(1) Excludes $45.3 million, $18.8 million and $20.8 million of premium assumed from our Individual Risk segment in the years ended December 31, 2005, 2004 and 2003, respectively.
The following is a discussion and analysis of our results of operations for the year ended December 31, 2005 compared with the years ended December 31, 2004 and December 31, 2003. The following also includes a discussion of our financial condition at December 31, 2005. This discussion and analysis should be read in conjunction with the audited consolidated financial statements and related notes included in this filing. This filing contains forward-looking statements that involve risks and uncertainties. Actual results may differ materially from the results described or implied by these forward-looking statements. See ‘‘Note on Forward-Looking Statements.’’
Since a substantial portion of the reinsurance and insurance we write provides protection from damages relating to natural and man-made catastrophes, our results depend to a large extent on the frequency and severity of such catastrophic events, and the coverages we offer to clients affected by these events.
Our expenses primarily consist of: 1) net claims and claim expenses incurred on the policies of reinsurance and insurance we sell; 2) acquisition costs which typically represent a percentage of the premiums we write; 3) operating expenses which primarily consist of personnel expenses, rent and other operating expenses; 4) corporate expenses which include certain executive, legal and consulting expenses, costs for research and development, and other miscellaneous costs associated with operating as a publicly traded company; and 5) interest and dividend costs related to our debt, preference shares and subordinated obligation to our capital trust. We are also subject to taxes in certain jurisdictions in which we operate; however, since the majority of our income is currently earned in Bermuda, a non-taxable jurisdiction, the tax impact to our operations has historically been minimal. In the future we expect our relative tax expenses to increase.
The operating results, also known as the underwriting results, of an insurance or reinsurance company are discussed frequently by reference to its net claims and claim expense ratio, underwriting expense ratio, and combined ratio. The net claims and claim expense ratio is calculated by dividing net claims and claim expenses incurred by net premiums earned. The underwriting expense ratio is calculated by dividing underwriting expenses (acquisition expenses and operational expenses) by net premiums earned. The combined ratio is the sum of the net claims and claim expense ratio and the underwriting expense ratio. A combined ratio below 100% generally indicates profitable underwriting prior to the consideration of investment income. A combined ratio over 100% generally indicates unprofitable underwriting prior to the consideration of investment income. We also discuss our net claims and claim expense ratio on an accident year basis. This ratio is calculated by taking net claims and claim expenses, excluding development on net claims and claim expenses from events that took place in prior years, divided by net premiums earned.
We define our Individual Risk segment to include underwriting that involves understanding the characteristics of the original underlying insurance policy. Our principal contracts include: 1) commercial and homeowners property coverages, including catastrophe-exposed products; 2) commercial liability coverages, including general, automobile, professional and various specialty products; 3) multi-peril crop insurance; and 4) reinsurance of other insurers on a quota share basis.
Our Individual Risk business is written by the Glencoe Group through its principal operating subsidiaries Glencoe and Lantana, which write on an excess and surplus lines basis, and through Stonington and Stonington Lloyds, which write on an admitted basis. As noted above, we rely on third parties for services including the generation of premium, the issuance of policies and the processing of claims. We actively oversee our third-party partners through an operations review team at Glencoe Group Services Inc., which conducts initial due diligence as well as ongoing monitoring.
The Company’s reserving methodology for each line of business, as discussed above, uses a loss reserving model that calculates a point estimate for the Company’s ultimate losses as opposed to a methodology that develops a range of estimates. The Company then uses this point estimate, along with paid and incurred data, to record its estimate of IBNR. The Company does not use sensitivity analysis in calculating reserves and therefore does not make any specific quantitative assumptions in connection with such an analysis. See ‘‘Reserves for Claims and Claim Expenses’’ for a breakdown of our case reserves and IBNR by line of business.
With the growth in our reserves for claims and claim expenses, we announced in early 2005 that we would review the processes and assumptions for establishing and evaluating our reserves during 2005. We completed reviews of our property catastrophe reinsurance reserves, specialty reinsurance reserves and Individual Risk reserves in the second, third and fourth quarters of 2005, respectively. As a result of these reviews, we reduced prior year reserves within our Reinsurance and Individual Risk segments by $248.1 million and $1.1 million, respectively. After adjusting for the impact of minority interest, our 2005 net loss was reduced by $226.9 million as a result of these reviews.
Within our Reinsurance segment, the reserve changes for our property catastrophe portfolio reflect a reassessment of our reserves for claims and claim expenses in light of historical paid loss trends and reported loss activity for the 1994 to 2004 accident years. For our specialty reinsurance business, the changes were principally due to a reassessment of our estimated loss reporting patterns. Since establishing the specialty reinsurance business unit in 2002, reported claim activity has been less than expected and therefore we have adjusted our estimated loss reporting patterns to reflect this experience. The changes within our Individual Risk segment as a result of the reserve review were insignificant.
All of our estimates are reviewed annually with an independent actuarial firm. We also review certain assumptions and methodologies on a quarterly basis. If we determine that adjustments to an earlier estimate are appropriate, such adjustments are recorded in the quarter in which they are identified. Adjustments to our prior year estimated claims reserves will impact our current year net income (loss) by increasing our net income or decreasing our net loss if the prior year estimated claims reserves are determined to be overstated, or by reducing our net income or increasing our net loss if the prior year estimated claims reserves prove to be insufficient. During the years ended December 31, 2005, 2004 and 2003, changes to prior year estimated claims reserves had the following impact: for 2005, prior year estimated claims reserves were reduced by $241.5 million; for 2004, prior year estimated claims reserves were reduced by $140.3 million; and for 2003, prior year estimated claims reserves were reduced by $93.6 million; and in each year there was a corresponding decrease to net loss or increase to net income. Although we believe we are cautious in our assumptions, and in the application of our methodologies, we cannot be certain that our ultimate payments will not vary, perhaps materially, from the estimates we have made. See ‘‘Reserves for Claims and Claim Expenses.’’
We enter into reinsurance agreements in order to help reduce our exposure to large losses and to help manage our risk portfolio. Amounts recoverable from reinsurers are estimated in a manner consistent with the claims and claim expense reserves associated with the related assumed reinsurance. For multi-year retrospectively rated contracts, we accrue amounts (either assets or liabilities) that are due to or from assuming companies based on estimated contract experience. If we determine that adjustments to earlier estimates are appropriate, such adjustments are recorded in the period in which they are determined.
We estimate our valuation allowance by applying specific percentages against each recovery based on our counterparty’s credit rating. The percentages applied are based on historical industry default statistics developed by major rating agencies and are then adjusted by us based on industry knowledge
and our judgment and estimates. We also apply case-specific valuation allowances against certain recoveries that we deem unlikely to be collected in full. We then evaluate the overall adequacy of the valuation allowance based on other qualitative and judgmental factors. The valuation allowance recorded against losses recoverable was $46.0 million at December 31, 2005 (2004 - $13.1 million). The reinsurers with the three largest balances accounted for 17.9%, 14.7% and 11.8%, respectively, of our losses recoverable balance at December 31, 2005 (2004 - 24.9%, 12.3% and 9.1%, respectively). The three largest company-specific components of the valuation allowance represented 39.6%, 18.1% and 10.3% of our total valuation allowance at December 31, 2005 (2004 - 54.9%, 15.3% and 9.7%).
Consistent with industry practice, we generally recognize premium on the date the contract is bound, even if the contract provides for an effective date prior to the date the contract is bound, thus preventing premature revenue recognition. The date the contract is bound is usually the date we are on risk for the policy and this is generally the date on which the reinsurance slip is signed. The signing of the reinsurance contract normally occurs after the date the slip is signed.
In our Individual Risk business, it is often necessary to estimate portions of premiums written from quota-share contracts and by program managers and the related commission expense. Management estimates these amounts based on discussions with ceding companies and program managers, together with historical experience and judgment. Total premiums written estimated in our Individual Risk business at December 31, 2005, 2004 and 2003 were $57.9 million, $30.1 million and $103.7 million, respectively, and total estimated premiums earned were $10.9 million, $3.5 million and $78.4 million, respectively. Total earned commissions estimated at December 31, 2005, 2004 and 2003 were $4.8 million, $1.1 million and $32.3 million, respectively. Management tracks the actual premium received and commissions incurred and compares this to the estimates previously booked. Such estimates are subject to adjustment in subsequent periods when actual figures are recorded. To date such subsequent adjustments have not been material.
(1) Represents premium ceded from the Individual Risk segment to the Reinsurance segment.
We incurred a net loss attributable to common shareholders of $281.4 million in 2005. This was the first time in our corporate history in which we have suffered an annual net loss attributable to common shareholders. Our 2005 financial performance compares unfavorably to the $133.1 million and $606.0 million of net income attributable to common shareholders generated in 2004 and 2003, respectively. As a result of the net loss attributable to common shareholders, we incurred a (13.6%) return on average common equity and our book value per common share plus accumulated dividends decreased to $29.80 at December 31, 2005, a decrease of 14.0% from the amount at December 31, 2004. In 2004 and 2003, we generated returns on average common equity of 6.2% and 33.8%, respectively, and increased our book value per common share plus accumulated dividends by 4.0% and 36.1%, respectively.
In addition to hurricanes Katrina, Rita and Wilma occurring in 2005, the year was also impacted by several other large natural catastrophes including hurricanes Dennis and Emily, European windstorm Erwin as well as flooding in several European cities. Total insured losses from the 2005 catastrophes are estimated to be the most costly on record for a single year. As one of the largest writers of property catastrophe reinsurance in the world, our financial results are negatively impacted when there are large insured catastrophe losses.
In 2004 we recorded a $570.2 million net negative impact from hurricanes Charley, Frances, Jeanne and Ivan. In 2003 there was an absence of similar large catastrophes and therefore our net income attributable to common shareholders was significantly higher in that year.
The following table summarizes the net financial statement impact of the 2005 hurricanes, reserve reviews and internal review related costs and 2004 hurricanes described above by segment.
Other significant items affecting 2005 include an increase in net investment income of $54.5 million to $217.3 million, compared to $162.7 million in 2004, due to higher investment returns and an increased level of invested assets in 2005 compared to 2004, and partially offset by net realized losses on investments of $7.0 million in 2005, compared to net realized investment gains of $23.4 million in 2004. The reduction in net realized gains on investments in 2005 was due to $33.2 million of other than temporary impairment charges recognized in the year compared to $1.2 million in 2004. Net realized gains on investments in 2003 were $80.5 million.
(1) Excludes combined gross premiums assumed from our Individual Risk segment of $45.3 million, $18.8 million and $20.8 million for the years ended December 31, 2005, 2004 and 2003, respectively.
gross premiums written, after deducting loss related premium, was primarily due to increased competition and softening prices in the property catastrophe market, in which we accordingly chose not to renew certain reinsurance contracts.
For 2006 we currently anticipate growth in our property catastrophe gross premiums written compared to 2005, after deducting the loss related premium described above. (See ‘‘Current Outlook’’ for additional disclosure.)
For 2006, we currently anticipate our specialty reinsurance gross premiums written will decline significantly compared to 2005, after deducting the loss related premium described above. Our specialty reinsurance premiums are prone to significant volatility as this business is characterized by a relatively small number of large transactions. (See ‘‘Current Outlook’’ for additional disclosure.)
In 2005, ceded premiums written include $49.9 million of premiums written which we view as loss related and attributable to the 2005 large hurricanes. This includes additional premium ceded on certain multi-year retrospectively rated reinsurance contracts which was triggered as a result of hurricanes Katrina and Wilma. Excluding this loss related premium, ceded premiums written decreased by $51.3 million, or 38.0% in 2005, and by $8.3 million, or 5.8% in 2004. The decrease in ceded premiums written is principally the result of a reduction in the availability of appropriately priced coverages.
To the extent that appropriately priced coverage is available, we anticipate continued use of reinsurance to reduce the impact of large losses on our financial results and to manage our portfolio of risk.
Our net premiums earned were essentially flat in 2005 at $947.4 million compared to $944.5 million in 2004. Included in net premiums earned are $103.5 million and $57.5 million of loss related net premium earned in 2005 and 2004, respectively. As discussed above, loss related premium includes reinstatement premiums written as a result of large catastrophes, back-up reinsurance coverage provided to companies to replace reinsurance protection lost following a large catastrophe, and reinsurance coverage provided to a company to cover named hurricanes. Excluding the impact of this loss related earned premium, which in the absence of similar large catastrophes we would not expect to recur, our net premiums earned declined by 4.9% to $843.9 million in 2005 from $887.0 million in 2004 and increased by 9.2% in 2004 from $812.1 million in 2003. The increase in net premiums earned in 2004 compared to 2003 was due to the increase in specialty premium written in 2004 when compared to 2003.
to our net claims and claim expense ratio. In 2004, hurricanes Charley, Frances, Jeanne and Ivan resulted in net claims and claim expenses of $581.8 million and increased our net claims and claim expense ratio by 61.6 percentage points. In 2003 there was an absence of similar large catastrophes and we generated a net claims and claim expense ratio of 25.9%, an expense ratio of 18.0% and an underwriting profit of $455.8 million in that year.
Our underwriting results have also been significantly impacted by reductions of prior year estimated ultimate net claims reserves over the last three years. We reduced prior year estimated ultimate net claims reserves by $231.3 million, $113.8 million and $68.7 million in 2005, 2004 and 2003, respectively. The increase in the reduction of prior year reserves in 2005 was principally the result of our 2005 reserve reviews. With the growth in our reserves for claims and claim expenses, we announced in early 2005 that we would review the processes and assumptions for establishing and evaluating our reserves during 2005. We completed reviews of our property catastrophe reinsurance and specialty reinsurance reserves in the second and third quarters of 2005, respectively. As a result of these reviews, we reduced prior year reserves within our Reinsurance segment by $248.1 million, which reduced our 2005 net claims and claim expense ratio by 26.2 percentage points. After adjusting for the impact of minority interest, our 2005 net loss was reduced by $225.8 million as a result of the Reinsurance segment reserve reviews. The reserve changes for our property catastrophe portfolio reflects a reassessment of our reserves for claims and claim expenses in light of historical paid loss trends and reported loss activity for the 1994 to 2004 accident years. For our specialty reinsurance business, the changes were principally due to a reassessment of our estimated loss reporting patterns. Since establishing the specialty reinsurance business unit in 2002, reported claim activity has been less than expected and therefore we have adjusted our estimated loss reporting patterns to reflect this experience.
The 2004 reduction in prior years’ estimated ultimate net claims reserves of $113.8 million was primarily due to a re-estimation of our ultimate losses associated with six large catastrophe events, a reduction in reserves from numerous smaller catastrophe events, and reductions from our specialty book of business.
The following financial data shows the net financial statement impact on our Reinsurance segment as a result of the 2005 large hurricanes and reserve reviews and the 2004 large hurricanes.
Also during 2005 and 2004, as discussed under the ‘‘Premiums’’ heading above, we increased our specialty reinsurance premiums written. This increase in specialty reinsurance premiums will normally produce higher net claims and claim expenses than the property catastrophe reinsurance business which will generally cause the combined ratio of our Reinsurance segment to increase in years with normal catastrophe loss activity.
principally due to the reversal of $20.1 million in accruals related to executive compensation, bonuses and incentive compensation in 2004 that did not recur in 2005. In addition, we have experienced growth in the number of employees in our Reinsurance segment and we were in our new facilities for the full year in 2005 when compared to 2004. As a result, our underlying operating expenses have increased.
We have entered into joint ventures and specialized quota share cessions of our book of business. In accordance with the joint venture and quota share agreements, we are entitled to certain fee income and profit commissions. We record these fees and profit commissions as a reduction in acquisition expenses or operating expenses and, accordingly, these fees have reduced our expense ratio.
(1) Includes $45.3 million, $18.8 million and $20.8 million of premium ceded to our Reinsurance segment in 2005, 2004 and 2003, respectively.
Our Individual Risk segment purchases catastrophe excess of loss reinsurance from our Reinsurance segment operating subsidiaries, namely Renaissance Reinsurance and DaVinci. Included in our Individual Risk underwriting result is $45.3 million, $18.8 million and $20.8 million of ceded premiums to the Reinsurance segment in 2005, 2004 and 2003, respectively. Also included in our Individual Risk underwriting result are ceded losses to our Reinsurance segment of $104.9 million, $80.0 million and $nil in 2005, 2004 and 2003, respectively. Our Individual Risk segment underwriting result benefited by $59.6 million and $61.2 million in 2005 and 2004, respectively, as a result of this reinsurance and was negatively affected by $20.8 million in 2003. There was a corresponding opposite effect on our Reinsurance segment underwriting results as a result of this reinsurance.
Also impacting the underwriting result in 2005, 2004 and 2003, were reductions of prior years’ estimated ultimate net claims reserves of $10.1 million, $26.4 million and $24.9 million, respectively. The reduction in prior years’ estimated ultimate net claims reserves was driven by the application of our formulaic reserving methodology used for the Individual Risk book of business and is primarily due to actual paid and reported loss activity being better than what we had anticipated when estimating the initial ultimate claims and claims expense ratios and the initial loss reporting patterns. The favorable development in 2005 includes a $1.1 million reduction of prior years’ reserves as a result of the 2005 reserve review.
Our underwriting expenses consist of acquisition expenses and operational expenses. Acquisition expenses consist of costs to acquire premiums and are comprised of fees and expenses paid to: 1) program managers, who source primary insurance premiums for us through specialized programs; 2) primary insurers, for whom we write quota share reinsurance; and 3) broker commissions and excise taxes paid to brokers, who source insurance for us on a risk-by-risk basis. Acquisition expenses are driven by contract terms and are generally determined based on a set percentage of premiums. Acquisition expenses as a percentage of net premiums earned have remained relatively consistent at 31.8%, 32.5% and 32.9% in 2005, 2004 and 2003, respectively. Operating expenses consist of compensation and other general and administrative expenses. Our Individual Risk business operates with a limited number of employees and, accordingly, we outsource much of the administration of our Individual Risk business to program managers and third-party administrators. Operating expenses increased by $0.9 million to $22.3 million in 2005 compared to $21.4 million in 2004. The increase in operating expenses of $6.5 million from 2004 to 2003 was principally due to an increase in staffing in our U.S. operations as well as the U.S. operations being fully operational for a full year in 2004 compared to a partial year in 2003.
During 2003, we began issuing insurance policies for certain commercial liability coverages, including general, automobile and professional liability risks. The claim reporting and claim development periods of these risks are longer than the reporting and development periods for our property risks, and, accordingly, there is typically greater uncertainty in the estimation of the reserves associated with these policies.
The increase in net investment income in 2004 compared to 2003 was largely a result of increased net investment income from hedge funds, private equity funds and other alternative investments, both as a result of higher returns and a higher level of invested assets over 2003. Net investment income from these investments was $46.9 million in 2004, compared to $25.9 million in 2003.
Our investment portfolio is structured to preserve capital and provide us with a high level of liquidity. A large majority of our investments are invested in the fixed income markets and, therefore, our realized holding gains and losses on investments are highly correlated to fluctuations in interest rates. Therefore, as interest rates decline, we will tend to have realized gains from the turnover of our investment portfolio, and as interest rates rise, we will tend to have realized losses from the turnover of our investment portfolio, although the actual amount of realized gains (losses) on sales of investments can be reduced depending on which specific securities we choose to sell.
realized losses in our consolidated statements of operations. Credit related impairment charges in our fixed maturity investments available for sale were $0.5 million in 2005.
Corporate expenses include certain executive, legal and consulting expenses, costs for research and development, and other miscellaneous costs associated with operating as a publicly traded company. The $54.2 million increase in such expenses in 2005 compared to 2004 was due in part to $39.7 million of professional fees and accruals for other costs incurred during 2005 related to our internal review and the ongoing investigations into the Company and certain of its present and former executive officers by governmental authorities. Also included in the 2005 corporate expense line is $13.3 million of compensation expense due to the accelerated vesting of our former Chairman and CEO’s equity grants upon his departure from the Company in the fourth quarter of 2005.
Our interest payments and preferred dividends increased during 2005, primarily as a result of higher interest rates, a drawdown in December 2005 of $150 million on our $500 million revolving credit facility, and dividends having been paid for the entire year on the $250 million of 6.08% Series C preference shares, which were issued in March 2004.
Our interest payments and preferred dividends increased during 2004, primarily as a result of the issuance of $250 million 6.08% Series C Preference Shares in March 2004. This capital was raised to support the growth in our insurance and reinsurance operations. Effective December 31, 2003, the Company adopted FASB Interpretation No. 46, ‘‘Consolidation of Variable Interest Entities - an interpretation of ARB No. 51’’, as revised (‘‘FIN 46(R)’’). Upon adoption of FIN 46(R), our Capital Trust was determined to be a VIE under FIN 46(R) and was deconsolidated effective December 31, 2003. This resulted in the reclassification of dividends on our Capital Securities from dividends in 2003 to interest expense in 2004 and 2005.
We currently plan to continue to increase the amount of business written by our U.S. tax-paying insurance subsidiaries. If, as a result, our U.S. operations begin to generate taxable income over a sustained period of time, the appropriateness of the valuation allowance will continue to be reassessed, and, at such time that we believe it is more likely than not that we will generate taxable income and therefore be able to recover our net deferred tax asset, we will reduce the valuation allowance in the period in which we make such determination. There will be a corresponding increase in net income at such time, which may be material to the period in which such determination is made. As of December 31, 2005, the valuation allowance against our net deferred tax asset was $33.7 million.
The payment of dividends by our Bermuda subsidiaries is, under certain circumstances, limited under U.S. statutory regulations and Bermuda insurance law, which require our Bermuda insurance
We have generated cash flows from operations in 2005, 2004 and 2003 significantly in excess of our operating commitments. Because a large portion of the coverages we provide typically can produce losses of high severity and low frequency, it is not possible to accurately predict our future cash flows from operating activities. As a consequence, cash flows from operating activities may fluctuate, perhaps significantly, between individual quarters and years. In addition, given the severity of losses incurred in 2005 from the large catastrophes, many of which were unpaid at December 31, 2005, it is likely that we will experience a significant amount of paid claims in 2006 which could result in us having negative cash flows from operations.
At December 31, 2005, our total reserves for claims and claim expenses were $2,614.6 million and our estimated additional case reserves and IBNR reserves were $1,694.9 million. A 5% adjustment to our additional case reserves and IBNR reserves would equate to an $84.7 million adjustment to net claims and claim expenses incurred, which represents 30.1% of our 2005 net loss attributable to common shareholders, and 3.8% of shareholders’ equity at December 31, 2005.
As discussed in the Summary of Critical Accounting Policies and Estimates, the most significant accounting judgment made by management is the estimation of claims and claim expense reserves. Because any reserve estimate is simply an insurer’s estimate of its ultimate liability, and because there are numerous factors which affect reserves but cannot be determined with certainty in advance, our ultimate payments will vary, perhaps materially, from our initial estimate of reserves.
For our Reinsurance and Individual Risk operations, our estimates of claims reserves include case reserves reported to us as well as our estimate of appropriate additional case reserves and IBNR. Our case reserves, additional case reserves, and our estimates for IBNR reserves are based on 1) claims reports from insureds and program managers; 2) our underwriters' experience in setting claims reserves; 3) the use of computer models where applicable; and 4) historical industry claims experience. For some classes of business we also use statistical and actuarial methods to estimate ultimate expected claims and claim expenses. We review our claims reserves on a regular basis. (Also see ‘‘Summary of Critical Accounting Policies and Estimates’’.)
During 2005, our capital resources decreased by $390.2 million primarily as a result of our net loss of $246.8 million, dividends paid to our common and preferred shareholders of $57.0 million and $34.7 million, respectively, and a reduction in our net unrealized gains on investments of $74.2 million.
In January 2003, we issued $100 million of 5.875% Senior Notes due February 15, 2013, with interest on the notes payable on February 15 and August 15 of each year, commencing August 15, 2003. In July 2001, we issued $150 million of 7.0% Senior Notes due July 15, 2008 with interest on the notes payable on January 15 and July 15 of each year. The notes can be redeemed by us prior to maturity subject to payment of a ‘‘make-whole’’ premium; however, we have no current intentions of calling the notes. The notes, which are senior obligations, contain various covenants, including limitations on mergers and consolidations, restrictions as to the disposition of stock of designated subsidiaries and limitations on liens on the stock of designated subsidiaries. RenaissanceRe was in compliance with the related covenants at December 31, 2005 and 2004.
Under the terms of certain reinsurance contracts, our insurance and reinsurance subsidiaries and joint ventures may be required to provide letters of credit to reinsureds in respect of reported claims and/or unearned premiums. Our principal letter of credit facility is a syndicated secured facility which accepts as collateral shares issued by our subsidiary RIHL. Our participating operating subsidiaries and our managed joint ventures have pledged (and must maintain as pledged) RIHL shares issued to them with a sufficient collateral value to support their respective obligations under the facility, including reimbursement obligations for outstanding letters of credit. The participating subsidiaries and joint ventures have the option to post alternative forms of collateral. In addition, for liquidity purposes, in order to be permitted to pledge RIHL shares as collateral, each participating subsidiary and joint venture must maintain additional unpledged RIHL shares that have a net asset value at least equal to 15% of its facility usage, and RIHL shares having an aggregate net asset value equal to at least 15% of the net asset value of all outstanding RIHL shares must remain unencumbered. In the case of a default under the facility, or in other circumstances in which the rights of our lenders to collect on their collateral may be impaired, the lenders may exercise certain remedies under the facility agreement, in accordance with and subject to its terms, including redemption of pledged shares and conversion of the collateral into cash or eligible marketable securities. The redemption of shares by the collateral agent takes priority over any pending redemption of unpledged shares by us or other holders. In March 2005, the reimbursement agreement was amended to conform certain default provisions of the agreement to comparable provisions in existing credit agreements of the Company and DaVinciRe, and in April 2005, the term of this facility was extended through April 28, 2006. As a result of losses incurred in the third and fourth quarters of 2005 from hurricanes Katrina, Rita and Wilma, the facility was increased from $900 million to $1.75 billion. At February 17, 2006, we had $1,371.5 million of letters of credit with effective dates on or before December 31, 2005 outstanding under the facility and total letters of credit outstanding under all facilities of $1,467.9 million.
Our subsidiary Stonington has provided a letter of credit in the amount of $48.6 million to one counterparty which is secured by cash and eligible marketable securities. Also, in connection with our Top Layer Re joint venture, we have committed $37.5 million of collateral to support a letter of credit and are obligated to make a mandatory capital contribution of up to $50.0 million in the event that a loss reduces Top Layer Re’s capital below a specified level.
During August 2004, we amended and restated our committed revolving credit agreement to increase the facility from $400 million to $500 million, to extend the term to August 6, 2009 and to make certain other changes. The interest rates on this facility are based on a spread above LIBOR. On December 2, 2005, $150 million was drawn under this facility and remains outstanding at December 31, 2005. No balance was outstanding at December 31, 2004. As amended, the agreement contains certain financial covenants. These covenants generally provide that consolidated debt to capital shall not exceed the ratio (the ‘‘Debt to Capital Ratio’’) of 0.35:1 and that the consolidated net worth (the ‘‘Net Worth Requirements’’) of RenaissanceRe and Renaissance Reinsurance shall equal or
In November 2005, following our announcement that our then Chairman and Chief Executive Officer had departed the Company in light of the government investigations resulting from our restatement of our financial results, and in the aftermath of Hurricane Katrina, each of the major rating agencies downgraded our ratings and those of most of our principal operating subsidiaries, and placed our ratings and the rating of our principal operating subsidiaries on credit watch negative or the equivalent. Our ratings generally remain under review with negative implications with these agencies. The current financial strength ratings of our principal operating subsidiaries are set forth under ‘‘RATINGS.’’ These ratings are not evaluations directed to investors in our securities or a recommendation to buy, sell or hold our securities. Our ratings may be revised or revoked at the sole discretion of the rating agencies.
downgrade, the prevailing market conditions and the pricing and availability of replacement reinsurance coverage. Therefore, in the event of a further downgrade, it is not possible to predict in advance the extent to which this cancellation right would be exercised, if at all, or what effect such cancellations would have on the financial condition or future operations, but such effect potentially could be material. To date we are not aware that we have experienced such a cancellation.
During 2005, shareholders' equity decreased by $390.2 million to $2.3 billion at December 31, 2005, from $2.6 billion at December 31, 2004. The significant components of the change in shareholders' equity included the net loss attributable to common shareholders of $281.4 million, a reduction in accumulated other comprehensive income of $74.2 million and dividends to our common shareholders of $57.0 million.
In August 2004, the Company’s shareholders approved the RenaissanceRe Holdings Ltd. 2004 Stock Option Incentive Plan (the ‘‘Premium Option Plan’’) under which 6,000,000 common shares were reserved for issuance upon the exercise of options granted under the Premium Option Plan. As described in the Company's Proxy Statement relating to the required shareholder vote, filed with the SEC in July 2004, the Premium Option Plan provides for, among other things, mandatory premium pricing such that options can generally only be issued thereunder with a strike price at a minimum of 150% of the fair market value on the date of grant, minimum 4-year cliff vesting, and no discretionary repricing. The Premium Option Plan includes a dividend protection feature that reduces the strike price for extraordinary dividends and a change in control feature that reduces the strike price based on a pre-established formula in the event of change in control. Grantees under the Premium Option Plan must satisfy performance criteria which is determined by the Company’s Compensation Committee. As at December 31, 2005, 3,924,000 options were outstanding under the Premium Option Plan with an average exercise price of $74.15 per share, and 1,250,000 options were outstanding with an exercise price of $98.98 per share.
The $491.6 million growth in our portfolio of invested assets for the year ended December 31, 2005 resulted primarily from net cash provided by operating activities of $335.6 million, and net cash
At December 31, 2005, $234.6 million (2004 - $265.3 million) of cash and cash equivalents and investments were invested in currencies other than the U.S. dollar, which represented 4.3% (2004 - 5.4%) of our cash and cash equivalents and invested assets. We hedge a significant portion of our foreign currency denominated cash and investments back to U.S. dollars by either matching these non-U.S. denominated assets with liabilities denominated in the same currency or through the use of foreign currency derivative contracts.
Fair values of certain of the other investments noted above are generally established on the basis of the net valuation criteria established by the managers of the investments. These net valuations are determined based upon the valuation criteria established by the governing documents of such investments. Such valuations may differ significantly from the values that would have been used had ready markets existed for the shares, partnership interests or notes. Many of the investments are subject to restrictions on redemptions and sales which are determined by the governing documents and limit the Company’s ability to liquidate these investments in the short term. Due to a lag in the valuations reported by the fund managers, the majority of our hedge fund and private equity partnership valuations are reported on a one month or one quarter lag. Interest income, income distributions and realized and unrealized gains and losses on other investments are included in net investment income and totaled $59.4 million (2004 - $46.9 million) of which $28.8 million (2004 - $24.4 million) was related to net unrealized gains.
The potential exists, after a catastrophe loss, for the development of inflationary pressures in a local economy. The anticipated effects on us are considered in our catastrophe loss models. The effects of
At December 31, 2005, we have not entered into any off-balance sheet arrangements, as defined by Item 303 (a)(4) of Regulation S-K.
(1) In accordance with FAS 128, EPS calculations use average common shares outstanding - basic, when in a net loss position.
The insurance industry experienced substantial catastrophe losses in 2005. Hurricane Katrina is estimated to have resulted in a record level of insured property losses, and there has also been an aggregation of other catastrophic insured losses in 2005, including hurricanes Emily, Rita and Wilma, European windstorm Erwin and flooding in several European cities. These losses are on top of an active year in 2004 in which there were four major hurricanes that made landfall in Florida. These losses may increase perceptions of risk which could result in increased demand for, and reduced availability of, catastrophe exposed insurance and reinsurance. The affected lines include catastrophe reinsurance and catastrophe exposed homeowner business, and also include other catastrophe exposed lines of business, such as offshore energy and large account commercial property. We have also increased certain of our assumptions of catastrophe frequency, and we expect to seek higher nominal prices for catastrophe exposed business, although it remains unclear whether our margins will expand meaningfully, or whether our clients will be prepared to pay the increased prices.
We believe that we are well-positioned to participate in the improving market environment. However, various factors could constrain us, including: (i) the possibility of a higher level of competition than currently anticipated, associated with the rapid movement of capital into the insurance and reinsurance sectors, which could result in a less attractive pricing environment; (ii) limitations on our growth or other adverse impacts arising from the recent downgrades of our various credit ratings (see - ‘‘Part I - Item 2 - Capital Resources - Credit ratings’’); and (iii) limitations on human or capital resources available to us.
We believe that the current market environment may create more opportunities for the creation of joint ventures and strategic investments. We have established Ventures to facilitate strategic investments. We may consider opportunities in other areas of the insurance and reinsurance markets, or in other financial markets, either through organic growth, the formation of new joint ventures, or the acquisition of other companies or books of business of other companies. We are currently in the
process of reviewing certain opportunities and periodically engage in discussions regarding possible transactions, although there can be no assurance that we will complete any such transactions or that any such transaction would contribute materially to our results of operations or financial condition.
On November 1, 2005, we also announced that Chief Operating Officer and Chief Financial Officer John M. Lummis has indicated that he intends to retire at the end of his contract term on June 30, 2006.
We also announced on November 1, 2005, that Neill A. Currie has been named by the Board of Directors as the new Chief Executive Officer of the Company and has also been appointed to the Board of Directors, effective immediately, and that Mr. MacGinnitie was appointed non-executive Chairman of the Board of Directors. From July 5, 2005 until November 1, 2005, Mr. Currie, age 53, served as Executive Vice President of the Company, and was responsible for the Company’s specialty reinsurance business. Mr. Currie was a co-founder of the Company in 1993 and served as a Senior Vice President through September 1997. Mr. MacGinnitie, 67, has served as a member of the Company’s Board of Directors since February 2000 and is an independent actuary and consultant. Prior to that, he served as Senior Vice President and Chief Financial Officer of CNA Financial from September 1997 to September 1999. Mr. MacGinnitie is a Fellow and a past President of the Casualty Actuarial Society, as well as the Society of Actuaries, the American Academy of Actuaries and the International Actuarial Association.
(2) The interest on this facility is based on a spread above LIBOR. We have reflected interest due in 2006 based on the current interest rate on the facility.
(4) Private equity commitments do not have a defined contractual commitment date and we have therefore included them in the less than one year category.
(5) We caution the reader that the information provided above related to estimated future payment dates of our reserves for claims and claim expenses is not prepared or utilized for internal purposes and that we currently do not estimate the future payment dates of claims and claim expenses. Because of the nature of the coverages that we provide, the amount and timing of the cash flows associated with our policy liabilities will fluctuate, perhaps significantly, and therefore are highly uncertain. In order to estimate the payment dates of our contractual obligations for our reserve for claims and claim expense, we have used the work of an actuarial firm.