We currently lease office space in Pembroke, Bermuda, where the Company and Montpelier Re are located. We also lease office space in London, U.K. where MUAL, PUAL, MCL and MUSL are located; in Zug, Switzerland, where MEAG is located; in Boston, MA, Chicago, IL, Hartford, CT and Overland Park, KS where MUI is located; in Scottsdale, AZ where MUSIC is located; and in Woburn, MA and Hanover, NH where MTR is located.
Selected consolidated statement of operations data, ending balance sheet data and share data for each of the five years ended December 31, 2010, follows:
(d) From January 2006 to June 2008, the period prior to Blue Ocean becoming a wholly-owned subsidiary, we fully consolidated Blue Ocean in our financial statements. Net income attributable to noncontrolling interest represents the portion of Blue Ocean’s net income attributable to shareholders other than the Company.
(e) During 2010 and 2009 we repurchased and retired $1.0 million and $21.0 million of our senior unsecured debt (the “Senior Notes”), respectively. During 2008 Blue Ocean fully repaid $75.0 million of its debt that was issued in 2006.
(f) During 2010 we repurchased 16,123,261 Common Shares for $293.8 million. During 2009 we repurchased 6,599,038 Common Shares for $112.6 million. During 2008 we repurchased 7,799,019 Common Shares for $125.7 million. During 2007 we repurchased 4,719,344 Common Shares for $81.0 million and all outstanding warrants to acquire Common Shares for $47.7 million. During 2006 we privately sold 6,896,552 Common Shares for $100.0 million.
This discussion contains forward-looking statements that are not historical facts, including statements about our beliefs and expectations. These statements are based upon current plans, estimates and projections. Our actual results may differ materially from those projected in these forward-looking statements as a result of various factors. See “Forward Looking Statements” appearing at the beginning of this report and “Risk Factors” contained in Item 1A herein.
We ended 2010 with a fully converted tangible book value per share of $24.53, an increase of 18.1% for the year inclusive of dividends declared. The increase in our fully converted tangible book value per share during 2010 resulted from good overall underwriting and investment results. Our comprehensive income for 2010 was $208.7 million and our GAAP combined ratio was 82.0%.
Our underwriting results for 2010 included $135.9 million of net catastrophe losses from earthquakes in both Chile and New Zealand, as well as $20.0 million from the Deepwater Horizon oil rig explosion and fire. These losses were partially offset by $109.3 million of prior year favorable loss reserve development. Our investment results for 2010 included $50.6 million of net realized and unrealized investment gains which were comprised of $21.2 million in net gains from fixed maturities, $25.1 million in net gains from equity securities and $4.3 million in net gains from other investments.
We ended 2009 with a fully converted tangible book value per share of $21.08, an increase of 34.7% for the year inclusive of dividends declared. The increase in our fully converted tangible book value per share during 2009 resulted from strong overall underwriting and investment results. Our comprehensive income for 2009 was $463.8 million and our GAAP combined ratio was 62.2%.
Our underwriting results for 2008 included $177.1 million of net catastrophe losses from Hurricanes Gustav and Ike, partially offset by $104.1 million of prior year favorable loss reserve development. The Company’s financial impact from Hurricanes Gustav and Ike, net of reinsurance, reinstatements and reductions in incentive accruals, was approximately $140.0 million. Our investment results for 2008 included $244.9 million of net realized and unrealized investment losses which were comprised of $82.4 million in net losses from fixed maturities, $103.5 million in net losses from equity securities and $59.0 million in net losses from other investments.
The following table presents our computation of book value per share, fully converted book value per share and fully converted tangible book value per share:
Our three-tiered risk management approach focuses on managing exposed overall contract limits, estimating the potential impact of a single natural catastrophe event, and simulating our yearly net operating result to reflect certain modellable underwriting and investment risks we face on an aggregate basis. We seek to refine and improve our risk management process over time. Our catastrophe and enterprise-wide risk management metrics entail significant estimates, judgments and uncertainties. The following discussion should be read in conjunction with our “Risk Factors” contained in Item 1A herein, in particular the specific risk factor entitled “Our stated catastrophe and enterprise-wide risk management exposures are based on estimates and judgments which are subject to significant uncertainties.”
We track gross reinsurance treaty contract limits that we believe are exposed to a single natural perils occurrence within certain broadly defined major catastrophe zones. The resulting measure represents the sum of all contract limits assumed through property reinsurance treaties, other specialty reinsurance treaties and event-linked insurance derivatives, but excludes limits relating to individual risk insurance business and the benefit of any reinsurance protections we have purchased. As of December 31, 2010, our largest single zonal concentration was Northern European windstorm (the zone consisting of the U.K., Ireland, Germany, France, the Benelux countries, Switzerland, Denmark, Norway and Sweden). For individual risk business, including both direct insurance and facultative reinsurance accounts, we supplement our treaty approach by tracking contract limits to a finer geographic resolution.
The market share estimates above represent an estimate of our average market share across multiple event scenarios corresponding to industry losses of a given size. However, it is important to note that our average market share may vary considerably within a particular territory depending on the specific characteristics of the event. This is particularly true for the direct insurance and facultative reinsurance portfolio we underwrite. Other factors contributing to such variation may include our decision to be overweight or underweight in certain regions within a territory. For example, our market share for a large European wind event may differ depending on whether the majority of loss comes from the U.K. or from Continental Europe. Additionally, our net market share may be impacted by the number and order of occurrence of catastrophic events during a year which could exhaust individual policy limits or trigger additional losses from certain policies offering second-event or aggregate protection. Further, certain reinsurance we purchase may have geographic restrictions or provide coverage for only a single occurrence within the policy period. Lastly, these estimates represent snapshots at December 31, 2010. The composition of our in-force portfolio will fluctuate due to the acceptance of new policies, the expiration of existing policies, and changes in our reinsurance program.
Each industry-recognized catastrophe model contains its own assumptions as to the frequency and severity of large events, and results may vary significantly from model to model. Given the relatively limited historical record, there is a great deal of uncertainty with regard to the accuracy of any catastrophe model, especially at relatively remote return periods.
There is no single standard methodology or set of assumptions utilized industry-wide in estimating property catastrophe losses. As a consequence, it may be difficult to compare estimates of risk exposure among different insurance and reinsurance companies, due to differences in modeling, portfolio composition and concentrations, modeling assumptions, and selected event scenarios.
Our consolidated financial results for the years ended December 31, 2010, 2009 and 2008 follow:
The following table summarizes Montpelier Bermuda’s gross premiums, by line of business, for the years ended December 31, 2010, 2009 and 2008:
The amount of gross premiums written by Montpelier Bermuda during 2010 was largely consistent with that written during 2009, increasing less than 1% in total. Underlying this overall consistency were offsetting changes within certain lines of business.
· Gross premiums written in 2010 within the Property Catastrophe - Treaty line of business include a $9.3 million increase in reinstatement premiums written over the 2009 level. Excluding the effects of these reinstatements, most of which related to the earthquake in Chile, Property Catastrophe - Treaty decreased by $12.4 million, or 5% in 2010 as compared to the prior year, due mainly to a softer pricing environment,
· Gross premiums written in 2010 within the Property Specialty - Treaty line of business decreased by $22.7 million, or 33%, as compared to 2009. Much of this decrease resulted from the non-renewal and subsequent reclassification of one large engineering contract into the Other Specialty - Treaty line of business. This contract generated $8.7 million of premium in 2009. Most of the remaining decrease was attributable to non-recurring premium adjustments recorded on certain proportional contracts in the first quarter of 2009,
· Gross premiums written in 2010 within the Other Specialty - Treaty line of business increased by $33.5 million, or 47%, over 2009 due primarily to an increase in space and aviation business,
· Montpelier Bermuda’s gross premiums written during 2009 included a $0.7 million net reversal of reinstatement premiums whereas gross premiums written during 2008 included $21.2 million of reinstatement premiums, primarily related to Hurricane Ike. Excluding the effects of these reinstatements, gross premiums written within our Montpelier Bermuda segment decreased by approximately 6% from 2008,
· The decrease, as adjusted for reinstatements, relates mainly to Montpelier Bermuda’s Property Catastrophe - Treaty line of business and reflects its decision to reduce its gross exposures in connection with the lapsing of certain outward reinsurance protections. This reduction was partially offset by price increases on 2009 renewal business.
Gross and net premiums written during the periods presented include amounts assumed from Montpelier Syndicate 5151 as part of an inter-segment excess-of loss reinsurance agreement. See “Corporate and Other” under this Item 7.
All of Montpelier Bermuda’s reinsurance purchases to date have represented prospective cover; that is, ceded reinsurance purchased to protect it against the risk of future losses as opposed to covering losses that have already occurred but have not been paid. The majority of these contracts are excess-of-loss contracts covering one or more lines of business. To a lesser extent Montpelier Bermuda has also purchased quota share reinsurance with respect to specific lines of business. Montpelier Bermuda also purchases industry loss warranty policies which provide coverage for certain losses provided they are triggered by events exceeding a specified industry loss size.
Net premiums earned within Montpelier Bermuda during 2010, 2009 and 2008 were $413.9 million, $426.0 million and $459.7 million, respectively, representing decreases of 3% and 7% during 2010 and 2009, respectively. Net premiums earned are a function of the amount and timing of net premiums written.
Our best estimate for Montpelier Bermuda’s ending gross loss and LAE reserves at December 31, 2010 and 2009 was $583.1 million and $569.4 million, respectively. Montpelier Bermuda’s gross IBNR reserves as a portion of total gross reserves has remained largely consistent since the prior year-end, amounting to 62% and 64% as of December 31, 2010 and 2009, respectively.
We estimated Montpelier Bermuda’s gross and net loss and LAE reserves using the methodology outlined in our “Summary of Critical Accounting Estimates” contained in Item 7 herein. We did not make any significant changes in the assumptions or methodology used in Montpelier Bermuda’s reserving process during the year ended December 31, 2010.
The largest drivers of Montpelier Bermuda’s current year net losses incurred during 2010 included the following:
· $76.8 million associated with the February 2010 earthquake in Chile,
· $20.0 million from the Deepwater Horizon oil rig explosion and fire.
During 2009 Montpelier Bermuda incurred $47.7 million of net loss and LAE from catastrophe losses, including European windstorm Klaus and hail storms in Europe and Canada.
Net favorable loss and LAE development occurring in 2010 that related to prior year losses was $88.9 million. The principal reasons for this decrease were the following:
· Casualty classes of business, excluding medical malpractice and individual risk contracts, relating to several prior accident years ($11.5 million decrease),
· The favorable commutation of reinsurance contracts, relating to multiple prior accident years ($4.9 million decrease), and
Net favorable loss and LAE development occurring in 2009 that related to prior year losses was $68.6 million. The principal reasons for this decrease were the following:
The loss and LAE development relating to the 2005 explosion and 2007 mining event was driven by the resolution of legal proceedings in 2009. The development relating to the 2006 furnace collapse was the result of new information provided to us by the ceding company in 2009,
Net favorable loss and LAE development occurring in 2008 that related to prior year losses was $104.8 million. The most significant drivers of this decrease were the following:
· Favorable adjustments relating to multiple smaller events and IBNR across all lines of business.
The prior year loss and LAE development recorded by Montpelier Bermuda in 2010, 2009 and 2008 associated with natural catastrophes such as hurricanes, wildfires, floods and windstorms was the result of new information received from multiple cedants and information regarding the impact of such losses on the entire reinsurance market.
The following table summarizes Montpelier Bermuda’s underwriting expenses incurred during the years ended December 31, 2010, 2009 and 2008:
The decrease in Montpelier Bermuda’s operating expenses during 2010, as compared to 2009, is largely due to a decrease in Montpelier’s centrally-managed information technology costs, as well as a change in the manner in which those costs are allocated across our reportable segments. The information technology costs allocated to Montpelier Bermuda during 2010 decreased by $10.5 million in 2010, as compared to 2009. In addition, operating expenses for 2010 include a recovery of $5.2 million of defense costs and accrued interest on overdue amounts awarded in connection with a resolved reinsurance contract dispute with MPCL. See Item 3, “Legal Proceedings.”
Underwriting results for Montpelier Syndicate 5151 for the years ended December 31, 2010, 2009 and 2008 were as follows :
The following table summarizes Montpelier Syndicate 5151’s gross premiums, by line of business, for the years ended December 31, 2010, 2009 and 2008:
The largest drivers of the increase in 2009 gross premiums written related to marine business written within the Property and Specialty Individual Risk line of business and excess-of-loss and proportional contracts written within the Other Specialty - Treaty line of business.
The following tables summarize Montpelier Syndicate 5151’s loss and LAE reserve activities for the years ended December 31, 2010, 2009 and 2008:
Our best estimate for Montpelier Syndicate 5151’s ending gross loss and LAE reserves at December 31, 2010 and 2009 was $166.4 million and $96.0 million, respectively. Montpelier Syndicate 5151’s gross IBNR reserves as a portion of total gross reserves were 64% and 78% as of December 31, 2010 and 2009, respectively. The decrease in the percentage of gross IBNR reserves to total gross reserves from 2009 to 2010 is reflective of Montpelier Syndicate 5151 having a more mature book of business as well as it experiencing higher favorable prior year loss reserve development in 2010 than in 2009.
During 2009 Montpelier Syndicate 5151 incurred $72.1 million of current year net loss and LAE, nearly all of which was recognized during the year in order to provide for claims and events that had been incurred but not yet reported to us.
During 2010, Montpelier Syndicate 5151 experienced $19.5 million of favorable development on its loss and LAE reserves relating to prior year losses. Losses associated with Hurricane Ike generated $1.0 million of the favorable development, and a further $1.7 million related to smaller claims and events. The remaining $16.8 million of favorable development related to losses that had been recognized in prior years in order to provide for events and claims not yet reported to us. These reserves were originally recorded largely on the basis of historical loss rates, industry data and actuarial judgment and experience as opposed to information received from cedants and other customers. As these prior underwriting years have matured, Montpelier Syndicate 5151 has increased its reliance on the loss data it has received, and as a result has reduced its estimate of ultimate losses, particularly in the Property Specialty - Treaty and Property and Specialty - Individual Risk lines of business.
· The settlement of two individual risk losses below the amounts previously reserved, which represented $5.4 million of favorable development,
Profit commissions, which are paid by assuming companies to ceding companies in the event of a favorable loss experience, change as Montpelier Syndicate 5151’s estimates of loss and LAE fluctuate. Profit commissions for Montpelier Syndicate 5151 totaled $2.4 million, $1.0 million and $0.3 million during 2010, 2009 and 2008, respectively. Montpelier Syndicate 5151 also incurred premium deficiency charges (reversals) of $(0.1) million, $(0.7) million and $0.1 million, respectively.
Absent profit commissions and premium deficiency charges (reversals), Montpelier Syndicate 5151’s acquisition cost ratio has gradually increased from 2008 to 2010. The primary reason for this increase is the growth in marine business, which is written at a higher acquisition cost ratio than most other business written by this segment.
The following table summarizes Montpelier Syndicate 5151’s general and administrative expenses during the years ended December 31, 2010, 2009 and 2008:
The increase in Montpelier Syndicate 5151’s incentive compensation expenses recognized during 2009 versus 2008 reflects a significant increase in our consolidated underwriting income experienced from year to year.
Our best estimate for MUSIC’s ending gross loss and LAE reserves at December 31, 2010 and 2009 was $35.1 million and $15.4 million, respectively.
MUSIC’s gross ending unpaid loss and LAE reserves and reinsurance recoverables on unpaid losses include $5.8 million, $6.1 million and $8.8 million of remaining Acquired Reserves at December 31, 2010, 2009 and 2008, respectively. MUSIC holds a GAINSCO-maintained trust deposit and reinsurance recoverables from third-party reinsurers rated “A-” (Excellent) or better by A.M. Best, which collectively support the Acquired Reserves. In addition, we have a full indemnity from GAINSCO covering any adverse development from its past business. If the Acquired Reserves were to develop unfavorably during future periods and the various protective arrangements, including GAINSCO’s indemnity, ultimately proved to be insufficient, these liabilities would become our responsibility.
As a result of MUSIC’s limited premium writings and loss experience, MUSIC’s loss and LAE expenses incurred to date primarily represent IBNR. MUSIC’s (favorable) and unfavorable prior year loss reserve development to date has not been significant, totalling $(0.9) million and $0.4 million and zero in 2010, 2009 and 2008, respectively.
The following table summarizes MUSIC’s general and administrative expenses during the years ended December 31, 2010, 2009 and 2008:
MUSIC’s operating expenses of $9.4 million, $7.4 million and $4.5 million for 2010, 2009 and 2008, respectively, represent: (i) salaries, employee benefits and premises expenses; and (ii) intercompany allocations of information technology and other centrally-managed expenses. The increase in operating expenses incurred during 2010 over 2009, was primarily due to a change in the manner in which Montpelier’s centrally-managed information technology costs are allocated. The increase experienced during 2009 over 2008 was also due largely to an increase in information technology costs, as well as increases in employee-related costs associated with MUSIC’s growing operations.
The increase in MUSIC’s incentive compensation expenses recognized during 2009 versus 2008 reflects a significant increase in our consolidated underwriting income experienced from year to year.
During 2007 Blue Ocean Re ceased writing new business and during 2008 Blue Ocean Re was deregistered as a Bermuda insurer.
Our Corporate and Other results for the years ended December 31, 2010, 2009 and 2008 were as follows:
The following table summarizes the general and administrative expenses of Corporate and Other during the years ended December 31, 2010, 2009 and 2008:
The following table summarizes our consolidated net investment income and total investment return for the years ended December 31, 2010, 2009 and 2008:
Our total investment return for 2010 was significantly lower than that of 2009, due to lower net realized and unrealized investment gains and net investment income experienced in 2010. Our total investment return for 2009 was significantly higher than that of 2008, due to net realized and unrealized investment gains (versus net realized and unrealized losses in 2008) offsetting reductions in net investment income experienced in 2009.
Our investment expenses were fairly consistent throughout each of the years presented and are impacted by our balances under management and changes in the allocation of invested balances among our various investment managers. As of December 31, 2010, 2009 and 2008, our ending investment portfolio, including cash and cash equivalents, totaled $2,765 million, $2,668 million and $2,355 million, respectively.
During 2010 we experienced $21.2 million in net realized and unrealized gains from our fixed maturity portfolio, $25.1 million in net realized and unrealized gains from our equity portfolio and $4.3 million in net realized and unrealized gains from our other investments. The fixed maturity gains and the majority of the other investment gains we experienced during 2010 were largely the result of a declining U.S. Treasury yield curve as well as tightening credit spreads between the yield on those securities versus that of U.S. Treasuries. In addition, we experienced a $4.3 million realized loss from a limited partnership investment carried as an other investment. The equity portfolio gains we experienced during 2010 followed a consistent trend to that of the U.S. equity market, as measured by the S&P 500 Index.
During 2010, 2009, and 2008 we experienced net foreign exchange gains (losses) on cash and investments of $(2.7) million, $0.8 million and $(3.3) million, respectively. The foreign exchange gains (losses) experienced during these years are due to the weakening (strengthening) of the U.S. dollar against the various foreign currencies in which we transact, principally the British pound and the European Union euro.
During 2009 and 2008 we recorded unrealized gains (losses) from our investment in Symetra Financial Corporation (“Symetra”) of $(0.5) million and $0.9 million, respectively. Our investment in Symetra was acquired in a private placement in 2004 and, in January 2010, Symetra’s common shares began trading on the New York Stock Exchange under the symbol SYA. As a result, during 2010 we reclassified the cumulative net appreciation associated with our investment in Symetra, which totaled $2.6 million at December 31, 2009, from other comprehensive income to net unrealized investment gains on the Company’s consolidated statements of operations and moved that investment from other investments to equity securities on the Company’s consolidated balance sheets. Symetra provides retirement plans, employee benefits, life insurance and annuities through a national network of independent advisors and agents.
As of December 31, 2010, $85.2 million, or 3.4%, of our total invested assets measured at fair value were considered to be Level 3 assets. Our investments classified as Level 3 at December 31, 2010 consisted primarily of the following: (i) with respect to fixed maturity investments, bank loans and certain asset-backed securities, many of which are not actively traded and; (ii) with respect to other investments, certain limited partnership interests.
As of December 31, 2008, $191.3 million, or 9.3%, of our total invested assets measured at fair value were considered to be Level 3 assets. Our investments classified as Level 3 at December 31, 2008 primarily consisted of the following: (i) with respect to fixed maturity investments, certain corporate bonds, convertible debt and asset-backed securities, many of which are not actively traded; (ii) with respect to equity securities, warrants to acquire equity securities and certain non-U.S. securities; and (iii) with respect to other investments, our investment in Symetra.
The decrease in our Level 3 securities from December 31, 2008 to December 31, 2009, was the result of an increase in pricing transparency of certain of our fixed maturities historically classified as Level 3.
See “Net Investment Income and Total Return on Investments” above for details of our net foreign exchange transaction gains on cash and investments.
In April 2008 we entered into ILW Swap I with a third-party in order to provide protection against our U.S. hurricane exposure. In return for a fixed-rate payment of $0.7 million, we received a floating-rate payment which was triggered on the basis of losses incurred by the insurance industry as a whole. Our maximum recovery under ILW Swap I was $5.0 million. ILW Swap I expired without value in April 2009.
We recorded expenses of $0.3 million and $0.7 million associated with the ILW swaps during 2010 and 2008, respectively.
Contract payments expensed in connection with the CAT Bond Protection were calculated at 12.83% per annum on the first tranche and 13.58% per annum on the second tranche.
We recorded expenses of $0.2 million and $11.9 million associated with the CAT Bond Protection during 2009 and 2008, respectively.
Those Foreign Exchange Contracts related to our underwriting activities do not eliminate fluctuations in the value of our assets and liabilities denominated in foreign currencies; rather, they are designed to protect us against adverse movements in foreign exchange rates. Those Foreign Exchange Contracts related to our investing activities are designed to either protect us from adverse movements in foreign exchange rates or to enhance our investment performance.
We recorded an expense of $0.1 million associated with the Interest Rate Contracts during 2010.
We recorded income (expense) of $(6.7) million, $8.1 million and $1.8 million associated with the Investment options and Futures during 2010, 2009 and 2008, respectively.
We recorded income of $1.0 million associated with the CAT Bond Facility during 2008.
We recorded income of $0.3 million and $0.6 million associated with the ILW Contracts during 2010 and 2008, respectively.
Our interest and other financing expenses decreased during 2010, as compared to 2009. The reduction in interest expense experienced in 2010 was due to the repurchase of $1.0 million and $21.0 million of our Senior Notes in 2010 and 2009, respectively. The reduction in letter of credit and trust fees experienced during 2010 was the result of the Lloyd’s Deposit Trust Deed and Multi-Beneficiary U.S. Reinsurance Trust (the “Reinsurance Trust”) replacing two non-renewed letter of credit facilities that expired during 2010.
During 2003, we issued $250.0 million of Senior Notes. The Senior Notes bear interest at a rate of 6.125% per annum, payable semi-annually in arrears on February 15 and August 15 of each year. The Senior Notes are scheduled to mature on August 15, 2013. As of December 31, 2010 and 2009, we had $228.0 million and $229.0 million of principal amount of Senior Notes outstanding, respectively, with an unamortized carrying value of $227.7 million and $228.6 million, respectively.
In November 2006 we obtained a secured loan of $75.0 million from a syndicate of lenders (the “Blue Ocean Debt”). The Blue Ocean Debt had an initial maturity date of February 28, 2008. The Blue Ocean Debt bore interest on the outstanding principal amount at a rate equal to a base rate plus a margin of 200 basis points. We repaid the Blue Ocean Debt in full in January 2008.
In the normal course of business we maintain letter of credit facilities and provide letters of credit to third parties as a means of providing collateral and/or statutory credit to certain of our constituents. In addition, during 2010 we established two trust arrangements as an alternative means of providing these assurances. See “Liquidity and Capital Resources” contained in Item 7.
Our consolidated income tax provision for the years ended December 31, 2010, 2009 and 2008 consisted of the following:
During 2010 we re-characterized an existing intercompany loan among two of our wholly-owned subsidiaries as a contribution of capital. In connection this re-characterization, we recorded a $1.0 million income tax benefit representing: (i) current and prior year reversals of U.K. deferred income tax expense; and (ii) the amended treatment of foreign exchange gains experienced while the loan was outstanding.
The Company has no operations of its own and relies on dividends and distributions from its subsidiaries to pay its operating expenses, interest on debt, dividends to common shareholders and to fund any Common Share repurchase activities. There are restrictions on the payment of dividends to the Company from its regulated operating companies as described under “Regulation” herein. We currently have in place a regular dividend of $0.10 per Common Share per quarter. Any future determination to pay dividends or distributions to our shareholders will, however, be at the discretion of our Board of Directors and will be dependent upon many factors, including our results of operations, cash flows, financial position, capital requirements, general business opportunities, legal, tax, regulatory and contractual restrictions.
As a provider of short-tail insurance and reinsurance, mainly from natural and man-made catastrophes, we could become liable for significant losses on short notice. As a result, we have structured our fixed maturity investment portfolio with high-quality securities with a short average duration in order to reduce our sensitivity to interest rate fluctuations and to provide adequate liquidity for the settlement of our expected liabilities. As of December 31, 2010, our fixed maturities had an average credit quality of “AA” (Very Strong) by Standard & Poor’s and an average duration of 3.4 years. Nonetheless, if our calculations with respect to the timing of the payment of our liabilities are incorrect, or if we improperly structure our investments, we could be forced to liquidate investments prior to maturity, potentially at a significant loss.
In 2008 our former $50.0 million one-year operational revolving credit facility expired and we elected not to renew that facility.
The following table summarizes our capital structure as of December 31, 2010 and December 31, 2009:
Our Trust Preferred Securities mature on March 30, 2036, but are redeemable at our option at par beginning March 30, 2011. We do not currently intend to redeem the Trust Preferred Securities in 2011.
Neither the Senior Notes nor the Trust Preferred Securities contain any covenants regarding financial ratios or specified levels of net worth or liquidity to which the Company or any of its subsidiaries must adhere.
We may need to raise additional capital in the future, through the issuance of debt, equity or hybrid securities, in order to, among other things, write new business, pay significant losses, respond to, or comply with, any changes in the capital requirements that rating agencies use to evaluate us, acquire new businesses, invest in existing businesses or to refinance our existing obligations.
The issuance of any new debt, equity or hybrid financial instruments might contain terms and conditions that are more unfavorable to us and our shareholders than those contained within our current capital structure. More specifically, any new issuances of equity or hybrid securities could include the issuance of securities with rights, preferences and privileges that are senior or otherwise superior to those of Common Shares and could be dilutive to our existing Common Shares. Further, if we cannot obtain adequate capital on favorable terms or otherwise, our business, financial condition and operating results could be adversely affected.
The agreements governing our letter of credit facilities contain covenants that limit our ability, among other things, to grant liens on our assets, sell our assets, merge or consolidate, incur debt and enter into certain agreements. In addition, the syndicated secured facilities require us to maintain a debt to capital ratio of no greater than 30% and for Montpelier Re to maintain an A.M. Best financial strength rating of no less than “B++”. If we were to fail to comply with these covenants or fail to meet these financial ratios, the lenders could revoke these facilities and exercise remedies against our collateral. As of December 31, 2010 and 2009, our debt to capital ratio (which, as defined in such agreements, is currently the ratio of the amount of the Senior Notes outstanding divided by the sum of the Senior Notes outstanding and the Company’s common shareholders’ equity) was 12.3% and 11.7%, respectively, and Montpelier Re’s A.M. Best financial strength rating was “A-”.
During 2010 we voluntarily terminated a $230.0 million letter of credit facility (the “Lloyd’s Standby Facility”), which was formerly used to meet our ongoing Fund’s at Lloyds “FAL” requirements, and entered into the Lloyd’s Capital Trust for such purposes. See “Trust Arrangements” below.
As of December 31, 2010, we had unfunded commitments to invest $5.0 million into three separate private investment funds. For purposes of this presentation, it is assumed that all of our unfunded commitments are called during 2011.
Our Foreign Exchange Contracts, Credit Derivatives, Interest Rate Contracts and Investment Options and Futures each constitute off-balance sheet arrangements.
Excluding the off-balance sheet derivative transactions outlined above, as of December 31, 2010, we are not party to any other off-balance sheet transaction that we believe is material to our investors.
· we paid $19.3 million for net purchases of fixed maturity investments,
Our cash flows provided from operations were $233.1 million which resulted primarily from premiums received, net of acquisition costs, exceeding net paid losses of $213.0 million.
· we had a $33.8 million increase in our restricted cash, and
· we received $32.0 million in connection with the termination of the second Forward Share Agreement,
· we received $301.6 million from net sales and maturities of fixed maturities,
· we had a $27.2 million decrease in our restricted cash, and
· we paid $28.4 million in dividends to our common shareholders,
Our consolidated financial statements have been prepared in accordance with GAAP. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported and disclosed amounts of our assets and liabilities as of the balance sheet dates and the reported amounts of our revenues and expenses during the reporting periods. We believe the items that require the most subjective and complex estimates are: (i) our loss and LAE reserves; (ii) our written and earned insurance and reinsurance premiums; (iii) our ceded reinsurance; and (iv) our share based compensation.
Our primary focus is on short-tail property treaty reinsurance, written on both an excess-of-loss and proportional basis. We also underwrite certain direct insurance and facultative reinsurance, as well as casualty specialty risks. The nature and extent of management judgment involved in the reserving process depends upon the type of business.
Most of our treaty reinsurance contracts comprise business which has both a low frequency of claims occurrence and a high potential severity of loss, such as claims arising from natural catastrophes, terrorism, large individual property risks, and marine, space and aviation risks. Given the high-severity, low-frequency nature of these events, the losses typically generated do not lend themselves to traditional actuarial reserving methods. Therefore, our reserving approach for these types of coverages is to estimate the ultimate cost associated with a single loss event rather than analyzing the historical development patterns of past losses as a means of estimating ultimate losses for an entire accident year. We estimate our reserves for these large events on a contract-by-contract basis by means of a review of policies with known or potential exposure to a particular loss event.
As a predominantly broker market reinsurer for both excess-of-loss and proportional contracts, we must rely on loss information reported to brokers by primary insurers who, in turn, must estimate their own losses at the policy level, often based on incomplete and changing information. The information we receive varies by cedant and may include paid losses, estimated case reserves, and, infrequently, an estimated provision for IBNR reserves. Reserving practices and the quality of data reporting varies among ceding companies, which adds further uncertainty to the estimation of our ultimate losses. The nature and extent of information received from ceding companies also varies widely depending on the type of coverage, the contractual reporting terms (which are affected by market conditions and practices) and other factors. Due to the lack of standardization of the terms and conditions of reinsurance contracts, the wide variability of coverage provided to individual clients and the tendency of those coverages to change rapidly in response to market conditions, the ongoing economic impact of such uncertainties and inconsistencies cannot be reliably measured. Additional risks to us involved in the reporting of retrocessional contracts include varying reserving methodologies used by the original cedants and an additional reporting lag due to the time required for the retrocedant to aggregate its assumed losses before reporting them to us. Furthermore, the number of contractual intermediaries is normally greater for retrocessional business than for direct business, thereby increasing the time lag and imprecision associated with loss reporting.
The nature and extent of loss information provided under many facultative and per occurrence excess contracts, where company personnel work closely with the ceding company in settling individual claims, may not differ significantly from the information received under a primary insurance contract. Loss information from aggregate excess-of-loss contracts, including catastrophe losses and proportional treaties, will often be less detailed. Occasionally, such information is reported in summary format rather than on an individual claim basis.
We do not typically experience significant claims processing backlogs, although such backlogs may occur following a major catastrophic event. At December 31, 2010 and 2009, we did not have a significant backlog in either our insurance or reinsurance claims processing.
The uncertainties inherent in the reserving process, together with the potential for unforeseen developments, including changes in laws and the prevailing interpretation of policy terms, may result in loss and LAE significantly greater or less than the reserves initially established. Changes to our prior year loss reserves will impact our current underwriting results by improving our results if the prior year reserves prove to be redundant or impairing our results if the prior year reserves prove to be insufficient. We expect volatility in our results in periods that significant loss events occur because GAAP does not permit insurers or reinsurers to reserve for loss events until they have occurred and are expected to give rise to a claim. As a result, we do not record contingency reserves to account for expected future losses. We anticipate that claims arising from future events will require the establishment of substantial reserves from time to time.
Favorable development of prior period net losses experienced as a percentage of our opening net loss reserves across all underwriting years were 17.9%, 11.0% and 14.7% for the years ended December 31, 2010, 2009 and 2008, respectively. As of December 31, 2010, we estimate that a 15% change in our net unpaid loss and LAE reserves would result in an increase or decrease of our net income and shareholders’ equity by approximately $108.3 million. The net income and shareholders’ equity impact of the change in net reserves may be partially offset by adjustments to items such as reinstatement premiums, profit commission expense, incentive compensation and income taxes.
Our assumed treaty reinsurance premium is written on an excess-of-loss or on a pro-rata basis. Reinsurance contracts are typically written prior to the time the underlying direct policies are written by cedants and accordingly they must estimate such premiums when purchasing reinsurance coverage. For the majority of excess-of-loss contracts, including insurance contracts, a deposit or minimum premium is defined in the contract wording. The deposit or minimum premium is based on the ceding companies’ estimated premiums, and this estimate is recorded as written premium in the period the underlying risks incept. In the majority of cases, this premium is adjustable at the end of the contract period to reflect the changes in underlying risks in force during the contract period. Subsequent adjustments, based on reports by the ceding companies of actual premium, are recorded in the period they are determined, which is normally within six months to one year subsequent to the expiration of the policy. To date these adjustments have not been significant.
We routinely review the creditworthiness of our cedants on the basis of our market knowledge, the cedant’s current financial strength ratings, the timeliness of cedants’ past payments and the status of current balances owing. In addition, we may also review the financial condition of ceding companies. Based on our reviews, we established allowances of $3.0 million and $2.3 million for uncollectible insurance and reinsurance premiums receivable as of December 31, 2010 and 2009, respectively, each of which represented less than one-half of one percent of our consolidated net insurance and reinsurance premiums earned in those years.
In the normal course of business, we purchase reinsurance from third parties in order to manage our exposures. The amount of ceded reinsurance that we buy varies from year-to-year depending on our risk appetite, as well as the availability and cost of the reinsurance coverage. Reinsurance premiums ceded are accounted for on a basis consistent with those used in accounting for the underlying premiums assumed, and are reported as a reduction of net premiums written. Certain of our assumed pro-rata contracts incorporate reinsurance protection provided by third-party reinsurers that inures to our benefit. These reinsurance premiums are reported as a reduction to our gross premiums written.
The cost of reinsurance purchased varies based on a number of factors. The initial premium associated with excess-of-loss reinsurance is normally based on the underlying premiums we assume. As these reinsurance contracts are typically purchased prior to the time the assumed risks are written, ceded premium recorded in the period of inception reflects an estimate of the amount that we will ultimately pay. In the majority of cases, the premium initially recorded is subsequently adjusted to reflect premium actually assumed by us during the contract period. These adjustments are recorded in the period that they are determined, and to date they have not been significant. In addition, losses which pierce excess-of-loss reinsurance cover may generate reinstatement premium ceded, depending on the terms of the contract. This reinstatement premium ceded is recognized as written and expensed at the time the reinsurance recovery is estimated and recorded.
The LTIP is our sole share-based long-term incentive plan. At the discretion of the Compensation and Nominating Committee (the “Compensation Committee”) of our Board of Directors, incentive awards, the value of which are based on Common Shares, may be made to plan participants. Incentive awards currently outstanding under the LTIP consist solely of RSUs.
From time to time we issue “Fixed RSUs” as a supplemental component of our ongoing long-term incentive compensation for certain of our employees and directors. Fixed RSUs are fixed and determinable on the grant date and are typically granted: (i) to induce individuals to join our company; (ii) to retain certain key employees; (iii) to reward employees exhibiting outstanding individual performance; and (iv) as remuneration to non-management members of the Boards of Directors of the Company and MUAL.
As part of our principal long-term incentive compensation for employees, we issue “Variable RSUs.” Variable RSUs are contingent awards in which the actual number of RSUs to be awarded is dependent on our corporate (as opposed to individual) performance during the initial year of the award cycle (the “Initial RSU Period”), meaning that the number of RSUs expected to be awarded for that cycle may fluctuate during this period. The actual number of Variable RSUs to be awarded is based on a targeted return on equity (“ROE”) assuming a standardized investment return. ROE is computed by dividing the sum of the Company’s actual underwriting result and standard investment result by the Company’s actual average shareholders’ equity for the period.