We lease office space in Hamilton, Bermuda where our principal executive office is located. Additionally, we lease office space in the United States, Ireland, the United Kingdom and other jurisdictions sufficient for the operation of our insurance and reinsurance operations. We renew and enter into new leases in the ordinary course of business. For further discussion of our leasing commitments at December 31, 2011, see Note 19 of our audited consolidated financial statements.
(1) Book value per share is calculated as shareholders’ equity divided by the number of common shares outstanding. Diluted book value per share is calculated as shareholders’ equity divided by the number of diluted common shares outstanding using the treasury stock method.
(2) Net operating income and net operating return on average shareholders’ equity are non-GAAP financial measures as defined by SEC Regulation G. See “Non-GAAP financial measures” for reconciliation to the nearest U.S. GAAP financial measure.
We consider growth in book value per share to be the most important financial performance measure in assessing whether we are meeting our business objectives. During the year ended December 31, 2011, our book value per share on a basic and diluted basis increased by 4.6% and 3.5%, respectively. We also distributed $0.52 per share in cash to our shareholders, which provided tangible value to shareholders and reduced our excess capital. We believe that a comparison of book value per share and diluted book value per share from December 31, 2010 to December 31, 2011 should be adjusted for these distributions to fully reflect the return generated for shareholders. Adding back $0.52 per share to our December 31, 2011 diluted book value per share of $26.91 would result in $27.43 per share, an increase of 5.5% over December 31, 2010. The increase in diluted book value per share, as adjusted, was principally due to a combination of positive operating results, unrealized gains on our investment portfolio and share repurchases at a discount to diluted book value per share.
We target a long-term net operating ROE of the risk free rate plus 10% over the cycle. For the year ended December 31, 2011, our net operating ROE and return on average shareholders’ equity fell short of our target primarily due to the significant property catastrophe event losses in the year and historically low fixed income investment yields.
The markets in which we operate historically have been cyclical. During periods of excess underwriting capacity, competition can result in lower pricing and less favorable policy terms for insurers and reinsurers. During periods of reduced underwriting capacity, pricing and policy terms are generally more favorable for insurers and reinsurers. We believe that the industry has been in a period of excess underwriting capacity, and while 2011’s property catastrophe events likely eroded some of that capacity, there was not sufficient pressure on the industry to improve pricing in 2011. The industry is also operating in a low interest rate environment, which makes it more difficult to generate significant investment income growth. Both of these factors generally result in lower net operating income, return on average shareholders’ equity and net operating return on average shareholders’ equity.
Although there remains uncertainty regarding the timing, location and scale of a favorable turn in the market, we believe that the industry is showing signs of improvement for 2012. However, we intend to maintain our underwriting discipline while actively managing our expenses. We expect our gross written premiums for the year ending December 31, 2012 to be consistent with the year ended December 31, 2011, and we expect to write more premiums in our short-tail lines of business than our long-tail casualty lines of business.
Our consolidated financial statements are prepared in accordance with U.S. GAAP, which require management to make estimates and assumptions. We believe that the following accounting policies affect the significant judgments and estimates used in the preparation of our consolidated financial statements.
The table below shows our reserves as of December 31, 2011 and 2010 by type and by segment.
There is normally a time lag between when a loss event occurs and when it is actually reported to us. These actuarial methods that we use to estimate losses have been designed to address the lag in loss reporting as well as the delay in obtaining information that would allow us to more accurately estimate future payments. There is also often a time lag between reinsurance clients establishing case reserves and re-estimating their reserves, and notifying us of the new or revised case reserves. As a result, reporting lag is more pronounced in our reinsurance contracts than in our insurance contracts due to the reliance on insurers to report their claims to us. On reinsurance transactions, the reporting lag will generally be 60 to 90 days after the end of a reporting period, but can be longer in some cases. Based on the experience of our actuaries and management, we select loss development factors and trending techniques to mitigate the problems caused by reporting lags. We regularly evaluate and update our loss development and trending factor selections using client specific and industry data.
Reported Loss Development Method. This method estimates ultimate losses by using past reported loss development factors and applying them to exposure periods with further expected reported loss development. Since reported losses include payments and case reserves, changes in both of these amounts are incorporated in this method. This approach provides a larger volume of data to estimate ultimate losses than paid loss methods. Thus, reported loss patterns may be less varied than paid loss patterns, especially for coverages that have historically been paid out over a long period of time but for which claims are reported relatively early and case loss reserve estimates established.
We rely on data reported by clients when calculating reserves. The quality of the data varies from client to client. Our actuarial and claims management teams periodically analyze our clients’ loss data to ascertain its quality and credibility. This process may involve comparisons with submission data and industry loss data, claims audits and inquiries about the methods of establishing case reserves associated with large industry events.
We believe that the provision for outstanding losses and benefits is adequate to cover the ultimate net cost of losses incurred to the balance sheet date, but the provision is necessarily an estimate and could potentially be settled for a significantly greater or lesser amount. These estimates are reviewed regularly and any adjustments to the estimates are recorded in the period they are determined. See Item 1A - Risk Factors-Our losses and loss adjustment expenses and benefits may exceed our loss and benefit reserves, which could significantly increase our liabilities and reduce our net income and could have a significant and negative effect on our financial condition and results of operations.
Casualty losses are generally long-tailed, which means that there can be a significant delay between the occurrence of a loss and the time it is settled by the insurer. These losses are also more susceptible to litigation and can be significantly affected by changing contract interpretations and a changing legal environment. In addition, the casualty business generally has a longer reporting lag and payment pattern than property business. Due to these factors, the estimation of loss reserves for casualty business generally involves a higher degree of judgment than for short-tailed business.
Property losses are generally short-tailed and are usually known and paid within a relatively short period of time after the underlying loss event has occurred. Our estimates for losses resulting from catastrophic events are based upon a combination of internal and external catastrophe models, as well as client- and location-specific assessments and reports, where available. These estimates are developed immediately after the loss event, and the loss estimates are subsequently refined based on broker advices and client notifications.
We evaluate and monitor the financial strength of each of our counterparties. Some reinsurance and retrocessional agreements give us the right to receive additional collateral or to terminate the agreement in the event of deterioration in the financial strength of the counterparty.
As of December 31, 2011, 85.9% of our losses recoverable were with reinsurers rated “A” or above by A.M. Best and 8.4% were rated “A-”. The remaining 5.7% were with “NR-not rated” reinsurers. Grand Central Re Limited, or Grand Central Re, a Bermuda domiciled reinsurance company in which we have a 7.5% equity investment, is our largest “NR-not rated” retrocessionaire and accounted for 3.3% of our losses recoverable as of December 31, 2011. As security for outstanding loss obligations, we retain funds from Grand Central Re amounting to 214.1% of its loss recoverable obligations. Of the remaining amount with “NR-not rated” retrocessionaires, we retain collateral equal to 84.0% of the losses and benefits recoverable. Our losses and benefits recoverable are not due for payment until the underlying loss has been paid. As of December 31, 2011, 95.6% of our losses and benefits recoverable were not due for payment.
The following table presents the development of balance sheet property and casualty loss reserves calculated in accordance with U.S. GAAP, as of December 31, 2002 through December 31, 2011. This table does not present accident or policy year development data. The top line of the table shows the gross reserves at the balance sheet date for each of the indicated years and is reconciled to the net reserve by adjusting for reinsurance recoverables. This represents the estimated amount of net claims and claim expenses arising in the current year and all prior years that are unpaid at the balance sheet date, including IBNR reserves. The table also shows the re-estimated amount of the previously recorded reserves as adjusted for new information received as of the end of each succeeding year.
(2) The difference between the reinsurance recoverable included above and that reflected in the reconciliation of losses and loss adjustment expenses in Note 7 to the consolidated financial statements relates to net deferred charges on retroactive reinsurance.
Net favorable development for our Alterra at Lloyd’s segment of $17.3 million, principally recognized on the financial institutions and property lines of business;
Net unfavorable development for our U.S. specialty segment of $11.5 million, including $6.7 million and $4.2 million of net unfavorable development on the general casualty and property lines of business, respectively, relating to our contract binding business, the renewal rights for which we sold during the year;
Our balance sheet reserves for 2002 and each subsequent balance sheet date through 2004 in the above tables shows the effects of the development on two specific contracts recorded in 2005. The development on these two contracts in the years subsequent to 2004 has not been significant. The first contract increased 2002 reserves by $50.2 million, with the recording of such increased losses triggering additional premiums and interest on additional premiums of $49.3 million, which are not reflected in the table above. The second contract increased 2002 reserves by $49.6 million, 2003 reserves by $64.8 million and 2004 reserves by $15.3 million, for a total increase of $129.7 million. The adverse development triggered additional premiums and interest on such additional premiums of $105.3 million, which are not reflected in the table above.
Since the development of our life and annuity reinsurance reserves is based upon cash flow projection models, we make estimates and assumptions based on cedant experience and industry mortality tables, longevity, expense and investment experience, including a provision for adverse deviation. The assumptions used to determine policy benefit reserves are best estimate assumptions that are determined at the inception of the contracts and are locked-in throughout the life of the reinsurance contract unless a premium
deficiency develops. The assumptions are reviewed no less than annually and are un-locked if they result in a material reserve change. We establish these estimates based upon transaction specific historical experience, information provided by the ceding company and industry experience studies. Actual results could differ materially from these estimates. As the experience on the contracts emerges, the assumptions are reviewed by management. We determine whether actual and anticipated experience indicates that existing policy reserves, together with the present value of future gross premiums, are sufficient to cover the present value of future benefits, settlement and maintenance costs and to recover unamortized acquisition costs. If such a review produces reserves in excess of those currently held then the lock-in assumptions are revised and an additional life and annuity benefit reserve is recognized at that time.
Because of the many assumptions and estimates used in establishing reserves and the long-term nature of reinsurance contracts, the reserving process, while based on actuarial science, is inherently uncertain.
Our other investments comprise our investments in hedge funds, investments in structured deposits and various derivative instruments, all of which are recorded at fair value. Other investments also include private equity investments in which we have significant influence and are accounted for under the equity method.
We measure fair value in accordance with Accounting Standards Codification, or ASC, 820, Fair Value Measurements. The guidance dictates a framework for measuring fair value and a fair value hierarchy based on the quality of inputs used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy are described below:
Fair value prices for all securities in our fixed maturities portfolio are independently provided by our investment custodians, investment accounting service provider and/or our investment managers, which each utilize internationally recognized independent pricing services. We record the unadjusted price provided by the investment custodian or the investment accounting service provider after an internal validation process. Our validation process includes, but is not limited to: (i) comparison of prices between two independent sources, with significant differences requiring additional price sources; (ii) quantitative analysis (e.g., comparing the quarterly return for each managed portfolio to its target benchmark with significant differences identified and investigated); (iii) evaluation of methodologies used by external parties to calculate fair value; and (iv) comparing the price to our knowledge of the current investment market.
Our hedge fund portfolio comprises a portfolio of limited partnership and stock investments in trading entities, or funds, which invest in a wide range of financial products. Investments in the funds are carried at fair value. The change in fair value is included in net realized and unrealized gains on investments and recognized in net income. The units of account that we fair value are our interests in the funds and not the underlying holdings of such funds. Thus, the inputs we use to value our investments in each of the funds may differ from the inputs used to value the underlying holdings of such funds. These funds are stated at fair value, which ordinarily will be the most recently reported net asset value as advised by the fund manager or administrator, where the fund’s underlying holdings can be in various quoted and unquoted investments. We believe the reported net asset value represents the fair value market participants would apply to an interest in the fund. The fund managers value their underlying investments at fair value in accordance with policies established by each fund, as described in each of their financial statements and offering memoranda. Based upon information provided by the fund managers, as of December 31, 2011, we estimate that over 72% of the underlying assets in the funds are publicly traded securities or have broker quotes available.
As of December 31, 2011, certain of our funds had either imposed a gate on redemptions or segregated a portion of the underlying assets into a side-pocket (whereby the funds are assigned to a separate memorandum capital account or designated account). A gate refers to funds which provide for periodic redemptions, however, in accordance with the funds’ governing documents, a fund with a gate has the ability to deny or delay a redemption request. Based on the review process applied by management on such funds, a reduction of $2.5 million was made to the net asset value reported by one fund manager as of December 31, 2011 (2010-$3.2 million) to adjust the carrying value of the fund to our best estimate of fair value.
We follow ASC, 944 - Financial Services - Insurance in determining the accounting for our insurance and reinsurance products. Assessing whether or not the contracts we write meet the conditions for risk transfer requires judgment. The determination of risk transfer is based, in part, on the use of actuarial and pricing models and assumptions.
Our reinsurance premiums are recorded at the inception of each contract based upon contract terms and information received from ceding clients and brokers. For excess of loss contracts, the amount of minimum and/or deposit premium is usually contractually documented at inception, and variances between this premium and final premium are generally small. An adjustment is made to the minimum and/or deposit premium, when notified, if there are changes in underlying exposures insured. For quota share or proportional reinsurance contracts, gross premiums written are normally estimated at inception based on information provided by cedants and/or brokers. We generally record such premiums using the client’s initial estimates, and then adjust them as more current information becomes available, with such adjustments recorded as premiums written in the period they are determined. We believe that the ceding clients’ estimate of the volume of business they expect to cede to us usually represents the best estimate of gross premium written at the beginning of the contract. As the contract progresses, we monitor actual premium received in conjunction with correspondence from the ceding client in order to refine our estimate. Variances from original premium estimates are normally greater for quota share contracts than excess of loss contracts. Premiums are earned on a pro rata basis over the coverage period. The pre-tax impact to net income may be mitigated by related acquisition costs and losses.
During the years ended December 31, 2011, 2010 and 2009, we wrote the following amounts of reinsurance premiums on a quota share or proportional basis and excess of loss basis:
Reinsurance-We offer property and casualty quota share and excess of loss reinsurance from our Bermuda, Bogota, Buenos Aires, Dublin, London and United States offices to insurance companies worldwide. Principal lines of business are agriculture, auto, aviation, credit/surety, general casualty, marine & energy, medical malpractice, professional liability, property, whole account and workers’ compensation.
U.S. specialty-We offer property and casualty insurance coverage from offices in the United States primarily to small- to medium- sized companies. Principal lines of business are general liability, marine, professional liability and property.
We manage our invested assets on an aggregated basis, and do not allocate investment income and realized and unrealized gains on investments to the property and casualty segments. Because of the longer duration of liabilities on life and annuity reinsurance business, investment returns are important in evaluating the profitability of this segment; accordingly, we allocate investment returns from the consolidated portfolio to this segment. The allocation is based on a notional allocation of invested assets from the consolidated portfolio using durations that are determined based on estimated cash flows for the life segment. The balance of investment returns from this consolidated portfolio is allocated to the corporate function for the purposes of segment reporting.
The following is a discussion and analysis of our consolidated results of operations for the years ended December 31, 2011, 2010 and 2009, which are summarized below:
(c) The general and administrative expense ratio is calculated by dividing general and administrative expenses by net premiums earned for the property and casualty business.
Premiums. Gross premiums written for the year ended December 31, 2011 increased by 35.0% compared to the prior year. The principal reason for the increase was the additional reinsurance premiums written as a result of the Amalgamation, which were not included in the comparative period prior to May 12, 2010. In addition, favorable market conditions in the property and auto lines of business in the reinsurance segment resulted in increased premiums written in these lines. We also continued to expand our product offerings in Alterra at Lloyd’s and our operations in Latin America generated increased levels of premiums written in the year ended December 31, 2011. Our insurance and U.S specialty segments also had modest growth in premiums written during the year primarily due to pricing increases and new business in certain lines of business as well as increased product offerings.
The decrease in our life and annuity segment was principally due to no new contracts being written in this segment during the years ended December 31, 2011 and 2010, compared to one contract written in the year ended December 31, 2009. We made the decision in 2010 not to write any new life and annuity contracts for the foreseeable future.
The ratio of reinsurance premiums ceded to gross premiums written for the year ended December 31, 2011 was 24.8% compared to 26.3% for the year ended December 31, 2010. The decrease in the percentage of reinsurance premiums ceded compared to the prior year was principally due to the Amalgamation and the reduction in the amount of business ceded by our reinsurance segment. This was partially offset due to the 100% retrocession of the business written through our contracted general agent distribution channel (our “contract binding” business) in our U.S. specialty segment starting from August 1, 2011 (see section entitled U.S. Specialty), along with the impact of additional ceded reinstatement premiums in our Alterra at Lloyd’s segment. We continually monitor our need for reinsurance based on aggregate risk exposures.
The ratio of reinsurance premiums ceded to gross premiums written for the year ended December 31, 2010 was 26.3% compared to 34.9% for the year ended December 31, 2009. The decrease was principally due to the inclusion of the former Harbor Point business from May 12, 2010 at a lower ratio of ceded to written premiums, and the cancellation of a significant property quota share treaty in our U.S. specialty segment. The cancellation of the property quota share treaty in our U.S. specialty segment reduced reinsurance premiums ceded by $20.6 million.
Net premiums earned is a function of the earning of gross premiums written and reinsurance premiums ceded over the last several quarters and, therefore, changes in net premiums earned generally lag quarterly increases and decreases in gross premiums written and reinsurance premiums ceded. As a result, net premiums earned tend to be less volatile than gross premiums written and reinsurance premiums ceded. The increase in net premiums earned for the year ended December 31, 2011 compared to the prior year was principally due to the incremental earnings as a result of the Amalgamation. In addition, organic growth in our Alterra at Lloyd’s segment contributed to the increase in net premiums earned. The increase in net premiums earned for the year ended December 31, 2010 compared to the year ended December 31, 2009 was principally due to the incremental earnings as a result of the Amalgamation.
Net investment income. Net investment income for the year ended December 31, 2011 increased by 5.6% compared to the prior year. The increase in net investment income was principally attributable to the increase in cash and invested assets as a result of the Amalgamation, with some additional benefit from shifting cash into higher yielding fixed maturity securities. Our average investment yield was 3.09% for the year ended December 31, 2011 compared to 3.39% and 3.56% for the years ended December 31, 2010 and 2009, respectively. The yields available in the current fixed maturity market generally are lower than the average yield on our existing portfolio. Due to the anticipated continuing low-yield market environment, we expect continued downwards pressure on our investment yield.
Net realized and unrealized gains (losses) on investments. Net realized and unrealized gains and losses on investments may vary significantly from period to period. For the year ended December 31, 2011, the principal component of the net loss was a $25.0 million loss on a catastrophe bond with exposure to the Japan earthquake and tsunami, compared to an increase in fair value of catastrophe bonds of $0.4 million in the prior year period. The year ended December 31, 2011 also included a decrease in fair value of our hedge funds of $11.8 million compared to an increase of $14.3 million in the prior year period, and a decrease in fair value of derivatives of $13.6 million compared to a decrease of $12.0 million in the prior year period.
The principal components of the decrease in net realized and unrealized gains and losses on investments from the 2009 year to the 2010 year were hedge fund and derivative returns. The increase in fair value of hedge funds for the year ended December 31, 2010 was $14.3 million compared to an increase of $75.8 million for the year ended December 31, 2009. Also contributing to the decrease year-over-year was a $10.4 million loss on an interest rate forward transaction entered into in the second quarter of 2010 in contemplation of a possible long term debt issuance.
Other income. During the year ended December 31, 2011, Alterra E&S sold the renewal rights to our contract binding business. We recognized a net gain on sale of $0.8 million, which included the derecognition of goodwill of $1.0 million. Commencing August 1, 2011, until the earlier of the date the purchaser or Alterra E&S elects and February 1, 2013, the contract binding business will be written by Alterra E&S and we will cede 100% of the premiums and losses to the purchaser. Under the terms of the sale, we are entitled to additional contingent consideration should gross premiums written by the contract binding business exceed a specified threshold while the quota share reinsurance agreement is still in effect. Also included in other income in the year ended December 31, 2011 are fees earned for the management of New Point Re IV.
Net favorable loss development for the year ended December 31, 2011 was principally the result of net favorable development in our property, workers compensation, general casualty, professional liability, aviation and whole account lines of business, partially offset by net unfavorable development in the medical malpractice line of business in our reinsurance segment and in the general liability line in our U.S. specialty segment. The unfavorable reserve development in our U.S. specialty segment principally related to the contract binding business, for which we sold the renewal rights for all renewals after August 1, 2011;
Excluding the net favorable loss development, the loss ratio was 77.3% for the year ended December 31, 2011 compared to 65.1% for the year ended December 31, 2010. The increase in the loss ratio for the year ended December 31, 2011 compared to the prior year was principally due to the increase in significant property catastrophe losses in 2011; and
Net favorable loss development for the year ended December 31, 2010 was principally the result of net favorable development in our workers’ compensation, property, general casualty, professional liability and whole account lines of business, partially offset by net unfavorable development on marine & energy lines, compared to net favorable development on professional liability, property and general casualty lines offset by net unfavorable development on marine & energy lines in the year ended December 31, 2009;
Acquisition costs. Our acquisition cost ratio for the year ended December 31, 2011 increased by 2.3 percentage points compared to the prior year. The increase in the acquisition cost ratio was principally due to changes in the mix of business written. The insurance and reinsurance contracts we write have a wide range of acquisition cost ratios. Our relative mix of insurance and reinsurance business has moved towards more reinsurance, with 66.9% of net premiums earned being from reinsurance business for the year ended December 31, 2011 compared to 60.4% for the year ended December 31, 2010. This resulted in an increase in the acquisition cost ratio as reinsurance business tends to have higher acquisition costs compared to insurance. A decrease in the level of reinsurance purchased across our segments also contributed to the increase in the ratio for the year ended December 31, 2011. As we retain more business in our segments, we receive less ceding commission income to offset our brokerage and commission costs, which increases our acquisition cost ratio.
Merger and acquisition expenses. Merger and acquisition expenses for the year ended December 31, 2010 comprised advisory, legal and other professional fees, the acceleration of stock based compensation expense and other merger related expenses related to the Amalgamation. These expenses were offset by the negative goodwill gain of $95.8 million recognized from the Amalgamation. Merger and acquisition expenses for the year ended December 31, 2009 comprised advisory, legal and other professional fees related to the proposed transaction with IPC Holdings Limited and IPC Limited, which was terminated in June 2009, offset by a $50.0 million termination fee received.
General and administrative expenses. General and administrative expenses for the year ended December 31, 2011 increased by $36.4 million compared to the year ended December 31, 2010. The increase was principally due to the increased size of the Company following the Amalgamation. The year ended December 31, 2011 was the first full fiscal year of post-Amalgamation level expenses. Expansion of our underwriting teams, growth in Latin America and regulatory changes in Europe also contributed to the increase in general and administrative expenses in the period. These increases were partially offset by decreases in incentive based compensation. The increase in net earned premiums resulted in a small decrease in our general and administrative expense ratio for the year ended December 31, 2011 compared to the year ended December 31, 2010.
Income tax expense (benefit). Corporate income tax expense or benefit is generated through our foreign operations outside of Bermuda, principally in the United States, Europe and Latin America. The effective tax rate was negative 17.0% for the year ended December 31, 2011 compared with 1.4% in the year ended December 31, 2010 and 3.9% in the year ended December 31, 2009. Our effective income tax rate, which we calculate as income tax expense or benefit divided by net income or loss before taxes, may fluctuate significantly from period to period depending on the geographic distribution of pre-tax net income or loss in any given period between different jurisdictions with different tax rates. The geographic distribution of pre-tax net income or loss can vary significantly between periods principally due to the mix of business written and earned during the period, the geographic location of investment income and realized and unrealized investment gains and losses and the geographic location of net losses and loss expenses incurred.
Our effective tax rate changed significantly for the year ended December 31, 2011 due principally to two factors. Our results for the year ended December 31, 2011 contained a significant amount of property catastrophe losses and the distribution of these losses was heavily weighted towards jurisdictions with a higher tax rate. Further contributing to the change in effective tax rate was the release of a valuation allowance related to deferred tax assets in our U.S. subsidiaries, which had the effect of increasing the tax benefit for the year.
The Company’s income before taxes, income tax expense (benefit) and effective income tax rate for the years ended December 31, 2011, 2010 and 2009 were:
(b) Long tail includes excess liability and professional liability lines of business.
Gross premiums written decreased in the year ended December 31, 2010 by 10.7% compared to the year ended December 31, 2009. Significant factors affecting 2010 gross premiums written were:
A decrease in gross premiums written in our excess liability line for the year ended December 31, 2010 due to fewer attractive opportunities.
Net favorable loss development in the year ended December 31, 2011 reflected better than expected loss emergence across all lines of business, most significantly in the property, excess liability and professional liability lines. Favorable loss development principally emerged on the 2009 and 2010 years for the property line of business and on the 2005 and 2006 years for excess liability and professional liability lines of business;
Excluding the net favorable loss development, the loss ratio was 81.9% for the year ended December 31, 2011 compared to 79.0% for the year ended December 31, 2010. The increase was principally due to higher losses related to property catastrophe and significant per-risk losses during the year ended December 31, 2011 compared to the year ended December 31, 2010; and
For the year ended December 31, 2011, our results included net losses of $15.4 million related to property catastrophe events and significant per-risk losses compared to $12.1 million for the year ended December 31, 2010. A portion of these losses fall within our attritional loss ratio, as we expect a certain level of property losses in each period. Large events during the year ended December 31, 2011 included losses resulting from the Australia floods, Cyclone Yasi, the New Zealand earthquake, the Japan earthquake and tsunami, tornadoes and flooding in the United States and Hurricane Irene.
Acquisition costs. Acquisition costs are presented net of ceding commission income associated with reinsurance premiums ceded. These ceding commissions are designed to compensate us for the costs of producing the portfolio of risks ceded to our reinsurers. Acquisition costs generally fluctuate based on shifts in business mix year over year.
General and administrative expenses. General and administrative expenses for the year ended December 31, 2011 increased $3.2 million compared to the year ended December 31, 2010. The increase was principally due to increased headcount and expenses associated with expanding our underwriting infrastructure within Alterra Insurance USA. These increases, together with the decrease in net premiums earned, resulted in a higher general and administrative expense ratio for the year ended December 31, 2011 compared to the prior year.
General and administrative expenses for the year ended December 31, 2010 increased $6.6 million compared to the year ended December 31, 2009. The increase was principally due to increased performance based compensation expense resulting from improved underwriting results compared to the prior year, and a shift to a larger cash component and fewer stock-based awards.
The underwriting results of the former Harbor Point companies have been included within the reinsurance segment for the period from May 12, 2010. As a result, a comparison of 2011 results with 2010 and 2009 results is not meaningful. For this reason, we have included certain financial information for the reinsurance segment on a combined pro forma basis for informational purposes only as if the Amalgamation had occurred on January 1, 2009. See the section entitled Reinsurance Segment on a pro forma basis for a presentation of the combined pro forma information.
(a) Short tail includes agriculture, auto, aviation, credit/surety, marine & energy, other, property and whole account lines of business.
Premiums. Gross premiums written for the year ended December 31, 2011 increased by 70.9% compared to the year ended December 31, 2010. Significant factors affecting 2011 gross premiums written were:
Gross premiums written in our property line increased due to new business and increases in participations due to improved pricing and market conditions. This growth included an increase in property gross premiums written related to our Latin America operations from $14.5 million for the year ended December 31, 2010 to $36.6 million for the year ended December 31, 2011;
An increase in agriculture premiums resulting from the Amalgamation was partially offset by the non-renewal of a $29.9 million contract resulting from the client retaining more business;
Medical malpractice premiums decreased principally due to reduction in line sizes, increase in client retentions and reduced estimates of assumed premiums on some quota share policies;
Net losses and loss expenses. The loss ratio increased 8.7 percentage points for the year ended December 31, 2011 compared to the year ended December 31, 2010. The net favorable and (unfavorable) development of prior year reserves in the years ended December 31, 2011, 2010 and 2009 by line of business was as follows:
Net favorable loss development of prior year reserves in the year ended December 31, 2010, excluding the effect of premium adjustments, was $44.6 million compared to $32.0 million in the year ended December 31, 2009. Included in the net favorable development for the year ended December 31, 2010 was an $8.9 million reduction to net loss reserves on a significant prior year workers’ compensation contract for which there was an offsetting reduction to net premiums earned of $9.5 million. As a result, the net favorable loss development on this workers’ compensation contract had a modest negative impact on net income;
The net favorable development in the year ended December 31, 2010 reflected better than expected loss emergence. Favorable loss development principally emerged on the 2008 and 2009 years for the property line of business, on the 2002 - 2009 years for the general casualty line of business and on the 2005 and prior years for the workers’ compensation lines of business. This favorable loss development was partially offset by unfavorable development principally on the 2004 and 2008-2009 years for the professional liability line of business, the 2005 - 2009 years for the marine & energy line of business and the 2007 and 2009 years for the aviation line of business;
Partially offsetting the decrease described above was the increased property catastrophe-related and significant per-risk losses. The year ended December 31, 2010 included $27.8 million in property catastrophe-related and significant per-risk losses, principally as a result of the Deepwater Horizon oil spill, Europe Windstorm Xynthia, Australia hailstorms, the New Zealand earthquake and floods in Australia. The year ended December 31, 2009 included $2.0 million in property catastrophe-related and significant per-risk losses.
Increases in net earned premiums, net of acquisition costs of $12.9 million, resulted in a increase in prior year loss reserves of $14.3 million for the year ended December 31, 2011. Decreases in net earned premiums, net of acquisition costs of $8.5 million and $11.7 million for the years ended December 31, 2010 and 2009, respectively, resulted in a decrease in prior year loss reserves of $7.8 million and $11.4 million for the years ended December 31, 2010 and 2009, respectively. Changes in premium estimates occur on prior year contracts each year as we receive additional information on the underlying exposures insured and the associated loss is recorded, at the original loss ratio, concurrently with the premium adjustment.
Acquisition costs. The ratio of acquisition costs to net premiums earned for the year ended December 31, 2011 increased 1.2 percentage points compared to the year ended December 31, 2010. The reinsurance contracts that we write have a wide range of acquisition cost ratios and the variance is the result of shifts in the mix of business written and earned. For the year ended December 31, 2011, a higher proportion of net earned premiums were from our auto, whole account and credit/surety lines of business, which generally have higher acquisition cost ratios compared to other lines of business.
The ratio of acquisition costs to net premiums earned for the year ended December 31, 2010 increased 2.6 percentage points compared to the year ended December 31, 2009. The increase in the acquisition cost ratio was principally due to changes in the mix of business written, partially influenced by the additional net premiums earned from the former Harbor Point companies. The former Harbor Point business contains a higher proportion of quota share contracts, which generally have higher acquisition cost ratios than excess of loss contracts.
General and administrative expenses for the year ended December 31, 2010 increased $34.2 million compared to the year ended December 31, 2009. The increase was principally due to the inclusion of Harbor Point’s expenses for the period from May 12, 2010. In addition, there was an increase in performance based compensation expense as a result of improved underwriting results compared to the prior year, and a shift to a larger cash component and fewer stock-based awards, compared to 2009.
The following table presents certain financial information for the reinsurance segment on an actual reported basis for the year ended December 31, 2011 and on a combined pro forma basis (after the elimination of intercompany transactions and the amortization of certain acquisition accounting adjustments) for the years ended December 31, 2010 and 2009, for informational purposes only, as if the Amalgamation had occurred on January 1, 2010 and January 1, 2009, respectively. The pro forma data does not necessarily represent results that would have occurred if the Amalgamation had taken place at the beginning of each period presented, nor is it indicative of future results.
(d) The combined ratio is calculated by dividing the sum of net losses and loss expenses, acquisition costs and general and administrative expenses by net premiums earned.
Gross premiums written in our auto line of business increased principally due to an increase in quota share contracts that renewed in the period due to price and volume increases at the ceding companies as well as an increased participation on one contract. In addition, the year ended December 31, 2011 included an increase in premium estimates of $9.5 million related to 2010 quota share contracts also primarily due to price and volume increases at the ceding companies;
Gross premiums written in our property line of business increased principally due to new business and increases in participations due to improved pricing and market conditions. In addition, the year ended December 31, 2011 included gross premiums written on property of $36.6 million compared to $14.5 million for the year ended December 31, 2010 related to our Latin America operations; and
Gross premiums written in our whole account line of business decreased due to reductions in our participation on two quota share contracts.
Gross premiums written would have decreased in our agriculture line of business principally due to the non-renewal of a contract as a result of a client merger in 2010;
Marine & energy, medical malpractice and professional liability premiums would have decreased principally due to reductions in line sizes, increase in client retentions and reduced estimates of assumed premiums on certain quota share policies;
The net favorable development in the year ended December 31, 2011 was principally due to favorable development on our property, workers compensation, aviation and professional liability lines of business, partially offset by unfavorable development on our medical malpractice line of business. The favorable development in the year ended December 31, 2010 would have been principally on our property, general casualty and workers’ compensation lines of business, partially offset by unfavorable development on our professional liability and marine & energy lines of business;
Excluding the net favorable loss development, the loss ratio was 73.9% for the year ended December 31, 2011, compared to 65.7% (and after adjusting for a $9.5 million reduction to net premiums earned for a workers’ compensation contract) for the year ended December 31, 2010. The increase in the loss ratio for the year ended December 31, 2011 would have been principally due to the significant increase in property catastrophe events; and
The favorable development in the year ended December 31, 2010 would have been principally on our property, general casualty and workers compensation lines of business, partially offset by unfavorable development on our professional liability and marine & energy lines of business. The favorable development in the year ended December 31, 2009 would have been principally on our property and general casualty lines of business, partially offset by unfavorable development recognized on our marine & energy line of business;
Included in the net favorable development for the year ended December 31, 2010 would have been an $8.9 million reduction to net loss reserves on a significant prior year workers’ compensation contract for which there was an offsetting reduction to net premiums earned of $9.5 million. As a result, the net favorable loss development on this workers’ compensation contract would have had a modest negative impact on net income;
Excluding the net favorable loss development (and after adjusting for the $9.5 million reduction to net premiums earned for the workers’ compensation contract discussed above), the loss ratio would have been 65.7% for the year ended December 31, 2010 and 56.5% for the year ended December 31, 2009. The increase in the loss ratio would have been principally due to the significant increase in property catastrophe events and significant per-risk losses; and
General and administrative expenses for the year ended December 31, 2010 would have decreased compared with the year ended December 31, 2009, principally due to the decrease in the amortization expense of renewal rights held by Harbor Point. The renewal rights were included in the assets of Chubb Re acquired by Harbor Point in 2005 and were fully amortized by the end of 2009. The general and administrative expense ratio would not have changed significantly from 2009 to 2010 as the 6.8% decrease in general and administrative expense would have been offset by an 8.5% decrease in net premiums earned.
During the year ended December 31, 2011, Alterra E&S sold the renewal rights to our contract binding business. Commencing August 1, 2011, until the earlier of the date the purchaser or Alterra E&S elects and February 1, 2013, the contract binding business will be written by Alterra E&S and we will cede 100% of the premiums and losses to the purchaser. As a result, our volume of gross premiums written with respect to the contract binding business is expected to continue for the foreseeable future. The 100% quota share reinsurance of this business means that we will not retain any written and earned premium or net losses, but we will earn a ceding commission, on new and renewal policies incepting after August 1, 2011.
The ratio of reinsurance premiums ceded to gross premiums written for the year ended December 31, 2010 decreased from 55.9% in the year ended December 31, 2009. This decrease was principally due to the cancellation of a property quota share treaty that was replaced with a surplus share treaty under which we retain more risk.
Net losses and loss expenses. The loss ratio for the year ended December 31, 2011 increased 6.6 percentage points compared to the year ended December 31, 2010. The net favorable and (unfavorable) development of prior year reserves in the years ended December 31, 2011, 2010 and 2009 by line of business was as follows:
Excluding the net favorable loss development, the loss ratio was 63.6% for the year ended December 31, 2011 compared to 63.2% for the year ended December 31, 2010. The increase was principally due to changes in the mix of business, particularly an increase in the marine and professional liability lines of business. These lines of business have a higher average loss ratio than property lines, which declined as a percentage of gross premiums written; and
Excluding the net favorable loss development, the loss ratio was 63.2% and 59.2% for the years ended December 31, 2010 and December 31, 2009, respectively. The increase in the loss ratio was principally due to changes in the mix of business; and
Our results for the year ended December 31, 2010 include net losses of $7.0 million for property catastrophe losses and significant per-risk losses. Large loss events in the year ended December 31, 2010 included flooding in Tennessee and storms in the northeastern United States. These losses were contained within our annual loss expectations for the property line of business. In the fourth quarter of 2010, we reduced our original estimate of net losses associated with these events by $2.0 million. During the year ended December 31, 2009, we did not incur any significant property catastrophe losses or significant per-risk losses.
Acquisition expenses. The acquisition cost ratio increased in each of the last two years as we reduced the amount of reinsurance purchased. As we retain more business, we receive less ceding commission income to offset our brokerage and commission costs, which increases our acquisition cost ratio. This effect should be tempered over the near term by the ceding commission income we expect to earn on the reinsurance of the contract binding business that we sold in August of 2011.
General and administrative expenses. General and administrative expenses for the year ended December 31, 2011 increased $5.7 million compared to the prior year. The increase was principally due to additional costs associated with the sale of our contract binding business, costs associated with the establishment of our new excess casualty platform and an increase in expenses related to stock based compensation. Notwithstanding these factors, the general and administrative expense ratio for the year ended December 31, 2011 was consistent with the prior year, principally due to the gradual increase in net premiums earned compared to the prior year period.
Our Alterra at Lloyd’s segment comprises all of our Lloyd’s operating businesses. This includes the underwriting operations of the Syndicates for which we record our proportionate share.
(a) Short tail includes accident & health, aviation, marine, property and surety lines of business.
(b) Long tail includes financial institutions, international casualty and professional liability lines of business.
Premiums. Gross premiums written for the year ended December 31, 2011 increased 43.4% compared to the prior year. The increase in 2011 gross premiums written was primarily due to:
An increase of $7.8 million in our financial institutions line of business for the year ended December 31, 2011 principally due to the addition of the specie product line during the year.
For the year ended December 31, 2011, the above increases were partially offset by a planned decrease in our aviation line of business.
Gross premiums written for the year ended December 31, 2010 increased 57.1% compared to the year ended December 31, 2009. The increase in 2010 gross premiums written was primarily due to:
The addition of aviation business to our Alterra at Lloyd’s segment in the fourth quarter of 2009, which largely represented a transfer of business previously written within our insurance segment;
The commencement of underwriting in Brazil in 2010, which generated $22.9 million of gross premiums written for the year ended December 31, 2010, primarily in the property line of business.
The ratio of reinsurance premiums ceded to gross premiums written for the year ended December 31, 2010 was 18.5% compared to 25.5% for the year ended December 31, 2009. The volume of reinsurance premiums ceded did not increase at the same rate as the increase in gross premiums written because a significant proportion of our reinsurance program are excess of loss contracts rather than quota share (proportional) contracts.
Excluding the net favorable loss development, the loss ratio was 102.0% for the year ended December 31, 2011 compared to 55.4% for the year ended December 31, 2010. The increase in the loss ratio was principally due to catastrophe-related and significant per-risk losses; and
The loss ratio for the year ended December 31, 2010 decreased by 1.9 percentage points compared to the year ended December 31, 2009. Significant items impacting the 2010 loss ratio were:
Net losses and loss expense for the year ended December 31, 2010 included $8.1 million in catastrophe-related and significant per-risk losses, which included net losses from the Chile earthquake, Europe Windstorm Xynthia, Australia hail storms, the New Zealand earthquake and Australia floods. Losses and loss expense for the year ended December 31, 2009 included $1.4 million in catastrophe-related and significant per risk losses.
Acquisition expenses. The acquisition cost ratio increased 4.9 percentage points for the year ended December 31, 2011 compared to the prior year. The year ended December 31, 2011 was impacted by the re-estimation of certain commission expenses based on updated information. The remaining increase was attributable to changes in the mix of business written.
The acquisition cost ratio decreased 1.2 percentage points for the year ended December 31, 2010 compared to the year ended December 31, 2009. The decrease in acquisition costs was principally attributable to the addition of international casualty business in the first quarter of 2010, which has a lower average acquisition cost ratio than other lines of business.
There were no new life and annuity contracts written during the years ended December 31, 2011 and 2010. One new reinsurance contract was written in the year ended December 31, 2009, accounting for most of the premiums written for that year. Our life and annuity business was focused exclusively on acquiring policies with significant reserve balances, which allowed us to earn a profit by investing at a higher yield than the cost of funds of those reserves. We were able to execute this strategy successfully in prior years as our investment in hedge funds constituted a significant portion of our total investments and investment yields in general were more attractive. Our investment strategy is now focused primarily on holding high quality fixed maturity securities, which makes it difficult to grow our life and annuity business profitably. As a result, we have decided not to write any new life and annuity contracts for the foreseeable future. This decision does not affect our existing life and annuity reinsurance contracts and we continue to service our existing life and annuity customer base.
The nature of life and annuity reinsurance transactions that we historically had written resulted in a limited number of transactions actually bound with potentially large variations in quarterly and annual premium volume. Consequently, components of our underwriting results, such as premiums written, premiums earned and claims and policy benefits can be volatile, and period-to-period comparisons are not necessarily representative of future trends.
Our life and annuity benefit reserves are recorded on a discounted present value basis. This discount is amortized through income as a claims and policy benefits expense over the term of the underlying policies. As a result, income is driven by the spread between the actual rate of return on our investments and the interest discount on our reserves, together with differences between estimated and actual claims, premiums, expenses and persistency of the underlying policies.
Net investment income. The increase in net investment income for each of the years since 2009 was attributable principally to the increase in cash and invested assets as a result of the Amalgamation on May 12, 2010. Partially offsetting the increased investment base were declining investment yields each year. The yields available in the current fixed maturity market are generally lower than the average yield on our existing portfolio. As a result, we expect continuing downwards pressure on our investment yield for the foreseeable future.
Six of the nine hedge fund strategies we employed experienced negative returns during the year ended December 31, 2011. The largest contributors by investment strategy to the decrease in fair value for the year ended December 31, 2011 were the event-driven arbitrage and diversified arbitrage strategies. As of December 31, 2011, 8.5% and 7.0% of our hedge fund portfolio was allocated to the event-driven arbitrage and diversified arbitrage strategies, respectively. The largest increase in fair value offsetting the overall decrease for year was contributed by the global macro strategy. As of December 31, 2011, 19.6% of our hedge fund portfolio was allocated to this strategy.
Eight of the nine hedge fund strategies we employed experienced positive returns during the year ended December 31, 2009. The largest contributors by investment strategy to the net gain for the year ended December 31, 2009 were the distressed securities and the event driven arbitrage strategies. As of December 31, 2009, 20.0% and 13.3% of our hedge fund portfolio was allocated to the distressed securities and the event driven arbitrage strategies, respectively.
The allocation of invested assets to our hedge fund portfolio as of December 31, 2011 was 3.2%, which is consistent with our expected ongoing allocation. The objective of our hedge fund portfolio is to achieve a market neutral/absolute return strategy, with diversification by strategy and underlying fund. A market neutral strategy strives to generate consistent returns in both up and down markets by selecting long and short positions with a total net exposure of zero. Returns are derived from the long/short spread, or the amount by which long positions outperform short positions. The objective of an absolute return strategy is to provide stable performance regardless of market conditions, with minimal correlation to market benchmarks.
The fair value of derivatives decreased by $13.6 million for the year ended December 31, 2011 compared to a decrease of $12.0 million for the year ended December 31, 2010. We hold various derivative instruments, including convertible bond equity call options, interest rate linked derivative instruments and foreign currency forward contracts. The majority of the loss for the year ended December 31, 2011 came from interest rate swap positions taken as part of a total return strategy followed by a portion of our investment portfolio.
As of December 31, 2011, we held an index-linked structured deposit. The deposit has a guaranteed minimum redemption amount of $24.3 million and a scheduled redemption date of December 18, 2013. Changes in the fair value of the structured deposit were due entirely to changes in the reference index.
Net impairment losses recognized in earnings. As a result of our quarterly review of securities in an unrealized loss position, we recorded OTTI losses through earnings for the years ended December 31, 2011, 2010 and 2009 of $2.9 million, $2.6 million and $3.1 million, respectively. These impairment losses are presented separately from all other net realized and unrealized gains and losses on investments. A discussion of our process for estimating OTTI is included in Note 3 of our audited consolidated financial statements included herein.
Cash and invested assets. Aggregate invested assets, comprising cash and cash equivalents, fixed maturities and other investments, were $7,814.7 million as of December 31, 2011 compared to $7,861.4 million as of December 31, 2010, a decrease of 0.6%. The modest decrease in cash and invested assets resulted principally from the combination of the timing of the settlement of premiums and losses, growth in our available for sale portfolio, partially offset by smaller held to maturity and other investment portfolios, foreign exchange losses on the held to maturity portfolio, and payments for share repurchases and dividends.
Our fixed maturity portfolio comprises high quality, liquid securities. As of December 31, 2011, our fixed maturities investments had a dollar-weighted average credit rating of Aa2/AA. Under our fixed maturities investment guidelines, a minimum weighted average credit rating of Aa3/AA-, or its equivalent, must be maintained for our fixed maturities investment portfolio as a whole. Our fixed maturities investment guidelines also provide that we cannot leverage our fixed maturities investments. Further details of the credit ratings on our fixed maturities investments are included in Note 3 of our audited consolidated financial statements included herein.
Our portfolio of fixed maturities includes mortgage-backed and asset-backed securities and collateralized mortgage obligations. These types of securities have cash flows that are backed by the principal and interest payments of a group of underlying mortgages or other receivables. As a result of the increasing default rates of borrowers, there currently is a greater risk of defaults on mortgage-backed and asset-backed securities and collateralized mortgage obligations than historically existed, especially those that are non-investment grade. These factors make estimating the fair value of these securities more uncertain. We obtain fair value estimates from multiple independent pricing sources in an effort to mitigate some of the uncertainty surrounding the fair value estimates. If we need to liquidate these securities within a short period of time, the actual realized proceeds may be significantly different from the fair values estimated as of December 31, 2011.
We performed a review of securities in an unrealized loss position as of December 31, 2011 for OTTI, which included the consideration of relevant factors, including prepayment rates, subordination levels, default rates, credit ratings, weighted average life and cash flow testing. Together with our investment managers, we continue to monitor our potential exposure to mortgage-backed and asset-backed securities, and we will make adjustments to the investment portfolio, if and when we deem necessary. As a result of this process, we recognized an other than temporary impairment charge through net income of $2.9 million during the year ended December 31, 2011.
As of December 31, 2011, we hold securities issued by European financial institutions with a fair value of $471.0 million, distributed as follows:
Fair value prices for all securities in our fixed maturities portfolio are independently provided by our investment custodians, our investment accounting service provider and our investment managers, with each utilizing internationally recognized independent pricing services. We record the unadjusted price provided by the investment custodian, investment accounting service provider or investment manager after validating the prices. Our validation process includes: (i) comparison of prices between two independent sources, with significant differences requiring additional price sources; (ii) quantitative analysis (e.g., comparing the quarterly return for each managed portfolio to its target benchmark, with significant differences identified and investigated); (iii) evaluation of methodologies used by external parties to calculate fair value, including a review of the inputs used for pricing; and (iv) comparing the price to our knowledge of the current investment market.
We have designed ongoing due diligence processes with respect to funds in which we invest and their managers. These processes are designed to assist us in assessing the quality of information provided by, or on behalf of, each fund and in determining whether such information continues to be reliable or whether further review is necessary. While reported net asset value is the primary input to the review, when the net asset value is deemed not to be indicative of fair value, we may incorporate adjustments to the reported net asset value. These adjustments may involve significant judgment. We obtain the audited financial statements for every fund annually and regularly review and discuss the fund performance with the fund managers to corroborate the reasonableness of the reported net asset values.
We are able to redeem the hedge fund portfolio on the same terms that the underlying funds can be liquidated. In general, the funds in which we are invested require at least 30 days notice of redemption, and may be redeemed on a monthly, quarterly, semi-annual, annual or longer basis, depending on the fund.
The majority of our hedge fund portfolio is redeemable within one year, and the imposition of gates by certain funds is not expected to significantly impact our cash flow needs. Based upon information provided by the fund managers, as of December 31, 2011, we estimate that over 72.0% of the underlying assets held by our hedge fund portfolio are traded securities or have broker quotes available. Typically, the imposition of a gate delays a portion of the requested redemption, with the remaining portion settled in cash shortly after the redemption date. Of our December 31, 2011 outstanding redemptions receivable of $23.8 million, none of which are gated, $21.1 million was received in cash prior to February 23, 2012. The fair value of our holdings in funds with gates imposed as of December 31, 2011 was $19.1 million.
As of December 31, 2011, 85.9% of our losses and benefits recoverable were with reinsurers rated “A” or above by A.M. Best, 8.4% were rated “A-” and the remaining 5.7% were with “NR-not rated” reinsurers. Grand Central Re, a Bermuda domiciled reinsurance company in which Alterra Bermuda has a 7.5% equity investment, is our largest “NR-not rated” retrocessionaire and accounted for 3.3% of our losses and benefits recoverable as of December 31, 2011. As security for outstanding loss obligations, we retain funds from Grand Central Re amounting to 214.1% of its loss recoverable obligations. Of the remaining amounts with “NR-not rated” retrocessionaires we retain collateral equal to 84.0% of the losses and benefits recoverable. Our losses and benefits recoverable are not due for payment until the underlying loss has been paid. As of December 31, 2011, 95.6% of our losses and benefits recoverable were not due for payment.
Liabilities for property and casualty losses. Property and casualty losses totaled $4,216.5 million as of December 31, 2011 compared to $3,906.1 million as of December 31, 2010, an increase of 7.9%. During the year ended December 31, 2011, we incurred gross losses of $1,188.8 million, we paid $873.2 million in property and casualty losses and we recorded gross favorable development on prior year reserves of $160.5 million. Net of reinsurance, we paid $748.6 million in property and casualty losses during the year ended December 31, 2011.
Liabilities for life and annuity benefits. Life and annuity benefits totaled $1,190.7 million as of December 31, 2011 compared to $1,275.6 million as of December 31, 2010. The decrease was principally attributable to movements in foreign exchange rates. We endeavor to match these liabilities with assets of similar currency and duration in order to limit the net impact to shareholders’ equity of movements in foreign exchange rates. In addition, we paid $120.5 million of benefit payments during the year ended December 31, 2011.
Liquidity. We generated $235.6 million of cash from operations during the year ended December 31, 2011 compared to $308.3 million for the year ended December 31, 2010. The two principal factors that impact our operating cash flow are premium collections and timing of loss and benefit payments.
Our casualty business generally has a long claim-tail. As a result, we expect that we will generate significant operating cash flow as we accumulate property and casualty loss reserves on our balance sheet. Our property business generally has a short claim-tail. Consequently, we expect volatility in our operating cash flow levels as losses are incurred. We believe that our property and casualty loss reserves and life and annuity benefit reserves currently have an average duration of approximately 4.9 years. We expect increases in the amount of expected loss payments in future periods with a resulting decrease in operating cash flow; however, we do not expect loss payments to exceed the premiums generated. Actual premiums written and collected and losses and loss expenses paid in any period could vary materially from our expectations and could have a significant and adverse effect on operating cash flow.
While we tailor our fixed maturities portfolios in an effort to match the duration of expected loss and benefit payments, increased loss amounts or settlement of losses and benefits earlier than anticipated can result in greater cash needs. We maintain a significant working cash balance and have generated positive cash flow from operations in each of our last eight years of operating history. We also have the ability to borrow an additional $250.0 million using our current credit facilities, subject to certain conditions. Our largest credit facility, a $1,100.0 million four-year secured facility, expires in December 2015. Our cash and cash equivalents balance was $922.8 million as of December 31, 2011. We believe that we currently maintain sufficient liquidity to cover existing requirements and provide for contingent liquidity. Nonetheless, significant deviations in expected loss and benefit payments can occur, potentially requiring us to liquidate a portion of our fixed maturities portfolios. If we need to liquidate our fixed maturities securities within a short period of time, the actual realized proceeds may be significantly different from the fair values estimated as of December 31, 2011. We believe that our portfolio has sufficient liquidity to mitigate this risk, and we believe that we can continue to hold any potentially illiquid position until we can initiate an appropriately priced transaction.
In the ordinary course of business, we are required to provide letters of credit or other regulatory approved security to certain of our clients to meet contractual and regulatory requirements. During the year ended December 31, 2011 we replaced our $850.0 million five-year credit facility and our $600.0 million five-year credit facility with a $1,100.0 million four-year credit facility. As of December 31, 2011, we had two U.S. dollar denominated letter of credit facilities totaling $1,175.0 million with an additional $500.0 million available, subject to certain conditions. On that date, we had $604.0 million in letters of credit outstanding under these facilities. We had a British pound sterling, or GBP, denominated letter of credit facility of GBP 30.0 million ($46.6 million) to support our London branch of Alterra Europe, of which GBP 16.8 million ($26.1 million) was utilized as of December 31, 2011. We also had a GBP denominated letter of credit facility of GBP 60.0 million ($93.3 million) which was used to support our Funds at Lloyd’s commitments but is no longer being used for this purpose and is scheduled to expire in June 2012. Each of our credit facilities requires that we comply with certain financial covenants, which may include covenants related to maximum debt to capital ratio, minimum consolidated tangible net worth, minimum insurer financial strength rating and restrictions on the payment of dividends. We were in compliance with all of the financial covenants of each of our credit facilities as of December 31, 2011.
As of December 31, 2011, we provided $209.5 million in Funds at Lloyd’s. These amounts are not available for distribution for the payment of dividends. Our Funds at Lloyd’s commitments are met using cash and fixed maturity securities. Our corporate members may also be required to maintain funds under the control of Lloyd’s in excess of their capital requirements and such funds also may not be available for distribution or the payment of dividends.
We may repurchase our shares from time to time through the open market, privately negotiated transactions or Rule 10b5-1 stock trading plans. During the year ended December 31, 2011, we repurchased 10,389,707 common shares for $225.1 million. As of December 31, 2011, the aggregate amount available under our Board approved share repurchase plan was $104.4 million. On February 8, 2012, our Board of Directors authorized an additional $150.0 million in repurchases.
The amounts in the above table represent our gross estimates of known liabilities as of December 31, 2011 and do not include any allowance for claims for future events within the time period specified. Accordingly, it is highly likely that the total amounts paid out in the time periods shown will be greater than those indicated in the table. Furthermore, life and annuity benefits and deposit liabilities recorded in the audited consolidated financial statements as of December 31, 2011 are computed on a net present value basis, whereas the expected payments by period in the table above are the estimated payments at a future time and do not reflect a discount of the amount payable.
In this Annual Report on Form 10-K, we have presented net operating income and net operating return on average shareholders’ equity, which are “non-GAAP financial measures” as defined in Regulation G. We believe that these non-GAAP financial measures, which may be defined differently by other companies, allow for a more complete understanding of the performance of our business. These measures, however, should not be viewed as a substitute for those determined in accordance with U.S. GAAP. A reconciliation of the non-GAAP financial measures to their respective most directly comparable U.S. GAAP financial measures is as follows:
ASU 2010-06, Fair Value Measurements and Disclosures (820) - Improving Disclosures about Fair Value Measurements
ASU 2010-20, Receivables (310) - Disclosures About the Credit Quality of Financing Receivables and the Allowance for Credit Losses
ASU 2010-26, Financial Services - Insurance (944) - Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts
ASU 2010-26 specifies how insurance companies should recognize costs that meet the definition of acquisition costs as defined by U.S.GAAP. ASU 2010-26 modifies the existing guidance to require that only costs that are associated with the successful acquisition of a new or renewal insurance contract should be capitalized as deferred acquisition costs. Costs that fall outside the proposed definition, such as indirect costs or salaries related to unsuccessful efforts, should be expensed as incurred. ASU 2010-26 is effective for fiscal periods beginning on or after December 15, 2011 with prospective or retrospective application permitted. We do not expect this standard to have a material impact on our consolidated financial statements.
Information with respect to this item is set forth under “Item 15 - Exhibits and Financial Statement Schedules.”