Platinum Holdings and Platinum Bermuda lease office space in Pembroke, Bermuda, where our principal executive office is located. Platinum US and all other U.S.-based subsidiaries are located in office space we lease in New York. Platinum US also leases office space in Chicago. Platinum UK leases office space in London. We renew and enter into new leases in the ordinary course of business and anticipate no difficulty in extending our leases or obtaining comparable office facilities in suitable locations. We consider our facilities to be adequate for our current needs.
The following table sets forth certain of our selected financial data as of and for the years ended December 31, 2008, 2007, 2006, 2005 and 2004. Our data as of December 31, 2008 and 2007, and for the years ended December 31, 2008, 2007 and 2006 were derived from our consolidated financial statements beginning on page of this Form 10-K. Our data as of December 31, 2006, 2005 and 2004, and for the years ended December 31, 2005 and 2004 were derived from our audited consolidated financial statements not included in this Form 10-K. You should read the selected financial data in conjunction with our consolidated financial statements as of December 31, 2008 and 2007 and for each of the three years in the period ended December 31, 2008 beginning on page of this Form 10-K, and the related “Management's Discussion and Analysis of Financial Condition and Results of Operations” beginning on page 27 of this Form 10-K.
Platinum Holdings was organized in 2002 as a Bermuda holding company and had $2,059,397,000 in capital as of December 31, 2008. We operate through our two licensed reinsurance subsidiaries, Platinum Bermuda and Platinum US. We provide property and marine, casualty and finite risk reinsurance coverages, through reinsurance intermediaries, to a diverse clientele of insurers and select reinsurers on a worldwide basis.
We completed our initial public offering of 33,044,000 common shares in November 2002. Concurrent with our initial public offering, we sold 6,000,000 common shares to St. Paul, and 3,960,000 common shares to RenaissanceRe in private placements. St. Paul sold its 6,000,000 common shares in June 2004 and RenaissanceRe sold its 3,960,000 common shares in December 2005, in each case in public offerings. As part of the private placements, St. Paul and RenaissanceRe received options to purchase up to 6,000,000 and 2,500,000 of additional common shares, respectively, at any time during the ten years following the initial public offering at a price of $27.00 per share. Both of these options were subsequently amended to provide that in lieu of paying $27.00 per share, any option exercise will be settled on a net share basis, which will result in our issuance of a number of common shares equal to the excess of the market price per share, determined in accordance with the amendments, over $27.00, less the par value per share, multiplied by the number of common shares issuable upon exercise of the option divided by that market price per share. Neither St. Paul nor RenaissanceRe has exercised its option. In November 2002, we entered into several agreements with St. Paul for the transfer of continuing reinsurance business and certain related assets of St. Paul. Among these agreements were the Quota Share Retrocession Agreements under which we assumed from St. Paul unpaid losses and LAE, unearned premiums and certain other liabilities on reinsurance contracts becoming effective in 2002 underwritten by St. Paul Re. In November 2002, we entered into a five-year Services and Capacity Reservation Agreement with RenaissanceRe, pursuant to which RenaissanceRe provided consulting services to us in connection with our property catastrophe book of business (the “RenRe Agreement”). The RenRe Agreement provided that, up to two times per year, RenaissanceRe would analyze our property catastrophe treaties and contracts and assist us in measuring risk and managing our aggregate catastrophe exposures. The RenRe Agreement expired in September 2007.
The reinsurance industry historically has been cyclical, characterized by periods of price competition due to excessive underwriting capacity as well as periods of favorable pricing due to shortages of underwriting capacity. Cyclical trends in the industry and the industry's profitability can also be significantly affected by volatile developments, including natural and other catastrophes. Property and casualty reinsurance rates often rise in the aftermath of significant catastrophe losses. To the extent that actual claim liabilities are higher than anticipated, the industry's capacity to write new business diminishes. The reinsurance industry is also affected by changes in the propensity of courts to expand insurance coverage and grant large liability awards, as well as fluctuations in interest rates, inflation and other changes in the economic environment that affect the fair values of investments.
In 2005 an unprecedented level of hurricane losses caused many reinsurers to report significant net losses after which rating agencies imposed higher capital requirements. Both reinsurers and their clients reassessed their catastrophe pricing parameters and procedures. The result was an increase in catastrophe pricing, particularly for wind exposures in the United States, in 2006 and the beginning of 2007. A number of new companies were formed to take advantage of the improved pricing. The combination of additional capacity and a lack of major catastrophe activity in 2006 and 2007 led to a decline in pricing for catastrophe exposed reinsurance in the second half of 2007. After initially stabilizing, the weakening of non-catastrophe pricing resumed in late 2006 and continued throughout 2007. The pricing of reinsurance continued to decline in the first half of 2008. However, during the second half of 2008, the financial markets experienced significant adverse credit events and a loss of liquidity, which reduced the amount of capital in the insurance industry. In addition, the 2008 hurricane season resulted in substantial losses to the insurance and reinsurance industry.
In the Finite Risk segment, we expect the relatively low level of demand will continue for the foreseeable future.
Assumed reinsurance premiums are recognized as revenues, net of any related ceded retrocessional coverage purchased. Both assumed and ceded premiums are recognized as earned and included in revenues generally on a basis proportionate with the coverage period. Assumed premiums written not yet recognized as revenue are recorded on the consolidated balance sheet as unearned premiums; ceded premiums written not yet earned are recorded on the consolidated balance sheet as prepaid reinsurance premiums.
The following table sets forth our estimated and reported premiums receivable as of December 31, 2008 and 2007 ($ in thousands):
We do not establish liabilities until the occurrence of an event that may give rise to a loss. When an event of sufficient magnitude occurs, such as a property catastrophe event that affects many ceding insurance companies, we may establish IBNR specific to such an event. If an event has occurred but has not resulted in reported losses, our actuaries will generally estimate the impact of the event and take it into consideration when estimating our liability for unpaid losses and LAE, including potentially separate evaluation as a large or catastrophic loss. Estimated ultimate loss related to a catastrophic event may be based on our estimated exposure to an industry loss and may rely on the use of catastrophe modeling software. This process may or may not differ for loss events that have been reported to us.
We receive information from ceding companies regarding our liability for unpaid losses and LAE. This information varies but typically includes information regarding paid losses and case reserves and may include a ceding company’s estimate of IBNR. We may increase or decrease case reserves based on receipt of additional information, including information received from ceding companies. An increase or decrease of reported case reserves is generally referred to as “additional case reserves”.
Over time, as a greater number of claims are reported, actuarial estimates of IBNR are based on the Bornhuetter-Ferguson and the chain ladder techniques. The Bornhuetter-Ferguson technique utilizes actual reported losses and expected patterns of reported losses, taking the initial expected ultimate losses into account to determine an estimate of expected ultimate losses. This technique is most appropriate when there are few reported claims and a relatively less stable pattern of reported losses. The chain ladder technique utilizes actual reported losses and expected patterns of reported losses to determine an estimate of expected ultimate losses that is independent of the initial expected ultimate losses. This technique is most appropriate when there are a large number of reported losses with significant statistical credibility and a relatively stable pattern of reported losses. The determination of when reported losses are sufficient and credible to warrant deviating from initial expected loss ratios also requires judgment. We generally make adjustments for reported loss experience indicating unfavorable variances from initial expected loss ratios sooner than reported loss experience indicating favorable variances. This is because the reporting of losses in excess of expectations tends to have greater credibility than an absence or lower than expected level of reported claims.
In property lines the expected patterns of reported losses are based on historical reported loss data. The only significant exception is the Florida pro rata business in 2004 and 2005. For the 2004 and 2005 Florida pro rata business a separate pattern was derived from ceding company data. For all lines, historical data by effective date and business type is used to determine patterns that reflect each year’s reinsurance contract inception date distribution and the distribution of underlying business written on a losses occurring versus on a risk attaching basis. In marine lines the expected patterns of reported losses are primarily based on historical reported loss data. Reported loss patterns are analyzed for various groups of reinsurance classes and an overall pattern is determined by the mix of business within each Underwriting Year.
In finite casualty expected patterns of reported losses for the largest contracts are based on ceding company data. We use appropriate patterns from our data or the RAA for other contracts when ceding company data is unavailable.
Our underwriters will typically prepare an initial estimate of our ultimate losses for a catastrophe event on a contract-by-contract basis. This estimate is typically based on estimates of losses for the insurance industry as a whole, estimates of losses prepared by ceding companies, estimates of market share of our ceding companies and, in certain cases, output from catastrophe models. Information is typically updated as it becomes available. Our actuaries and underwriters will also consider a variety of factors, including: (1) the credibility of ceding company estimates, (2) whether the ceding company estimates include IBNR, and (3) whether the ceding company information is current. After reviewing loss estimates and other information with our underwriters, our actuaries make an estimate of ultimate loss.
As losses from catastrophes mature, our actuaries consider losses reported to us relative to loss development patterns from prior catastrophe events. Our estimate of ultimate liability for losses and LAE related to a catastrophe event will generally be based on these development patterns after approximately twelve months following the event. However, since loss development patterns may be inconsistent between events, for the very large catastrophes, such as Hurricane Katrina in 2005, we will generally review information on a contract-by-contract basis for a longer period. Ultimate losses for a catastrophe event are typically reasonably well known within 12 to 24 months following the event, although ultimate losses from an earthquake may take longer to develop.
We have established specific reserves for the following 2008 major catastrophes: European storm Emma, Hurricane Gustav, Hurricane Ike and two other U.S. catastrophic events referred to by Property Claim Services (“PCS”) as Catastrophe 42 and 43. PCS is a division of ISO.
Our assumptions regarding the initial expected loss ratio and the estimated pattern of reported losses significantly affect our loss estimates. Loss estimates for the North American casualty excess of loss classes of business, which generally have the longest pattern of reported losses and a higher degree of uncertainty than our other classes of business have a higher degree of uncertainty than other reserving classes. IBNR for these classes as of December 31, 2008 was $1,094,136,000, which was 63% of the total IBNR at that date. Because estimates of unpaid losses and LAE related to North American casualty excess business have a higher degree of uncertainty, we would not consider a variance of five percentage points from the initial expected loss ratio to be unusual. If we increased the initial expected loss ratio for these classes, for example, from 68% to 73%, we would increase the IBNR for these classes by $65,214,000 which represents approximately 4.6% of unpaid losses and LAE for these classes as of December 31, 2008. If we accelerated the estimated pattern of reported losses by 5%, as another example, we would decrease the IBNR for these classes by $4,331,000, which is less than 1% of unpaid losses and LAE for these classes as of December 31, 2008. We have selected these two inputs as examples of sensitivity analyses because we believe that the two most important inputs to the loss estimation methodologies described above are the initial expected loss ratio and the estimated pattern of reported losses.
Net income and diluted earnings per common share for the years ended December 31, 2008 and 2007 was as follows (amounts in thousands, except earnings per share):
Net underwriting income for the years ended December 31, 2008 and 2007 was $90,104,000 and $222,959,000, respectively. The decrease in net underwriting income was primarily due to an increase in major catastrophes in 2008 as compared with 2007. Net premiums written decreased in 2008 as compared with 2007 primarily due to decreases in premiums written across most classes in the Casualty segment, partially offset by an increase in premiums written in the Property and Marine segment. Net favorable development is the development of prior years’ unpaid losses and LAE and the related impact on premiums and commissions. Net favorable development was $147,630,000 and $77,806,000 in 2008 and 2007, respectively.
The increases in net losses and LAE and the related ratios in 2008 as compared with 2007 were due to an increase in major catastrophe losses, partially offset by an increase in net favorable loss development. We had net losses from major catastrophes of $224,889,000 in 2008 and $44,585,000 in 2007. The net losses from major catastrophes, with related premium adjustments, increased the net loss and LAE ratio in 2008 and 2007 by 36.1 points and 8.5 points, respectively. Net losses and LAE and the resulting net loss and LAE ratios were also impacted by net favorable loss development of $71,220,000 in 2008 as compared with $48,508,000 in 2007. Net favorable loss development in 2008 included $21,211,000 related to prior years’ major catastrophes, primarily hurricane losses. Net favorable loss development and premium adjustments related to prior years’ losses decreased the net loss and LAE ratios in 2008 and 2007 by 13.4 and 9.6 points, respectively. Exclusive of losses related to major catastrophes and net favorable loss development, the net loss and LAE ratio increased by approximately 3.4 points in 2008 as compared with 2007 primarily due to an increase in crop quota share business that has a higher expected loss ratio in 2008 than in 2007 as well as a higher loss ratio than the remainder of the segment. The net loss and LAE ratios were also affected by other changes in the mix of business.
The increase in net acquisition expenses in 2008 as compared with 2007 was primarily due to an increase in net premiums earned. The increase in the net acquisition expense ratio in 2008 as compared with 2007 was due in part to higher commission rates in the crop and marine classes in the 2008 underwriting year as compared with 2007 as well as changes in the mix of business. Net acquisition expenses and the related net acquisition expense ratio were also affected by commissions related to prior years. Net increases in commissions related to prior years were $5,079,000 and $1,677,000 in 2008 and 2007, respectively.
The decreases in net losses and LAE and the related ratios in 2008 as compared with 2007 were primarily due to a decrease in net premiums earned and an increase in net favorable loss development. Net favorable loss development was $73,242,000 in 2008 and $19,474,000 in 2007. Net favorable loss development in 2008 included $58,406,000 from certain long-tailed casualty classes. Net favorable loss development and premium adjustments related to prior years’ losses decreased the net loss and LAE ratios in 2008 and 2007 by 14.7 and 3.1 points, respectively. Additionally, the net loss and LAE ratio increased in 2008 as compared with 2007 due to $35,764,000 of losses in 2008 related to a reinsurance contract covering leased private passenger automobile residual values. Exclusive of net favorable loss development and the residual value reinsurance contract, the net loss and LAE ratio increased in 2008 as compared with 2007 due to higher initial expected loss ratios in certain significant classes reflecting a decline in price adequacy. The net loss and LAE ratios were also affected by changes in the mix of business.
The Finite Risk portfolio consists of a small number of contracts that can be large in premium size and, consequently, overall premium volume may vary significantly from year to year. The decreases in net premiums written and net premiums earned in 2008 as compared with 2007 reflect the continuing reduction in the demand for finite business.
Net realized investment gains (losses) were $26,568,000 and ($1,222,000) in 2008 and 2007, respectively, and were comprised as follows ($ in thousands):
Interest expense for the years ended December 31, 2008 and 2007 was $19,006,000 and $21,470,000, respectively, and was primarily related to our $250,000,000 of Series B 7.5% Notes due June 1, 2017 (the "Series B Notes"). The decrease in interest expense was the result of a reduction in our debt obligations outstanding in 2008 as compared with 2007. Interest expense for 2007 also included interest related to $42,840,000 of Series B 6.371% Senior Guaranteed Notes due November 16, 2007 (the "Senior Notes"). Platinum Finance repaid the $42,840,000 of Senior Notes when they came due in November 2007.
The decrease in income tax expense in 2008 as compared with 2007 was due to the decrease in taxable income generated by our subsidiaries that operate in taxable jurisdictions. The decrease in the effective tax rate was the result of a greater portion of income before income tax expense being generated by Platinum Holdings and Platinum Bermuda, which are not subject to corporate income tax, in 2008 as compared with 2007. In 2008, the percentage of income before income tax expense derived from Platinum Holdings and Platinum Bermuda was 84.4% as compared with 79.8% in 2007. The effective tax rate in any given period is based on income before income tax expense of our subsidiaries that operate in various taxable jurisdictions, each of which has its own corporate income tax rate.
Year Ended December 31, 2007 as Compared with the Year Ended December 31, 2006
Net income and diluted earnings per common share for the years ended December 31, 2007 and 2006 was as follows (amounts in thousands, except earnings per share):
The increase in net income in 2007 as compared to 2006 was primarily due to an increase in net investment income of $26,235,000, a decrease in income tax expense of $6,342,000 and an increase in net underwriting income of $4,079,000. Diluted earnings per common share increased due to the increase in net income.
Other underwriting expenses for the years ended December 31, 2007 and 2006 were $42,422,000 and $39,887,000, respectively. The increase in 2007 as compared with 2006 was due, in part, to increased property underwriting activity in Bermuda and a corresponding increase in its staff. The additions to staff in Bermuda were made during 2006. The increase in 2007 as compared with 2006 was due, in part, to increased incentive-based compensation and costs associated with an employee retention plan. Other underwriting expenses in 2007 and 2006 also included fees of $7,787,000 and $7,829,000, respectively, relating to the RenRe Agreement. The RenRe Agreement expired on September 30, 2007 and was not renewed.
The decrease in net acquisition expenses in 2007 as compared with 2006 was due to the decrease in net premiums earned. The decrease in the net acquisition expense ratio in 2007 as compared with 2006 was due to decreases in the North American umbrella and first dollar general liability classes, both of which had higher acquisition expense ratios than the remainder of the casualty segment. Net acquisition expenses included decreases in estimated commissions related to prior years of $4,912,000 in 2007, representing 0.8% of net premiums earned, as compared with decreases of $318,000 in 2006.
The increase in net premiums written in 2007 as compared with 2006 was primarily attributable to the termination of a significant finite casualty proportional contract effective January 1, 2006 on a cut-off basis, which resulted in the return of previously written but unearned premium, reducing net premiums written in 2006 by $56,589,000. The decrease in net premiums earned reflects the reduction in our finite business in 2007 and 2006.
Other expense for the years ended December 31, 2007 and 2006 was $2,173,000 and $651,000, respectively. Other expense in 2007 included $468,000 of net expense on reinsurance contracts accounted for as deposits. Other expense in 2006 included $706,000 of net expense on reinsurance contracts accounted for as deposits.
As part of our investment strategy, we seek to establish a level of cash and liquid short-term and intermediate-term securities which, combined with expected cash flow from our subsidiaries, we believe to be adequate to meet our foreseeable payment obligations. Our reinsurance subsidiaries have liquidity from premiums, which are generally received in advance of the time losses are paid. The period of time from the occurrence of a claim through the settlement of the liability may extend many years into the future. However, due to the nature of our reinsurance operations, cash flows are affected by claim payments that can fluctuate from year to year. We believe that our liquid investments and operating cash flow will provide us with sufficient liquidity in order to meet our foreseeable claim payment obligations. However, the timing and amounts of actual claim payments can vary based on many factors, including the size of individual losses, changes in the legal environment, and general market conditions. The ultimate amount and timing of the claim payments could differ materially from our estimates and create significant variations in cash flows from operations between periods, which may cause us to make payments from other sources of liquidity, such as sales of investments, borrowings from credit facilities or proceeds from capital market transactions. If the source of liquidity arises from the sale of investments, we may be forced to sell such investments at a loss, which may be material.
Although interest rates decreased during the year, interest rate spreads widened relative to treasuries across many asset classes in our investment portfolio resulting in the increase in our unrealized loss position.
Overall, we believe that the gross unrealized loss in our available-for-sale portfolio represents temporary declines due primarily to the loss of liquidity in the financial markets and that the gross unrealized losses on our available-for-sale securities are not necessarily predictive of ultimate performance. We also believe that the provisions we have made for other-than-temporary impairments are adequate and that we have the ability and intent to hold our securities for a sufficient period of time to recover the value, which may be maturity if necessary. Economic conditions may deteriorate more than expected and adversely affect the expected cash flows of our securities, which in turn may lead to other-than-temporary impairments recorded in future periods.
We expect that our operational liquidity needs, including our anticipated reinsurance obligations and operating and capital expenditures, for the next twelve months will be met by our cash and cash equivalents, short-term investments, positive cash flow from operations, investment income and proceeds on the sale or maturity of our investments.
To the extent that our existing capital is insufficient to fund our future operating requirements or maintain our financial strength or debt ratings, we may need to raise additional capital through financings. If we are not able to obtain adequate capital, our business, results of operations and financial condition could be adversely affected, which could include, among other things, the following possible outcomes: (1) potential downgrades in the financial strength ratings assigned by ratings agencies to our operating subsidiaries, which could place those operating subsidiaries at a competitive disadvantage compared to higher-rated competitors; (2) reductions in the amount of business that our operating subsidiaries are able to write in order to meet capital adequacy-based tests enforced by statutory agencies; and (3) increases in the cost of bank credit and letters of credit. We can provide no assurance that, if needed, it would be able to obtain additional funds through financing on satisfactory terms or at all.
In addition to common share capital, we depend on external financing sources to support our underwriting activities, which can be in the form of debt securities, preference shares, common equity, bank credit facilities providing loans and/or letters of credit, or any combination of these sources. Any equity or debt financing, if available at all, may be on terms that are unfavorable to us. In the case of equity financings, dilution to our shareholders could result, and, in any case, such securities may have rights, preferences and privileges that are senior to those of our outstanding securities.
Our board of directors has authorized the repurchase of up to $250,000,000 of our common shares through a share repurchase program. Since the program was incepted, our board of directors has monitored the level of share repurchase activity and periodically restored the repurchase authority under the program to $250,000,000, most recently on October 22, 2008. During 2008 and 2007, Platinum Holdings repurchased 14,698,000 of its common shares under the share repurchase program at an average price of $34.51 per share. The timing and amount of the repurchase transactions under this program will depend on a variety of factors, including market conditions and corporate and regulatory considerations.
On September 13, 2006, we amended and restated an existing credit agreement with a syndicate of lenders, increasing the term from three to five years and increasing the credit facility from $200,000,000 to $400,000,000. The credit facility consists of a $150,000,000 senior unsecured credit facility available for revolving borrowings and letters of credit and a $250,000,000 senior secured credit facility available for letters of credit. The credit facility generally will be available for our working capital, liquidity and general corporate requirements and those of our subsidiaries. Platinum Holdings and Platinum Finance guarantee borrowings by our reinsurance subsidiaries under the credit facility. The interest rate on borrowings under the credit facility is based on our election of either: (1) LIBOR plus 50 basis points or (2) the higher of: (a) the prime interest rate of the lead bank providing the credit facility, or (b) the federal funds rate plus 50 basis points. The interest rate based on LIBOR rate would increase or decrease by up to 12.5 basis points should our senior unsecured debt rating increase or decrease. As of December 31, 2008, $150,000,000 was available for borrowing on an unsecured basis and $68,652,000 was available for letters of credit on a secured basis under the credit facility.
Our principal consolidated cash requirements are the payment of losses and LAE, commissions, brokerage, operating expenses, dividends to our preferred and common shareholders, the servicing of debt, capital expenditures, purchase of retrocessional contracts and payment of taxes.
Our contractual obligations as of December 31, 2008 by estimated maturity are presented below ($ in thousands):
There are generally no notional or stated amounts related to unpaid losses and LAE. Both the amounts and timing of future loss and LAE payments are estimates and subject to the inherent variability of legal and market conditions affecting the obligations and make the timing of cash outflows uncertain. The ultimate amount and timing of unpaid losses and LAE could differ materially from the amounts in the table above. Further, the gross unpaid losses and LAE do not represent all of the obligations that will arise under the contracts, but rather only the estimated liability incurred through December 31, 2008. There are reinsurance contracts that have terms extending into 2009 under which additional obligations will be incurred.
See Note 1 to the Consolidated Financial Statements contained elsewhere in this Form 10-K for a discussion of recently issued accounting standards.