidated statements of operations. Upon the disposition of a security where an other-than-temporary impairment has been taken, the Company will record a gain or loss based on the adjusted cost or carrying value of the investment.
The following tables reflect the fair value and gross unrealized depreciation of the Company’s fixed income securities, preferred stocks and common stocks, at fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized depreciation position, as of December 31, 2009 and 2008 (in thousands):
The Company believes the gross unrealized depreciation is temporary in nature and we have not recorded a realized investment loss related to these securities. Given the size of our investment portfolio and capital position, the Company believes it is likely that it will not be required to sell or liquidate these securities before the fair value recovers the gross unrealized depreciation.
Common stocks, at equity, totaled $158.5 million as of December 31, 2009 and $141.5 million as of December 31, 2008. The following table sets forth the components of common stocks, at equity, as of December 31, 2009 and 2008 (in thousands):
Other invested assets totaled $146.7 million as of December 31, 2009, compared to $222.8 million as of December 31, 2008. The following table shows the components of other invested assets as of December 31, 2009 and 2008 (in thousands):
The Company’s hedge fund and private equity partnership investments may be subject to restrictions on redemptions or sales, which are determined by the governing documents thereof, and limit the Company’s ability to liquidate these investments in the short term. Due to a time lag in reporting by a majority of hedge fund and private equity fund managers, valuations for these investments are reported by OdysseyRe on a one month or one quarter lag. For the years ended December 31, 2009 and 2007, the Company recognized net investment income of $17.9 million and $8.2 million, respectively, from its hedge funds and private equity investments and incurred a loss of $19.6 million, which is netted against net investment income, for the year ended December 31, 2008. For the year ended December 31, 2009, the Company recognized a loss of $0.3 million from its private equity investments that are held as trading securities. Interest and dividend income, and realized and unrealized gains and losses of hedge funds and private equity partnerships, are included in net investment income. With respect to the Company’s $22.7 million investment in private equity partnerships included in other invested assets as of December 31, 2009, the Company has commitments that may require additional funding of up to $128.3 million. As of December 31, 2009, other invested assets include $6.7 million related to the Company’s investment in O.R.E Holdings Limited, which is net of other-than-temporary write-downs of $9.9 million.
In the normal course of effecting its economic hedging strategy with respect to credit risk and equity risk, the Company expects that there may be periods where the notional value of the hedging instrument may exceed or be less than the exposure item being hedged. This situation may arise when management compensates for imperfect correlations between the hedging item and the hedge, due to the timing of opportunities related to the Company’s ability to exit and enter hedged or hedging items at attractive prices or when management desires to only partially hedge an exposure.
The initial premium paid for each credit default swap contract is recorded as a derivative asset and is subsequently adjusted for changes in the unrealized fair value of the contract at each balance sheet date. As these contracts do not qualify for hedge accounting, changes in the unrealized fair value of the contract are recorded as net realized investment gains or losses in the Company’s consolidated statements of operations and comprehensive income. Sales of credit default swap contracts required the Company to reverse through net realized investment gains previously recorded unrealized fair value changes since the inception of the contract, and to record the actual amount based upon the final cash settlement. Derivative assets are reported gross, on a contract-by-contract basis, at fair value in other invested assets in the consolidated balance sheets. The sale, expiration or early settlement of a credit default swap will not result in a cash payment owed by the Company; rather, such an event can only result in a cash payment by a third party purchaser of the contract, or the counterparty, to the Company. Accordingly, there is no opportunity for netting of amounts owed in settlement. Cash receipts at the date of sale of the credit default swaps are recorded as cash flows from investing activities arising from net sales of assets and liabilities classified as held for trading.
The fair values of credit default swaps may be subject to significant volatility, given potential differences in the perceived risk of default of the underlying issuers, movements in credit spreads and the length of time to the contracts’ maturities. The fair value of the credit default swaps may vary dramatically either up or down in short periods, and their ultimate value may therefore only be known upon their disposition. Credit default swap transactions generally settle in cash. As the Company funds all of its obligations relating to these contracts upon initiation of the transaction, there are no requirements in these contracts for the Company to provide collateral.
The Company’s holdings of credit default swap contracts have declined significantly in 2009 relative to prior years, largely as a result of significant sales in 2008. In the latter part of 2008, the Company revised the financial objectives of its hedging program by determining not to replace its credit default swap hedge position as sales or expiries occurred, primarily based on the Company’s judgment that its exposure to elevated levels of credit risk had moderated, but also due to (i) the significant increase in the cost of purchasing credit protection (reducing the attractiveness of the credit default swap contract as a hedging instrument), (ii) improvement in the Company’s capital and liquidity (having benefited significantly from, among other things, more than $568.9 million in gains from sales of credit default swaps realized since 2007), and (iii) the Company’s judgment that managing credit risk through means other than the use of derivatives was, given the market environment, once again appropriate for mitigating the Company’s credit exposure arising from financial assets.
For the year ended December 31, 2009, the Company sold a portion of its credit default swaps, which contributed to the decrease in the fair value of the portfolio to $10.0 million as of December 31, 2009, from $82.8 million as of December 31, 2008. The credit default swap portfolio has an average term to expiration of 1.5 years as of December 31, 2009, a decrease from 2.5 years as of December 31, 2008.
The Company has entered into forward currency contracts to manage its foreign currency exchange rate risk on a macro basis. Under a forward currency contract, the Company and the counterparty are obligated to purchase or sell an underlying currency at a specified price and time. Forward currency contracts are recorded at fair value in other liabilities as of December 31, 2009 and other invested assets as of December 31, 2008, with the related changes in fair value recognized as realized investment gains or losses in the consolidated statements of operations in the period in which they occur.
The Company has investments in warrants, which are contracts that grant the holder the right, but not the obligation, to purchase an underlying financial instrument at a given price and time or at a series of prices and
The Company has entered into interest rate swaps to protect it from adverse movements in interest rates. Under its current interest rate swap contracts, the Company receives a floating interest rate and pays a fixed interest rate based on the notional amounts in the contracts. Interest rate swaps are recorded in other invested assets or other liabilities based on their positive or negative fair value with the related changes in fair value recognized as realized investment gains or losses in the consolidated statements of operations in the period in which they occur.
The Company held short positions, primarily in equity securities, all of which were closed out during the second quarter of 2008. In connection with the short positions, the Company purchased a SPDR call option as protection against a decline in the value of the short positions. The call option was closed out on July 7, 2008. The call option was recorded at fair value in other invested assets in the consolidated balance sheets, and changes in the fair value were recorded as realized investment gains or losses in the consolidated statements of operations in the period in which they occur.
Counterparties to the derivative instruments expose the Company to credit risk in the event of non-performance. The Company believes this risk is low, given the diversification among various highly rated counterparties. The credit risk exposure is reflected in the fair value of the derivative instruments.
The following table shows the components of the change in accumulated other comprehensive income, net of deferred income taxes, for the years ended December 31, 2009, 2008 and 2007 (in thousands):
The components of comprehensive income for the years ended December 31, 2009 2008 and 2007 are shown in the following table (in thousands):
The following table sets forth the activity in the liability for unpaid losses and loss adjustment expenses for the years ended December 31, 2009, 2008 and 2007 (in thousands):
Estimates of reserves for unpaid losses and loss adjustment expenses, with respect to loss events that have occurred on or before the balance sheet date, are contingent on many assumptions that may or may not occur in the future. These assumptions include loss estimates attributable to a variety of loss events, including hurricanes, windstorms and floods. The eventual outcome of these loss events may be different from the assumptions underlying the Company’s reserve estimates. When the business environment and loss trends diverge from expected trends, the Company may have to adjust its reserves accordingly, potentially resulting in adverse or favorable effects to the Company’s financial results. The Company believes that the recorded estimate represents the best estimate of unpaid losses and loss adjustment expenses based on the information available as of December 31, 2009. The estimate is reviewed on a quarterly basis and the ultimate liability may be more or less than the amounts provided, for which any adjustments will be reflected in the periods in which they become known.
The effects of exchange rate changes on net unpaid losses and loss adjustment expenses resulted in an increase of $58.8 million for the year ended December 31, 2009, a decrease of $143.2 million for the year ended December 31, 2008 and an increase of $26.6 million for the year ended December 31, 2007. The effects of exchange rate changes were attributable to changes in foreign currency exchange rates for unpaid losses and loss adjustment expenses in the London Market division.
Ceded unpaid losses and loss adjustment expenses were $841.5 million, $690.2 million and $643.5 million as of December 31, 2009, 2008 and 2007, respectively. The increase in ceded unpaid losses and loss adjustment expenses for the year ended December 31, 2009 was principally attributable to a $139.5 million increase in unpaid reinsurance recoverables related to non-catastrophe exposure, principally in the London Market division. The increase in ceded unpaid losses and loss adjustment expenses for the year ended December 31, 2008 was attributable to a $62.9 million increase in unpaid reinsurance recoverables related to property catastrophe events, principally Hurricane Ike.
The Company uses tabular reserving for workers’ compensation indemnity loss reserves, which are considered to be fixed and determinable, and discounts such reserves using an interest rate of 3.5%. Workers’ compensation indemnity loss reserves have been discounted using the Life Table for Total Population: United States, 2004. Reserves reported at the discounted value were $115.8 million and $118.2 million as of December 31, 2009 and 2008, respectively. The amount of case reserve discount was $54.3 million and $55.6 million as of December 31, 2009 and 2008, respectively. The amount of incurred but not reported reserve discount was $21.9 million and $24.0 million as of December 31, 2009 and 2008, respectively.
Estimation of ultimate asbestos and environmental liabilities is unusually complex due to several factors resulting from the long period between exposure and manifestation of these claims. This lag can complicate the identification of the sources of asbestos and environmental exposure, the verification of coverage, and the allocation of liability among insurers and reinsurers over multiple years. This lag also exposes the claim settlement process to changes in underlying laws and judicial interpretations. There continues to be substantial uncertainty regarding the ultimate number of insureds with injuries resulting from these exposures.
Company revised its loss development assumptions used in its asbestos loss reserving analyses, which had the effect of increasing the asbestos loss estimates for these calendar periods.
The Company’s survival ratio for asbestos and environmental-related liabilities as of December 31, 2009 is seven years. The Company’s underlying survival ratio for asbestos-related liabilities is eight years and for environmental-related liabilities is three years. The asbestos and environmental-related liability survival ratio represents the asbestos and environmental reserves, net of reinsurance, as of December 31, 2009, divided by the average paid asbestos and environmental claims for the last three years of $37.8 million, which are net of reinsurance. Our survival ratios may fluctuate over time due to the variability of large payments and adjustments to liabilities.
There is a credit risk with respect to reinsurance, which would result in the Company recording a charge to earnings 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 and a reserve for uncollectible reinsurance recoverables is established, based on the Company’s evaluation of each reinsurer’s or retrocessionaire’s ability to meet its obligations under the 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 for the years ended December 31, 2009, 2008 and 2007 follow (in thousands):
The total amount of reinsurance recoverable on paid and unpaid losses as of December 31, 2009 and 2008 was $912.0 million and $773.2 million, respectively. The reserve for uncollectible recoverables as of December 31, 2009 and 2008 was $41.9 million and $44.5 million, respectively, and has been netted against reinsurance recoverables on loss payments in the consolidated balance sheets. The Company has also established a reserve for potentially uncollectible assumed reinsurance balances of $5.5 million and $3.0 million as of December 31, 2009 and 2008, respectively, which has been netted against premiums receivable.
The Company’s ten largest reinsurers represent 46.0% of its total reinsurance recoverables as of December 31, 2009. Amounts due from all other reinsurers are diversified, with no other individual reinsurer representing more than $22.7 million, or 2.5%, of reinsurance recoverables as of December 31, 2009, and the average balance is less than $1.5 million. The Company held total collateral of $220.2 million as of December 31, 2009, representing 24.1% of total reinsurance recoverables. The following table shows the total amount that is recoverable from each of the Company’s ten largest reinsurers for paid and unpaid losses as of December 31, 2009, the amount of collateral held, and each reinsurer’s A.M. Best rating (in thousands):
Reinsurance recoverables were $773.2 million and collateral was $225.7 million, or 29.2% of the reinsurance recoverable balance, as of December 31, 2008.
The Company is the beneficiary of letters of credit, cash and other forms of collateral to secure certain amounts due from its reinsurers. The total amount of collateral held by the Company as of December 31, 2009 is $220.2 million, which represents 24.1% of the total amount of reinsurance recoverables, comprised of the following forms of collateral (in thousands):
On November 28, 2006, the Company completed the private sale of $40.0 million aggregate principal amount of floating rate senior debentures, series C, due December 15, 2021 (the “Series C Notes”). Interest on the Series C Notes accrues at a rate per annum equal to the three-month London Interbank Offer Rate (“LIBOR”), reset quarterly, plus 2.50%, and is payable quarterly in arrears on March 15, June 15, September 15 and December 15 of each year. The Company has the option to redeem the Series C Notes at par, plus accrued and unpaid interest, in whole or in part on any interest payment date on or after December 15, 2011. For the years ended December 31, 2009 and 2008, the average annual interest rate on the Series C Notes was 3.48% and 5.71%, respectively.
amount of the Convertible Notes held by such holder, which represented a conversion price of $21.28 per share. These conditions included the common stock of the Company trading at or above $25.54 per share for a specified period of time. Pursuant to the terms of the Indenture, the Company was permitted to satisfy the conversion obligations in stock or in cash, or in a combination thereof. The conversion conditions were first satisfied on August 9, 2006, and in accordance with the Indenture, the Convertible Notes became convertible, at the option of the holders, on August 14, 2006. As of March 31, 2007, 1.9 million shares of the Company’s common stock were issued to the Convertible Notes holders who elected to convert their Convertible Notes. In March 2007, the Company announced that it had called for the redemption of the remaining $22.5 million principal value of the outstanding Convertible Notes. At the close of business on April 30, 2007, all holders of the Convertible Notes had exercised their rights of conversion with respect to the Convertible Notes. Accordingly, on May 1, 2007, the Company issued 1,056,107 shares of its common stock related to the final conversion of $22.5 million principal value of the Convertible Notes, and no Convertible Notes remained outstanding as of such date.
As of December 31, 2009, the aggregate maturities of the Company’s debt obligations, at face value, were as follows (in thousands):
As of December 31, 2009 and 2008, the amortized cost of the Company’s debt obligations was $489.4 million and $489.3 million respectively, as reflected in the respective consolidated balance sheets. As of December 31, 2009 and 2008, the estimated fair value of the Company’s debt obligations was $503.6 million and $407.0 million, respectively. The estimated fair value is based on quoted market prices of the Company’s debt, where available, and for debt similar to the Company’s, and discounted cash flow calculations.
On July 13, 2007, the Company entered into a $200.0 million credit facility (the “Credit Agreement”) with Wachovia Bank National Association (“Wachovia”), KeyBank National Association and a syndicate of lenders. The original Credit Agreement provided for a five-year credit facility of $200.0 million, $100.0 million of which was available for direct, unsecured borrowings by the Company, and all of which was available for the issuance of secured letters of credit to support the Company’s insurance and reinsurance business. As of June 17, 2009, the Credit Agreement was amended to explicitly permit the Company to pledge collateral to secure its obligations under swap agreements, subject to certain financial limitations, in the event that such collateral is required by the counterparty or counterparties. As of February 24, 2010, the Credit Agreement was amended (i) to reduce the size of the facility to $100.0 million, removing the unsecured $100.0 million tranche, (ii) to remove the previous limitation on dividends and other “restricted payments” that the Company may pay to its shareholders and (iii) amend certain of the covenants and default provisions, the minimum ratings requirement, and the pricing of the credit facility.
In December 2008, the Company entered into interest rate swaps, with an aggregate notional value of $140.0 million, to protect it from adverse movements in interest rates. Under these swap contracts, the Company receives a floating interest rate of three-month LIBOR and pays a fixed interest rate of 2.49% on the $140.0 million notional value of the contracts, for a five-year period ending in December 2013.
The Company’s Board of Directors authorized a share repurchase program whereby the Company was authorized to repurchase shares of its common stock on the open market from time to time through December 31, 2009, up to an aggregate repurchase price of $600.0 million. Shares repurchased under the program were retired. During the year ended December 31, 2009, the Company repurchased and retired 1,789,100 shares of its common stock, at a cost of $72.6 million, an average repurchase price of $40.56 per share. From the inception of the program through October 21, 2009, the Company repurchased and retired 13,906,845 shares of its common stock at a total cost of $518.4 million.
In each of the first three quarters of 2009, the Company paid a dividend of $0.075 per common share, resulting in an aggregate annual dividend of $0.225 per common share, totaling $13.4 million. The dividends were paid on March 31, 2009, June 30, 2009 and September 30, 2009. No common stock dividend was declared or paid during the fourth quarter of 2009. On March 28, 2008 and June 27, 2008, the Company paid dividends of $0.0625 per common share, and on September 26, 2008 and December 30, 2008, the Company paid dividends of $0.075 per common share. These common share dividends resulted in an aggregate annual dividend of $0.275 per common share in 2008, totaling $17.4 million.
The Company’s 8.125% Series A preferred shares (2.0 million shares outstanding) have a liquidation preference of $25.00 per share and are redeemable at $25.00 per share at the Company’s option, in whole, or in part from time to time, starting on or after October 20, 2010. Dividends on the Company’s floating rate Series B preferred shares (1.2 million shares outstanding) are payable at an annual rate equal to 3.25% above the three-month LIBOR on the applicable quarterly determination date. The Series B preferred shares have a liquidation preference of $25.00 per share and are redeemable at the Company’s option, in whole or in part from time to time, at the redemption prices below (in thousands, except per share amounts):
Dividends on each series of preferred shares are deferrable on a non-cumulative basis, provided that no dividends or other distributions have been declared or paid or set apart for payment on any other class or series of the Company’s capital shares ranking junior to or equal with the preferred shares. Dividends on Series A and Series B preferred shares will each be payable when, as and if declared by the Company’s Board of Directors, quarterly in arrears on the 20th day of January, April, July, and October of each year. Deferred dividends on either series will not accrue interest prior to the date of redemption. On December 16, 2009, the Company’s Board of Directors declared quarterly dividends of $0.5078125 per share on the Company’s 8.125% Series A
preferred shares and $0.2208788 per share on the Company’s floating rate Series B preferred shares. The total dividends of $1.5 million were paid on January 20, 2010 to Series A and Series B preferred shareholders of record on December 31, 2009.
As of December 31, 2009, a subsidiary of Fairfax owned 253,599 shares and 70,000 shares of the Company’s Series A and Series B preferred stock, respectively.
The Company’s operations are managed through four operating divisions: Americas, EuroAsia, London Market and U.S. Insurance. The Americas division is comprised of the Company’s reinsurance operations in the United States, Canada and Latin America, and writes property and casualty reinsurance business on a treaty and facultative basis. The EuroAsia division writes treaty reinsurance business. The London Market division operates through three distribution channels: Newline Syndicate (1218) at Lloyd’s and NICL, which focus on casualty insurance, and the London branch of Odyssey America, which focuses on worldwide property and casualty reinsurance. The U.S. Insurance division writes specialty insurance lines and classes of business, such as medical professional liability, professional liability, crop and commercial automobile.
The following table reconciles federal and foreign income taxes at the statutory federal income tax rate to the Company’s tax provision and effective tax rate for the years ended December 31, 2009, 2008 and 2007 (in thousands):
During the third quarter of 2006, Fairfax reduced its ownership of the Company to below 80%, and as a result, the Company was deconsolidated from the United States tax group of Fairfax. Accordingly, the Company filed or will file separate company tax returns for the period August 2, 2006 to October 20, 2009. As a result of the Merger (see Note 1), effective October 21, 2009, the Company rejoined the United States tax group of Fairfax. The Merger had no effect on the Company’s tax position. The Company has elected to recognize accrued interest and penalties associated with uncertain tax positions as part of the income tax provision. As of December 31, 2009 and 2008, the Company has not recorded any interest or penalties. The Company paid federal and foreign income taxes of $355.9 million, $348.4 million and $224.6 million for the years ended December 31, 2009, 2008 and 2007, respectively. As of December 31, 2009, the Company had a current tax payable of $31.5 million, which reflects $21.1 million payable to Fairfax and a net payable of $10.4 million to the U.S. federal government and various foreign governments. As of December 31, 2008, the Company had a current tax payable of $238.1 million, which reflects $9.3 million payable to Fairfax and a net payable of $228.8 million to the U.S. federal government and various foreign governments. The federal income tax provision is allocated to each of the Company’s subsidiaries in the consolidated group pursuant to a written agreement, on the basis of each subsidiary’s separate taxable income.
In July 2006, Fairfax, the Company’s then-majority (now 100%) shareholder, filed a lawsuit in the Superior Court, Morris County, New Jersey, seeking damages from a number of defendants who, the complaint alleges, participated in a stock market manipulation scheme involving Fairfax shares, and the complaint was subsequently amended to add additional allegations and two defendants. In January 2008, two of these defendants filed a counterclaim against Fairfax and a third-party complaint against, among others, OdysseyRe
On September 7, 2005, the Company announced that it had been advised by Fairfax, the Company’s then-majority (now 100%) shareholder, that Fairfax had received a subpoena from the SEC requesting documents regarding any nontraditional insurance and reinsurance transactions entered into or offered by Fairfax and any of its affiliates, which included OdysseyRe. On June 25, 2009, the Company announced that Fairfax had been informed by the New York Regional Office of the SEC that its investigation as to Fairfax had been completed, and that it did not intend to recommend any enforcement action by the SEC.
The Company participates in Lloyd’s through its 100% ownership of Newline Syndicate (1218), for which the Company provides 100% of the capacity. The results of Newline Syndicate (1218) are consolidated in the financial statements of the Company. In support of Newline Syndicate (1218)’s capacity at Lloyd’s, NCNL and Odyssey America have pledged securities and cash with a fair value of $139.1 million and $123.5 million, respectively, as of December 31, 2009 in a deposit trust account in favor of the Society and Council of Lloyd’s. These securities may be substituted with other securities at the discretion of the Company, subject to approval by Lloyd’s. The securities are carried at fair value and are included in investments and cash in the Company’s consolidated balance sheets. Interest earned on the securities is included in investment income. The pledge of assets in support of Newline Syndicate (1218) provides the Company with the ability to participate in writing business through Lloyd’s, which remains an important part of the Company’s business. The pledged assets effectively secure the contingent obligations of Newline Syndicate (1218) should it not meet its obligations. NCNL and Odyssey America’s contingent liability to the Society and Council of Lloyd’s is limited to the aggregate amount of the pledged assets. The Company has the ability to remove funds at Lloyd’s annually, subject to certain minimum amounts required to support outstanding liabilities as determined under risk-based capital models and approved by Lloyd’s. The funds used to support outstanding liabilities are adjusted annually and the obligations of the Company to support these liabilities will continue until they are settled or the liabilities are reinsured by a third party approved by Lloyd’s. The Company expects to continue to actively operate Newline Syndicate (1218) and support its requirements at Lloyd’s. The Company believes that Newline Syndicate (1218) maintains sufficient liquidity and financial resources to support its ultimate liabilities and the Company does not anticipate that the pledged assets will be utilized.
The Company 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 India. On January 29, 2004, ORE was capitalized by the Company 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 purchase by ORE of 45% of the 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. The joint venture agreement governing CEPL contains a provision whereby Odyssey America could have been called upon to provide a guarantee of a credit facility, if such a facility had been established by CEPL, in an amount up to $65.0 million for the funding of proposed developments. The credit facility was never established, and the requisite conditions for any future provision of the guarantee no longer exist. ORE’s Indian joint venture partner claimed that the guarantee should be available and pursued legal actions against the Company. The Company found this claim without merit and vigorously defended the legal actions. On August 13, 2008, the Company Law Board in Chennai, India ruled in ORE’s favor and directed CEPL to return to ORE the full amount of its investment in CEPL, plus 8% interest, within the one-year period commencing November 1, 2008. As of December 31, 2009, the Company had written down the value of its investment in ORE by $9.9 million. The carrying value of the Company’s investment in ORE as of both December 31, 2009 and 2008 was $6.7 million. Because no payment of the award has yet been received and collection may require additional legal action on the part of ORE, the Company has taken no steps to reverse the write-downs that have been taken to date. The Company continues to vigorously pursue collection of the award.
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, 2009, 2008 and 2007 (in thousands):
The statutory provision for potentially uncollectible reinsurance recoverables due from unauthorized companies is reduced to the extent collateral is held. Pursuant to indemnification agreements between the Company and Clearwater, and between the Company and Hudson, the Company previously provided a $20.5 million letter of credit to Clearwater and a $0.5 million letter of credit to Hudson as of December 31, 2008, which were used as collateral for balances due from unauthorized reinsurers in regard to the indemnification agreements. The use of such collateral provided by the Company is a permitted accounting practice approved by the Insurance Department of the State of Delaware, the domiciliary state of Clearwater and Hudson. Effective January 15, 2010, the letters of credit were cancelled at the request of Clearwater and Hudson, and the
The Company has entered into various reinsurance arrangements with Fairfax and its affiliates. The approximate amounts included in or deducted from income, expense, assets and liabilities in the accompanying consolidated financial statements, with respect to reinsurance assumed and ceded from and to affiliates, as of and for the years ended December 31, 2009, 2008 and 2007 follow (in thousands):
any excess amounts carried into the following year. These agreements may be terminated by either party on 30 days’ notice. For the years ended December 31, 2009, 2008 and 2007, total fees, including incentive fees, of $28.8 million, $21.4 million and $17.3 million, respectively, are included in the consolidated statements of operations.
The Company measures the assets and liabilities of its employee benefit plans as of the date of the Company’s financial statements, as required by GAAP. During 2008, the measurement date for the Company’s defined benefit pension plan and the supplemental employee retirement plan (the “Supplemental Plan”) were changed from October 1 to December 31. The Company elected to apply the “fifteen-month” approach to these two benefit plans to measure plan assets and liabilities from the plans’ previous measurement date of October 1, 2007, for a fifteen-month period through December 31, 2008. As of January 1, 2008, the net periodic benefit costs of $1.8 million ($1.2 million, after tax) and the change in the minimum benefit plan liabilities of $0.2 million ($0.1 million, after tax) for the period October 1 through December 31, 2007 related to the defined benefit pension plan and Supplemental Plan have been reflected as a direct charge to retained earnings and an increase to accumulated other comprehensive income, respectively.
The Company’s Level 3 Plan assets are valued by a third party by using valuation techniques that include unobservable inputs. To verify Level 3 pricing, the Company’s investment manager assesses the reasonableness of the fair values by comparing them to the market’s overall performance. During the year ended December 31, 2009, the Company purchased $6.0 million of investments that are classified as Level 3, which had a fair value of $6.6 million as of December 31, 2009.
The net amount recognized in the consolidated balance sheets related to the accrued pension cost of $9.5 million and $12.0 million, as of December 31, 2009 and 2008, respectively, is included in other liabilities. The net amount of accumulated other comprehensive loss recognized is $0.3 million and $5.5 million, before taxes, as of December 31, 2009 and 2008, respectively.
The weighted average assumptions used to calculate the net periodic benefit cost for the years ended December 31, 2009, 2008 and 2007 are as follows:
The Company estimates that it will record a $6.4 million expense related to the net periodic benefit cost during the year ended December 31, 2010. The Company does not expect any refunds of Plan assets during the year ended December 31, 2010.
The Company maintains two non-qualified excess benefit plans (“Excess Plans”) that provide more highly compensated officers and employees with defined retirement benefits in excess of qualified plan limits imposed by federal tax law. The following tables set forth the combined amounts recognized for the Excess Plans in the Company’s consolidated financial statements as of December 31, 2009 and 2008 (in thousands):
The discount rate represents the Company’s estimate of the interest rate at which the Excess Plans’ benefits could be effectively settled. The discount rates are used in the measurement of the expected and accumulated post retirement benefit obligations and the service and interest cost components of net periodic post retirement benefit cost.
A trust fund, which was established related to the Excess Plans, is included in other invested assets, and had a fair value of $3.8 million and $5.6 million as of December 31, 2009 and 2008, respectively. During 2009, the trust fund reallocated its invested assets from U.S. government securities to money market accounts. Plan benefits are paid by the Company as they are incurred by the participants, accordingly, there are no assets held directly by the Excess Plans.
The Company expects to contribute $1.1 million to the Excess Plans during the year ended December 31, 2010, which represents the amount necessary to fund the 2010 expected benefit payments.
The Company provides certain health care and life insurance (“postretirement”) benefits for retired employees. Substantially all employees may become eligible for these benefits if they reach retirement age while working for the Company. The Company’s cost for providing postretirement benefits other than pensions is accounted for in accordance with ASC 715, “Compensation - Retirement Benefits.” The following tables set forth the amounts recognized for the postretirement benefit plan, which has a measurement date of December 31, in the Company’s consolidated financial statements as of December 31, 2009 and 2008 (in thousands):
The net amount recognized in the consolidated balance sheets related to the accrued benefit cost of $24.5 million and $14.2 million, as of December 31, 2009 and 2008, respectively, is included in other liabilities. The net amount of accumulated other comprehensive loss, before taxes, recognized is $5.7 million as of December 31, 2009 and accumulated other comprehensive income, before taxes, of $2.3 million as of December 31, 2008.
The weighted average assumptions used to calculate the benefit obligation as of December 31, 2009 and 2008 are as follows:
The discount rate represents the Company’s estimate of the interest rate at which the postretirement benefit plan benefits could be effectively settled. The discount rates are used in the measurement of the expected and accumulated post retirement benefit obligations and the service and interest cost components of net periodic post retirement benefit cost.
The accumulated benefit obligation for the postretirement plan was $24.5 million and $14.2 million as of December 31, 2009 and 2008, respectively.
The Company estimates that it will record $4.6 million in benefit costs relating to this plan during the year ended December 31, 2010.
In connection with the Merger, each unvested restricted share under the Restricted Share Plan (a “Restricted Share”) was cancelled and converted into a right to acquire $65.00 in cash, without interest (a “Restricted Cash Unit”), subject to the same vesting, transfer and other restrictions that applied to the Restricted Shares. Following the amendment and restatement of the REVR Plan, certain holders of Restricted Cash Units elected to convert each of their Restricted Cash Units into 1.2524 REVRs, which REVRs are subject to the same vesting, transfer and other restrictions that applied to the Restricted Cash Units.
In 2001, the Company established the Employee Share Purchase Plan (the “ESPP”). Under the terms of the ESPP, eligible employees were given the election to purchase Company common shares in an amount up to 10% of their annual base salary. The Company issued, or purchased on the employee’s behalf, a number of the Company’s common shares equal in value to 30% of the employee’s contribution. In the event that the Company achieved a return on equity of at least 15% in any calendar year, additional shares were issued, or purchased by the Company for the employee’s benefit, in an amount equal in value to 20% of the employee’s contribution during that year. As a result of the Merger (see Note 1), the Company suspended issuances, purchases and contributions made for the ESPP. During the years ended December 31, 2009, 2008 and 2007, the Company purchased 58,699 shares, 75,757 shares and 68,542 shares, respectively, on behalf of employees pursuant to the ESPP, at average purchase prices of $43.23, $38.46 and $38.67, respectively. The compensation expense recognized by the Company for purchases of the Company’s common shares under the ESPP was $0.8 million for the year ended December 31, 2009 and $0.9 million for each of the years ended December 31, 2008 and 2007.
For the years ended December 31, 2009, 2008 and 2007, the Company received $0.9 million, $3.6 million and $2.5 million, respectively, in cash from employees for the exercise of stock options. For the years ended December 31, 2009, 2008 and 2007, the Company recognized an expense related to all stock-based compensation of $11.9 million, $9.5 million and $6.7 million, respectively. The total tax benefits recognized for the years ended December 31, 2009, 2008 and 2007 were $4.2 million, $3.3 million and $2.3 million, respectively.
The following tables summarize the activity for the Stock-Based Compensation Plans for the year ended December 31, 2009:
The Company previously underwrote assumed financial guaranty reinsurance. The maximum exposure to loss related to this business, in the event of nonperformance by the underlying insured and assuming that the
underlying collateral proved to be of no value, was $9.7 million and $10.0 million as of December 31, 2009 and 2008, respectively. It is the responsibility of the ceding insurer to collect and maintain collateral under financial guaranty reinsurance. The Company ceased writing financial guaranty business in 1992.
As of December 31, 2009, financial guaranty reinsurance in force had a remaining maturity term of one (1) to 19 years. The approximate distribution of the estimated debt service (principal and interest) of bonds, by type, for the years ended December 31, 2009 and 2008 is as follows (in thousands):
Due to changes in the number of weighted average common shares outstanding during 2009 and 2008, the sum of quarterly earnings per common share amounts will not equal the total for the year. As a result of the Merger (see Note 1), the Company has not presented net income per share for the quarter and year ended December 31, 2009.