(Expressed in millions of U.S. dollars or shares, except per share data)
The Company is a leading global reinsurer, with a broadly diversified and balanced portfolio of traditional reinsurance risks and capital markets risks.
The Company generates its reinsurance revenue from premiums. Premium rates and terms and conditions vary by line of business depending on market conditions. Pricing cycles are driven by supply of capital in the
In 2009, the non-life reinsurance market overall remained relatively unchanged from 2008. Pricing and profitability improved in certain catastrophe-exposed property lines in the U.S. and Japan, but elsewhere, especially in casualty lines, the impact of stagnant pricing and interest rates near historic lows caused continued pressure on returns on capital, pricing and profitability. Beginning in the second quarter, and continuing through the rest of 2009, financial markets showed improvement, primarily with increases in worldwide equity and credit markets.
Diluted Book Value per Share: Management uses growth in diluted book value per share as a prime measure of the value the Company is generating for its common shareholders, as Management believes that growth in the Company’s diluted book value per share ultimately translates into growth in the Company’s stock price. Diluted book value per share is calculated using common shareholders’ equity (shareholders’ equity less the liquidation value of preferred shares) divided by the number of fully diluted common shares outstanding (assuming exercise of all stock-based awards and other dilutive securities). Diluted book value per share is impacted by the Company’s net income and external factors such as foreign exchange, interest rates and equity markets, which can drive changes in unrealized gains or losses on its investment portfolio. Over the past seven years, since December 31, 2002, the Company has generated a compound annual growth rate in diluted book value per share in excess of 13%.
A key challenge for Management is to maintain an appropriate level of capital, especially in light of the recent disruptions in the global credit and capital markets. Management’s first priority is to hold sufficient capital to meet all of the Company’s obligations to cedants, meet regulatory requirements and support its position as one of the stronger reinsurers in the industry. Holding an excessive amount of capital, however, will reduce the Company’s ROE. Consequently, Management closely monitors its capital needs and capital level throughout the cycle and in times of volatility and turmoil in global capital markets, and actively takes steps to increase or decrease the Company’s capital in order to achieve the proper balance of financial strength and shareholder returns. Capital management is achieved by either deploying capital to fund attractive business opportunities, or in times of excess capital, returning capital to shareholders by way of share repurchases and dividends.
The Company aims to be a reliable and financially secure partner to its cedants. This means that the Company must maintain sufficient liquidity at all times so that it can support its cedants by settling claims quickly. The Company generates cash flows primarily from its underwriting and investment operations. Management believes that a profitable, well-run reinsurance organization will generate sufficient cash from premium receipts to pay claims, acquisition costs and operating expenses in most years. To the extent that underwriting cash flows are not sufficient to cover operating cash outflows in any year, the Company may utilize cash flows generated from investments and may ultimately liquidate assets from its investment portfolio. Management ensures that its liquidity requirements are supported by maintaining a high-quality, well-balanced and liquid investment portfolio, and by matching the duration of its investments and investments underlying the funds held - directly managed account with that of its net reinsurance liabilities. In 2010, the Company expects to continue to generate positive operating cash flows, absent a series of unusual catastrophic events. The Company also maintains credit facilities with banks that can provide efficient access to cash in the event of an unforeseen cash requirement.
The Company manages assumed risk at a strategic level through diversification, risk appetite, and absolute limits. For each key risk, the Board approves a risk appetite that the Company defines as the percentage of economic capital the Company is willing to expose to economic loss with a modeled probability of occurring once every 15 years and once every 75 years. The Company manages its exposure to key risks such that the modeled economic loss at a 1 in 15 year and a 1 in 75 year return period are less than the economic capital the Company is willing to expose to the key risks at those return periods. In addition, the Risk Management and Finance Committee of the Board approve aggregate and absolute risk limits for the key risks. The Company’s risk limits are stated as explicit numerical expressions, such as total aggregate limits in a catastrophe zone, earned premium for casualty business, and the market value of equity and equity-like securities. Executive and Business Unit Management set additional specific and aggregate risk limits within those limits approved by the Risk Management and Finance Committee. The actual level of risk is dependent on current market conditions and the need for balance in the Company’s portfolio of risks. On a quarterly basis, Management reviews and reports to the Board the actual utilization of limits against approved limits and modeled economic loss against approved appetite for the key risks.
On October 2, 2009, the Company closed its block purchase of Paris Re’s common shares and warrants (Block Purchase). This purchase represented, in the aggregate, approximately 77% of the outstanding common shares of Paris Re, resulting in the Company’s ownership of Paris Re’s common shares increasing to approximately 83%. Subsequent to October 2, 2009, the Company acquired additional common shares of Paris Re and effected a statutory merger (Merger), resulting in the Company obtaining 100% ownership of Paris Re on December 7, 2009. The Consolidated Statements of Operations and Cash Flows for the year ended December 31, 2009 include the results of Paris Re for the period from October 2, 2009, the date of acquisition of the controlling interest (Acquisition Date), to December 31, 2009 (See Note 3).
Valuation of certain assets and derivative financial instruments that are measured using significant unobservable inputs.
In June 2009, the Financial Accounting Standards Board (FASB) established the Accounting Standards Codification (the Codification) as the source of authoritative U.S. GAAP for non-governmental entities, in addition to guidance issued by the Securities and Exchange Commission. The Codification supersedes all previously existing, non-SEC accounting and reporting standards and reorganizes existing U.S. GAAP into authoritative accounting topics and sub-topics. The Company adopted the Codification as of September 30, 2009, and it impacted the Company’s disclosures by eliminating all references to pre-Codification standards.
Gross premiums written and earned are based upon reports received from ceding companies, supplemented by the Company’s own estimates of premiums written and earned for which ceding company reports have not been received. Differences between such estimates and actual amounts are recorded in the period in which the estimates are changed or the actual amounts are determined. Net premiums written and earned are presented net of ceded premiums, which represent the cost of retrocessional protection purchased by the Company. Premiums are earned on a basis that is consistent with the risks covered under the terms of the reinsurance contracts, which is generally one to two years. For U.S. and European wind and certain other risks, premiums are earned commensurate with the seasonality of the underlying exposure. Unearned premiums represent the portion of premiums written which is applicable to the unexpired risks under contracts in force. Premiums related to individual life and annuity business are recorded over the premium-paying period on the underlying policies. Premiums on annuity and universal life contracts for which there is no significant mortality or critical illness risk are accounted for in a manner consistent with accounting for interest-bearing financial instruments and are not reported as revenues, but rather as direct deposits to the contract. Amounts assessed against annuity and universal life policyholders are recognized as revenue in the period assessed.
Acquisition costs, primarily brokerage fees, commissions and excise taxes, which vary directly with, and are primarily related to, the acquisition of reinsurance contracts, are capitalized and charged to expense as the related premium is earned. Anticipated losses and loss expenses, other costs and investment income related to these premiums are considered in determining the recoverability of deferred acquisition costs. Acquisition costs related to individual life and annuity contracts are deferred and amortized over the premium-paying periods in proportion to anticipated premium income, allowing for lapses, terminations and anticipated investment income. Acquisition costs related to universal life and single premium annuity contracts for which there is no significant mortality or critical illness risk are deferred and amortized over the lives of the contracts as a percentage of the estimated gross profits expected to be realized on the contracts.
In certain circumstances, the Company may receive an investment return based upon either the result of a pool of assets held by the cedant, generally used to collateralize the funds held balance, or the investment return earned by the cedant on its entire investment portfolio. This is most common in the Company’s life reinsurance business. In these arrangements, gross investment returns are typically reflected in net investment income with a corresponding increase or decrease (net of a spread) being recorded as life policy benefits in the Company’s Consolidated Statements of Operations. In these arrangements, the Company is exposed, to a limited extent, to the underlying credit risk of the pool of assets inasmuch as the underlying life policies may have guaranteed minimum returns. In such cases, an embedded derivative exists and its fair value is recorded by the Company as an increase or decrease to the funds held balance, which is substantially offset by a comparable but opposite adjustment to deferred acquisition costs.
The Company elected the fair value option as of the Acquisition Date for substantially all of the fixed maturities, short-term investments and certain other invested assets in the segregated investment portfolio underlying the funds held - directly managed account, and accordingly, all changes in the fair value of the segregated investment portfolio underlying the funds held - directly managed account subsequent to the Acquisition Date are recorded in net realized and unrealized investment gains and losses in the Consolidated Statements of Operations (see Note 7).
Effective January 1, 2008, the Company adopted the fair value measurements guidance under U.S. GAAP. Fair value is the price received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The Company measures the fair value of financial instruments according to a fair value hierarchy that prioritizes the information used to measure fair value into three broad levels. The adoption of the guidance on fair value measurements, and subsequent fair value guidance, did not have a material impact on the Company’s consolidated shareholders’ equity or net income. See Note 5 for additional information on fair value.
Effective January 1, 2008, the Company elected the fair value option for all of its fixed maturities, short-term investments, equities and certain other invested assets (including swaps and derivatives but excluding certain other invested assets, such as those that are accounted for using the equity method of accounting or investment company accounting). Following the election of the fair value option for an eligible item, changes in that item’s fair value in subsequent reporting periods must be recognized in earnings.
Goodwill represents the excess of the purchase price over the fair value of the net assets acquired of PartnerRe SA, Winterthur Re and Paris Re. The Company assesses the appropriateness of its valuation of
Intangible assets represent the fair value adjustments related to unpaid losses and loss expenses and unearned premiums, as well as the fair values of renewal rights and U.S. licenses all arising from the acquisition of Paris Re. Definite-lived intangible assets are amortized over their useful lives, generally ranging from two to eleven years. The Company recognizes the amortization of all intangible assets in the Consolidated Statement of Operations. Indefinite-lived intangible assets are not subject to amortization. The carrying values of intangible assets are regularly reviewed for indicators of impairment. Impairment is recognized if the carrying value of the intangible assets is not recoverable from its undiscounted cash flows and is measured as the difference between the carrying value and the fair value.
The reporting currency of the Company is the U.S. dollar. The national currencies of the Company’s subsidiaries and branches are generally their functional currencies, except for the Bermuda subsidiaries and the Company’s Swiss subsidiaries and branch, whose functional currencies are the U.S. dollar. In translating the financial statements of those subsidiaries or branches whose functional currency is other than the U.S. dollar, assets and liabilities are converted into U.S. dollars using the rates of exchange in effect at the balance sheet dates, and revenues and expenses are converted using the average foreign exchange rates for the period. The effect of translation adjustments are reported in the Consolidated Balance Sheets as currency translation adjustment, a separate component of accumulated other comprehensive income.
As part of its overall strategy to manage its level of currency exposure, from time to time the Company uses forward foreign exchange derivatives to hedge or partially hedge the net investment in certain non-U.S. dollar functional currency subsidiaries and branches. These derivatives have been designated as net investment hedges, and accordingly, the changes in fair value of the derivative and the hedged item related to foreign currency are recognized in currency translation adjustment in the Consolidated Balance Sheets.
In January 2010, the FASB issued new accounting guidance which requires companies to disclose additional information about their fair value measurements at a greater level of disaggregation. The additional disclosures include information about transfers into and/or out of the Level 1 and 2 categories of inputs, increased disclosures of activity in Level 3 fair value measurements, and other disclosures about inputs and valuation techniques. The guidance related to disclosures at a greater level of disaggregation, disclosures about transfers
On July 4, 2009, the Company entered into definitive agreements (Transaction Agreements) to effect a multi-step acquisition of all of the outstanding common shares and warrants of Paris Re. The acquisition of Paris Re was undertaken to achieve greater market presence, risk diversification and capital strength, while at the same time maintaining the core of the Company’s existing franchise.
On the Acquisition Date, the Company caused a wholly-owned subsidiary (Merger Subsidiary) to complete the Block Purchase in which the Company acquired approximately 57% of the outstanding Paris Re common shares and certain outstanding Paris Re warrants. These shares, when added together with the approximately 6% of the outstanding Paris Re common shares that the Company purchased in July 2009 and an additional approximately 20% of the outstanding Paris Re common shares that the Company subsequently committed to acquire simultaneously with the closing of the Block Purchase from certain other Paris Re shareholders, gave the Company an aggregate ownership of approximately 83% of the outstanding Paris Re common shares following the closing of the Block Purchase on the Acquisition Date. Accordingly, the Company obtained a controlling interest in Paris Re as of the Acquisition Date. In connection with the Block Purchase, the Company issued approximately 20.0 million of its common shares.
amount of CHF 4.17 per Paris Re common share (the Swiss franc equivalent of $3.85 as of July 7, 2009, the date on which Paris Re fixed the U.S. dollar/Swiss franc currency exchange rate to be used for the extraordinary cash distribution) (Share Capital Repayment), effected the Share Capital Repayment. The Paris Re shareholders that previously sold their Paris Re common shares to the Company in July 2009, received a payment of $3.85 at the closing of the Block Purchase for each Paris Re common share sold (net of dividends paid on the Company’s common shares with respect to the period after such sale and prior to the closing of the Block Purchase). All other Paris Re shareholders who sold their common shares to the Company prior to the Share Capital Repayment received a payment of CHF 4.17 for each Paris Re common share sold either in cash or in the form of a promissory note issued by the Company at the time of the acquisition of their Paris Re common shares. On November 3, 2009, the Company paid in full all promissory notes issued to such sellers of Paris Re common shares.
By virtue of the Merger, each remaining issued and outstanding Paris Re common share (other than those held by Merger Subsidiary) was converted into the right to receive 0.3018 PartnerRe common shares, which is the same per share consideration paid by the Company in connection with its previous purchases of Paris Re common shares, as adjusted upwards to account for the cash dividend declared on the Company’s common shares as described above. In connection with the Merger, the Company issued approximately 2.8 million of its common shares.
The total purchase price, fair value of net assets acquired and goodwill as of the Acquisition Date, are calculated as follows (in millions of U.S. dollars, except share (in thousands) and per share data):
The fair value of the 25.7 million common shares issued as a part of consideration paid for Paris Re and the fair value of the noncontrolling interests as of the Acquisition Date was determined based on the closing market price of the Company’s common shares on the Acquisition Date.
Paris Re’s results have been included in the Company’s Consolidated Financial Statements from October 2, 2009 to December 31, 2009. The following pro forma financial information for 2009 and 2008 is presented for informational purposes only and is not necessarily indicative of the results that would have occurred had the acquisition been consummated at the beginning of each period presented, nor is it necessarily indicative of future results. Significant assumptions used to determine pro forma results include amortization of intangible assets related to the acquisition and assumes the Company’s acquisition of Paris Re occurred on January 1 of each of the respective years. The table presents unaudited pro forma consolidated information for the years ended December 31, 2009 and 2008 (in millions of U.S. dollars, except per share data):
Of the total intangible asset amortization of $40,277, $46,410 is recorded within acquisition costs and $(6,133) is recorded within amortization of intangible assets in the Consolidated Statements of Operations for the year ended December 31, 2009, respectively. The amount recorded within acquisition costs in the Consolidated Statements of Operations approximates the amount of Paris Re’s deferred acquisition costs that would have been recorded as acquisition costs had they not been fair valued under purchase accounting.
The Company determines the appropriate level in the hierarchy for each financial instrument that it measures at fair value. In determining fair value, the Company uses various valuation approaches, including market, income and cost approaches. The hierarchy is broken down into three levels based on the reliability of inputs as follows:
The Company’s financial instruments that it measures at fair value using Level 2 inputs generally include: U.S. Treasury bonds; U.S. Government Sponsored Entities; Organization for Economic Co-operation and Development Sovereign Treasury bonds; investment grade and high yield corporate bonds; catastrophe bonds; mortgage-backed securities; asset-backed securities (ABS); foreign exchange forward contracts and over-the-counter derivatives such as foreign currency option contracts, equity put and call options, interest rate swaps and credit default swaps.
The Company’s financial instruments measured at fair value include investments classified as trading securities, certain other invested assets and the segregated investment portfolio underlying the funds held - directly managed account (see Note 7). At December 31, 2009 and 2008, the Company’s financial instruments measured at fair value were categorized between Levels 1, 2 and 3 as follows (in thousands of U.S. dollars):
Substantially all of the accrued investment income in the Consolidated Balance Sheets as of December 31, 2009 and 2008 related to the Company’s fixed maturities, short-term investments and equities for which the fair value option was elected. In addition, accrued investment income of $25.2 million at December 31, 2009, related to the investments underlying the funds held - directly managed account, is included within the value of the funds held - directly managed account.
Changes in the fair value of the Company’s financial instruments measured at fair value during the years ended December 31, 2009 and 2008 were as follows (in thousands of U.S. dollars):
The majority of the Company’s equities are categorized as Level 1 within the fair value hierarchy. For equities categorized as Level 1, the Company receives prices based on closing exchange prices from independent pricing sources to measure fair value. While the Company did not hold any assets categorized as Level 2 at December 31, 2009, equities categorized as Level 2 at December 31, 2008 were generally mutual funds invested in securities other than the common stock of publicly traded companies (such as emerging market debt funds or bank loan funds). These funds provide daily net asset values which the Company uses in determining fair value for these investments. For funds where the net asset value is not provided on a daily basis, the asset is classified as Level 3.
The Company’s foreign exchange forward contracts, foreign currency option contracts, equity put and call options, interest rate swaps and credit default swaps are categorized as Level 2 within the fair value hierarchy. Included in the Company’s Level 3 categorization are unlisted equities including preference shares, unit trusts, credit linked notes, loans receivable, total return swaps and weather derivatives. The Company will generally
either (i) receive a price based on a manager’s or trustee’s valuation for the asset; or (ii) develop an internal discounted cash flow model to measure fair value. Where the Company receives prices from the manager or trustee, these prices are based on the manager’s or trustee’s estimate of fair value for the assets and are generally audited on an annual basis. Where the Company develops its own discounted cash flow models, the inputs will be specific to the asset in question, based on appropriate historical information, adjusted as necessary, and using appropriate discount rates. As part of the Company’s modeling to determine the fair value of an investment, the Company considers counterparty credit risk as an input to the model, however, the majority of the Company’s counterparties are highly rated institutions and the failure of any counterparty would not have a significant impact on the Company’s financial statements.
The segregated investment portfolio underlying the funds held - directly managed account is comprised of fixed maturities, short-term investments and other invested assets and are fair valued on a basis consistent with the methods described above. Substantially all fixed maturities and short-term investments within the funds held - directly managed account are categorized as Level 2 within the fair value hierarchy.
The following methods and assumptions were used by the Company in estimating the fair value of each class of financial instrument liability recorded in the Consolidated Balance Sheets for which the Company does not measure that instrument at fair value. Disclosures about fair value of financial instruments exclude insurance contracts (other than financial guarantees), investment contracts and certain other financial instruments.
(2) PartnerRe Finance A LLC, the issuer of the Senior Notes, does not meet consolidation requirements under U.S. GAAP. Accordingly, the Company shows the related intercompany debt of $250.0 million in its Consolidated Balance Sheets at December 31, 2009 and 2008, respectively.
The cost, gross unrealized gains, gross unrealized losses and fair value of investments classified as trading securities at December 31, 2009 and 2008 were as follows (in thousands of U.S. dollars):
(1) Cost is amortized cost for fixed maturities and short-term investments and cost for equities. For investments acquired from Paris Re, cost is based on the fair value at the date of acquisition and subsequently adjusted for amortization of fixed maturities and short-term investments.
The change in net unrealized gains on investments, net of applicable taxes, reflected in other comprehensive income for the years ended December 31, 2009, 2008 and 2007 was $8.1 million (net of tax of $nil), $15.2 million (net of tax benefit of $32.8 million) and $37.8 million (net of tax of $17.3 million), respectively.
The components of the net realized and unrealized investment gains (losses) for the years ended December 31, 2009, 2008 and 2007 are as follows (in thousands of U.S. dollars):
Included within accounts payable, accrued expenses and other in the Consolidated Balance Sheet at December 31, 2009 were gross payable balances for securities purchased and gross receivable balances for securities sold. At December 31, 2008, the receivable for securities sold is included within other assets in the Consolidated Balance Sheet. The amounts of gross payables for securities purchased and gross receivables for securities sold at December 31, 2009 and 2008 were as follows (in thousands of U.S. dollars):
Following Paris Re’s acquisition of substantially all of the reinsurance operations of Colisée Re (previously known as AXA RE), a subsidiary of AXA SA (AXA), in 2006, Paris Re and its subsidiaries entered into an issuance agreement and a quota share retrocession agreement to assume business written by Colisée Re from January 1, 2006 to September 30, 2007 as well as the in-force business as of December 31, 2005. The agreements provided that the premium related to the transferred business was retained by Colisée Re and credited to a funds held account. The assets underlying the funds held - directly managed account are maintained by Colisée Re in a segregated investment portfolio and managed by Paris Re. The segregated investment portfolio underlying the funds held - directly managed account is carried at fair value. Realized and unrealized investment gains and losses and net investment income related to the underlying investment portfolio in the funds held - directly managed account inure to the benefit of Paris Re.
The Company elected the fair value option as of the Acquisition Date for substantially all of the fixed maturities, short-term investments and certain other invested assets in the segregated investment portfolio underlying the funds held - directly managed account, and accordingly, all changes in the fair value of the segregated investment portfolio underlying the funds held - directly managed account subsequent to the Acquisition Date are recorded in net realized and unrealized investment gains and losses in the Consolidated Statements of Operations.
The cost, gross unrealized gains, gross unrealized losses and fair value of investments underlying the funds held - directly managed account at December 31, 2009 were as follows (in thousands of U.S. dollars):
(1) Cost is based on the fair value at the date of acquisition and subsequently adjusted for amortization of fixed maturities and short-term investments.
The components of the net realized losses and change in net unrealized investment gains on the funds held - directly managed account from October 2, 2009 to December 31, 2009 were as follows (in thousands of U.S. dollars):
The components of net investment income underlying the funds held - directly managed account from October 2, 2009 to December 31, 2009 were as follows (in thousands of U.S. dollars):
The following table summarizes the net prior year favorable development of loss reserves for each of the Company’s Non-life sub-segments for the years ended December 31, 2009, 2008 and 2007 (in millions of U.S. dollars):
Within the Company’s U.S. sub-segment, the Company reported net favorable loss development for prior accident years in 2009, 2008 and 2007. The net favorable loss development in 2009 included net favorable loss development for prior accident years in most lines of business, predominantly in casualty, while the multiline and motor lines of business experienced combined net adverse loss development for prior accident years of $11 million. The net favorable loss development in 2008 included net favorable development for prior accident years in all lines of business, with the exception of the motor and multiline lines of business, which experienced net adverse loss development for prior accident years of $10 million. The net favorable loss development in 2007 included net favorable development for prior accident years in all lines of business, with the exception of multiline, which included net adverse loss development of $5 million. Loss information provided by cedants during each of these years for prior accident years included no individually significant losses or reductions but a series of attritional losses or reductions. Attritional losses are losses that may not be significant on an individual basis, but are monitored on an aggregated basis by the Company to identify trends that may be meaningful from a reserving standpoint.
Favorable or adverse development related to the guaranteed reserves is recorded as a change in unpaid losses and loss expenses in the Consolidated Balance Sheet and as a change in the Paris Re Reserve Agreement payable or receivable balance to/from Colisée Re, which is included within Other reinsurance balances payable in the Consolidated Balance Sheet. Accordingly, the reconciliation of the beginning and ending liability for unpaid losses and loss expenses for the year ended December 31, 2009 includes the change in the Paris Re Reserve Agreement. The Company’s net liability for unpaid losses and loss expenses includes $1,500 million of guaranteed reserves and Other reinsurance balances payable includes $116 million payable to Colisée Re related to the Reserve Agreement.
For credit/surety, the analysis was based on information received from cedants both at the time the exposed business was written supplemented by discussions with cedants, historical experience in times of similar financial stress, reported claim information and internal modeling. The Company monitored actual claim experience during 2009 against original expectations. Reported claims for prior accident years have come in slightly higher than originally expected, resulting in a moderate increase of prior year loss reserves. Reported claims for the current accident year were significantly higher than expected and the Company’s loss reserves reflect this higher than expected claim activity.
Based on information currently available and the range of potential estimated ultimate liabilities, the Company believes that the unpaid loss and loss expense reserves for U.S. and Global (Non-U.S.) specialty casualty, U.S., Global (Non-U.S.) and Paris Re credit/surety lines of business and other potentially exposed classes of business contemplate a reasonable provision for exposures related to the effect of increased financial stress in the world economies. The Company is unaware of any specific issues that would materially affect its unpaid loss and loss expenses estimates related to this exposure.
The Company’s net reserves for unpaid losses and loss expenses at December 31, 2009 and 2008 included $232 million and $82 million, respectively, that represents estimates of its net ultimate liability for asbestos and environmental claims. The gross liability for such claims at December 31, 2009 and 2008 was $239 million and $92 million, respectively. The increase in asbestos and environmental claims reserves is due to the acquisition of Paris Re. The Company’s gross liability for Paris Re’s claims at December 31, 2009 of $159 million relates to pre-2006 accident years and any favorable or adverse development is subject to the Reserve Agreement. Of the remaining $80 million in gross reserves, the majority of the reserves relate to U.S. casualty exposures arising from business written by PartnerRe SA and PartnerRe U.S.
The Company used interest rate assumptions to estimate its liabilities for policy benefits for life and annuity contracts which ranged from 1.0% to 6.0% and 1.0% to 5.0% at December 31, 2009 and 2008, respectively.
The Company uses retrocessional agreements to reduce its exposure to risk of loss on reinsurance assumed. These agreements provide for recovery from retrocessionaires of a portion of losses and loss expenses. The Company remains liable to its cedants to the extent that the retrocessionaires do not meet their obligations under these agreements, and therefore the Company evaluates the financial condition of its reinsurers and monitors concentration of credit risk on an ongoing basis. The Company actively manages its reinsurance exposures by generally selecting retrocessionaires having a credit rating of A- or higher. In certain cases where an otherwise suitable retrocessionaire has a credit rating lower than A-, the Company generally requires the posting of collateral, including escrow funds and letters of credit, as a condition to its entering into a retrocession agreement. The selection of retrocessionaires follows a precise qualitative and quantitative process. Provisions are made for amounts considered potentially uncollectible. The allowance for uncollectible reinsurance recoverable was $6.8 million and $5.8 million at December 31, 2009 and 2008, respectively.
Net premiums written, net premiums earned and losses and loss expenses and life policy benefits are reported net of reinsurance in the Company’s Consolidated Statements of Operations. Assumed, ceded and net amounts for the years ended December 31, 2009, 2008 and 2007 were as follows (in thousands of U.S. dollars):
The Company has subsidiaries and branches that operate in various other jurisdictions around the world that are subject to tax in the jurisdictions in which they operate. The significant jurisdictions in which the Company’s subsidiaries and branches are subject to tax are Canada, France, Ireland, Switzerland and the United States.
The Company is currently under examination in Switzerland for the tax years 2003-2007. Income tax returns are open for examination for the tax years 2005-2009 in Canada and Ireland, 2006-2009 in the United States, 2007-2009 in France and 2008-2009 in Switzerland. As a global organization, the Company may be subject to a variety of transfer pricing or permanent establishment challenges by taxing authorities in various jurisdictions. Management believes that adequate provision has been made in the Consolidated Financial Statements for any potential assessments that may result from tax examinations for all open tax years.
Income tax expense for the years ended December 31, 2009, 2008 and 2007 was as follows (in thousands of U.S. dollars):
The total amount of unrecognized tax benefits for which it is reasonably possible to change within twelve months was $2.8 million at December 31, 2009, which primarily relates to the expected expiration of the statute of limitations related to various intra-group transactions in Europe.
In the normal course of its underwriting activities, the Company and certain subsidiaries entered into reinsurance contracts with Delta Lloyd. The activity included in the Consolidated Statements of Operations related to Delta Lloyd for the year ended December 31, 2009 includes net premiums earned of $1.4 million and losses and loss expenses and life policy benefits of $0.5 million (2008, $1.8 million and $1.2 million, respectively). Included in the Consolidated Balance Sheets at December 31, 2009 and 2008 were unpaid losses and loss expenses of $8.5 million and $8.1 million, respectively.
The Company incurred expenses for these defined contribution arrangements of $18.7 million, $13.1 million, and $10.3 million for the years ended December 31, 2009, 2008 and 2007, respectively.
The Company maintains the Zurich Plan, which is classified as a hybrid plan and accounted for as a defined benefit plan under U.S. GAAP. At December 31, 2009 and 2008, the funded status of the Zurich Plan was as follows (in thousands of U.S. dollars):
Of the $6.9 million transition adjustment that was recorded in 2006 resulting from the adoption of U.S. GAAP guidance related to defined benefit plans, $4.9 million remains in accumulated other comprehensive income at December 31, 2009.
The net periodic benefit costs for the years ended December 31, 2009, 2008 and 2007 were $6.0 million, $4.1 million and $4.7 million, respectively.
At December 31, 2009, estimated employer contributions to be paid in 2010 were $5.5 million and future benefit payments were estimated to be paid as follows (in thousands of U.S. dollars):
In May 2005, the shareholders approved the PartnerRe Ltd. 2005 Employee Equity Plan (EEP) and replaced the existing employee plan, the Employee Incentive Plan (EIP). The EEP permits the grant of share options, RS, RSUs, SSARs or other share-based awards to employees of the Company. The EEP is administered by the Compensation Committee of the Board (the Committee).
In May 2008 and in September 2009 (in connection with the acquisition of Paris Re), the shareholders approved an allocation of an additional 0.6 million shares and 0.4 million shares, respectively, to the EEP. Currently, the plan permits the grant of up to 3.3 million shares, of which a total of 1.7 million shares can be issued as either RS or RSUs and 1.6 million shares can be issued as share options or SSARs. If an award under the EEP is cancelled or forfeited without the delivery of the full number of shares underlying such award, only the net number of shares actually delivered to the participant will be counted against the EEP’s authorized shares. Under the EEP, the exercise price of the award will not be less than the fair value of the award at the time of grant. The fair value is defined in the EEP as the closing price reported on the grant date. Awards issued under the EEP generally vest over 3 years of continuous service, either ratably or with a cliff-vest provision, are expensed ratably over the vesting period and have a ten year contractual term. Participants in the EEP are eligible to receive dividends, which the Company records as an expense, on RSUs that are unvested. Shares available for grant under the EIP at the time of replacement were transferred and became available for grant under the EEP.
The 2003 Non-Employee Directors Stock Plan (Directors’ Stock Plan), which is shareholder-approved, permits the grant of up to 0.8 million share options, RS, RSUs, alternative awards and other share-based awards. Under the Directors’ Stock Plan, the exercise price of the share options will be equivalent to the fair value of the share options at the time of grant. The fair value is defined in the Directors’ Stock Plan as the closing price reported on the grant date. Option awards issued under the Directors’ Stock Plan generally vest at the time of grant and are expensed immediately and have a ten year contractual term. RSU awards issued under the Directors’ Stock Plan generally vest at the time of grant with a delivery date restriction of one year and are expensed immediately. At December 31, 2009, 0.3 million shares remained available for issuance under this plan.
The Swiss Share Purchase Plan (SSPP) has two offering periods per year with two purchase periods of six months each. All full-time Swiss employees are eligible to participate in the SSPP and can contribute between 1% and 8% of their base salary toward the purchase of the Company’s shares up to a maximum of 5,000 Swiss francs per annum. Employees who enroll in the SSPP may purchase the Company’s shares at a 40% discount of the fair value. There is a restriction on transfer or sale of these shares for a period of two years following purchase. Participants in the SSPP are eligible to receive dividends on their shares as of the purchase date. A total of 0.2 million common shares may be issued under the SSPP.
For the years ended December 31, 2009, 2008 and 2007, the Company’s share-based compensation expense was $21.7 million, $28.1 million and $24.9 million, respectively, with a tax benefit of $2.2 million, $2.0 million and $1.0 million, respectively.
The replacement share options issued related to the acquisition of Paris Re with a weighted average grant date fair value of $7.86, are fully vested. The weighted average remaining contractual term and the aggregate intrinsic value of share options outstanding, exercisable, vested and expected to vest at December 31, 2009 was 4.5 years and $43.4 million, respectively.
The expected life of the replacement share options issued as part of the acquisition of Paris Re was assumed to be 3 years. The expected life of all other share options issued during the year was assumed to be 6 years. Expected volatility is based on the historical volatility of the Company’s common shares over a period equivalent to the expected life of the Company’s share options. The risk-free interest rate is based on the market yield of U.S. treasury securities with maturities equivalent to the expected life of the Company’s share options. The dividend yield is based on the average dividend yield of the Company’s shares over the expected life of the Company’s share options.
Of the 1,192,040 RSUs outstanding at December 31, 2009, 89,652 and 14,736 are subject to a five year and one year delivery date restriction from the grant date, respectively, and were not released for conversion into shares.
During 2009, 2008 and 2007, the Company issued 105,344 SSARs, 339,920 SSARs, and 360,228 SSARs with a weighted average grant date fair value of $8.42, $11.50 and $13.88, respectively.
The activity related to the Company’s SSARs for the years ended December 31, 2009, 2008 and 2007 was as follows:
The Company values SSARs issued with a Black-Scholes valuation model and used the following assumptions for the years ended December 31, 2009, 2008 and 2007:
The Company’s ability to pay common and preferred shareholders’ dividends and its corporate expenses is dependent mainly on cash dividends from Partner Reinsurance, PartnerRe Europe, PartnerRe U.S., Paris Re France and Paris Re Switzerland (collectively, the reinsurance subsidiaries). The payment of such dividends by the reinsurance subsidiaries to the Company is limited under Bermuda, Irish, Swiss and French laws and certain statutes of various U.S. states in which PartnerRe U.S. is licensed to transact business. The restrictions are generally based on net income and/or certain levels of policyholders’ earned surplus as determined in accordance with the relevant statutory accounting practices. As of December 31, 2009, there were no significant restrictions on the payment of dividends by the Company’s subsidiaries that would limit the Company’s ability to pay common and preferred shareholders’ dividends and its corporate expenses.
The reinsurance subsidiaries are required to file annual statements with insurance regulatory authorities prepared on an accounting basis prescribed or permitted by such authorities (statutory basis), maintain minimum levels of solvency and liquidity and comply with risk-based capital requirements and licensing rules. As of December 31, 2009, the reinsurance subsidiaries’ solvency, liquidity and risk-based capital amounts were in excess of the minimum levels required. The typical adjustments to insurance statutory basis amounts to convert to U.S. GAAP include elimination of certain statutory reserves, deferral of certain acquisition costs, recognition of goodwill, intangible assets and deferred income taxes, valuation of bonds at fair value and presentation of ceded reinsurance balances gross of assumed balances.
The statutory net income (loss) of the Company’s principal reinsurance subsidiaries for the years ended December 31, 2009, 2008 and 2007 was as follows (in millions of U.S. dollars):
The Company incurred interest expense of $3.9 million, $15.2 million and $23.5 million and paid interest of $6.3 million, $16.1 million and $23.7 million for the years ended December 31, 2009, 2008 and 2007, respectively, in relation to this loan.
In connection with the acquisition of the reinsurance operations of Winterthur Re in 1998, the Company’s subsidiary, PartnerRe U.S. Corporation (PartnerRe U.S. Holdings) obtained a $220.0 million, 5.81% fixed rate bank loan. The loan was repaid in 2008 using the proceeds from the issuance of the Senior Notes (see Note 16). PartnerRe U.S. Holdings incurred interest expense of $8.7 million and paid interest of $9.6 million for the year ended December 31, 2008 and incurred interest expense and paid interest of $13.0 million for the year ended December 31, 2007 in relation to this loan.
In May 2008, PartnerRe Finance A LLC (PartnerRe Finance A), an indirect wholly-owned subsidiary of the Company, issued $250.0 million aggregate principal amount of 6.875% Senior Notes (Senior Notes). The Senior Notes will mature on June 1, 2018 and may be redeemed at the option of the issuer, in whole or in part, at any time. Interest on the Senior Notes is payable semi-annually and commenced on December 1, 2008 at an annual fixed rate of 6.875%, and cannot be deferred.
Contemporaneously, PartnerRe U.S. Holdings issued a 6.875% promissory note, with a principal amount of $250.0 million to PartnerRe Finance A. Under the terms of the promissory note, PartnerRe U.S. Holdings promises to pay to PartnerRe Finance A the principal amount on June 1, 2018, unless previously paid. Interest on the promissory note is payable semi-annually and commenced on December 1, 2008 at an annual fixed rate of 6.875%, and cannot be deferred.
For the years ended December 31, 2009 and 2008, the Company incurred interest expense of $17.2 million and $10.2 million, respectively, and paid interest of $17.2 million and $8.8 million, respectively.
In November 2006, PartnerRe Finance II Inc. (PartnerRe Finance II), an indirect wholly-owned subsidiary of the Company, issued $250.0 million aggregate principal amount of 6.440% Fixed-to-Floating Rate Junior Subordinated CENts. The CENts will mature on December 1, 2066 and may be redeemed at the option of the issuer, in whole or in part, after December 1, 2016 or earlier upon occurrence of specific rating agency or tax events. Interest on the CENts is payable semi-annually and commenced on June 1, 2007 through to December 1, 2016 at an annual fixed rate of 6.440% and will be payable quarterly thereafter until maturity at an annual rate of 3-month LIBOR plus a margin equal to 2.325%.
On March 13, 2009, PartnerRe Finance II purchased approximately 75% of the issue, or $186.6 million, for $93.3 million. Contemporaneously, under the terms of a cross receipt agreement, PartnerRe U.S. Holdings paid PartnerRe Finance II consideration of $93.3 million for the extinguishment of $186.6 million of the principal amount of PartnerRe U.S. Holdings’ 6.440% Fixed-to-Floating Rate promissory note due December 1, 2066. All other terms and conditions of the remaining CENts and promissory note remain unchanged. A pre-tax gain of $88.4 million, net of deferred issuance costs and fees, was realized on the foregoing transactions. The aggregate principal amount of the CENts and promissory note outstanding at December 31, 2009 was $63.4 million and $71.0 million, respectively.
The Company does not consolidate PartnerRe Finance A, which issued the Senior Notes, or PartnerRe Finance II, which issued the CENts, as they do not meet the consolidation requirements under U.S. GAAP. The Company has reflected the intercompany debt related to the Senior Notes and the CENts in its Consolidated Balance Sheets.
At December 31, 2009 and 2008, the total authorized shares of the Company were 200 million shares, par value $1.00 per share, as follows (in millions of shares):
During 2009, no shares were repurchased and at December 31, 2009, the Company had 5 million common shares remaining under its then existing share repurchase authorization approved by the Company’s Board of Directors (see Note 25).
At December 31, 2009, 5,000 common shares are held in treasury and available for reissuance.
In November 2004, the Company issued 9.2 million of 6.5% Series D cumulative redeemable preferred shares (Series D preferred shares) for a total consideration of $222.3 million after underwriting discounts and commissions totaling $7.7 million. The Company may redeem the Series D preferred shares at $25.00 per share
(1) Net income and net income available to common shareholders include $4.3 million, and basic net income per share and diluted net income per share include $0.07 per share related to the noncontrolling interests’ share of Paris Re’s net income for the period from October 2, 2009 to December 31, 2009.
The extension with the forward counterparty allows the Company to deliver 3,366,295 of the 6,732,590 common shares subject to the original contract to the forward counterparty at any time during the remaining term
of the agreement, which will mature beginning on April 28, 2010. The future sale price of the Company’s common shares under the amended half of the forward sale agreement will vary depending upon the market price of its common shares over a 40 trading day period surrounding the maturity of the forward sale agreement in April 2010, subject to a minimum price per share of $59.13 and a maximum price per share of $84.23 at December 31, 2009. If the Company elects to settle all or a portion of the forward sale agreement prior to its maturity, the Company will deliver common shares to the forward counterparty and will initially receive the present value of the minimum price per share, and the remaining payment, if any, due the Company will be made at maturity of the agreement based on the excess of the market price of the Company’s common shares over the minimum price per share at maturity of the contract. Settlement of the forward sale agreement may be accelerated by the forward counterparty upon the occurrence of certain events, and the maximum and minimum purchase prices will be reduced or increased quarterly depending on the amount of the Company’s dividends.
Under the terms of the extended forward sale agreement, contract fees of approximately $8.1 million were recorded against additional paid-in capital in 2008 and will be paid over the contract period. Prior to the issuance of shares under the forward sale agreement, this transaction has no other impact on the Company’s common shareholders’ equity, and the Company calculates the dilutive impact related to the forward sale agreement, if any, using the treasury stock method.
The Company’s investment portfolio is managed following prudent standards of diversification and a prudent investment philosophy. The Company is not exposed to any significant credit concentration risk on its investments, except for debt securities issued or guaranteed by the U.S. and other AAA-rated sovereign governments. The Company keeps cash and cash equivalents in several banks and may keep up to $500 million, excluding custodial accounts, at any point in time in any one bank.
The Company is also exposed to credit risk in its underwriting operations, most notably in the credit/surety line and for different life and alternative risk products. Loss experience in these lines of business is cyclical and is affected by the state of the general economic environment. The Company provides its clients in these lines of business with reinsurance protection against credit deterioration, defaults or other types of financial non-performance of or by the underlying credits that are the subject of the reinsurance provided and, accordingly, the Company is exposed to the credit risk of those credits. The Company mitigates the risks associated with these
The Company is also subject to the credit risk of its cedants in the event of insolvency or the cedant’s failure to honor the value of funds held balances for any other reason. The funds held-directly managed account is with one cedant and is supported by an underlying portfolio of investments, which are managed by the Company (see Note 7). The Company’s credit risk related to funds held is mitigated, to some extent, by the fact that the Company generally has the contractual ability to offset any shortfall in the payment of the premiums receivable or funds held balances with amounts owed by the Company to the cedant for losses payable and other amounts contractually due.
Rent expense for the years ended December 31, 2009, 2008 and 2007 was $30.9 million, $28.8 million, and $25.9 million, respectively.
In addition, the Company has entered into agreements with Paris Re’s Chief Executive Officer that provide for certain termination payments and retirement benefits.
The Company has entered into service agreements and lease contracts that provide for business and information technology support and computer equipment. Future payments under these contracts amount to $44.2 million through 2015.
The Company has entered into strategic investments with unfunded capital commitments totaling $128.0 million through 2014. The Company expects to fund capital commitments of $59.5 million, $43.4 million, $15.1 million, $5.0 million and $5.0 million during 2010, 2011, 2012, 2013 and 2014, respectively.
As of December 31, 2009, the Company was not a party to any litigation or arbitration that it believes could have a material adverse effect on the financial condition, results of operations or liquidity of the Company.
The Company has entered into various weather derivatives, weather futures and a longevity total return swap for which the underlying risks include parametric weather risks for the weather derivatives and weather futures, and longevity risk for the longevity total return swap.
The fair value of all derivatives at December 31, 2009 and 2008 is recorded in other invested assets in the Company’s Consolidated Balance Sheets. The effective portion of net investment hedging derivatives recognized in accumulated other comprehensive income at December 31, 2009 and 2008 was a $66.3 million loss and a $37.5 million loss, respectively. The effective portion of interest rate derivatives in accumulated other comprehensive income at December 31, 2009 was a gain of $6.4 million.
The gains and losses included in the Consolidated Statements of Operations for derivatives not designated as hedges for the years ended December 31, 2009 and 2008 was as follows (in thousands of U.S. dollars):
Included in the total credit facilities available to the Company at December 31, 2009 is a $660 million five-year syndicated, unsecured credit facility. This unsecured credit facility has the following terms: (i) a maturity date of September 30, 2010, (ii) a $300 million accordion feature, which enables the Company to potentially increase its available credit from $660 million to $960 million, and (iii) a minimum consolidated tangible net worth requirement as defined below. The ability of the Company to increase its available credit to $960 million is subject to the agreement of the credit facility participants and, given the recent financial crisis and related credit environment, this may be limited.
This facility is predominantly used for the issuance of letters of credit, although the Company and its subsidiaries have access to a revolving line of credit of up to $330 million as part of the Company’s syndicated unsecured credit facility. At December 31, 2009 and 2008, there were no borrowings under this revolving line of credit.
Additionally, the syndicated unsecured credit facility allows for an adjustment to the level of pricing should the Company experience a change in its senior unsecured debt ratings. The pricing grid provides the Company greater flexibility and simultaneously provides participants under the facility some price protection. As long as the Company maintains a minimum senior unsecured debt rating of BBB+ by Standard & Poor’s and Baa1 by Moody’s, the pricing on the facility will not change significantly.
The Company monitors the performance of its operations in three segments, Non-life, Life and Corporate and Other. The Non-life segment is further divided into five sub-segments: U.S., Global (Non-U.S.) P&C, Global (Non-U.S.) Specialty, Catastrophe and Paris Re.
The U.S. sub-segment includes property, casualty, motor, multiline, agriculture, surety and other risks generally originating in the United States. The Global (Non-U.S.) P&C sub-segment includes property, casualty and motor business generally originating outside of the United States. The Global (Non-U.S.) Specialty sub-segment is comprised of business that is generally considered to be specialized due to the sophisticated technical underwriting required to analyze risks, and is global in nature. This sub-segment consists of several lines of business for which the Company believes it has developed specialized knowledge and underwriting capabilities. These lines of business include agriculture, aviation/space, credit/surety, engineering, energy, marine, specialty property, specialty casualty and other lines. The Catastrophe sub-segment is comprised of the Company’s catastrophe line of business. The Paris Re sub-segment includes agriculture, aviation/space, catastrophe, credit/surety, energy, engineering, marine, motor, property, specialty casualty, specialty property and other lines underwritten by Paris Re. The Life segment includes life, health and annuity lines of business. Corporate and Other is comprised of the capital markets and investment related activities of the Company, including principal finance transactions, insurance-linked securities and strategic investments, and its corporate activities, including other operating expenses.
Because the Company does not manage its assets by segment, net investment income is not allocated to the Non-life segment. However, because of the interest-sensitive nature of some of the Company’s Life products, net investment income is considered in Management’s assessment of the profitability of the Life segment. The following items are not considered in evaluating the results of the Non-life and Life segments: net realized and unrealized investment gains and losses, net realized gain on purchase of CENts, interest expense, amortization of intangible assets, net foreign exchange gains and losses, income tax expense or benefit and interest in earnings and losses of equity investments. Segment results are shown before consideration of intercompany transactions.
The following tables provide a summary of the segment revenues and results for the years ended December 31, 2009, 2008 and 2007 (in millions of U.S. dollars, except ratios):
The following table provides the geographic distribution of gross premiums written based on the location of the underlying risk for the years ended December 31, 2009, 2008 and 2007:
The Company produces its business both through brokers and through direct relationships with insurance company clients. None of the Company’s cedants accounted for more than 6% of total gross premiums written during the year ended December 31, 2009 and more than 7% during the years ended December 31, 2008 and 2007.
(1) The Company’s results for the three months and year ended December 31, 2009 include the results of Paris Re from October 2, 2009 to December 31, 2009.
In addition to ChannelRe Holdings’ results for the twelve month period ended September 30, 2007 below, the Company recorded an additional charge of $87 million in its Consolidated Statements of Operations for the year ended December 31, 2007. This additional charge represented the write-down to $nil of its investment in ChannelRe Holdings due to unrealized mark-to-market losses on Channel Reinsurance’s credit derivative portfolio, which Channel Reinsurance expected to incur during the three months ended December 31, 2007, and which were expected to result in ChannelRe Holdings having negative U.S. GAAP shareholders’ equity at that date. ChannelRe Holdings’ financial statements as of December 31, 2007 and September 30, 2008 and 2009 did present negative U.S. GAAP shareholders’ equity, and accordingly at December 31, 2009 and 2008, the carrying value of the Company’s investment in ChannelRe Holdings remains $nil.
In February 2010, the Company repurchased 1.8 million of its common shares at a total cost of $140.0 million, representing an average cost of $75.83 per share. On February 25, 2010, the Company’s Board of Directors approved an increase in the Company’s stock repurchase authorization up to a total of 8 million common shares.
On February 27, 2010, a major earthquake measuring 8.8 on the Richter scale caused substantial damage in southern Chile. The Company has exposure to this event in Chile primarily through its property and casualty, specialty and catastrophe lines. In addition, on February 28, 2010, Atlantic storm Xynthia swept across parts of France, Portugal and Spain causing torrential rain and widespread flooding. The Company is exposed to this event primarily through its property and catastrophe lines. The Company is currently assessing its potential claims relating to these events, but information as of March 1, 2010 is not sufficient to arrive at reasonable estimates.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2009, based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 1, 2010 expressed an unqualified opinion on the Company’s internal control over financial reporting.