lease expiring on March 29, 2011. Talbot currently occupies office space in London, England under a lease expiring on December 24, 2013 and in Singapore under a lease expiring on December 14, 2008. We believe that our current office space is suitable for the foreseeable future.
The following table sets forth summarized balance sheet data as of December 31, 2007, 2006 and 2005:
General and administrative expenses for the years ended December 31, 2007 and 2006 and the period ended December 31, 2005 include $4,000,000, $1,000,000 and $0, respectively, related to our Advisory Agreement with Aquiline. Our Advisory Agreement with Aquiline terminated upon completion of our IPO, in connection with which recorded general and administrative expense of $3,000,000 in the third quarter of the year ended December 31, 2007.
The loss and loss expense ratio is calculated by dividing losses and loss expenses by net premiums earned.
The general and administrative expense ratio for the year ended December 31, 2007 is calculated by dividing the total of general and administrative expenses plus share compensation expenses less the $3,000,000 Aquiline termination fee by net premiums earned. The general and administrative expense ratio for the year ended December 31, 2006 is calculated by dividing the sum of general and administrative expenses and share compensation expenses by net premiums earned.
The Company was formed on October 19, 2005 and has limited historical financial and operating information. Insurance and reinsurance companies face substantial risk in their initial stages of development. See “Cautionary Note Regarding Forward-Looking Statements”. In addition, for a variety of reasons, including the Company’s recent formation, the acquisition of Talbot and relatively few significant catastrophe events in 2006 and 2007, the Company’s historical financial results may not accurately indicate future performance.
Specialty: The Company underwrites other specialty lines with very limited exposure correlation with its property, marine and energy portfolios. Validus Re underwrites other lines of business depending on an evaluation of pricing and market conditions, which include aerospace, terrorism, life and accident & health and workers’ compensation catastrophe. With the exception of the aerospace line of business, which has a meaningful portion of its gross premiums written volume on a proportional basis, Validus Re’s other specialty lines are primarily written on an excess of loss basis. Talbot underwrites war, political risks, political violence, financial institutions, contingency, bloodstock and livestock, accident and health, and aviation and other treaty. With the exception of aviation and other treaty, most of the Talbot specialty business is written on a direct or facultative basis or through a binding authority or coverholder.
Income from the Company’s investment portfolio is primarily comprised of interest income on fixed maturity investments net of investment expenses and net realized/unrealized gains/losses on investments. A significant portion of the Company’s contracts provide short-tail coverage for damages resulting mainly from natural and man-
The global property and casualty insurance and reinsurance industry has historically been highly cyclical. During the latter half of the 1990s, the industry experienced excess capacity for writers of insurance and reinsurance, which resulted in highly competitive market conditions. After this extended period of intense competition and eroding premium rates, the reinsurance markets began experiencing improvements in rates, terms and conditions for reinsurers in the first quarter of 2000. Continuing improvements through 2001 extended to the primary insurance industry and were accelerated by the events of September 11, 2001. While 2002 and 2003 proved to be relatively uneventful catastrophe years, the reinsurance markets were again significantly affected by natural catastrophe losses in 2004 and 2005. Taken together, 2004 and 2005 set a record for most Atlantic-basin tropical storms, hurricanes, major hurricanes (defined as category 3 or higher on the Saffir-Simpson Hurricane
Intensity Scale) and major hurricanes making U.S. landfall. The 2005 Atlantic-basin hurricane season was the costliest on record, with Hurricanes Rita and Wilma each generating in excess of $10 billion in insured losses and Katrina responsible for an estimated $45 billion in insured losses, which places it as the most costly natural catastrophe on record.
In the aggregate, the Company observed substantial increases in premium rates in 2006 compared to 2005 levels. Such rate increases were most significant in the United States catastrophe-exposed lines of business. For risks outside of the U.S., or for risks which were not substantially exposed to catastrophes, rate increases were more modest, or in some cases, decreased. During the year ended December 31, 2007 and the 2008 January renewal period, the Company experienced increased competition in most lines of business. Capital provided by new entrants or by the commitment of additional capital by existing insurers and reinsurers may increase the supply of insurance and reinsurance which could affect pricing. An increase in the supply of insurance and reinsurance could accelerate rate decreases.
Management believes the supply and demand pressures which exerted upward pressure on prices in peak U.S. property zones in 2006 will continue to decline in the near term, assuming normal catastrophe activity.
The Company’s consolidated financial statements have been prepared in accordance with U.S. GAAP. The preparation of financial statements in accordance with U.S. GAAP requires management to make estimates and assumptions that affect reported and disclosed amounts of assets and liabilities, as well as disclosure of contingent assets and liabilities as at the balance sheet date and the reported amounts of revenues and expenses during the reporting period. Management believes the following accounting policies are critical to the Company’s operations as the application of these policies requires management to make significant judgments. Management believes the
The Company writes a mix of predominantly short-tail business, both insurance and reinsurance. The combination of low claim frequency and high claim severity that is characteristic of much of this short-tail business makes the available data more volatile and less reliable for predicting ultimate losses. For example, in property lines, there can be additional uncertainty in loss estimation related to large catastrophe events, whether natural or man-made. With winds events, such as hurricanes, the damage assessment process may take more than a year. The cost of claims is subject to volatility due to supply shortages for construction materials and labor. In the case of earthquakes, the damage assessment process may take longer as buildings are discovered to have structural weaknesses not initially detected.
1. In addition to information received from clients on reported claims, the Company also uses information on the patterns of client loss reporting and loss settlements from previous events in order to estimate the Company’s ultimate liability related to these events.
Management anticipates that the loss estimates will be subject to annual corroborative review by independent actuaries using generally accepted actuarial principles.
The Company’s three lines of business, property, marine and specialty are exposed to event-related risks that are generally reported and paid within three years of the event except for financial institutions and marine liability. The Company estimates that 86.1% of its current reserves will be paid within three years. The Company writes longer tail business in its financial institutions and energy and marine liabilities lines. Factors contributing to uncertainty in reserving for these lines include longer duration of loss development patterns, difficulty applying older loss experience to newer years, and the possibility of future litigation. The Company considers these factors when reserving for longer tail lines.
b. Attritional losses - IBNR reserves are established using some combination of the actuarial methods described above, including the Chain Ladder method, the Generalized Cape Cod method and the Bornhuetter-Ferguson method. In situations where limited historic development data is available and/or the year being analyzed is more recent (less mature), the expected loss method and the Bornhuetter-Ferguson method are more commonly used. Under all methods used at both Validus Re and Talbot, an ultimate loss amount is established. Paid losses, case reserves and additional case reserves are then deducted from the ultimate to ascertain the attritional IBNR reserves.
reserves to account for expected future losses. The Company anticipates that claims arising from future events will require the establishment of substantial reserves in future periods.
Net reserve for losses and loss expenses at December 31, 2007 - Sensitivity to
For reinsurance business where the assumed reinsurance premium is written on an excess of loss or on a pro rata basis, reinsurance contracts are generally written prior to the time the underlying direct policies are written by cedants and accordingly cedants must estimate such premiums when purchasing reinsurance coverage. For excess of loss contracts, the deposit premium is defined in the contract. The deposit premium is based on the client’s estimated premiums, and this estimate is the amount recorded as written premium in the period the risk incepts. In the majority of cases, these contracts are adjustable at the end of the contract period to reflect the changes in underlying risks during the contract period. Subsequent adjustments, based on reports by the clients of actual premium, are recorded in the period in which the cedant reports are received, which would normally be reported within six months to one year subsequent to the expiration of the contract. For pro rata reinsurance contracts, an estimate of written premium is recorded in the period in which the risk incepts. The written premiums estimate is based on the pro rata cession percentage, on information provided by ceding companies and on management’s judgment. Management critically evaluates the information provided by ceding companies based on experience with the cedant, broker and the underlying book of business. Subsequent adjustments are recorded when the actual premiums are reported by the ceding company. Reporting by the ceding company may be on a three or six month lag and may be significantly different from the original estimate.
The Company evaluates the appropriateness of these premium estimates based on the latest information available, which may include actual reported premium to date, the latest premium estimates as provided by cedants and brokers, historical experience, management’s professional judgment, information obtained during the underwriting renewal process, as well as an assessment of relevant economic conditions.
As a company with a short operating history, we have limited past history that reflects how our premium estimates will develop. Furthermore, past experience may not be indicative of how future premium estimates develop. Gross premiums written on a proportional basis are recorded using estimated premiums and thus are the portion of the Company’s business that may be subject to adjustment. The Company re-evaluates estimates on a quarterly basis taking into consideration information obtained since the estimate was established, including information received from the cedant (and validated in a manner similar to how the Company evaluates cedant loss information). Based on information received, management has not made material adjustments to premium estimates to date. The Company believes that reasonably likely changes in assumptions made in the estimation process would not have a significant impact on gross premiums written as recorded.
Management includes an assessment of the creditworthiness of cedants in the review process above, primarily based on market knowledge, reports from rating agencies, the timeliness of cedants’ payments and the status of current balances owing. Based on this assessment, management believes that as at December 31, 2007 no provision for doubtful accounts is necessary for receivables from cedants.
Reinsurance Premiums Ceded and Reinsurance Recoverables. As discussed in “Business - Risk Management”, the Company primarily uses ceded reinsurance for risk mitigation purposes in its Talbot segment. Talbot purchases reinsurance on an excess of loss and a proportional basis together with a relatively small amount of facultative reinsurance.
Reinsurance receivable and reinsurance recoverable balances include amounts owed to us in respect of paid and unpaid ceded losses and loss expenses, respectively. The balances are presented net of a reserve for non-recoverability. As at December 31 2007, reinsurance recoverable balances were $134.4 million and reinsurance receivable balances were $7.8 million. In establishing our reinsurance recoverable balances, significant judgment is exercised by management in determining the amount of unpaid losses and loss expenses to be ceded as well as our ability to cede losses and loss expenses under our reinsurance contracts.
Our ceded unpaid losses and loss expense consists of two elements, those for reported losses and those for losses incurred but not reported (“IBNR”). Ceded amounts for IBNR are developed as part of our loss reserving process. Consequently, the estimation of ceded unpaid losses and loss expenses is subject to similar risks and uncertainties in the estimation of gross IBNR (see “Reserve for Losses and Loss expenses”). As at December 31 2007, ceded IBNR recoverable balances were $35.3 million.
Although our reinsurance receivable and reinsurance recoverable balances are derived from our determination of contractual provisions, the recoverability of such amounts may ultimately differ due to the potential for a reinsurer to become financially impaired or insolvent or for a contractual dispute over contract language or coverage. Consequently, we review our reinsurance recoverable balances on a regular basis to determine if there is a need to establish a provision for non-recoverability. In performing this review, we use judgment in assessing the credit worthiness of our reinsurers and the contractual provisions of our reinsurance agreements. As at December 31 2007, we had a provision for non-recoverability of $3.1 million. In the event that the credit worthiness of our
reinsurers were to deteriorate, actual uncollectible amounts could be significantly greater than our provision for non-recoverability.
The Company has early adopted FAS 157 and FAS 159 as of January 1, 2007 and elected the fair value option on all securities previously accounted for as available-for-sale. Validus Re’s unrealized gains on available-for-sale investments at December 31, 2006 of $875,000 previously included in the accumulated other comprehensive income, were treated as a cumulative-effect adjustment as of January 1, 2007. The cumulative-effect adjustment transferred the balance of unrealized gains from accumulated other comprehensive income to retained earnings and had no impact on the results of operations for the annual or interim periods beginning January 1, 2007. The Company’s investments are accounted for as trading for the annual or interim periods beginning January 1, 2007 and as such, all unrealized gains and losses are included in net income. Upon acquisition by the Company, Talbot adopted FAS 157 and FAS 159. On January 1, 2007 Talbot had unrealized gains on available-for-sale investments of $769,000.
Net income for the three months ended December 31, 2007 was $139.0 million compared to $69.1 million for the three months ended December 31 2006, an increase of $69.9 million or 101.3%. The primary factors driving the increase were:
An increase in Validus Re underwriting income of $26.7 million or 47.4% as a result of net premiums earned which were increased by $57.4 million or 54.6% compared to the same period in 2006, offset by losses including those from the California wildland fires;
Increased realized and unrealized gains on investments of $10.2 million. The majority of this increase is due to the early adoption on FAS 157 and FAS 159 resulting in unrealized gains on investments being recorded in net income rather than comprehensive income. The increases above were partially offset by the following factors:
Increased finance expenses of $21.8 million, primarily resulting from $4.3 million finance expense on the 8.480% Junior Subordinated Deferrable Debentures and $17.2 million of Talbot Funds at Lloyd’s (“FAL”) finance expense.
Details of gross premiums written by line of business are provided below.
The results of operations for Talbot are consolidated only from the July 2007 date of acquisition. Consequently, 2006 data does not include Talbot financial results.
Validus Re. Validus Re gross premiums written for the three months ended December 31, 2007 were $47.5 million compared to $65.5 million for the three months ended December 31, 2006, a decrease of $18.0 million or 27.5%. Details of Validus Re gross premiums written by line of business are provided below.
The decrease in Validus Re gross premiums written was primarily driven by a $25.6 million decrease in the property lines due to a 16 month contract written in the three month period ended December 31, 2006. Due to the term of this $30.0 million contract, it will come up for renewal in the first quarter of 2008. The decrease in property lines was partially offset by the marine lines which accounted for an increase of $11.5 million in gross premiums written due primarily to a surplus contract with gross premiums written of $16.5 million.
Talbot. In the three months ended December 31, 2007, Talbot gross premiums written were $143.5 million compared to $171.8 million for the three months ended December 31, 2006, a decrease of $28.3 million or 16.5%. Gross premiums written were primarily driven by the marine and specialty lines which contributed $122.9 million. Details of gross premiums written by line of business are provided below.
The decrease in the Talbot gross premiums written was primarily driven by:
A decrease of $13.1 million in energy gross premiums written offset by an increase in hull gross premiums written of $6.2 million; and
Talbot. Talbot reinsurance premiums ceded for the three months ended December, 2007 were $0.8 million compared to $3.4 million for the three months ended December 31, 2006, a decrease of $2.6 million or 76%. Talbot primarily purchases reinsurance protection in the first quarter, accounting for the small figure in the fourth quarter. Talbot reinsurance premiums ceded include reinstatement premiums on large losses included in both case reserves and IBNR. To the extent that such large loss provision is no longer required, the corresponding reinstatement premium is released giving rise to a negative reinsurance premium ceded.
Net premiums written for the three months ended December 31, 2007 were $186.4 million compared to $65.9 million for the three months ended December 31, 2006, an increase of $120.6 million or 183.1%. Details of net premiums written by line of business are provided below:
The increase in net premiums written was primarily driven by $142.7 million resulting from the consolidation of Talbot which was partially offset by a $29.2 million decrease in Validus Re’s property lines.
The ratio of net premiums written to gross premiums written were 92.0% and 100.5% for the three month periods ended December 31, 2007 and 2006. The decrease in the ratio is attributable to a greater amount of reinsurance premiums ceded in the fourth quarter of 2007.
Talbot. Talbot net premiums written for the three months ended December 31, 2007 were $142.7 million compared to $168.4 million for the three months ended December 31, 2006, a decrease of $25.7 million or 15.3%. Details of net premiums written by line of business are provided below:
The decrease in the net premium written was driven by the factors highlighted above in respect of gross premiums written and reinsurance premiums ceded. The ratio of net premiums written to gross premiums written for the three month periods ended December 31, 2007 and 2006 was 99.5% and 98.0.%, respectively, as most reinsurance premiums are written in the first quarter.
Change in unearned premiums for the three months ended December 31, 2007 was $131.6 million compared to $39.3 million for the three months ended December 31, 2006, an increase of $92.3 million or 234.9%. This reflects the higher level of premiums written at Validus Re for the year ended December 31, 2007 compared to the same period in 2006 and the earning of Validus Re premiums on business written in 2006.
Net premiums earned for the three months ended December 31, 2007 were $318.0 million compared to $105.2 million for the three months ended December 31, 2006, an increase of $212.9 million or 202.4%. The increase in net premiums earned was driven by $155.5 million resulting from the consolidation of Talbot and increased premiums earned at Validus Re which accounted for $57.4 million of the increase.
The results of operations for Talbot are consolidated only from the July 2, 2007 date of acquisition. Consequently, 2006 data (1) does not include Talbot financial results.
Validus Re. Validus Re net premiums earned for the three months ended December 31, 2007 were $162.5 million compared to $105.2 million for the three months ended December 31, 2006, an increase of $57.4 million or 54.6%. The increase in net premiums earned reflects the increased premiums written in the period and the benefit of earning premiums on business written in 2006. As Validus Re did not write premium prior to January 1, 2006, the three month period ended December 31, 2006 benefited minimally from the earning of premiums written in prior periods. Contracts written on a risks-attaching basis are generally earned over 24 months and therefore have less immediate effect on premiums earned than contracts written on a losses-occurring basis which are generally earned on a 12 month basis.
The results of operations for Talbot are consolidated only from the July 2007 date of acquisition.
The amount recorded represents management’s best estimate of expected losses and loss expenses on premiums earned. The increase in loss and loss expenses reflects the consolidation of Talbot. The relative absence
The loss ratio in 2007 is not necessarily comparable to the 2006 loss ratio due to the consolidation of Talbot effective July 2, 2007. In general, Talbot has experienced a higher loss ratio than Validus Re in the periods since inception of Validus Re, attributable to the different mix of business written by Validus Re and Talbot. In periods of light natural catastrophe activity, Validus Re can generally be expected to have a lower loss ratio than Talbot.
At December 31, 2007 and December 31, 2006, gross and net reserves for losses and loss expenses were estimated using the methodology as outlined in the Summary of Critical Accounting Policies and Estimates above. The Company did not make any significant changes in the assumptions or methodology used in its reserving process during the three months ended December 31, 2007.
Validus Re. Validus Re losses and loss expenses for the three months ended December 31, 2007 were $48.2 million compared to $24.3 million for the three months ended December 31, 2006, an increase of $24.0 million or 98.8%. The loss ratio, defined as losses and loss expenses divided by net premiums earned, was 29.7% and 23.1% for the three months ended December 31, 2007 and 2006, respectively. In the three months ended December 31, 2007, Validus Re experienced favorable development of $0.9 million related to the 2006 underwriting year, primarily in its property line. Details of loss ratios by line of business are provided below.
Talbot. Talbot losses and loss expenses for the three months ended December 31, 2007 were $59.3 million compared to $36.9 million for the three months ended December 31, 2006, an increase of $22.4 million or 60.7%. The loss ratio was 38.1% and 25.4% for the three months ended December 31, 2007 and 2006, respectively. Details of loss ratios by line of business are provided below.
Validus Re. Validus Re policy acquisition costs for the three months ended December 31, 2007 were $22.1 million compared to $11.5 million for the three months ended December 31, 2006, an increase of $10.6 million or 92.3%. Policy acquisition costs include brokerage, commission and excise tax and are generally driven by contract terms and are normally a set percentage of premiums. Policy acquisition costs were higher as a result of the higher level of premiums earned in the three months ended December 31, 2007 compared to the same period in 2006. Policy acquisition costs as a percent of net premiums earned for the three month periods ended
December 31, 2007 and 2006 were 13.6% and 10.9%, respectively. The policy acquisition ratio increased largely due to an increase in the policy acquisition ratio on specialty lines of 5.8 points.
General and administrative expenses for the three months ended December 31, 2007 were $33.7 million compared to $13.0 million for the three months ended December 31, 2006, an increase of $20.7 million or 159.0%. The increase is primarily a result of Talbot expenses of $23.6 million.
General and administrative expense ratios for the three month periods ended December 31, 2007 and 2006 were 12.5% and 14.5%, respectively. General and administrative expense ratio is the sum of general and administrative expenses and share compensation expense divided by net premiums earned.
Validus Re. Validus Re general and administrative expenses for the three months ended December 31, 2007 were $7.9 million compared to $11.5 million for the three months ended December 31, 2006, a decrease of $3.6 million or 31.5%. The decrease in expenses reflects the absence in 2007 of certain start up costs incurred in 2006 which is offset by an increase in staff to 62 at December 31, 2007 from 34 at December 31, 2006. General and administrative expenses are generally comprised of salaries and benefits, professional fees, rent and office expenses. General and administrative expenses as a percent of net premiums earned for the three month periods ended December 31, 2007 and 2006 were 4.9% and 10.9%, respectively.
Share compensation expense for the three months ended December 31, 2007 was $6.1 million compared to $2.2 million for the three months ended December 31, 2006, an increase of $3.9 million or 176.0%. The increase is primarily a result of $2.6 million in respect of the Employee Seller shares issued to Talbot employees as part of the
purchase of the group by the Company. This expense is non-cash and has no net effect on shareholders’ equity, as it balanced by an increase in additional paid-in capital.
Validus Re. Validus Re share compensation expense for the three months ended December 31, 2007 was $1.2 million compared to $1.5 million for the three months ended December 31, 2006, a decrease of $0.3 million or 23.0%. Share compensation expense as a percent of net premiums earned for the three month periods ended December 31, 2007 and 2006 were 0.7% and 1.5%, respectively.
Talbot. Talbot share compensation expense for the three months ended December 31, 2007 was $0.1 million. Share compensation expense as a percent of net premiums earned for the three month period ended December 31, 2007 was 0.6%.
The underwriting results of an insurance or reinsurance company are often measured by reference to its combined ratio, which is the sum of the loss ratio and the expense ratio. The net loss ratio is calculated by dividing losses and loss expenses incurred (including estimates for incurred but not reported losses) by net premiums earned. The expense ratio is calculated by dividing acquisition costs combined with general and administrative expenses by net premiums earned. The following table presents the loss and loss expense ratio, policy acquisition cost ratio, general and administrative expense ratio, expense ratio and combined ratio for the three months ended December 31, 2007 and 2006.
Talbot results for the three months ended December 31, 2006 are presented for comparative purposes. The results of operations for Talbot are consolidated only from the July 2, 2007 date of acquisition.
Underwriting income for the three months ended December 31, 2007 was $117.4 million compared to $54.2 million for the three months ended December 31, 2006, an increase of $63.2 million or 116.7%.
Underwriting income should not be viewed as a substitute for U.S. GAAP net income as there are inherent material limitations associated with the use of underwriting income as compared to using net income, which is the most directly comparable U.S. GAAP financial measure. The most significant limitation is the ability of users of the financial information to make comparable assessments of underwriting income with other companies, particularly as underwriting income may be defined or calculated differently by other companies. Therefore, the Company provides more prominence in this filing to the use of the most comparable U.S. GAAP financial measure, net income, which includes the reconciling items in the table above. The Company compensates for these limitations by providing both clear and transparent disclosure of net income and reconciliation of underwriting income to net income.
Net investment income for the three months ended December 31, 2007 was $37.5 million compared to $17.7 million for the three months ended December 31, 2006, an increase of $19.9 million or 112.6%. Net
investment income increased as a result of growth in the Validus Re investment portfolio and the addition of the Talbot investment portfolio. Net investment income is comprised of accretion of premium or discount on fixed maturities, interest on coupon-paying bonds, short-term investments and cash and cash equivalents, partially offset by investment management fees. The components of net investment income for the three months ended December 31, 2007 and 2006 is as presented below.
Investment management fees incurred relate to BlackRock Financial Management, Inc. (“BlackRock”) and Goldman Sachs Asset Management L.P. and its affiliates (“GSAM”). Each of Merrill Lynch & Co, Inc. (“Merrill Lynch”) and Goldman Sachs is a major shareholder of the Company. BlackRock is considered a related party due to its merger in February 2006 with Merrill Lynch Investment Managers. Investment management fees earned by BlackRock for the three month periods ended December 31, 2007 and December 31, 2006 were $0.4 million and $0.2 million, respectively. Investment management fees earned by GSAM for the three month periods ended December 31, 2007 and December 31, 2006 were $0.3 million and $0.2 million, respectively. Management believes that the fees charged were consistent with those that would have been charged by unrelated third parties.
Annualized effective investment yield is based on the weighted average investments held calculated on a simple period average and excludes net unrealized gains (losses), foreign exchange gains (losses) on investments and the foreign exchange effect of insurance balances. The Company’s annualized effective investment yield was 4.91% and 5.03% for the three months ended December 31, 2007 and 2006, respectively and the average duration at December 31, 2007 was 2.0 years (December 31, 2006 - 0.9 years).
Because Validus Re provides short-tail reinsurance coverage for losses resulting mainly from natural and man-made catastrophes, Validus Re could become liable to pay substantial claims on short notice. Accordingly, the investment portfolio has been structured to preserve capital and provide a high level of liquidity, which means that the large majority of the investment portfolio contains short-term fixed maturity investments, such as U.S. government and agency bonds, U.S. government-sponsored enterprises, corporate debt securities and mortgage-backed and asset-backed securities.
Finance expenses also include the amortization of debt offering costs and offering discounts and fees related to our credit facilities.
Net unrealized gains on investments for the three months ended December 31, 2007 were $9.2 million compared to $nil for the three months ended December 31, 2006. The Company early adopted FAS 157 and the FAS 159 Fair Value Option on January 1, 2007 for its investment portfolio. As a result, for the year ended December 31, 2007 and subsequent periods, net unrealized gains on investments are recorded as a component of net income whereas for the comparable period in 2006, unrealized losses were recorded as a component of comprehensive income and therefore not a component of net income. Talbot also adopted FAS 157 and the FAS 159 Fair Value Option for its investment portfolio upon acquisition by the Company on July 2, 2007.
Non-GAAP Financial Measures. In presenting the Company’s results, management has included and discussed certain schedules containing underwriting income that is not calculated under standards or rules that comprise U.S. GAAP. Such measures are referred to as non-GAAP. Non-GAAP measures may be defined or calculated differently by other companies. These measures should not be viewed as a substitute for those determined in accordance with U.S. GAAP. A reconciliation of this measure to net income, the most comparable U.S. GAAP financial measure, is presented in the section below entitled “Underwriting Income.”
Net income for the year ended December 31, 2007 was $403.0 million compared to $183.1 million for the year ended December 31, 2006, an increase of $219.9 million or 120.1%. The primary factors driving the increase were:
An increase in net investment income of $54.3 million or 93.6% as a result of growth in the Validus Re investment portfolio and the addition of the Talbot portfolio;
Increased realized and unrealized gains on investments of $15.1 million. The majority of this increase is due to the early adoption on FAS 157 and FAS 159 resulting in unrealized gains on investments being recorded in net income rather than comprehensive income and;
The results of operations for Talbot are consolidated only from the July 2, 2007 date of acquisition. Consequently, 2006 data does not include Talbot financial results.
The increase in gross premiums written was primarily driven by $286.5 million resulting from the consolidation of Talbot effective in the third quarter of 2007. The increase from Talbot was further improved by growth of $127.4 million and $32.1 million, respectively, in the Validus Re property and marine lines, discussed further below.
Validus Re. Validus Re gross premiums written for the year ended December 31, 2007, were $702.1 million compared to $540.8 million for the year ended December 31, 2006, an increase of $161.3 million or 29.8%. Gross premiums written were primarily driven by the property line which accounted for $498.4 million of gross premium written. Details of gross premiums written by line of business are provided below.
The increase in gross premiums written was primarily driven by the property and marine lines which accounted for $127.4 million and $32.1 million of the increase, respectively. In the year ended December 31, 2007 Validus Re wrote additional U.S. regional and European property premium as compared to the prior year as a result of being operational for the entire 2006 fiscal year. Validus Re was unable to write these premiums in 2006 as much of the business was placed prior to Validus Re’s formation in late 2005. Validus Re also wrote higher premiums in property and marine lines during the first half of 2007 as a result of continued attractive pricing.
Growth in the energy account of $13.0 million due to new construction opportunities and increased asset values resulting from the higher oil price; and,
Reinsurance premiums ceded for the year ended December 31, 2007 were $70.2 million compared to $63.7 million for the year ended December 31, 2006, an increase of $6.5 million or 10.2%.
Validus Re. Validus Re reinsurance premiums ceded for the year ended December 31, 2007 were $68.8 million compared to $63.7 million for the year ended December 31, 2006, an increase of $5.1 million or 8.1%. Reinsurance premiums are primarily ceded to Petrel Re Limited (“Petrel Re”). During the year end periods ended December 31, 2007 and 2006, gross premiums written of $53.2 million and $44.5 million, respectively, were ceded to Petrel Re. For the year ended December 31, 2007, gross premiums written ceded to Petrel Re represents 5.4% and 75.8% of the Company’s total gross premiums written and total premiums ceded, respectively.
Talbot. Talbot reinsurance premiums ceded for the year ended December 31, 2007 were $89.9 million compared to $118.9 million for the year ended December 31, 2006, a decrease of $29.1 million or 24.4%. Reinsurance premiums ceded decreased because a number of contracts purchased to protect the property account were not needed in 2007 as the underlying exposure which was protected by these covers had been eliminated. Further, a number of working layer covers were eliminated. Finally, Talbot reinsurance premiums ceded include reinstatement premiums on large losses included in both case reserves, and IBNR. To the extent that such large loss provision is no longer required, the corresponding reinstatement premium is released giving rise to a negative reinsurance premium ceded. This reduction was offset by the cost of protecting the new accident and health and bloodstock and livestock classes.
Net premiums written for the year ended December 31, 2007 were $918.4 million compared to $477.1 million for the year ended December 31, 2006, an increase of $441.3 million or 92.5%. Details of net premiums written by line of business are provided below:
The increase in net premiums written was primarily driven by $285.2 million resulting from the consolidation of Talbot effective in the third quarter of 2007 and the Validus Re property and marine lines which accounted for $125.6 million and $30.6 million of the increase, respectively.
The ratio of net premiums written to gross premiums written was 90.2% and 88.2% for the year ended December 31, 2007 and 2006. The increase in the ratio is attributable to lower reinsurance premiums ceded in 2007, due to lower amount of premiums ceded to Petrel Re.
The increase in net premiums written was primarily driven by the marine and specialty lines which accounted for $30.2 million and $29.1 million of the increase, respectively. The increase in marine and specialty lines reflects the increase in gross premiums written.
The ratio of net premiums written to gross premiums written was 86.9% and 81.7% for the years ended December 31, 2007 and 2006.
Change in unearned premiums for the year ended December 31, 2007 was $60.3 million compared to $170.6 million for the year ended December 31, 2006, a decrease of $110.2 million or 64.6%.
Talbot. The Talbot change in unearned premiums for the year ended December 31, 2007 was $(14.0) million compared to $(38.0) million for the year ended December 31, 2006, an increase of $24.0 million or 63.2%. The change in unearned premiums at Talbot is analyzed as follows:
As a result, the change in gross unearned premium reflects the higher gross written premium in 2007 relative to 2006. The reinsurance program is mostly earned in the year. The outstanding amount reflects the few protections incepting mid-year which is consistent with 2006.
Net premiums earned for the year ended December 31, 2007 were $858.1 million compared to $306.5 million for the year ended December 31, 2006, an increase of $551.6 million or 179.9%. The increase in net premiums
Talbot. Talbot net premiums earned for the year ended December 31, 2007 were $583.9 million compared to $492.1 million for the year ended December 31, 2006, an increase of $91.8 million or 18.6%.
Losses and loss expenses for the year ended December 31, 2007 were $284.0 million compared to $91.3 million for the year ended December 31, 2006, an increase of $192.7 million or 211.0%. $108.5 million of the increase is
attributable to the consolidation of Talbot. The loss ratio, which is defined as losses and loss expenses divided by net premiums earned, was 33.1% and 29.8% for the years ended December 31, 2007 and 2006, respectively. Details of loss ratios by line of business are provided below.
At December 31, 2007 and December 31, 2006, gross and net reserves for losses and loss expenses were estimated using the methodology as outlined in the Summary of Critical Accounting Policies and Estimates above. The Company did not make any significant changes in the assumptions or methodology used in its reserving process during the year ended December 31, 2007.
For the year ended December 31, 2007, Validus Re has estimated losses of $64.5 million related to windstorm Kyrill, the Australian windstorms, flooding in parts of England and the California wildland fires. Validus Re paid losses of $56.1 million for the year ended December 31, 2007. The loss ratios in property lines declined by 2.9 percentage points as a result of the low level of catastrophic events in the year ended December 31, 2007, partially offset by losses from the events mentioned above. The loss ratio on the marine line increased due to losses from windstorm Kyrill. The specialty line incurred losses of $7.0 million and $6.1 million related to two satellite launch failures.
Talbot. Talbot losses and loss expenses for the year ended December 31, 2007 were $251.0 million compared to $178.5 million for the year ended December 31, 2006, an increase of $72.5 million or 40.6%. The loss ratio, which is defined as losses and loss expenses divided by net premiums earned, was 43.0% and 36.3% for the year ended December 31, 2007 and 2006 respectively. Details of loss ratios by line of business are provided below.
The amount recorded represents management’s estimate of expected losses and loss expenses on premiums earned. Favorable loss development on prior years was experienced in all lines of business and totaled $50.6 million. Favorable loss development primarily resulted from better than expected loss experience on the 2005 and prior year of account year and accounted for 8.7 percentage points of benefit to Talbot’s loss ratio.
The results of operations for Talbot are consolidated only from the July 2, 2007 date of acquisition.
Validus Re. Validus Re policy acquisition costs for the year ended December 31, 2007 were $70.3 million compared to $36.1 million for the year ended December 31, 2006, an increase of $34.3 million or 95.0%. Policy acquisition costs include brokerage, commission and excise tax and are generally driven by contract terms and are normally a set percentage of premiums. Policy acquisition costs were higher as a result of the higher level of premiums written and earned in the year ended December 31, 2007 compared to the same period in 2006. Validus Re policy acquisition costs as a percent of net premiums earned were 12.6% and 11.8%, respectively, for the years ended December 31, 2007 and 2006.
General and administrative expense ratios for the years ended December 31, 2007 and 2006 were 13.3% and 15.1%, respectively. The decrease in the general and administrative expense ratio reflects the increased premiums earned in 2007. General and administrative expense ratio is the sum of general and administrative expenses and share compensation expense divided by net premiums earned.
General and administrative expenses of $97.8 million in the year ended December 31, 2007 represents 11.4 percentage points of the expense ratio. Share compensation expense is discussed in the following section.
Validus Re. Validus Re general and administrative expenses for the year ended December 31, 2007 were $31.4 million compared to $24.6 million for the year ended December 31, 2006, an increase of $6.8 million or 27.9%. The increase in expenses reflects an increase in staff to 62 at December 31, 2007 from 34 at December 31, 2006. General and administrative expenses are generally comprised of salaries and benefits, professional fees, rent and office expenses. Validus Re general and administrative expenses as a percentage of net premiums earned for the year ended December 31, 2007 and 2006 were 5.6% and 8.0%, respectively. The decrease in the general and administrative expense ratio reflects the absence in 2007 of certain start up costs incurred in 2006 and the higher level of earned premiums in the year ended December 31, 2007.
Talbot. Talbot general and administrative expenses for the year ended December 31, 2007 were $100.3 million compared to $68.2 million for the year ended December 31, 2006, an increase of $32.1 million or 47.1%. General and administrative expenses are generally comprised of salaries and benefits, professional fees and rent and office expenses. Expenses have increased as a result of:
$6.2 million due to the amendment of Talbot’s acquisition expense policy to match that of Validus Re, resulting in reduced deferral of underwriter and associated expenses; and
Increased expenses as a result of sterling expenses being translated into dollars at a higher rate in 2007.
Share compensation expense for the year ended December 31, 2007 was $16.2 million compared to $7.9 million for the year ended December 31, 2006, an increase of $8.3 million or 105.4%. The increase is primarily a result of $5.2 million in respect of the Employee Seller shares issued to Talbot employees as part of the purchase of the group by the Company. This expense is non-cash and has no net effect on shareholders’ equity, as it is balanced by an increase in additional paid-in capital.
Share compensation expense of $16.2 million in the year ended December 31, 2007 represents 1.9 percentage points of the general and administrative expense ratio.
Validus Re. Validus Re share compensation expense for the year ended December 31, 2007 was $4.0 million compared to $3.1 million for the year ended December 31, 2006, an increase of $0.9 million or 29.2%. The increase is primarily a result of an increase in staff to 62 at December 31, 2007 from 34 at December 31, 2006. Share compensation expense as a percent of net premiums earned for the years ended December 31, 2007 and 2006 was 0.7% and 1.0%, respectively.
Corporate. Corporate share compensation expense for the year ended December 31, 2007 was $10.5 million compared to $4.8 million for the year ended December 31, 2006, an increase of $5.7 million or 119.2%. The increase is primarily a result of $5.2 million in respect of the Employee Seller shares issued to Talbot employees as part of the purchase of the group by the Company.
Includes Corporate general and administrative expense, including share compensation expense for the Talbot employee seller shares.
Underwriting income for the year ended December 31, 2007 was $325.9 million compared to $132.9 million for the year ended December 31, 2006, an increase of $193.0 million or 145.2%. The table below show underwriting income split by segment.
Annualized effective investment yield is based on the weighted average investments held calculated on a simple period average and excludes net unrealized gains (losses), foreign exchange gains (losses) on investments and the foreign exchange effect of insurance balances. The Company’s annualized effective investment yield was 4.94% and 4.74% for the years ended December 31, 2007 and 2006, respectively, and the average duration at December 31, 2007 was 2.0 years (December 31, 2006 - 0.9 years).
As of December 31, 2007, Validus had approximately $22.8 million of asset-backed securities with sub-prime collateral and $15.3 million of insurance enhanced asset-backed securities that have no underlying credit ratings, representing 0.74% and 0.49% of total cash and investments, respectively.
Finance expenses for the year ended December 31, 2007 were $51.8 million compared to $8.8 million for the year ended December 31, 2006, an increase of $43.0 million or 488.8%. The higher finance expenses in 2007 were primarily attributable to the following:
On July 2, 2007, the Company borrowed $188.0 million on its unsecured credit facility to finance the purchase of Talbot. On July 31, 2007 the Company used $189.00 million of the net proceeds to fully repay borrowings and to pay accrued interest of $1.0 million under its unsecured credit facility.
Capital in Lloyd’s entities, whether personal or corporate, is required to be set annually for the prospective year and held by Lloyd’s in trust (“Funds at Lloyd’s” or “FAL”). In underwriting years up to and including 2007, Talbot’s FAL has been provided both by Talbot and by third parties. Because the third party FAL providers remain “on risk” until each year of account that they support closes normally after three years, Talbot must manage third party FAL even if a third party FAL provider has ceased to support the active underwriting year. This is achieved by placing such FAL in escrow outside Lloyd’s. Thus the total FAL facility available to the Company is the total FAL for active and prior underwriting years, although the Company can only apply specific FAL against losses incurred by an underwriting year that such FAL is contracted to support.
Between 30% and 40% of an amount equivalent to each underwriting years’ profit is payable to Talbot third party FAL providers. However some of these costs are fixed. Further the 2005 underwriting year only became profitable on a cumulative basis in September 2007, thus triggering profit-related payments for that underwriting year.
Talbot results for the year ended December 31, 2006 and prior are presented for comparative purposes. The results of operations for Talbot are consolidated only from the July 2, 2007 date of acquisition.
Historical FAL finance charges respond to the total syndicate profit which was analyzed by underwriting year as follows.
Talbot results for the year ended December 31, 2006 and prior are presented for comparative purposes. The results of operations for Talbot are consolidated only from the July 2007 date of acquisition.
Net unrealized gains on investments reflected in net income for the year ended December 31, 2007 were $12.4 million compared to $nil for the year ended December 31, 2006. The Company early adopted FAS 157 and the FAS 159 Fair Value Option on January 1, 2007 for its investment portfolio. As a result, for the year ended December 31, 2007 and subsequent periods, net unrealized gains (losses) on investments are recorded as a component of net income whereas for the comparable period in 2006, unrealized losses were recorded as a component of comprehensive income and therefore not a component of net income. Talbot also adopted FAS 157 and the FAS 159 Fair Value Option for its investment portfolio upon acquisition by the Company on July 2, 2007.
Foreign exchange gains for the year ended December 31, 2007 were $6.7 million compared to $2.2 million for the year ended December 31, 2006, an increase of $4.5 million. Foreign exchange gains during the year ended December 31, 2007 and 2006 are primarily due to the weakening of the U.S. dollar resulting in gains on translation arising out of receipts of non-U.S. dollar premium installments. The gains in 2007 were partially offset by losses resulting from the effect of the fluctuation in foreign currency exchange rates on liabilities denominated in foreign currencies, primarily at Talbot. Certain premiums receivable and liabilities for losses incurred in currencies other than the U.S. dollar are exposed to the risk of changes in value resulting from fluctuations in foreign exchange rates and may affect financial results in the future. The consolidation of Talbot for the first time in the third quarter of 2007 decreased foreign exchanges gains by $0.8 million. At December 31, 2007, 8.7% of our investments and 30.9% of our reserves for losses and loss expenses were in foreign currencies.
During the year ended December 31, 2007, the Company made a $3.0 million payment to Aquiline in connection with the termination of our Advisory Agreement with them.
Three main sources provide cash flows for the Company; operating activities, investing activities and financing activities. Cash flow from operating activities is primarily derived form the net receipt of premiums less claims and expenses related to underwriting activities. Cash flow from investing activities is primarily derived from the receipt of investment income on the Company’s total investment portfolio. Cash flow from financing activities is primarily derived from the issuance of common shares and debentures payable.
On July 30, 2007, the Company completed its IPO, selling 15,244,888 common shares at a price of $22.00 per share. The net proceeds to the Company from the IPO were approximately $310.7 million, after deducting the underwriters’ discount and fees. On July 31, 2007, the Company used $189.0 million of the net proceeds to fully repay borrowings and to pay accrued interest under its unsecured credit facility. The Company used the remaining $121.8 million of net proceeds to make a $118.0 million capital contribution to Validus Re to support the future
growth of reinsurance operations and to pay certain expenses related to the Talbot acquisition and made a $3.0 million payment to Aquiline in connection with the termination of the Advisory Agreement.
On August 27, 2007, the Company issued an additional 453,933 common shares at a price of $22.00 per share pursuant to the underwriters’ option to purchase additional common shares. The net proceeds to the Company of $9.4 million were contributed to Validus Re.
On June 15, 2006, the Company completed a private placement of $150.0 million of junior subordinated deferrable interest debentures due 2036 (the “9.069% Junior Subordinated Deferrable Debentures”). The 9.069% Junior Subordinated Deferrable Debentures mature on June 15, 2036, are redeemable at the Company’s option at par beginning June 15, 2011, and require quarterly interest payments by the Company to the holders of the 9.069% Junior Subordinated Deferrable Debentures. Interest will be payable at 9.069% per annum through June 15, 2011, and thereafter at a floating rate of three-month LIBOR plus 355 basis points, reset quarterly. The proceeds of $150.0 million from the sale of the 9.069% Junior Subordinated Deferrable Debentures, after the deduction of commissions paid to the placement agents in the transaction and other expenses, are being used by the Company to fund ongoing reinsurance operations and for general working capital purposes. Debt issuance costs of $3.8 million were deferred as an asset and are amortized to income over the five year optional redemption period.
The Company’s contractual obligations and commitments as at December 31, 2007 are set out below.
The reserve for losses and loss expenses represents an estimate, including actuarial and statistical projections at a given point in time of an insurer’s or reinsurer’s expectations of the ultimate settlement and administration costs of claims incurred. As a result, it is likely that the ultimate liability will differ from such estimates, perhaps significantly. Such estimates are not precise in that, among other things, they are based on predictions of future developments and estimates of future trends in loss severity and frequency and other variable factors such as inflation, litigation and tort reform. This uncertainty is heightened by the short time in which the Company has operated, thereby providing limited claims loss emergence patterns specifically for the Company. The lack of historical information for the Company has necessitated the use of industry loss emergence patterns in deriving IBNR. Further, expected losses and loss ratios are typically developed using vendor and proprietary computer models and these expected loss ratios are a material component in the calculation deriving IBNR. Actual loss
ratios will deviate from expected loss ratios and ultimate loss ratios will be greater or less than expected loss ratios. During the loss settlement period, it often becomes necessary to refine and adjust the estimates of liability on a claim either upward or downward. Even after such adjustments, ultimate liability will exceed or be less than the revised estimates. The actual payment of the reserve for losses and loss expenses will differ from estimated payouts.
The obligations to Talbot third party FAL providers are based on the contractual payment terms. Talbot’s practice has been to pay amounts accrued but not contractually due, however, this practice is subject to change in the future.
In February 2007, the FASB issued FAS No. 159, “The Fair Value Option for Financial Assets and Liabilities Including amendment of FASB Statement No. 115” (FAS 159), which permits entities to choose to measure many financial instruments and certain other items at fair value. FAS 159 includes a provision whereby investments accounted for as available-for-sale or held-to-maturity are eligible for the fair value option at the adoption date and will be accounted for as trading securities subsequent to adoption. If FAS 157 is adopted simultaneously with FAS 159, any change in an existing eligible item’s fair value shall be accounted for as a cumulative-effect adjustment. FAS No. 159 is effective as of the beginning of the Company’s fiscal year beginning after November 15, 2007 and may be early adopted.
The third party FAL facility comprises $174,365,000 which supports the 2007 and prior underwriting years. These funds have now been withdrawn from Lloyd’s and placed in escrow but remain available to pay losses on those years for which such FAL has been contracted to support.
On November 25, 2003, Talbot entered into a standby Letter of Credit facility as subsequently amended (the “2003 Talbot FAL Facility”). The 2003 Talbot FAL Facility provided for dollar-based letter of credit availability for Talbot and designated subsidiaries for the purpose of providing funds at Lloyd’s. The commitment amount under the 2003 Talbot FAL Facility was $30,000,000 and the Talbot FAL Facility was provided by Lloyds TSB Bank plc. The 2003 Talbot FAL Facility contains affirmative covenants that include, among other things, (i) the requirement that Talbot maintain a minimum level of consolidated tangible net worth, (ii) the requirement that Talbot maintain at all times a consolidated net borrowings to consolidated tangible net worth ratio not greater than 0.35:1.00, (iii) the requirement that Talbot’s subordinated FAL (Funds at Lloyd’s which in accordance with the applicable providers agreement, is intended to be drawn in priority to any letters of credit under the 2003 Talbot FAL Facility ) be at least $200,000,000 and (iv) a requirement that the forecast losses of the syndicate not exceed 7.5% of the syndicate premium limit in any one open year of account and a requirement that the per scenario estimated net losses not exceed 15% of the syndicate premium limit in any year of account. The 2003 Talbot FAL Facility also contained restrictions on Talbot’s ability to incur debt at the parent or subsidiary level, sell assets, incur liens, merge or consolidate with others and make investments or change investment strategy. As of December 31, 2006 and throughout the reporting periods presented, where appropriate, the Company was in compliance with all covenants and restrictions. This facility was cancelled in November 2007 and replaced by a $100,000,000 standby Letter of Credit facility.
On March 12, 2007, we entered into a new $200,000,000 three-year unsecured facility, as subsequently amended on October 25, 2007, which provides for letter of credit availability for Validus Re and our other subsidiaries and revolving credit availability for the Company (the full $200,000,000 of which is available for letters of credit and/or revolving loans), and a new $500,000,000 five-year secured letter of credit facility, as subsequently amended, which provides for letter of credit availability for Validus Re and our other subsidiaries. The new credit
The credit facilities contain affirmative covenants that include, among other things, (i) the requirement that we initially maintain a minimum level of consolidated net worth of at least $872,000,000, and commencing with the end of the fiscal quarter ending March 31, 2007 to be increased quarterly by an amount equal to 50% of our consolidated net income (if positive) for such quarter plus 50% of any net proceeds received from any issuance of common shares during such quarter, (ii) the requirement that we maintain at all times a consolidated total debt to consolidated total capitalization ratio not greater than 0.35:1.00, and (iii) the requirement that Validus Re and any other material insurance subsidiaries maintain a financial strength rating by A.M. Best of not less than “B++” (Fair). At December 31, 2007 and for the period then ended, we were in compliance with the covenants under our new credit facility. The credit facilities also contain restrictions on our ability to pay dividends and other payments in respect of equity interests at any time that we are otherwise in default with respect to certain provisions under the credit facilities, make investments, incur debt at our subsidiaries, incur liens, sell assets and merge or consolidate with others. As of December 31, 2007 and throughout the reporting periods presented, where appropriate, the Company was in compliance with all covenants and restrictions.
On July 2, 2007, the Company made a draw upon the $200,000,000 unsecured credit facility in the amount of $188,000,000. These funds were used to fund a portion of the cash purchase price for the Company’s acquisition of Talbot and associated expenses. The interest rate set in respect of borrowing amounts under its credit facility borrowings as of July 2, 2007 was 6.0% per annum. On July 31, 2007, the Company fully repaid these borrowings and paid accrued interest with $188,971,000 of proceeds from its initial public offering. As of December 31, 2007, we have $104,524,000 in outstanding letters of credit under our five-year secured letter of credit facility and no amounts outstanding under our three-year unsecured facility.
On November 28, 2007, Talbot entered into a $100,000,000 standby Letter of Credit facility (the “Talbot FAL Facility”) to provide Funds at Lloyd’s; this facility is guaranteed by the Company and is secured against the assets of Validus Re. The Talbot FAL Facility was provided by a syndicate of commercial banks arranged by Lloyds TSB Bank plc and ING Bank N.V., London Branch. The Talbot FAL Facility contains affirmative covenants that include,
Validus Re and a Talbot subsidiary (the “Bermuda registered companies”) are registered under the Insurance Act 1978 of Bermuda (“the Act”). Under the Act, the Bermuda registered companies are required annually to prepare and file Statutory Financial Statements and a Statutory Financial Return. The Act also requires the Bermuda registered companies to meet minimum solvency requirements. For the year ended December 31, 2007, the Bermuda registered companies satisfied these requirements.
The indenture governing our Junior Subordinated Deferrable Debentures would restrict us from declaring or paying dividends on our common shares if the Company was downgraded by A.M. Best to a financial strength rating of “B” (Fair) or below or if A.M. Best withdraws its financial strength rating on any of the Company’s material insurance subsidiaries.
A downgrade of the Company’s A.M. Best financial strength rating below “B++” (Fair) would also constitute an event of default under our credit facilities and a downgrade by A.M. Best could trigger provisions allowing some cedants to opt to cancel their reinsurance contracts. Either of these events could, among other things, severely reduce the Company’s financial flexibility.
During the years ended December 31, 2007 and 2006, the Company generated net cash from operating activities of $563.4 million and $270.5 million respectively. Cash flows from operations generally represent premiums collected, investment earnings realized and investment gains realized less losses and loss expenses paid and underwriting and other expenses paid. Cash flows from operations may differ substantially, however, from net income.
Sources of funds primarily consist of the receipt of premiums written, investment income and proceeds from sales and redemptions of investments. In addition, cash will also be received from financing activities. Cash is used primarily to pay losses and loss expenses, brokerage commissions, excise taxes, general and administrative expenses, purchase new investments, and payment of premiums retroceded. The Company has had sufficient resources to meet its liquidity requirements.
cyclicality of demand and pricing in the insurance and reinsurance markets;
our ability to successfully implement our business strategy during “soft” as well as “hard” markets;
potential loss of business from one or more major insurance or reinsurance brokers;
general economic and market conditions (including inflation, interest rates and foreign currency exchange rates) and conditions specific to the insurance and reinsurance markets in which we expect to operate;
company, are even more difficult to make than those made in a mature company because of limited historical information;
the failure of reinsurers, retrocessionaires, producers or others to meet their obligations to us;
the timing of loss payments being faster or the receipt of reinsurance recoverables being slower than anticipated by us;
changes in domestic or foreign laws or regulations, or their interpretations;
The foregoing review of important factors should not be construed as exhaustive and should be read in conjunction with the other cautionary statements that are included herein or elsewhere. Any forward-looking statements made in this report are qualified by these cautionary statements, and there can be no assurance that the actual results or developments anticipated by us will be realized or, even if substantially realized, that they will have the expected consequences to, or effects on, us or our business or operations. We undertake no obligation to update publicly or revise any forward-looking statement, whether as a result of new information, future developments or otherwise.