Catastrophe losses are presented net of reinsurance and reinstatement premiums. Effective April 1, 2010, a catastrophe is defined, for purposes of the consolidated Selected Financial Data, as an event that caused a loss on property exposures before reinsurance of at least $10.0 million before corporate level reinsurance and taxes. All prior periods reflect a catastrophe as a property event with expected reported losses of at least $5.0 million before corporate level reinsurance and taxes. Catastrophe insurance provides coverage for one event. When limits are exhausted, some contractual arrangements provide for the availability of additional coverage upon the payment of additional premium. This additional premium is referred to as reinstatement premium.
Based on weighted average diluted common shares outstanding of 56.8 million, 60.8 million, 62.0 million, 63.6 million, and 65.3 million for 2010, 2009, 2008, 2007 and 2006, respectively.
Based on $54.4 million, 59.3 million, 61.4 million, 62.9 million and 65.0 million common shares outstanding for December 31, 2010, 2009, 2008, 2007 and 2006, respectively.
Rates in the international markets have generally been stable and we have seen some increases, particularly for catastrophe exposed business. We have grown our business in the Middle East, Latin America and Asia.
Overall, we believe that current marketplace conditions offer pockets of profit opportunities for us given our strong ratings, distribution system, reputation and expertise. We continue to employ our strategy of targeting business that offers the greatest profit potential, while maintaining balance and diversification in our overall portfolio.
Premiums. Gross written premiums increased by $71.8 million, or 1.7%, in 2010, compared to 2009, reflecting an increase of $63.7 million in our reinsurance business and $8.1 million increase in our insurance business. The increase in reinsurance premiums was primarily the result of increased writings in our U.S. treaty property and international books of business, driven by a combination of new business, increased participations on renewal contracts, rate increases in select areas, and economic and insurance growth in several regions. The increase in insurance premiums was due to increased writings in professional liability and California workers’ compensation business, partially offset by a reduction in the audit premium accrual for workers’ compensation business. Net written premiums increased $15.8 million, or 0.4%, in 2010 compared to 2009. The lower increase in net written premiums relative to the change in gross written premiums was due to the increased use of reinsurance on several large programs in the insurance book. Premiums earned increased $40.5 million, or 1.0%, in 2010, compared to 2009. The change in net premiums earned is relatively consistent with the increase in net written premiums.
Net Investment Income. Net investment income increased $105.7 million, or 19.3%, in 2010 compared with net investment income of $547.8 million in 2009, primarily as a result of an $89.7 million increase in investment income from our limited partnerships. Net pre-tax investment income, as a percentage of average invested assets, was 4.5% in 2010 compared to 3.8% for 2009. The variance in this yield was primarily the result of fluctuations in our limited partnership income.
Net investment income decreased by 3.2% in 2009, compared to 2008, due primarily to lower yields on new money, partially offset by a decrease in losses from our limited partnership investments that invest in public and non-public securities, both equity and debt. As a result, net pre-tax investment income, as a percentage of average invested assets, was 3.8% for 2009 compared to 4.0% for 2008.
Net Derivative Gain (Loss). In 2005 and prior, we sold seven equity index put option contracts, which are outstanding. These contracts meet the definition of a derivative in accordance with FASB guidance and as such, are fair valued each quarter with the change recorded as net derivative gain or loss in the consolidated statements of operations and comprehensive income (loss). As a result of these adjustments in value, we recognized a net derivative loss of $1.1 million in 2010, a net derivative gain of $3.2 million in 2009 and a net derivative loss of $20.9 million in 2008. The change in the fair value of these equity index put option contracts is indicative of the change in the financial markets over the same periods.
Other Income (Expense). We recorded other income of $16.9 million and other expense of $22.5 million and $15.9 million in 2010, 2009 and 2008, respectively. The changes were primarily the result of fluctuations in foreign currency exchange rates for the corresponding periods.
Incurred losses and LAE increased by $571.6 million, or 24.1%, for the year ended December 31, 2010 compared to the same period in 2009. Of the $571.6 million increase, current year catastrophe losses increased $522.7 million (13.3 points), period over period, primarily due to losses on the Chilean earthquake, New Zealand earthquake, Australian hailstorms and floods, and the Canadian hailstorm. The current year attritional losses also increased $208.7 million (4.8 points) reflecting higher expected loss ratios on current year business due to prevailing market conditions. Partially offsetting these higher current year losses was a decrease of $159.6 million, or 4.1 points, in prior year loss development as the 2010 reserve studies indicated net favorable reserve development and loss estimates for prior year catastrophes were reduced.
Commission, brokerage, taxes and fees decreased by $2.4 million, or 0.3%, in 2009 compared to the same period in 2008. The change in this directly variable expense was influenced by reduction in contingent commissions and changes in the mix of business.
Corporate Expenses. Corporate expenses, which are expenses that are not allocated to segments, were $14.9 million, $17.6 million and $13.8 million for the years ended December 31, 2010, 2009 and 2008, respectively. These expenses were previously included as underwriting expenses and therefore included in the other underwriting expense ratio. Effective January 1, 2010, these expenses were removed from the calculation of the other underwriting expense ratio and prior periods were recalculated to conform.
Our net income was $807.0 million, in 2009, compared to a net loss of $18.8 million, in 2008. This increase was primarily driven by smaller after-tax net realized capital losses and fewer catastrophe losses in 2009 compared to 2008.
Our combined ratio increased by 13.7 points to 102.8% in 2010 compared to 89.1% in 2009. The loss ratio component increased 13.9 points in 2010 over the same period last year, principally due to the increase in current year catastrophe losses as a result of the Chilean earthquake, Australian hailstorms and floods, New Zealand earthquake and the Canadian hailstorm. Both the other underwriting expense ratio component and the commission and brokerage ratio component remained relatively flat over the same periods last year.
underwriting expense ratio component increased by 0.3 points in 2009 compared to the same period last year.
Net investment income decreased 3.2% to $547.8 million in 2009 from $565.9 million in 2008, primarily due to lower yields on new money, partially offset by a decrease in losses from our limited partnership investments that invest in public and non-public securities, both equity and debt.
The pre-tax equivalent total return for the bond portfolio was approximately 5.7%, 10.1% and 1.0%, respectively, in 2010, 2009 and 2008. The pre-tax equivalent return adjusts the yield on tax-exempt bonds to the fully taxable equivalent.
Premiums. Gross written premiums decreased by 2.4% to $1,143.7 million in 2010 from $1,172.3 million in 2009, primarily due to a $40.7 million (48.2%) decrease in the crop hail quota share treaties, a $32.4 million (8.9%) decrease in U.S. treaty casualty volume and a $28.6 million (29.2%) decrease in facultative volume, partially offset by a $73.7 million (11.8%) increase in treaty property volume. Net written premiums decreased 1.9% to $1,145.2 million in 2010 compared to $1,167.2 million in 2009, which is in line with the decline in gross written premiums. Correspondingly, premiums earned decreased 1.8% to $1,129.3 million in 2010 compared to $1,150.3 million in 2009.
Incurred losses were $131.5 million (12.5 points) higher at $706.3 million in 2010 compared to $574.8 million in 2009, primarily as a result of the $62.3 million (6.4 points) increase in current year attritional losses, reflective of current competitive market conditions, $28.5 million (2.5 points) increase in prior year attritional losses, and a $41.2 million (3.6 points) increase in catastrophe losses, largely due to the New Zealand earthquake and the Chilean earthquake. The increase in prior years’ attritional losses was primarily driven by reserve strengthening in casualty lines for construction liability claims.
Incurred losses were $223.4 million (26.0 points) lower at $574.8 million in 2009 compared to $798.2 million in 2008, primarily as a result of the $281.0 million (26.7 points) decrease in catastrophe losses due to the absence of current year catastrophes in 2009. The prior years’ reserve development in 2009 primarily related to sub-prime liability exposures.
Premiums. Gross written premiums increased by 1.0% to $850.7 million in 2010 compared to $842.6 million in 2009. This was primarily due to increased writings in professional liability and California workers’ compensation business partially offset by a reduction in audit premiums for workers’ compensation business. Net written premiums decreased 7.7% to $605.6 million compared to $656.2 million in 2009 due to an increase in the use of reinsurance on several large programs. Ceded premiums generally relate to specific reinsurance purchased and fluctuate based upon the level of premiums written in the individual reinsured programs. Premiums earned decreased 6.7% to $626.4 million in 2010 compared to $671.1 million in 2009. The change in premiums earned is relatively consistent with the decrease in net written premium.
Incurred losses and LAE decreased by 2.1% to $527.5 million in 2010 compared to $538.6 million in 2009. The decrease was due to lower net premiums earned, partially offset by an increase in the attritional loss ratio, year over year. Current year attritional losses increased $11.1 million (6.8 points), due to higher expected loss ratios on several programs, reflective of current market conditions. Offsetting the increase in current year losses was a decrease of $22.2 million (2.9 points) in prior years’ loss development compared to 2009. The 2010 prior years’ unfavorable development of $36.8 million was primarily the result of reserve strengthening on several terminated programs.
Segment Expenses. Commission and brokerage decreased by 5.0% to $118.1 million in 2010 compared to $124.4 million in 2009. This decrease was primarily the result of a decrease in net premiums earned and changes in the mix of business. Segment other underwriting expenses decreased to $69.7 million in 2010 compared to $74.6 million in 2009. This decrease was the result of management’s direct actions to reduce operating expenses.
Commission and brokerage decreased by 15.2% to $124.4 million in 2009 compared to $146.7 million in 2008. The decrease was primarily due to the change in the mix of business written and the reinsurance purchased on the business written. Segment other underwriting expenses in 2009 increased to $74.6 million compared to $64.3 million in 2008. The increase was primarily due to increased costs associated with the expanded infrastructure.
Premiums. Gross written premiums increased by 13.5% to $266.4 million in 2010 compared to $234.8 million in 2009, primarily due to an increase in A&H business with its entry into the stop-loss primary market for coverages on self-insured companies in 2010 and increased writings on special per risk reinsurance programs. Correspondingly, net written premiums increased 14.0% to $262.2 million in 2010 compared to $230.0 million in 2009. Premiums earned increased 16.1% to $272.3 million in 2010 compared to $234.5 million in 2009, relatively consistent with the increase in net written premiums.
Gross written premiums decreased by 9.8% to $234.8 million in 2009 compared to $260.4 million for 2008, primarily due to a $33.7 million decrease in marine premiums and a $5.9 million decrease in surety premiums, partially offset by a $10.0 million increase in aviation premiums and a $2.7 million increase in A&H premiums. Net written premiums decreased 9.5% to $230.0 million in 2009 compared to $254.2 million in 2008, in line with the decrease in gross writings. Premiums earned decreased 6.8% to $234.5 million in 2009 compared to $251.8 million in 2008. The change in premiums earned relative to net written premiums is the result of timing; premiums are earned ratably over the coverage period whereas written premiums are recorded at the initiation of the coverage period.
Incurred losses and LAE increased by 24.8% to $203.9 million in 2010 compared to $163.4 million in 2009, due to an increase in net premiums earned coupled with an increase in the loss ratio. Current year attritional losses increased $32.7 million (2.5 points) as a result of losses on the offshore oil rig in the Gulf and higher expected loss ratios in A&H and surety lines of business. In addition, prior years’ attritional losses increased $8.1 million (3.2 points) due to unfavorable reserve development on select specialty classes of business in 2010 compared to favorable reserve development in 2009.
Incurred losses and LAE decreased by 1.5% to $163.4 million for 2009 compared to $165.9 million in 2008, primarily as a result of a decrease in catastrophe losses on the marine book of business, period over period. Partially offsetting this decrease were the proportionally higher current year attritional losses on the marine business in addition to less favorable reserve development on prior years’ attritional losses on most of the Specialty Underwriting lines.
Commission and brokerage increased 2.5% to $72.6 million in 2009 compared to $70.8 million in 2008 as commissions increased on the A&H business. Segment other underwriting expenses for 2009 increased slightly to $8.7 million compared to $8.1 million for 2008.
Premiums. Gross written premiums increased by 11.3% to $1,207.0 million in 2010 compared to $1,084.5 million in 2009, due to continued strong growth in premiums written through the Brazil, Miami and New Jersey offices, a $42.7 million increase; Asia, a $55.7 million increase; and Canada, a $24.2 million increase; resulting from a combination of new business, rate increases in select areas, and economic and insurance growth in some markets. Also contributing to the increase was $16.0 million in reinstatement premiums from the Chilean earthquake and Calgary hailstorm. Net written premiums increased by 10.9% to $1,199.6 million in 2010 compared to $1,081.3 million in 2009, principally as a result of the increase in gross written premiums. Premiums earned increased 10.9% to $1,168.1 million in 2010 compared to $1,053.5 million in 2009, consistent with the trend noted for net written premiums.
Gross written premiums increased by 19.9% to $1,084.5 million in 2009 compared to $904.7 million in 2008. As a result of our strong financial strength ratings, we saw increased participations on treaties in most regions, new business writings and preferential signings, including preferential terms and conditions. In addition, rates, in some markets, also contributed to the increased written premiums. Premiums written through the Brazil, Miami and New Jersey offices increased by $122.9 million (21.3%), the Asian branch increased by $32.4 million (17.1%) and the Canadian branch premiums increased by $24.5 million (17.7%). Net written premiums increased by 19.9% to $1,081.3 million in 2009 compared to $902.1 million in 2008, principally as a result of the increase in gross written premiums. Premiums earned increased 19.0% to $1,053.5 million in 2009 compared to $885.5 million in 2008, consistent with the increase in net written premiums.
Incurred losses and LAE increased 71.2% to $1,050.1 million in 2010 compared to $613.3 in 2009. The increase was principally due to a $417.3 million (35.3 points) increase in current year catastrophes related to the Chilean earthquake, the Australian hailstorms and floods, the New Zealand earthquake and the Canadian hailstorm compared to the absence in 2009 of any similar large events. Attritional losses also increased, primarily due to an increase in premiums earned and higher expected loss ratios, which were partially offset by favorable development on prior years’ reserves.
Segment Expenses. Commission and brokerage increased 8.0% to $288.4 million in 2010 compared to $267.1 million in 2009. The increase was primarily in line with the increases in premiums earned. Segment other underwriting expenses increased to $27.6 million in 2010 compared to $23.1 million in 2009. The increase was consistent with the growth in premiums earned resulting in stable other underwriting expense ratios for the periods.
Premiums. Gross written premiums decreased 7.8% to $733.0 million in 2010 compared to $794.8 million in 2009. Bermuda home office business was down 4.4%, or $12.8 million, due to lower property catastrophe excess of loss business. Premiums written by the U.K. branch and Ireland subsidiary in the U.K. and continental Europe, decreased $49.0 million, or 9.7% in response to softening market conditions. Net written premiums decreased 7.8% to $733.0 million in 2010 compared to $795.1 million in 2009, in line with the decrease in gross written premiums. Premiums earned decreased 5.9% to $738.4 million in 2010 compared to $784.6 million in 2009. The change in premiums earned relative to net written premiums is the result of timing; premiums are earned ratably over the coverage period whereas written premiums are recorded at the initiation of the coverage period.
Gross written premiums increased 1.5% to $794.8 million in 2009 compared to $783.4 million in 2008. The Bermuda home office gross written premium increased $33.0 million, or 12.8%. Premiums written out of the UK branch decreased $21.3 million, or 4.1%, as a result of the change in foreign exchange rates period over period. Excluding the impact of the foreign exchange, the branch premiums were up approximately 15.7%. Net written premiums also increased 1.5% to $795.1 million in 2009 compared to $783.1 million in 2008. Premiums earned decreased 2.1% to $784.6 million in 2009 compared to $801.2 million in 2008.
Commission and brokerage decreased 8.0% to $192.1 million in 2009 as compared to $208.9 million in 2008. The variance was principally the result of lower earned premiums and changes in the mix of business. Segment other underwriting expenses in 2009 increased slightly to $24.6 million compared to $24.2 million in 2008.
It is more difficult to accurately estimate loss reserves for reinsurance liabilities than for insurance liabilities. At December 31, 2010, we had reinsurance reserves of $7,072.2 million and insurance loss reserves of $2,268.0 million, of which $446.3 million and $108.5 million, respectively, were loss reserves for A&E liabilities. A detailed discussion of additional considerations related to A&E exposures follows later in this section.
We sort both our reinsurance and insurance reserves into exposure groupings for actuarial analysis. We assign our business to exposure groupings so that the underlying exposures have reasonably homogeneous loss development characteristics and are large enough to facilitate credible estimation of ultimate losses. We periodically review our exposure groupings and we may change our grouping over time as our business changes. We currently use over 200 exposure groupings to develop our reserve estimates. One of the key selection characteristics for the exposure groupings is the historical duration of the claims settlement process. Business, in which claims are reported and settled relatively quickly, are commonly referred to as short tail lines, principally property lines. On the other hand, casualty claims tend to take longer to be reported and settled and casualty lines are generally referred to as long tail lines. Our estimates of ultimate losses for shorter tail lines, with the exception of loss estimates for large catastrophic events, generally exhibit less volatility than those for the longer tail lines.
Given the inherent variability in our loss reserves, we have developed an estimated range of possible gross reserve levels. A table of ranges by segment, accompanied by commentary on potential and historical variability, is included in “Financial Condition - Loss and LAE Reserves”. The ranges are statistically developed using the exposure groups used in the reserve estimation process and aggregated to the segment level. For each exposure group, our actuaries calculate a range for each accident year based principally on two variables. The first is the historical changes in losses and LAE incurred but not reported (“IBNR”) for each accident year over time; the second is volatility of each accident year’s held reserves related to estimated ultimate losses, also over time. Both are measured at various ages from the end of the accident year through the final payout of the year’s losses. Ranges are developed for the exposure groups using statistical methods to adjust for diversification; the ranges for the exposure groups are aggregated to the segment level, likewise, with an adjustment for diversification. Our estimates of our reserve variability may not be comparable to those of other companies because there are no consistently applied actuarial or accounting standards governing such presentations. Our recorded reserves reflect our best point estimate of our liabilities and our actuarial methodologies focus on developing such point estimates. We calculate the ranges subsequently, based on the historical variability of such reserves.
We have direct relationships with Mt. McKinley policyholders and we attempt to uphold our contractual rights and assert valid defenses to coverage where appropriate. The uncertainties inherent in asbestos coverage and bankruptcy litigations have provided us the opportunity to engage in settlement negotiations with a number of policyholders who have potentially significant asbestos liabilities. Those discussions are aimed at achieving reasonable negotiated settlements that limit Mt. McKinley’s liability to a given policyholder to a sum certain. Because of the risks and uncertainties inherent in litigation, we cannot be certain that this approach will lead to a negotiated settlement in the range expected by us in each or every instance. Between 2004 and 2010, we concluded settlements or reached agreement in principle with 22 of our high profile policyholders. We continue the approach of attempting to negotiate with such policyholders that may have significant asbestos liabilities, in part because their exposures have developed to the point where we and the policyholder have sufficient information to be motivated to settle. We believe that this active approach will ultimately result in a more cost-effective liquidation of Mt. McKinley’s liabilities than a passive approach, although it may also introduce additional variability in Mt. McKinley’s losses and cash flows as reserves are adjusted to reflect the developments in litigation, negotiations and, ultimately, potential settlements.
There is little potential for similar settlements of our reinsurance asbestos claims where we have no direct relationships with the insureds. Our ceding companies have the direct obligation to insureds and are responsible for their own claim settlements. They are not consistently prompt in developing and providing claim settlement information to their reinsurers, which can introduce inconsistencies and significant delays in the reporting of asbestos claims/exposures to reinsurers, including us. These delays not only extend the timing of reinsurance claim settlements, but also limit the available information from which reinsurers, including us, estimate their ultimate exposure. See the discussion below under the heading “Financial Condition - Loss and LAE Reserves”.
Reinsurance Receivables. We have purchased reinsurance to reduce our exposure to adverse claim experience, large claims and catastrophic loss occurrences. Our ceded reinsurance provides for recovery from reinsurers of a portion of losses and loss expenses under certain circumstances. Such reinsurance does not relieve us of our obligation to our policyholders. In the event our reinsurers are unable to meet their obligations under these agreements or are able to successfully challenge losses ceded by us under the contracts, we will not be able to realize the full value of the reinsurance receivable balance. To minimize exposure from uncollectible reinsurance receivables, we have a reinsurance security committee that evaluates the financial strength of each reinsurer prior to our entering into a reinsurance arrangement. In some cases, we may hold full or partial collateral for the receivable, including letters of credit, trust assets and cash. Additionally, creditworthy foreign reinsurers of business written in the U.S. are generally required to secure their obligations. We have established reserves for uncollectible balances based on our assessment of the collectability of the outstanding balances. As of December 31, 2010 and 2009, the reserve for uncollectible balances was $21.6 million and $51.6 million, respectively. The decline in reserve for uncollectible reinsurance was primarily due to a $30.0 million write-off of a reinsurance receivable balance with a corresponding reduction in the provision of uncollectible reinsurance. This write-off of the reinsurance receivable had no impact upon 2010 net income as the reserve for uncollectibility had been fully established in previous periods. Actual uncollectible amounts may vary, perhaps substantially, from such reserves, impacting income (loss) in the period in which the change in reserves is made. See also ITEM 8, “Financial Statements and Supplementary Data” - Note 12 of Notes to the Consolidated Financial Statements and “Financial Condition - Reinsurance Receivables” below.
limited partnerships and due to inherent reporting lags, the carrying values are based on values with “as of” dates from one month to one quarter prior to our financial statement date.
Cash and Invested Assets. Aggregate invested assets, including cash and short-term investments, were $15,365.0 million at December 31, 2010, an increase of $446.2 million compared to $14,918.8 million at December 31, 2009. This increase was primarily the result of $918.5 million of cash flows from operations, $73.1 million in equity adjustments of our limited partnership investments, $70.4 million in fair value re-measurements, $50.0 million revolving credit borrowings and $48.4 million of unrealized appreciation, partially offset by $398.6 million paid for share repurchases, $200.0 million payoff of debt maturity, $108.5 million paid out in dividends to shareholders and $17.4 million due to fluctuations in foreign currencies.
The Company’s limited partnership investments are comprised of limited partnerships that invest in public equities and limited partnerships that invest in private equities. Generally, the public equity limited partnerships are reported on a one month lag while the private equity partnerships are included in the financials on a quarter lag. All of the limited partnerships are required to report using fair value accounting in accordance with FASB guidance. We receive annual audited financial statements for all of the limited partnerships. For the quarterly reports, the Company’s staff performs reviews of the financial reports for any unusual changes in carrying value. If the Company becomes aware of a significant decline in value during the lag reporting period, the loss will be recorded in the period in which the Company identifies the decline.
Reinsurance Receivables. Reinsurance receivables for both paid and recoverable on unpaid losses totaled $684.7 million and $636.4 million at December 31, 2010 and 2009, respectively. At December 31, 2010, $171.7 million, or 25.1%, was receivable from C.V. Starr; $105.0 million, or 15.3% was receivable from Transatlantic; $100.0 million, or 14.6%, was receivable from Continental; $48.9 million, or 7.1%, was receivable from Munich Re and $45.0 million, or 6.6%, was receivable from Berkley. The receivable from C.V. Starr is fully collateralized by a trust agreement. The receivable from Continental is collateralized by a funds held arrangement under which we have retained the premiums earned by the retrocessionaire to secure obligations of the retrocessionaire, recorded them as a liability, credited interest on the balances at a stated contractual rate and reduced the liability account as payments became due. No other retrocessionaire accounted for more than 5% of our receivables.
There can be no assurance that reserves for, and losses from, claim obligations will not increase in the future, possibly by a material amount. However, we believe that our existing reserves and reserving methodologies lessen the probability that any such increase would have a material adverse effect on our financial condition, results of operations or cash flows. In this context, we note that over the past 10 years, our calendar year operations have been affected by effects from prior period reserve re-estimates, ranging from a favorable $30.9 million in 2010, representing 0.4% of the net prior period reserves for the year in which the adjustment was made, to an unfavorable $249.4 million in 2004, representing 3.7% of the net prior period reserves for the year in which the adjustment was made.
Depending on the specific segment, the range derived for the loss reserves, excluding reserves for A&E exposures, ranges from minus 8.5% to minus 20.1% for the low range and from plus 8.5% to plus 20.1% for the high range. Both the higher and lower ranges are associated with the U.S. Insurance segment. The size of the range is dependent upon the level of confidence associated with the outcome. Within each range, our best estimate of loss reserves is based upon the point estimate derived by our actuaries in detailed reserve studies. Such ranges are necessarily subjective due to the lack of generally accepted actuarial standards with respect to their development. For the above presentation, we have assumed what we believe is a reasonable confidence level but note that there can be no assurance that our claim obligations will not vary outside of these ranges.
Everest Re was formed in 1973 but was not fully engaged in underwriting casualty business, under which A&E exposures generally arise, until 1974, and it effectively eliminated A&E exposures beginning in 1984 through contract exclusions. Therefore, Everest Re has an approximate 11-year window of A&E exposure, much shorter than that of many long established reinsurance companies. In the earlier years of its existence, Everest Re mainly wrote property business, which generally is not exposed to asbestos claims. Everest Re reinsured both primary and excess policies. However, its claim experience indicates that the majority of its exposure was on excess policies, similar to those directly written by Mt. McKinley.
With respect to asbestos only, at December 31, 2010, we had gross asbestos loss reserves of $530.4 million, or 95.6%, of total A&E reserves, of which $426.2 million was for assumed business and $104.2 million was for direct business.
Industry analysts use the “survival ratio” to compare the A&E reserves among companies with such liabilities. The survival ratio is typically calculated by dividing a company’s current net reserves by the three year average of annual paid losses. Hence, the survival ratio equals the number of years that it would take to exhaust the current reserves if future loss payments were to continue at historical levels. Using this measurement, our net three year asbestos survival ratio was 5.9 years at December 31, 2010. These metrics can be skewed by individual large settlements occurring in the prior three years and therefore, may not be indicative of the timing of future payments.
Because the survival ratio was developed as a comparative measure of reserve strength and does not indicate absolute reserve adequacy, we consider, but do not rely on, the survival ratio when evaluating our reserves. In particular, we note that year to year loss payment variability can be material. This is due, in part, to our orientation to negotiated settlements, particularly on our Mt. McKinley exposures, which significantly reduces the credibility and utility of this measure as an analytical tool. During 2010, we made asbestos net claim payments of $22.2 million to Mt McKinley high profile claimants where the claim was either closed or a settlement had been reached. Such payments, which are non-repetitive, distort downward our three year survival ratio for 2010 and will continue to do so for 2011 and 2012. Adjusting for such settlements, recognizing that total settlements are generally considered fully reserved to an agreed settlement, we consider that our adjusted asbestos survival ratio for net unsettled claims is 8.7 years, which is better than prevailing industry norms.
Shareholders’ Equity. Our shareholders’ equity increased to $6,283.5 million as of December 31, 2010 from $6,101.7 million as of December 31, 2009. This increase was the result of $610.8 million in net income, unrealized appreciation on investments, net of tax, of $60.2 million, share-based compensation transactions of $17.8 million and $1.9 million of foreign currency translation adjustments, partially offset by repurchasing 5.1 million common shares for $398.6 million, $108.5 million of shareholder dividends and $1.8 million of benefit plan obligation adjustments.
Over the past few years and particularly in 2010, we have expanded the allocation of our investments funded by shareholders’ equity to include: 1) a greater percentage of publicly traded equity securities, 2) emerging market fixed maturities through mutual fund structures, 3) high yield fixed maturities, 4) bank loan securities and 5) private equity limited partnership investments. The objective of this portfolio diversification is to enhance the risk-adjusted total return of the investment portfolio by allocating a prudent portion of the portfolio to higher return asset classes, which are also less subject to changes in value with movements in interest rates. We limit our allocation to these asset classes because of 1) the potential for volatility in their values and 2) the impact of these investments on regulatory and rating agency capital adequacy models. We use investment managers experienced in these markets and adjust our allocation to these investments based upon market conditions. At December 31, 2010, the market value of investments in these investment market sectors, carried at both market and fair value, approximated 36% of shareholders’ equity.
As the timing of payments for claims and benefits cannot be predicted with certainty, we maintain portfolios of long term invested assets with varying maturities, along with short-term investments that provide additional liquidity for payment of claims. At December 31, 2010 and 2009, we held cash and short-term investments of $1,043.7 million and $920.7 million, respectively. All of our short-term investments are readily marketable and can be converted to cash. In addition to these cash and short-term investments, at December 31, 2010, we had $580.5 million of available for sale fixed maturity securities maturing within one year or less, $4,057.2 million maturing within one to five years and $5,088.2 million maturing after five years. Our $1,085.2 million of equity securities are comprised primarily of publicly traded securities that can be easily liquidated. We believe that these fixed maturity and equity securities, in conjunction with the short-term investments and positive cash flow from operations, provide ample sources of liquidity for the expected payment of losses in the near future. We do not anticipate selling securities or using available credit facilities to pay losses and LAE but have the ability to do so. Sales of securities might result in realized capital gains or losses. At December 31, 2010 we had $439.6 million of net pre-tax unrealized appreciation, comprised of $555.5 million of pre-tax unrealized appreciation and $115.9 million of pre-tax unrealized depreciation.
At December 31, 2010, the Company had outstanding $50.0 million of short-term borrowings from the Holdings Credit Facility revolving credit line, with a maturity date of January 18, 2011. These short-term borrowings can be paid either through renewal with a one, two, three or six month term; or out of cash flows from operations. The highest amount outstanding in short-term borrowings was $133.0 million for the period from June 15, 2010 to August 9, 2010. In addition, at December 31, 2010 and 2009, the Holdings Credit Facility had outstanding letters of credit of $9.5 million and $28.0 million, respectively.
Costs incurred in connection with the Group Credit Facility and the Holdings Credit Facility were $1.8 million and $1.5 million for December 31, 2010 and 2009, respectively.
Nevertheless, when combined with traditional risk management techniques and sound underwriting judgment, catastrophe models are a useful tool for underwriters to price catastrophe exposed risks and for providing management with quantitative analyses with which to monitor and manage catastrophic risk exposures by zone and across zones for individual and multiple events.
Management estimates that the projected economic loss from its largest 100-year event in a given zone represents approximately 10% of its projected 2011 shareholders’ equity. Economic loss is the gross PML reduced by estimated reinstatement premiums to renew coverage and estimated income taxes. The impact of income taxes on the PML depends on the distribution of the losses by corporate entity, which is also affected by inter-affiliate reinsurance. Management also monitors and controls its largest PMLs at multiple points along the loss distribution curve, such as loss amounts at the 20, 50, 100, 250, 500 and 1,000 year
return periods. This process enables management to identify and control exposure accumulations and to integrate such exposures into enterprise risk, underwriting and capital management decisions.
Contractual Obligations. The following table shows our contractual obligations for the period indicated.
Improving Disclosures About Fair Value Measurements. In January 2010, the FASB amended the authoritative guidance for disclosures on fair value measurements. Effective for interim and annual reporting periods beginning after December 15, 2009, the guidance requires a new separate disclosure for: significant transfers in and out of Level 1 and 2 and the reasons for the transfers; and provided clarification on existing disclosures to include: fair value measurement disclosures by class of assets and liabilities and disclosure on valuation techniques and inputs used to measure fair value that fall in either Level 2 or Level 3. The Company implemented this guidance effective January 1, 2010. Effective for interim and annual reporting periods beginning after December 15, 2010, the guidance requires another new separate disclosure in regards to Level 3 fair value measurements in that, the period activity will present separately information about purchases, sales, issuances and settlements. Comparative disclosures shall be required only for periods ending after initial adoption. The Company implemented this guidance beginning with the third quarter of 2010.
Other-Than-Temporary Impairments on Investment Securities. In April 2009, the FASB revised the authoritative guidance for the recognition and presentation of other-than-temporary impairments. This new guidance amends the recognition guidance for other-than-temporary impairments of debt securities and expands the financial statement disclosures for other-than-temporary impairments on debt and equity securities. For available for sale debt securities that the Company has no intent to sell and more likely than not will not be required to sell prior to recovery, only the credit loss component of the impairment would be recognized in earnings, while the rest of the fair value loss would be recognized in accumulated other comprehensive income. The Company adopted this guidance effective April 1, 2009. Upon adoption the Company recognized a cumulative-effect adjustment increase in retained earnings and decrease in accumulated other comprehensive income (loss) of $57.3 million, net of $8.3 million of tax.
Fair Value Disclosures about Pension Plan Assets. In December 2008, the FASB revised the authoritative guidance for employers’ disclosures about pension plan assets. This new guidance requires additional disclosures about the components of plan assets, investment strategies for plan assets and significant concentrations of risk within plan assets. The Company, in conjunction with fair value measurement of plan assets, separated plan assets into the three fair value hierarchy levels and provided a roll forward of the changes in fair value of plan assets classified as Level 3 in the 2009 annual consolidated financial statements. These disclosures had no effect on the Company’s accounting for plan benefits and obligations.
Interest Rate Risk. Our $15.4 billion investment portfolio, at December 31, 2010, is principally comprised of fixed maturity securities, which are generally subject to interest rate risk and some foreign currency exchange rate risk, and some equity securities, which are subject to price fluctuations and some foreign exchange rate risk. The impact of the foreign exchange risks on the investment portfolio is partially mitigated by changes in the dollar value of foreign currency denominated liabilities and their associated income statement impact.
The tables below display the potential impact of market value fluctuations and after-tax unrealized appreciation on our fixed maturity portfolio (including $785.3 million of short-term investments) for the period indicated based on upward and downward parallel and immediate 100 and 200 basis point shifts in interest rates. For legal entities with a U.S. dollar functional currency, this modeling was performed on each security individually. To generate appropriate price estimates on mortgage-backed securities, changes in prepayment expectations under different interest rate environments were taken into account. For legal entities with a non-U.S. dollar functional currency, the effective duration of the involved portfolio of securities was used as a proxy for the market value change under the various interest rate change scenarios.
We had $9,340.2 million and $8,937.9 million of gross reserves for losses and LAE as of December 31, 2010 and 2009, respectively. These amounts are recorded at their nominal value, as opposed to present value, which would reflect a discount adjustment to reflect the time value of money. Since losses are paid out over a period of time, the present value of the reserves is less than the nominal value. As interest rates rise, the present value of the reserves decreases and, conversely, as interest rates decline, the present value increases. These movements are the opposite of the interest rate impacts on the fair value of investments. While the difference between present value and nominal value is not reflected in our financial statements, our financial results will include investment income over time from the investment portfolio until the claims are paid. Our loss and loss reserve obligations have an expected duration of approximately 3.8 years, which is reasonably consistent with our fixed income portfolio. If we were to discount our loss and LAE reserves, net of $0.7 billion of reinsurance receivables on unpaid losses, the discount would be approximately $1.4 billion resulting in a discounted reserve balance of approximately $7.3 billion, representing approximately 54.3% of the market value of the fixed maturity investment portfolio funds.
Equity Risk. Equity risk is the potential change in fair and/or market value of the common stock, preferred stock and mutual fund portfolios arising from changing prices. Our equity investments consist of a diversified portfolio of individual securities and mutual funds, which invest principally in high quality common and preferred stocks, that are traded on the major exchanges, and mutual fund investments in emerging market debt. The primary objective of the equity portfolio is to obtain greater total return relative to our core bonds over time through market appreciation and income.
We sold six equity index put option contracts, based on the S&P 500 index, for total consideration, net of commissions, of $22.5 million. At December 31, 2010, fair value for these equity index put option contracts was $52.4 million. These equity index put option contracts each have a single exercise date, with maturities ranging from 12 to 30 years and strike prices ranging from $1,141.21 to $1,540.63. The S&P 500 index value at December 31, 2010 was $1,257.64. No amounts will be payable under these equity index put option contracts if the S&P 500 index is at, or above, the strike prices on the exercise dates, which fall
Because the equity index put option contracts meet the definition of a derivative, we report the fair value of these instruments in our consolidated balance sheets as a liability and record any changes to fair value in our consolidated statements of operations and comprehensive income (loss) as a net derivative gain (loss). Our financial statements reflect fair values for our obligations on these equity index put option contracts at December 31, 2010, of $58.5 million and at December 31, 2009, of $57.3 million; even though it may not be likely that the ultimate settlement of these transactions would require a payment that would exceed the initial consideration received, or any payment at all.