The following Selected Consolidated Financial Data is prepared in accordance with accounting principles generally accepted in the United States. This data should be read in conjunction with the Consolidated Financial Statements and the accompanying Notes to Consolidated Financial Statements.
The Company generates its revenue primarily 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 industry and demand for reinsurance and other risk transfer products. The reinsurance business is also influenced by several other factors, including variations in interest rates and financial markets, changes in legal, regulatory and judicial environments, loss trends, inflation and general economic conditions.
The Company’s profitability is significantly affected by the level of its losses and loss expenses incurred. The Company recognizes losses and loss expenses on the basis of actual and expected claims on business written and earned. The Company’s Non-life net reserve position at December 31, 2007 was $7.1 billion. Management believes that it follows prudent reserving policies to maintain a strong financial position. A key challenge for the Company is the accurate estimation of loss reserves for each line of business, which is critical in order to accurately determine the profitability of each line and allocate the optimal amount of capital to each line. Another key challenge for the Company is to appropriately allocate capital in a manner that optimizes profitability.
In addition to the Consolidated Balance Sheets and Consolidated Statement of Operations and Comprehensive Income, Management uses three key measures to evaluate its financial performance, as well as the overall growth in value generated for the Company’s common shareholders.
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 interest rates and equity markets, which can drive changes in unrealized gains or losses on its investment portfolio. Since December 31, 2002, the Company has generated a compound annual growth rate in diluted book value per share in excess of 14%.
A key challenge in the reinsurance industry is to create economic value through the intelligent assumption of reinsurance and investment risk, but also to limit or mitigate those risks that can destroy tangible as well as intangible value. Management believes that every organization faces numerous risks that could threaten the successful achievement of a company’s goals and objectives. These include choice of strategy and markets, economic and business cycles, competition, changes in regulation, data quality and security, fraud, business interruption and management continuity; all factors which can be viewed as either strategic or operational risks that are common to any industry. (See Risk Factors in Item 1A of Part I of this report). In addition to these risks, the Company assumes risks and its results are primarily determined by how well the Company understands, prices and manages assumed risk. While many industries and companies start with a return goal and then attempt to shed risks that may derail that goal, the Company starts with a capital-based risk appetite and then looks for risks that meet its return targets within that framework. Management believes that this construct allows the Company to balance the cedants’ need for absolute certainty of claims payment with shareholders’ need for an adequate return on their capital.
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 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 portfolio, and by matching the duration of its investment portfolio with that of its net reinsurance liabilities. In 2008, the Company expects to continue to generate positive operating cash flows. Management also maintains credit facilities with banks that can provide efficient access to cash in the event of an unforeseen cash requirement.
The Board approves maximum limits of the key assumed risks as a percentage of the Company’s economic value (defined below), while the Executive Management operates at levels equal to or lower than the maximum limits approved by the Board. The actual level of risks is dependent on current market conditions and the need for balance in the Company’s portfolio of risks. The strategic risks include the direction and governance of the Company, as well as its response to key external factors faced by the reinsurance industry. Operational risks are managed by designated functions within the organization. They include failures or weaknesses in financial reporting and controls, regulatory non-compliance, poor cash management, fraud, breach of information technology security and reliance on third party vendors. The Company seeks to minimize these risks through robust processes and controls. Controls and monitoring processes throughout the organization seek to ensure that the Executive Management and the Board have a comprehensive view of the Company’s risks and related mitigation strategies at all times. Individual business units manage assumed risks, subject to the limits and policies established by the Executive Management and the Board. These are the reinsurance risks that the Company’s clients want to transfer and are the core of the Company’s business. They also include the capital market risks that the Company assumes in the investment of its assets.
The Company believes that it maintains a risk appetite moderately above the average of the reinsurance market because Management believes that this position offers the best potential for creating shareholder value at an acceptable risk level. The most profitable products generally present the most volatility and potential
downside risk. The Company manages that risk through diversification, risk appetite for different risk classes and absolute limits on any one risk. The Company accepts that results on a quarterly basis may be volatile; however, it seeks to protect itself from downside risk that can materially impair its balance sheet. The limits imposed represent the boundaries of risk tolerance and are based on the amount of capital that may be lost over the return period.
The major risks to the Company’s balance sheet are typically due to events that Management refers to as shock losses. The Company defines a shock loss as an event that has the potential to materially damage economic value. The Company defines its economic value as the difference between the net present value of tangible assets and the net present value of liabilities, using appropriate risk discount rates. For traded assets, the calculated net present values are equivalent to market values.
(Expressed in thousands of U.S. dollars, except parenthetical share and per share data)
PartnerRe Ltd. (the Company) provides reinsurance on a worldwide basis through its principal wholly owned subsidiaries, Partner Reinsurance Company Ltd. (Partner Reinsurance), PartnerRe SA, Partner Reinsurance Company of the U.S. (PartnerRe U.S.) and Partner Reinsurance Europe Limited (formerly Partner Reinsurance Ireland Limited) (PartnerRe Europe). Risks reinsured include, but are not limited to property, casualty, motor, agriculture, aviation/space, catastrophe, credit/surety, engineering, energy, marine, specialty property, specialty casualty, multiline and other lines, life/annuity and health and alternative risk products. The Company’s alternative risk products include weather and credit protection to financial, industrial and service companies on a worldwide basis.
The Company’s Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States (U.S. GAAP). The Consolidated Financial Statements include the accounts of the Company and its subsidiaries, including those that meet the consolidation requirements of variable interest entities (VIEs). The Company assesses the consolidation of VIEs based on whether the Company is the primary beneficiary of the entity in accordance with FASB Interpretation No. 46 (revised December 2003) “Consolidation of Variable Interest Entities” (FIN 46(R)). Intercompany accounts and transactions have been eliminated. To facilitate comparison of information across periods, certain reclassifications have been made to prior year amounts to conform to the current year’s presentation.
Fixed maturities, short-term investments and equities that are classified as available for sale are carried at fair value, based on quoted market prices, with the difference between cost or amortized cost and fair value, net of the effect of taxes, included as a separate component of accumulated other comprehensive income in the Consolidated Balance Sheets. Short-term investments comprise securities with a maturity greater than three months but less than one year from the date of purchase. Investment purchases and sales are recorded on a trade-date basis.
Fixed maturities, short-term investments and equities that are bought and held principally for the purpose of selling in the near term are classified as trading securities and are carried at fair value, based on quoted market prices, with the changes in fair value included in net realized investment gains and losses in the Consolidated Statements of Operations.
The Company also uses equity short sales, which are sales of securities that are not owned by the Company at the time of the sale. The obligations arising from such transactions are carried at fair value, based on quoted market prices, in net receivable (payable) for securities sold (purchased) in the Consolidated Balance Sheets, with the changes in fair value included in net realized investment gains and losses in the Consolidated Statements of Operations.
The Company evaluates the fair value of its investments on a periodic basis to determine whether a decline in fair value below the amortized cost basis (original cost basis for equities) is other-than-temporary. FASB Staff Position FAS 115-1 and FAS 124-1 “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” requires that the Company determine when an investment is considered to be impaired, whether that impairment is other-than-temporary, and measure the impairment loss. If the decline in fair value is judged to be other-than-temporary, the cost or amortized cost of the individual security is written down to fair value and a new cost basis is established, with the amount of the write-down included as a realized investment loss in the period in which the determination of other-than-temporary impairment is made. For fixed maturities, the difference between the new cost basis established and the maturity (or par) value of the investment is accreted to net investment income over the remaining period of time to contractual maturity. While the cost basis cannot be adjusted upward through net income if the value of the security subsequently increases, the cost basis may be written down again if further other-than-temporary impairments are determined. See Note 2(u) regarding the adoption of SFAS No. 157 and No. 159 as of January 1, 2008.
The Company’s investment strategy allows for the use of derivative instruments, subject to strict limitations. The Company utilizes various derivative instruments such as futures contracts, credit default swaps, foreign currency options, foreign exchange forward contracts related to designated and non-designated hedges, and
The Company monitors the performance of its underwriting operations in three segments, Non-life, Life and Corporate & Other. The Non-life segment is further divided into four sub-segments: U.S., Global (Non-U.S.) Property and Casualty (Global (Non-U.S.) P&C), Global (Non-U.S.) Specialty, and Catastrophe.
As a result of recent organizational changes, during the fourth quarter of 2007, the Company redefined its financial reporting segments. Segment data for the years ended December 31, 2006 and 2005 has been recast to conform to the current year presentation. See Note 18.
In September 2006, the FASB issued Statement No. 157, “Fair Value Measurements” (SFAS 157). This statement defines fair value, establishes a framework for measuring fair value and expands disclosures regarding fair value measurements. SFAS 157 provides guidance on how to measure fair value when required under existing accounting standards and requires disclosure of 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. Quantitative and qualitative disclosures will focus on the inputs used to measure fair value for such fair value measurements and the effects of the measurements on the financial statements.
SFAS 159 will be effective for fiscal years beginning after November 15, 2007. The Company will adopt SFAS 159 as of January 1, 2008. The Company will elect the fair value option for the following financial assets:
Other invested assets (excluding investments accounted for by the equity method or investment company accounting).
On adoption of SFAS 159, the Company expects to record a cumulative effect adjustment of approximately $97.2 million, net of taxes, which will decrease accumulated other comprehensive income and increase opening retained earnings as of January 1, 2008. The Company expects the adoption of SFAS 159 to add more volatility to net realized investment gains and losses in its Consolidated Statement of Operations, but the adoption will have no impact on its shareholders’ equity in its Consolidated Balance Sheet nor its comprehensive income.
In December 2007, the FASB issued Statement No. 160, “Noncontrolling Interests in Consolidated Financial Statements-an amendment of ARB No. 51” (SFAS 160). SFAS 160 amends Accounting Research Bulletin No. 51, “Consolidated Financial Statements” (ARB 51) to establish accounting and reporting standards for a noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. It also amends certain of ARB 51’s consolidation procedures for consistency with the requirements of FASB Statement No. 141 (revised 2007), “Business Combinations”.
The Company’s investment security with the largest unrealized loss position at December 31, 2007, for which an other-than-temporary impairment charge has not been taken, was an equity security with an unrealized loss of $4.8 million, representing 22% of the cost of the security. At December 31, 2007, this equity security carried the unrealized loss position for approximately two months, which was primarily due to the turmoil in the equity market in the second half of 2007. The Company’s investment security with the largest unrealized loss position at December 31, 2006, for which an other-than-temporary impairment charge has not been taken, was a fixed maturity security rated AAA with an unrealized loss of $5.4 million, representing 6.4% of the amortized cost of the security.
The majority of the total unrealized losses related to fixed maturity securities for which an other-than-temporary impairment charge has not been taken, are due to wider credit spreads. Typically, as interest rates rise, market values of fixed maturity portfolios fall, and vice versa. At December 31, 2007, 99% of the fixed maturity securities with an unrealized loss position were rated investment grade or higher.
The Company’s investments in equity securities consist primarily of investments in common stocks of companies in various industries and investments in equity mutual funds. The Company evaluated the equity issuers in relation to the severity and duration of the impairment. The majority of unrealized losses on equity securities were in the consumer cyclical, real estate and finance sectors.
The analysis of the change in net unrealized gains (losses) on investments, net of applicable taxes, reflected in accumulated other comprehensive income for the years ended December 31, 2007, 2006 and 2005, is as follows (in thousands of U.S. dollars):
Proceeds from the sale of investments classified as available for sale for the years ended December 31, 2007, 2006 and 2005 were $5,989.3 million, $13,550.3 million and $9,968.0 million, respectively. Realized investment (losses) gains on securities classified as available for sale for the years ended December 31, 2007, 2006 and 2005 were as follows (in thousands of U.S. dollars):
Included in net receivable (payable) for securities sold (purchased) at December 31, 2007 and 2006 were gross payable and receivable balances for unsettled trades and equity securities sold but not yet purchased, which represent sales of securities not owned at the time of the sale. The components of net receivable (payable) for securities sold (purchased) at December 31, 2007 and 2006 were as follows (in thousands of U.S. dollars):
Other invested assets consist primarily of investments in non-publicly traded companies (including ChannelRe Holdings), private placement equity investments, private placement bond investments, derivative financial instruments and other specialty asset classes. For additional information on the Company’s investment in ChannelRe Holdings, see Note 20.
Unpaid losses and loss expenses are categorized into three types of reserves: reported outstanding loss reserves (case reserves), additional case reserves (ACRs) and incurred but not reported (IBNR) reserves. Case reserves represent unpaid losses reported by the Company’s cedants and recorded by the Company. ACRs are established for particular circumstances where, on the basis of individual loss reports, the Company estimates that the particular loss or collection of losses covered by a treaty may be greater than those advised by the cedant. IBNR reserves represent a provision for claims that have been incurred but not yet reported to the Company, as well as future loss development on losses already reported, in excess of the case reserves and ACRs. The following table shows unpaid losses and loss expenses reported by cedants (case reserves) and those estimated by the Company (ACRs and IBNR reserves) at December 31, 2007 and 2006 (in thousands of U.S. dollars):
The table below is a reconciliation of the beginning and ending liability for unpaid losses and loss expenses, excluding policy benefits for life and annuity contracts, for the years ended December 31, 2007, 2006 and 2005 (in thousands of U.S. dollars):
Within the Company’s U.S. sub-segment, the Company reported net favorable loss development for prior years in 2007 and 2006, and net adverse loss development in 2005. The net favorable loss development in 2007 included net favorable loss development for prior accident years in all lines of business, with the exception of multiline, which included net adverse loss development of $5 million. The net favorable loss development in 2006 included net favorable loss development for prior accident years in the agriculture, casualty and multiline lines of $27 million, partially offset by net adverse development in the property, motor, surety and structured risk lines of $25 million (including a net adverse development of $13 million related to the 2005 Hurricanes Katrina, Rita and Wilma). The net adverse loss development in 2005 was primarily due to a revaluation of the loss development assumptions used by the Company to estimate future liabilities in a number of recent underwriting years on a limited number of treaties, predominantly in the specialty casualty line. Other than for losses related to the 2005 hurricanes, losses reported by cedants during each of these years included no 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.
The table below is a reconciliation of losses and loss expenses including life policy benefits for the years ended December 31, 2007, 2006 and 2005 (in thousands of U.S. dollars):
these agreements, and therefore the Company evaluates the financial condition of its reinsurers and monitors concentration of credit risk on an ongoing basis. Provisions are made for amounts considered potentially uncollectible. The allowance for uncollectible reinsurance recoverable was $9.4 million and $10.9 million at December 31, 2007 and 2006, respectively.
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, which is fully collateralized, is repayable in December 2008, with interest payments due semiannually. PartnerRe U.S. Holdings incurred interest expense and paid interest of $13.0 million in each of the years ended December 31, 2007, 2006 and 2005 in relation to this loan.
In October 2005, the Company entered into a loan agreement with Citibank, N.A. under which the Company borrowed $400.0 million. The loan, which matures in April 2009, bears interest quarterly at a floating rate of 3-month LIBOR plus 0.50%. The Company is not permitted to prepay the loan prior to its maturity, and the loan is not callable or puttable by the lender other than upon an event of default. Citibank, N.A. has pledged its rights under the loan agreement, including the proceeds of any repayment or syndication of the loan, to the Company to secure its obligations to the Company under a forward sale agreement (see Note 14), subject to Citibank, N.A.’s right to substitute cash collateral. The Company incurred interest expense of $23.5 million, $22.7 million and $3.2 million for the years ended December 31, 2007, 2006 and 2005, respectively, and paid interest of $23.7 million, $21.8 million and $nil for the years ended December 31, 2007, 2006 and 2005, respectively, in relation to this loan.
The total amount of unrecognized tax benefits at January 1, 2007 (date of adoption) and December 31, 2007, was as follows (in thousands of U.S. dollars):
The following table is a reconciliation of the actual income tax rate for the years ended December 31, 2007, 2006 and 2005 to the amount computed by applying the effective rate of 0% under Bermuda law to income or loss before income taxes (in thousands of U.S. dollars):
The following table summarizes the changes in accumulated other comprehensive income and the related tax benefit for the years ended December 31, 2007, 2006 and 2005 (in thousands of U.S. dollars):
For employee retirement benefits, the Company maintains defined-contribution plans, an active defined benefit plan and a frozen non-contributory defined benefit plan.
accumulated benefits for the majority of these plans vest immediately or over a four-year period. As required by law, certain retirement plans also provide for death and disability benefits and lump sum indemnities to employees upon retirement.
Since 1999, the Company has maintained an active pension plan for its Zurich office employees (the Zurich Plan), which was classified and accounted for as a defined contribution plan. Amendments to the Zurich Plan during 2006, in conjunction with changes to Swiss pension law (BVG) led the Company to conclude that the features of the plan made it a hybrid plan (which is accounted for as a defined benefit plan) for the year ended December 31, 2006 and onwards.
At December 31, 2007 and 2006, the funded status of the Zurich Plan was as follows (in thousands of U.S. dollars):
At December 31, 2007 and 2006, the funded status at the end of the year was included in accounts payable, accrued expenses and other in the Consolidated Balance Sheets. Employer contributions for the year ended December 31, 2007 were $4.6 million. For the year ended December 31, 2006, contributions of $3.9 million were paid by the Company prior to the conversion of the Zurich Plan to a defined benefit plan and $0.2 million were paid after the conversion.
The incremental effect of applying FAS 158 in 2006 was to decrease total assets by $5.7 million, increase total liabilities by $1.2 million and decrease total shareholders’ equity (accumulated other comprehensive income) by $6.9 million. Of the $6.9 million transition adjustment recorded under FAS 158 in 2006, $6.0 million remains in accumulated other comprehensive income at December 31, 2007. Of this transition adjustment, $0.6 million (pre-tax) is expected to be recognized in net periodic benefit cost in 2008.
At December 31, 2007 and 2006, the projected pension obligation was $72.4 million and $66.1 million, respectively, the accumulated pension obligation was $70.0 million and $63.7 million, respectively, and the fair value of plan assets was $70.0 million and $58.5 million, respectively. At December 31, 2007 and 2006, the Zurich Plan’s asset allocation was as follows:
The assumptions used to determine the pension obligation and net periodic benefit cost for the years ended December 31, 2007 and 2006 were as follows:
The Company does not believe that any plan assets will be returned to the Company during 2008.
The Swiss Share Purchase Plan (the SSPP) has two offering periods per year with two purchase periods of six months. 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 market 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.
During 2007, 2006 and 2005 the Company issued 76,434, 83,435 and 462,019 stock options with a weighted average grant-date fair value of $13.76, $14.87 and $17.15, respectively.
Stock options vested and expected to vest and the weighted average exercise price for these stock options was 2,430,552 stock options and $55.07, respectively, at December 31, 2007. The aggregate intrinsic value and weighted average remaining contractual term of stock options vested and expected to vest at December 31, 2007 was $63.5 million and 5.4 years, respectively. The aggregate intrinsic value and weighted average remaining contractual term of stock options exercisable at December 31, 2007 was $58.0 million and 5.5 years, respectively.
Total unrecognized share-based compensation expense related to unvested stock options was approximately $0.4 million at December 31, 2007, which is expected to be recognized in 2008.
The Company values stock options issued with a Black-Scholes valuation model and used the following assumptions for the years ended December 31, 2007, 2006 and 2005:
Since the adoption of SFAS 123(R) on January 1, 2006, the Company has used the simplified method for vanilla options under Staff Accounting Bulletin No. 107, “Share-Based Payment” (SAB 107) to determine the expected life of options. 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 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 options. The dividend yield is based on the average dividend yield of the Company’s shares over the expected life of the Company’s options.
During 2007, 2006 and 2005, the Company issued 316,427, 118,193 and 223,231 RSU with a weighted average grant date fair value of $71.63, $61.77 and $62.71, respectively. The Company values RSU issued under all plans at the fair market value of its common shares at the time of grant, as defined by the plan document.
Total unrecognized share-based compensation expense related to unvested RSU was approximately $15.6 million at December 31, 2007, which is expected to be recognized over a weighted-average period of 1.9 years.
The activity related to the Company’s SAR for the years ended December 31, 2007 and 2006 was as follows:
Total unrecognized share-based compensation expense related to unvested SAR was approximately $3.6 million at December 31, 2007, which is expected to be recognized over a weighted-average period of 2.0 years.
The Company’s ability to pay common and preferred shareholders’ dividends and its expenses are dependent mainly on cash dividends from Partner Reinsurance, PartnerRe SA and PartnerRe U.S. (collectively the reinsurance subsidiaries). The payment of such dividends by the reinsurance subsidiaries to the Company is limited under Bermuda 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, 2007, there were no significant restrictions on the payment of dividends by the reinsurance subsidiaries.
The following table summarizes the statutory stockholder’s equity of the Company’s reinsurance subsidiaries as of December 31, 2007 and 2006 (in thousands of U.S. dollars):
12. Debt Related to Capital Efficient Notes and Trust Preferred Securities
Contemporaneously, PartnerRe U.S. Holdings issued a 6.440% Fixed-to-Floating Rate promissory note, with a principal amount of $257.6 million to PartnerRe Finance II. Under the term of the promissory note, PartnerRe U.S. Holdings promises to pay to PartnerRe Finance II the principal amount on December 1, 2066 unless previously paid. Interest on the promissory note is payable semi-annually commencing on June 1, 2007 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%.
The Company does not consolidate PartnerRe Finance II, which issued the CENts, as it does not meet the consolidation requirements under FIN 46(R). The Company has reflected the debt related to the CENts on its Consolidated Balance Sheets.
On December 21, 2006, the Trust redeemed all of its outstanding 7.90% trust preferred securities. The redemptions were conducted pursuant to the terms of the documents governing the trust preferred securities, including the trust agreement relating to the Trust and the junior subordinated indenture of PartnerRe Finance I. The aggregate redemption price for the trust preferred securities was $203.5 million, which included all unpaid distributions accrued to the date of redemption.
At December 31, 2007 and 2006, the total authorized shares of the Company were 200 million shares, par value $1.00 per share, as follows (in millions of shares):
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 Series D preferred shares cannot be redeemed before November 15, 2009. Beginning November 15, 2009, the Company may redeem the Series D preferred shares at $25.00 per share plus accrued and unpaid dividends without interest. Dividends on the Series D preferred shares are cumulative from the date of issuance and are payable quarterly in arrears. In the event of liquidation of the Company, the holders of outstanding preferred shares would have preference over the common shareholders and would receive a distribution of $25.00 per share, or an aggregate value of $230 million, plus accrued and unpaid dividends.
Contract fees of approximately $29 million related to the forward sale agreement were recorded against additional paid-in capital in 2005 and will be paid over the three year 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 using the treasury stock method prescribed under SFAS 128, “Earnings per Share”.
For the fourth quarter of 2007, the diluted net income per share included the dilutive effect of 115,350 shares related to this agreement using the treasury stock method, as the Company’s average share price exceeded the maximum price per share during the fourth quarter of 2007. The 2006 and 2005 diluted net income (loss) per share did not include any dilutive effect related to this agreement.
The Company is also exposed to credit risk in its underwriting operations, most notably in the credit/surety line and for different 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 credit-sensitive lines of business through the use of risk management techniques such as risk diversification, careful monitoring of risk aggregations and accumulations and, at times, through the use of retrocessional reinsurance protection and the purchase of credit default swaps and total return and interest rate swaps.
The Company has exposure to credit risk related to reinsurance balances receivable and reinsurance recoverable on paid and unpaid losses (see Note 5). The credit risk exposure related to these balances is mitigated by several factors, including but not limited to, credit checks performed as part of the underwriting process and monitoring of aged receivable balances. As of December 31, 2007 and 2006, the Company has recorded a provision for uncollectible premiums receivable of $10.8 million and $9.2 million, respectively.
Fair value for fixed maturities, short-term investments, equities and trading securities are based on quoted market prices. Carrying value of other invested assets, excluding investments accounted for using the equity method, approximates fair value. Policy benefits for life and annuity contracts have a fair value equal to the cash value available to the policyholder should the policyholder surrender the policy. The fair value of the long-term debt and the debt related to the capital efficient notes have been calculated as the present value of estimated future cash flows using a discount rate reflective of the current market cost of borrowing under similar terms and conditions. The fair value of the capital efficient notes was based on the initial issuance of $250 million from PartnerRe Finance II.
(2) Policy benefits for life and annuity contracts included short-duration and long-duration contracts.
The Company also utilizes foreign currency options contracts to mitigate foreign currency risk. For the years ended December 31, 2007 and 2006, the balances related to contracts maturing on December 31 were a receivable of $0.8 million and $2.2 million, respectively. At December 31, 2007 and 2006, there were no outstanding contracts.
Exchange traded treasury note futures are used by the Company for the purposes of managing portfolio duration. The notional value of the treasury futures was a long position of $485 million and a long position of $1,170 million, respectively, at December 31, 2007 and 2006. The fair value for futures contracts was a net unrealized gain of $0.9 million at December 31, 2007 and a net unrealized loss of $11.2 million at December 31, 2006.
The Company has entered into various weather derivatives. The fair value of weather derivatives (the Company’s net liabilities) was a net unrealized loss of $1.8 million and $2.0 million, respectively, at December 31, 2007 and 2006. The notional value of the Company’s weather derivatives was $39 million and $23 million, respectively, at December 31, 2007 and 2006.
The Company has entered into total return swaps referencing various project and principal finance obligations. The Company has also entered into interest rate swaps to mitigate interest rate risk on certain total return swaps. The fair value of those derivatives (the Company’s net liabilities) was a net unrealized loss of $33.7 million and $0.3 million, respectively, at December 31, 2007 and 2006. The notional value of the Company’s total return swaps was $273 million and $315 million, respectively, at December 31, 2007 and 2006.
In the normal course of its operations, the Company enters into agreements with financial institutions to obtain unsecured credit facilities. As of December 31, 2007, the total amount of such credit facilities available to the Company was $810.3 million. These facilities are used primarily for the issuance of letters of credit, although a portion of these facilities may also be used for liquidity purposes. Under the terms of certain reinsurance agreements, irrevocable letters of credit were issued on an unsecured basis in the amount of $435.5 million at December 31, 2007, in respect of reported loss and unearned premium reserves.
Some of the credit facilities contain customary default and cross default provisions and require that the Company maintain certain covenants, including the following:
(5) Other operating expense ratio is obtained by dividing other operating expenses by net premiums earned.
The following table provides the distribution of net premiums written by line of business for the years ended December 31, 2007, 2006 and 2005:
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, 2007, 2006 and 2005:
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 7% of total gross premiums written during the years ended December 31, 2007, 2006 and 2005.
The following table summarizes the percentage of gross premiums written through these two brokers by segment and sub-segment for the years ended December 31, 2007, 2006 and 2005:
In addition to ChannelRe Holdings’ results for the twelve month period ended September 30, 2007 below, the Company has recorded an additional charge of $87 million in its Consolidated Statements of Operations for the year ended December 31, 2007. This additional charge represents the write-down of its total investment in ChannelRe Holdings due to unrealized mark-to-market losses on Channel Reinsurance’s credit derivative portfolio, which Channel Reinsurance expects to incur during the three month period ended December 31, 2007 and which are expected to result in Channel Reinsurance having negative U.S. GAAP shareholders’ equity at that date.