Our corporate offices are located in 101,420 total square feet of leased space in Stamford, Connecticut. Our other locations occupy a total of 135,581 square feet, all of which are leased. The Americas division principally operates out of offices in New York, Stamford, Mexico City, Miami, and Toronto; the EuroAsia division operates out of offices in Paris, Singapore, Stockholm and Tokyo; the London Market division operates out of offices in London; and the U.S. Insurance division operates principally out of offices in New York, Chicago, Napa and Overland Park, Kansas.
Operations” and the consolidated financial statements and notes thereto that are included in this Annual Report on Form 10-K. Financial information in the table reflects the results of operations and financial position of OdysseyRe.
We encourage you to read the consolidated financial statements included in this Annual Report on Form 10-K because they contain our complete consolidated financial statements for the years ended December 31, 2008, 2007 and 2006. The results of operations for the year ended December 31, 2008 are not necessarily indicative of future results.
The Emerging Issues Task Force (“EITF”) Issue 4-08 “The Effect of Contingently Convertible Instruments on Diluted Earnings Per Share,” which is effective for periods ending after December 15, 2004, requires that the dilutive effect of contingently convertible debt securities, with a market price threshold, should be included in diluted earnings per share. The terms of our convertible senior debentures, which were issued in June 2002, (see Note 13 to our consolidated financial statements) meet the criteria defined in EITF Issue 4-08, and accordingly, the effect of conversion of our convertible senior debentures to common shares has been assumed when calculating our diluted earnings per share for the years ended December 31, 2004 through 2007. See Notes 2(l) and 5 to our consolidated financial statements included in this Annual Report on Form 10-K.
Inclusion of restricted common shares, stock options and the effect of the conversion of our convertible debt to common shares would have an anti-dilutive effect on the 2005 diluted loss per common share (i.e., the diluted loss per common share would be less than the basic loss per common share). Accordingly, such common shares were excluded from the calculations of the 2005 diluted loss per common share. See Notes 2(l) and 5 to our consolidated financial statements included in this Annual Report on Form 10-K.
Book value per common share, a non-GAAP financial measure often used by investors, is calculated using common shareholders’ equity, a non-GAAP financial measure, which represents total shareholders’ equity, a GAAP financial measure, reduced by the equity attributable to our preferred stock, which was issued during 2005. The common shareholders’ equity is divided by our common shares outstanding at each respective year end to derive book value per common share as reflected in the following table (in millions, except per share and share amounts).
Our gross premiums written for the year ended December 31, 2008 were $2,294.5 million, an increase of $11.8 million, or 0.5%, compared to gross premiums written for the year ended December 31, 2007 of $2,282.7 million. Our United States business accounted for 48.8% of our gross premiums written for the year ended December 31, 2008, compared to 51.8% for the year ended December 31, 2007. For the years ended December 31, 2008 and 2007, our net premiums written were $2,030.8 million and $2,089.4 million, respectively. For the years ended December 31, 2008 and 2007, we had net income available to common shareholders of $543.1 million and $587.2 million, respectively. As of December 31, 2008, we had total assets of $9.7 billion and total shareholders’ equity of $2.8 billion.
The property and casualty reinsurance and insurance industries use the combined ratio as a measure of underwriting profitability. The GAAP combined ratio is the sum of losses and loss adjustment expenses (“LAE”) incurred as a percentage of net premiums earned, plus underwriting expenses, which include acquisition costs and other underwriting expenses, as a percentage of net premiums earned. The combined ratio reflects only underwriting results, and does not include investment results. Underwriting profitability is subject to significant fluctuations due to catastrophic events, competition, economic and social conditions, foreign currency fluctuations and other factors. Our combined ratio was 101.2% for the year ended December 31, 2008, compared to 95.5% for the year ended December 31, 2007.
We are exposed to losses arising from a variety of catastrophic events, such as hurricanes, windstorms and floods. The loss estimates for these events represent our best estimates based on the most recent information available. We use various approaches in estimating our losses, including a detailed review of exposed contracts and information from ceding companies and claims adjusters. As additional information becomes available, including information from ceding companies and claims adjusters, actual losses may exceed our estimated losses, potentially resulting in adverse effects to our financial results. The extraordinary nature of these losses, including potential legal and regulatory implications, creates substantial uncertainty and complexity in estimating these losses. Considerable time may elapse before the adequacy of our estimates can be determined. For the years ended December 31, 2008, 2007 and 2006, current year catastrophe events were $264.7 million, $105.9 million and $34.9 million, respectively.
The London Market division is comprised of our Lloyd’s of London business, in which we participate through our 100% ownership of Newline, our London branch office and NICL, our London-based insurance company. The London Market division writes insurance and reinsurance business worldwide, principally through brokers.
The consolidated financial statements and related notes included in Item 8 of this Annual Report on Form 10-K, have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and include the accounts of Odyssey Re Holdings Corp. and its subsidiaries.
We derive our revenues from two principal sources: (i) premiums from insurance placed and reinsurance assumed, net of premiums ceded (net premiums written); and (ii) income from investments. Net premiums written are earned (net premiums earned) as revenue over the terms of the underlying contracts or certificates in force. The relationship between net premiums written and net premiums earned will, therefore, vary depending on the volume and inception dates of the business assumed and ceded and the mix of such business between proportional and excess of loss reinsurance.
Gross premiums written estimates, acquisition costs, premiums receivable and unearned premium reserves are established on a contract level for significant accounts due but not reported by the ceding company at the end of each accounting period. The estimated ultimate premium for the contract, actual accounts reported by the ceding company, and our own experience on the contract are considered in establishing the estimate at the end of each accounting period. Subsequent adjustments, based on actual results, are recorded in the period in which they become known. The estimated premiums receivable balances are considered fully collectible. The estimates primarily represent the most current two underwriting years of account for which all corresponding reported accounts have been settled within contract terms. The estimates are considered “critical accounting estimates” because changes in these estimates can materially affect net income.
In any specific financial period, the original estimated premium for a specific contract may vary from actual premium reported through the life of the contract by up to 15% due to the reporting patterns of the ceding companies
We review information received from ceding companies for reasonableness based on past experience with the particular ceding company or our general experience across the subject class of business. We also query information provided by ceding companies for reasonableness. Reinsurance contracts under which we assume business generally contain specific provisions which allow us to perform audits of the ceding company to ensure compliance with the terms and conditions of the contract, including accurate and timely reporting of information.
We rely on initial and subsequent claim reports received from ceding companies for reinsurance business, and the estimates advised by our claims adjusters for insurance business, to establish our estimates of unpaid losses and LAE. The types of information that we receive from ceding companies generally vary by the type of contract. Proportional, or quota share, reinsurance contracts are typically reported on a quarterly basis, providing premium and
Our estimate of ultimate loss is determined based on a review of the results of several commonly accepted actuarial projection methodologies incorporating the quantitative and qualitative information described above. The specific methodologies we utilize in our loss reserve review process include, but may not be limited to (i) incurred and paid loss development methods, (ii) incurred and paid Bornhuetter Ferguson (“BF”) methods and (iii) loss ratio methods. The incurred and paid loss development methods utilize loss development patterns derived from historical loss emergence trends usually based on cedant supplied claim information to determine ultimate loss. These methods assume that the ratio of losses in one period to losses in an earlier period will remain constant in the future. Loss ratio methods multiply expected loss ratios, derived from aggregated analyses of internally developed pricing trends, by earned premium to determine ultimate loss. The incurred and paid BF methods are a blend of the loss development and loss ratio methods. These methods utilize both loss development patterns, as well as expected loss ratios, to determine ultimate loss. When using the BF methods, the initial treaty year ultimate loss is based predominantly on expected loss ratios. As loss experience matures, the estimate of ultimate loss using this methodology is based predominantly on loss development patterns. We generally do not utilize methodologies that are dependent on claim counts reported, claim counts settled or claim counts open. Due to the nature of our business, this information is not routinely provided by ceding companies for every treaty. Consequently, actuarial methods utilizing this information generally cannot be relied upon by us in our loss reserve estimation process. As a result, for much or our business, the separate analysis of frequency and severity loss activity underlying overall loss
Historically, our actual results have varied considerably in certain instances from our estimates of losses and LAE because historical loss emergence trends have not been indicative of future emergence for certain segments of our business. In recent years, we experienced loss emergence, resulting from a combination of higher claim frequency and severity of losses, greater than expectations that were established based on a review of prior years’ loss emergence trends, particularly for business written in the late 1990s and early 2000s. General liability and excess workers’ compensation classes of business during these years were adversely impacted by the highly competitive conditions in the industry at that time. These competitive conditions resulted in price pressure and relatively broader coverage terms, thereby affecting the ability of standard actuarial techniques to generate reliable estimates of ultimate loss. Similarly, directors’ and officers’ professional liability lines were impacted by the
The following table provides detail on net adverse (favorable) loss and LAE development for prior years, by division, for the years ended December 31, 2008, 2007, and 2006 (in millions):
The Americas division reported net increases in prior period loss estimates of $66.6 million, $143.1 million and $212.7 million for the years ended December 31, 2008, 2007 and 2006, respectively. The increase in prior period loss estimates for the year ended December 31, 2008 was principally attributable to loss emergence greater than expectations in the period on asbestos. The increase in prior period loss estimates for the year ended December 31, 2007 was principally due to loss emergence greater than expectations in the period on U.S. casualty business, including asbestos, and included $21.2 million related to settlement of litigation during the period. The increase in prior period loss estimates for the year ended December 31, 2006 was principally attributable to loss emergence greater than expectations in the period on U.S. casualty business, including asbestos, and included an increase of $43.0 million related to prior period catastrophe activity, principally due to an increase in loss estimates on marine business for Hurricane Rita and the triggering of industry loss warranty contracts written by us for Hurricane Wilma due to unexpected deterioration in industry-wide Wilma loss estimates as well as unexpected loss emergence on Florida proportional property accounts in the period.
We believe that these uncertainties and factors make projections of these exposures, particularly asbestos, subject to less predictability relative to non-environmental and non-asbestos exposures. Current estimates, as of December 31, 2008, of our asbestos and environmental losses and LAE reserves, net of reinsurance, are $230.5 million and $29.8 million, respectively. See Note 10 to the consolidated financial statements for additional historical information on losses and LAE reserves for these exposures.
The following table provides the gross and net asbestos and environmental losses and LAE incurred from business written prior to 1986 for the years ended December 31, 2008, 2007 and 2006 (in millions):
The following table provides gross asbestos and environmental outstanding claim information from business written prior to 1986 for the years ended December 31, 2008 and 2007 (in millions):
The number of asbestos claims, with case reserves, as of December 31, 2008 was 1,672, amounting to $204.8 million in gross case losses and LAE reserves. The largest 10 reported claims accounted for 11.6% of the gross case reserves, with an average reserve of $2.4 million. The number of asbestos claims, with case reserves, as of December 31, 2007 was 1,554, amounting to $216.8 million in gross case losses and LAE reserves. The largest 10 reported claims accounted for 14.9% of the gross case reserves, with an average reserve of $3.2 million. Gross case reserves decreased in 2008, as newly reported claims and additional reported reserves on existing claims were less than claim payments in the year. The asbestos open claim count increased by 118, or 7.6%, during calendar year 2008. Based on an aggregation of claims by insured, our 10 largest insured involvements accounted for 36.9% of our gross case reserves as of December 31, 2008, compared to 42.3% as of December 31, 2007. Net losses and LAE for the year ended December 31, 2008 for asbestos claims were increased by $41.0 million, principally attributable to loss emergence greater than expectations during the period.
The number of environmental claims, with case reserves, as of December 31, 2008 was 556, amounting to $20.9 million in gross case losses and LAE reserves. The largest 10 reported claims accounted for 30.6% of the gross case reserves, with an average case reserve of $0.6 million. The number of environmental claims, with case reserves, as of December 31, 2007 was 605, amounting to $29.8 million in gross case losses and LAE reserves. The largest 10 reported claims accounted for 30.5% of the gross case reserves, with an average case reserve of $0.9 million. Overall gross case reserves decreased in 2008, as newly reported claims and additional reported reserves on existing claims were less than claim payments in the year. The environmental open claim count decreased by 49, or 8.1%, during calendar year 2008. Based on an aggregation of claims by insured, our 10 largest
insured involvements accounted for 45.9% of our gross case reserves as of December 31, 2008, compared to 47.0% as of December 31, 2007. Net losses and LAE for the year ended December 31, 2008 for environmental claims were increased by $4.1 million, principally attributable to the annual review of this exposure.
In the event that loss trends diverge from expected trends, we may have to adjust our reserves for asbestos and environmental exposures accordingly. Any adjustments will be reflected in the periods in which they become known, potentially resulting in adverse or favorable effects on our financial results. Due to the uncertainty involving estimates of ultimate asbestos and environmental exposures, management does not attempt to produce a range around its best estimate of loss.
We may purchase reinsurance to increase our aggregate premium capacity, to reduce and spread the risk of loss on our insurance and reinsurance business and to limit our exposure to multiple claims arising from a single occurrence. We are subject to accumulation risk with respect to catastrophic events involving multiple contracts. To protect against this risk, we may purchase catastrophe excess of loss reinsurance protection. The retention, the level of capacity purchased, the geographical scope of the coverage and the costs may vary from year to year. Specific reinsurance protections are also placed to protect selected portions of our business outside of the United States.
Our reinsurance protection covering certain amounts of our 1995 and prior unpaid losses and loss adjustment expenses (the “1995 Stop Loss Agreement”), provided by nSpire Re Limited (“nSpire Re”), a wholly-owned subsidiary of Fairfax, was commuted effective September 29, 2006, for consideration of $63.2 million. In accordance with the terms of the commutation agreement, we commuted ceded loss reserves of $71.8 million, resulting in a pre-tax commutation loss of $5.5 million for the year ended December 31, 2006. The 1995 Stop Loss Agreement had been accounted for as retroactive reinsurance. Accordingly, losses ceded under the contract in excess of premiums paid had been recorded as a deferred gain rather than as a benefit in the applicable periods. The deferred gain had been amortized into income over the estimated remaining settlement period of the underlying claims. Prior to commutation, on March 29, 2006, we received $78.0 million in cash from nSpire Re, which reduced the outstanding recoverable. As the $78.0 million was received in advance of the payment of the underlying claims by us, it was included as an adjustment to net unpaid losses and loss adjustment expenses, which increased by $78.0 million. In connection with the receipt of this cash, during 2006, we recognized $19.3 million ($12.5 million after tax) of the cumulative deferred gain, an increase of $17.9 million ($11.7 million after tax) over the anticipated deferred gain amortization for the period, as a reduction in losses and loss adjustment expenses.
During the second quarter of 2008, as a result of the final settlement of ceded ultimate net losses recoverable under the 2000 underwriting year Whole Account Excess of Loss Agreement, we received cash in the amount of $16.2 million in settlement of ceding commissions payable.
The maximum coverage available under the Whole Account Excess of Loss Agreements is based on a proportion of net premiums earned during each of the coverage periods, subject to a predetermined aggregate limit. The maximum coverage available will increase or decrease as premium adjustments applicable to a particular coverage period, if any, are recognized. The attachment point represents the aggregate amount of losses, and in certain cases, acquisition costs, expressed as a proportion of net premiums earned, that will be retained by us. Losses attributable to business written during a particular period in excess of the attachment point, subject to a maximum limit, are ceded to the reinsurer. The following table provides a summary of the significant terms of the Whole Account Excess of Loss Agreements that were in effect as of December 31, 2008 (in millions):
In addition to the Whole Account Excess of Loss Agreements, we entered into a three-year aggregate excess of loss reinsurance contract protecting our United States facultative casualty business for underwriting years 1998 through 2000 (“Facultative Excess of Loss Agreement”), which indemnified us for losses in excess of an annual retention, subject to an annual limit of liability. During December 2006, we entered into a commutation and release agreement related to this contract, pursuant to which all rights, obligations and liabilities were fully and finally settled. As a result of the commutation, a pre-tax loss of $1.4 million was recognized. Additionally, reinsurance recoverables were reduced by $16.1 million for the year ended December 31, 2006.
The income before income taxes reflected in our consolidated statements of operations related to our Whole Account and Facultative Excess of Loss Agreements for the years ended December 31, 2008, 2007, and 2006 is as follows (in millions):
The reinsurance recoverables on paid and unpaid losses related to the 2000 and 2001 underwriting years Whole Account Excess of Loss Agreements are $46.5 million and $74.0 million as of December 31, 2008 and 2007, respectively. Funds held under reinsurance contracts, related to these agreements, shown as a liability on our consolidated balance sheets, reflect $34.8 million and $58.1 million as of December 31, 2008 and 2007, respectively. Other collateral related to these agreements is $12.3 million and $33.6 million as of December 31, 2008 and 2007, respectively.
We record deferred income taxes as net assets or liabilities on our consolidated balance sheets to reflect the net tax effect of the temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and their respective tax bases. As of December 31, 2008 and 2007, a net deferred tax asset of $290.2 million and $32.3 million, respectively, was recorded. In recording this deferred tax asset, we have made estimates and judgments that future taxable income will be sufficient to realize the value of the net deferred tax asset. Accordingly, deferred tax assets have not been reduced by a valuation allowance, as management believes it is more likely than not that the deferred tax assets will be realized.
We are responsible for determining the fair value of our investment portfolio by utilizing market-driven fair value measurements obtained from active markets where available, by considering other observable and unobservable inputs and by employing valuation techniques that make use of current market data. For the majority of our investment portfolio, we use quoted prices and other information from independent pricing sources in determining fair values.
On a quarterly basis, we review our investment portfolio for declines in value, and specifically consider securities with fair values that have declined to less than 80% of their cost or amortized cost at the time of review. Declines in the fair value of investments that are determined to be temporary are recorded as unrealized depreciation, net of tax, in accumulated other comprehensive income. If we determine that a decline is
United States - Gross premiums written of $579.0 million for the year ended December 31, 2008 decreased $71.6 million, or 11.0%, compared to $650.6 million for the year ended December 31, 2007. The decrease in the United States relates to all classes of business except property. Property business increased by $24.4 million, or 16.4%, to $172.4 million in 2008 from $148.1 million in 2007. Treaty and facultative casualty business decreased by $93.5 million, or 20.7%, to $358.5 million in 2008 from $452.0 million in 2007 due to an increase in competitive market conditions and the nonrenewal of certain business that did not meet our underwriting criteria. All other classes of business accounted for the remaining decrease of $2.5 million.
Latin America - Gross premiums written of $158.1 million for the year ended December 31, 2008 increased $16.7 million, or 11.8%, compared to $141.4 million for the year ended December 31, 2007. The Latin America unit writes treaty and facultative reinsurance business throughout Latin America and the Caribbean. The increase in gross premiums written is comprised of treaty pro rata business of $15.4 million and treaty excess business of $2.9 million, offset by a decrease in property facultative business of $1.6 million.
EuroAsia. Gross premiums written in the EuroAsia division for the year ended December 31, 2008 were $596.7 million, an increase of $31.1 million, or 5.5%, compared to $565.6 million for the year ended December 31, 2007. These amounts represent 26.0% of our gross premiums written for the year ended December 31, 2008 and 24.8% in 2007. The increase in gross premiums written was comprised of: 1) $42.4 million attributable to the movement in foreign exchange rates during 2008 compared to 2007; and 2) a modification to the estimating process during 2008, which contributed $6.2 million to the increase over 2007. The modification to the estimating process impacted gross and net premiums written but had no effect on earned premiums. Excluding the effects of foreign exchange rate movements and the modification to the estimating process, gross premiums would have decreased $17.5 million.
London branch - Gross premiums written of $129.1 million for the year ended December 31, 2008 decreased $16.2 million, or 11.1%, compared to $145.3 million for the year ended December 31, 2007. Gross premiums written for property business, which represent 49.2% of the London branch for the year ended December 31, 2008, decreased by $3.9 million, or 5.8%, compared to 2007. Marine and aviation business decreased $7.9 million, or 14.3%, and casualty business decreased by $4.4 million, or 19.3% in 2008 compared to 2007.
Newline and NICL - Gross premiums written of $252.6 million for the year ended December 31, 2008 increased $48.0 million, or 23.5%, compared to $204.6 million for the year ended December 31, 2007. This increase is primarily due to new medical professional liability and motor business.
Professional liability gross premiums written decreased $8.4 million, or 6.0%, to $130.9 million for the year ended December 31, 2008, from $139.3 million for the year ended December 31, 2007. This class of business is the largest for the U.S. Insurance division and represents 24.3% of the total gross written premium in the division.
Ceded Premiums Written. Ceded premiums written for the year ended December 31, 2008 increased by $70.4 million, or 36.4%, to $263.7 million (11.5% of gross premiums written), from $193.3 million (8.5% of gross premiums written) for the year ended December 31, 2007. The increase in ceded premiums written was primarily related to (i) an increase in the London Market division of $31.0 million related to cessions associated with a new program incepting in 2008, (ii) the U.S. Insurance division of $37.0 million related to cessions associated with a new program incepting in 2008, and (iii) increased cessions on the crop program due to growth in the business and medical professional liability business due to an increase in quota share reinsurance ceded.
Net Premiums Written. Net premiums written for the year ended December 31, 2008 decreased by $58.6 million, or 2.8%, to $2,030.8 million, from $2,089.4 million for the year ended December 31, 2007. Net premiums written represent gross premiums written less ceded premiums written. Net premiums written decreased over 2007 at a higher rate than gross premiums written, reflecting an increase in ceded premiums written during 2008.
The increase in net losses and LAE incurred of $100.3 million was principally related to an increase in current year catastrophe events of $158.8 million, to $264.7 million for the year ended December 31, 2008, from $105.9 million for the year ended December 31, 2007. This increase was partially offset by a decrease in prior
period losses of $50.6 million, to a decrease of $10.1 million for the year ended December 31, 2008, from an increase of $40.5 million for the year ended December 31, 2007. Losses and LAE for the year ended December 31, 2008 included $143.8 million attributable to Hurricane Ike, $45.9 million related to the China winter storm, $19.1 million related to Windstorm Emma, $11.3 million related to Hurricane Gustav and a decrease in prior period losses of $10.1 million, principally attributable to decreased loss estimates due to loss emergence lower than expectations in the period in the EuroAsia, London Market and U.S. Insurance divisions, partially offset by increased loss estimates due to loss emergence greater than expectations in the period in the Americas division. Losses and LAE for the year ended December 31, 2007 included $38.5 million for Windstorm Kyrill, $12.3 million for Cyclone Gonu, $10.0 million for the Mexico flood in Tabasco and an increase in prior period losses of $40.5 million, predominantly attributable to increased loss estimates due to loss emergence greater than expectations in the period in the Americas division, partially offset by reduced loss estimates due to loss emergence lower than expectations in the period in the EuroAsia, London Market and U.S. Insurance divisions.
Ceded losses and LAE incurred for the year ended December 31, 2008 increased by $121.4 million, or 114.6%, to $227.3 million, from $105.9 million for the year ended December 31, 2007. This increase was principally related to loss cessions on Hurricane Ike and increased loss cessions related to our crop business.
U.S. Insurance Division - Losses and LAE increased $29.5 million, or 11.9%, to $277.4 million for the year ended December 31, 2008, from $247.9 million for the year ended December 31, 2007. This resulted in a loss and LAE ratio of 66.8% for the year ended December 31, 2008, compared to 57.8% for the year ended December 31, 2007. This increase in losses and LAE for the year ended December 31, 2008 was related to current year catastrophe losses of $27.6 million, principally attributable to Hurricane Ike. For the years ended December 31, 2008 and 2007, prior period losses decreased by $34.3 million and $38.7 million, respectively, principally due to loss emergence lower than expectations on professional liability business in each period.
Acquisition costs are reduced by ceding commissions related to our Whole Account and Facultative Excess of Loss Agreements of $1.2 million and $2.7 million for the years ended December 31, 2008 and 2007, respectively. Ceding commissions due under certain of our Whole Account Excess of Loss Agreements are deferred and will be received by us in future periods. Ceding commissions related to our Whole Account Excess of Loss Agreements have therefore been recorded at their present value, with the discount amortized over the expected collection period. For years ended December 31, 2008 and 2007, the discount amortized and included in ceding commissions was $1.3 million and $2.8 million, respectively.
Other Underwriting Expenses. Other underwriting expenses for the year ended December 31, 2008 were $175.0 million, compared to $178.6 million for the year ended December 31, 2007. The other underwriting expense ratio, expressed as a percentage of net premiums earned, was 8.4% for each of the years ended December 31, 2008 and December 31, 2007.
a decrease in net investment income from short-term investments and cash of $26.9 million, or 33.7%, for the year ended December 31, 2008, compared to the corresponding period in 2007, which is representative of a decrease in short-term interest rates during the period;
lower net realized investment gain on preferred stock of $0.4 million.
Other Expenses, Net. Other expenses, net for the year ended December 31, 2008, were $60.4 million, compared to $14.0 million for the year ended December 31, 2007. Other expenses are primarily comprised of operating expenses at our holding company, including audit related fees, corporate-related legal fees, consulting fees, and compensation expense and foreign currency exchange gains and losses. The increase of $46.4 million for the year ended December 31, 2008 compared to 2007 is primarily comprised of $45.8 million related to foreign exchange related adjustments.
$317.7 million for the year ended December 31, 2007, resulting from decreased pre-tax income. Our effective tax rates were 33.7% and 34.8% for the years ended December 31, 2008 and 2007, respectively.
Total reinsurance gross premiums written for the year ended December 31, 2007 were $1,545.9 million compared to $1,623.6 million for 2006, a decrease of 4.8%. Total insurance gross premiums written for the year ended December 31, 2007, which includes our U.S. Insurance division, our Lloyd’s syndicate and NICL, were $736.8 million, compared to $712.1 million for 2006, an increase of 3.5%. For the year ended December 31, 2007, total reinsurance gross premiums written represented 67.7% (69.5% in 2006) of our business and insurance represented the remaining 32.3% (30.5% in 2006) of our business.
U.S. Insurance. Gross premiums written in the U.S. Insurance division for the year ended December 31, 2007 were $532.3 million, an increase of $22.7 million, or 4.4%, as compared to $509.6 million for the year ended December 31, 2006. These amounts represent 23.3% of our gross premiums written for the year ended December 31, 2007 and 21.8% in 2006. Gross premiums written in our specialty insurance unit increased by $45.3 million, or 12.7%, offset by a decrease in medical professional liability business of $22.6 million, or 14.8%. Gross premiums written across each line of business is as follows:
Commercial automobile increased $16.8 million to $52.4 million for the year ended December 31, 2007, from $35.6 million for the year ended December 31, 2006. This increase resulted from increased production of ongoing accounts.
Our personal automobile business, which primarily includes non-standard automobile business written in California and Florida, decreased $26.1 million, or 33.6%, to $51.6 million for the year ended December 31, 2007, from $77.7 million for the year ended December 31, 2006. This decrease is primarily due to market conditions, which has resulted in the non-renewal of several programs.
Americas. Net premiums written in the Americas division for the year ended December 31, 2007 were $817.8 million, compared to $897.8 million for the 2006 period, a decrease of 8.9%. These amounts represented 39.1% of our net premiums written for the year ended December 31, 2007 and 39.6% for the year ended December 31, 2006. The net retention ratio, which represents net premiums written as a percent of gross premiums written, was 98.0% for the year ended December 31, 2007, compared to 97.1% for the year ended December 31, 2006.
The increase in net premiums written is consistent with an increase in gross premiums written.
The decrease in net premiums written consisted of an increase in gross premiums written of $9.2 million, offset by an increase in ceded premiums written of $16.2 million. The increase in ceded premiums written was primarily related to a change in the retention level of Newline Syndicate 1218’s excess loss contracts.
The loss and LAE ratio for the years ended December 31, 2007 and 2006 and the percentage point change for each of our divisions and in total are as follows:
principally due to favorable loss emergence on liability, property catastrophe and other miscellaneous property lines of business in the period. For the year ended December 31, 2006, losses and LAE included a reduction in prior period losses of $24.8 million principally due to favorable loss emergence on satellite, accident and health, non-catastrophe property and aviation exposures in the period, and included a $3.6 million increase on prior period catastrophe losses, principally Hurricane Rita.
The GAAP combined ratio is the sum of losses and LAE as a percentage of net premiums earned, plus underwriting expenses, which include acquisition costs and other underwriting expenses, as a percentage of net premiums earned. The combined ratio reflects only underwriting results, and does not include investment results. Underwriting profitability is subject to significant fluctuations due to catastrophic events, competition, economic and social conditions, foreign currency fluctuations and other factors. Our combined ratio was 95.5% for the year
a decrease in investment income from short-term investments and cash of $42.7 million, or 34.9%, for the year ended December 31, 2007 compared to the year ended December 31, 2006, which is representative of a shift from shorter term to longer term investments and a decrease in short term interest rates over the same period;
a decrease in investment income from other invested assets of $11.7 million for the year ended December 31, 2007 compared to the year ended December 31, 2006, which primarily reflects a decrease in investment income from hedge funds and private equity funds accounted for under the equity method, offset by an increase in interest income attributable to total return swaps on indexes;
an increase of $9.6 million in net investment income from equity securities for the year ended December 31, 2007 compared to the year ended December 31, 2006, excluding the effect of HWIC Asia. Included in net investment income from equity securities is an other-than-temporary write-down of $5.3 million for the year ended December 31, 2007 related to Advent Capital (Holdings) PLC (“Advent”).
an increase in net realized investment gains on derivative securities of $386.8 million for the year ended December 31, 2007, primarily attributable to the net change in fair value related to our credit default swaps and total return swaps on indexes, caused by widening credit spreads and declining equity indexes;
Our shareholders’ equity increased by $173.0 million, or 6.5%, to $2,827.7 million as of December 31, 2008, from $2,654.7 million as of December 31, 2007. The net increase as of December 31, 2008 compared to December 31, 2007 was primarily attributable to net income of $549.0 million, an increase in foreign currency translation adjustments of $4.1 million and a decrease in pension plan liability of $7.8 million, both components of accumulated other comprehensive income. Offsetting these increases were the repurchase of $351.4 million of our common shares, under our share repurchase program, a decrease in the net unrealized appreciation on securities of $13.1 million, and dividends on preferred and common shares of $24.7 million. Our book value per common share was $45.37 as of December 31, 2008, representing an increase of $8.59, or 23.4%, from our book value per common share of $36.78 as of December 31, 2007.
The following table reconciles total shareholders’ equity, a GAAP financial measure, to common shareholders’ equity, a non-GAAP financial measure, as used in the book value per common share calculation. We believe this presentation may be useful to investors who utilize common shareholders’ equity in their return on equity calculation.
Odyssey Re Holdings Corp. is a holding company that does not have any significant operations or assets other than its ownership of Odyssey America, and its principal sources of funds are cash dividends and other permitted payments from its operating subsidiaries, primarily Odyssey America. Holding company cash, cash equivalents and short-term investments totaled $23.9 million as of December 31, 2008, compared to $56.5 million as of December 31, 2007. Among the major activities that contributed to the decrease in the holding company’s cash, cash equivalents and short-term investments were: (i) the $354.1 million repurchase of our common shares, (ii) $33.8 million of interest paid on our debt obligations, (iii) $24.9 million of dividends paid on our common and preferred shares, (iv) $14.7 million of net tax payments and 5) $14.0 million of treasury shares repurchased. These payments were offset by $410.0 million of dividends received from Odyssey America in 2008. During the year ending December 31, 2009, Odyssey America can pay dividends of $544.8 million to the holding company, without requiring prior regulatory approval. If our subsidiaries are unable to make payments to us, or are able to pay only limited amounts, we may be unable to pay dividends on our common or preferred shares or make payments on our indebtedness. The payment of dividends by our operating subsidiaries is subject to restrictions set forth in the insurance laws and regulations of Connecticut, Delaware, New York and the United Kingdom. The holding company received dividends from Odyssey America of $410.0 million for the year ended December, 31 2008, compared to $155.0 million for the year ended December 31, 2007. The 2008 dividends to the holding company
Our total reinsurance recoverable on paid losses as of December 31, 2008, net of the reserve for uncollectible reinsurance, was $83.0 million. The top ten reinsurers measured on total reinsurance recoverables represent $52.0 million, or 62.6%, of the total paid loss recoverable, of which $2.0 million is collateralized and the remaining $50.0 million is with highly rated companies. The remaining $31.0 million recoverable on paid losses is with numerous companies, and no single company has a balance greater than $3.5 million net of the reserve on uncollectible reinsurance.
Total investments and cash amounted to $7.9 billion as of December 31, 2008, an increase of $113.1 million compared to December 31, 2007. Our average invested assets were $7.8 billion for the year ended December 31, 2008, as compared to $7.4 billion for the year ended December 31, 2007. It is anticipated that our cash and cash equivalents will continue to be reinvested on a basis consistent with our commitment to maintaining our financial strength and security. Cash, cash equivalents and short-term investments, excluding cash and cash equivalents held as collateral, of $2.0 billion and $1.4 billion as of December 31, 2008 and 2007, respectively, represented 25.1% and 18.5%, respectively, of our total investments and cash, excluding cash and cash equivalents held as collateral. Total fixed income securities were $3.9 billion as of December 31, 2008, compared to $4.6 billion as of December 31, 2007. As of December 31, 2008, 81.9% of the fixed income securities portfolio was rated “AAA,” as measured by Standard and Poor’s, with 8.4% of securities rated below investment grade. U.S. Treasury notes and bonds were
Total investments and cash exclude amounts receivable for securities sold and amounts payable for securities purchased, representing the timing between the trade date and settlement date of securities sold and purchased. As of December 31, 2008 and 2007, we had a receivable for securities sold of $6.3 million and $23.6 million, respectively, which are included in other assets, and payables for securities purchased of $126.6 million and $27.1 million, respectively, which are included in other liabilities.
Please see Note 13 to our consolidated financial statements included in this Annual Report on Form 10-K for complete disclosure of our debt obligations, common shares and preferred shares.
On June 15, 2007, our Board of Directors authorized a share repurchase program. Under the initial authorization, effective as of such date, we were authorized to repurchase shares of our common stock on the open market from time to time through June 15, 2009, up to an aggregate purchase price of $200.0 million. On March 18, 2008, we announced that our Board of Directors had increased the share repurchase program authorization by an additional $200.0 million, to a total repurchase authorization of $400.0 million. On September 3, 2008, we announced that our Board of Directors had increased the share repurchase plan by an additional $200.0 million, to a total repurchase authorization of $600.0 million, and extended the termination date of the repurchase program to December 31, 2009. Shares repurchased under the program are retired. Depending on market conditions and other factors, these repurchases may be commenced or suspended at any time, or from time to time, without prior notice. For the year ended December 31, 2008, we repurchased and retired 9,480,756 shares of our common stock, at a cost of $351.4 million, an average repurchase price of $37.06 per share. From inception of the program through December 31, 2008, we have purchased and retired 12,117,745 shares of our common stock at a total cost of $445.8 million.
Lloyd’s. We believe that Syndicate 1218 maintains sufficient liquidity and financial resources to support its ultimate liabilities and we do not anticipate that the pledged assets will be utilized.
During the year ended December 31, 2008, we purchased $72.7 million of investments that are classified as Level 3, (approximately 0.9% of total invested assets and cash). These Level 3 investments are valued using a discounted cash flow model, including unobservable inputs that are supported by limited market-based activity. We have determined that our investments in Level 3 securities are not material to our operations.
After considering the current economic conditions and the liquidity concerns in the credit markets, we have determined that we should not re-classify any of our investments from Level 1 or Level 2 to Level 3.
On January 1, 2007, we adopted SFAS 155, “Accounting for Certain Hybrid Financial Instruments - an amendment of SFAS 133 and 140.” SFAS 155 applies to certain “hybrid financial instruments,” which are instruments that contain embedded derivatives. The standard established a requirement to evaluate beneficial interests in securitized financial assets to determine if the interests represent freestanding derivatives, or are hybrid financial instruments containing embedded derivatives requiring bifurcation. SFAS 155 permits an election for fair value measurement of any hybrid financial instrument containing an embedded derivative that otherwise would have required bifurcation under SFAS 133, including financial instruments previously recorded by us under SFAS 133. As a result of the adoption of SFAS 155 on January 1, 2007, we no longer bifurcate the embedded derivatives included in certain fixed income securities, and, beginning on January 1, 2007, changes in the fair value of the hybrid financial instruments, which have been categorized as trading securities, are recorded as realized investment gains and losses in our consolidated statements of operations. Prior to the adoption of SFAS 155, changes in the fair value of the host instrument were recorded as unrealized investment gains and losses, a component of shareholders’ equity, while changes in the fair value of the embedded derivative were recorded as
We elected to recognize accrued interest and penalties, if any, associated with uncertain tax positions as part of the income tax provision. As of December 31, 2008 and 2007, we have not recorded any taxes, interest or penalties related to FIN 48.
On October 10, 2008, the FASB issued FSP FAS 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active,” to clarify the application of SFAS 157 to financial assets traded in inactive or distressed markets. FSP FAS 157-3 was effective upon issuance. FSP FAS 157-3 evaluates third party pricing quotes and the development of models, with a focus on discount rates, to determine the fair value of the investments. Entities are permitted to move financial assets and liabilities from Level 2 to Level 3, if a market becomes inactive or distressed, making it difficult to determine the fair value. FSP FAS 157-3 did not have a material effect on the way in which we measure the fair value of our investments.
On January 1, 2008, we adopted SFAS 159, “The Fair Value Option for Financial Assets and Financial Liabilities - Including an Amendment of FASB Statement No. 115,” which provides a fair value option (“FVO”) to measure many financial instruments and certain other assets and liabilities at fair value on an instrument-by-instrument basis. We elected the FVO for one investment that had previously been recorded under the equity method of accounting. On January 1, 2008, we discontinued applying the equity method of accounting for this investment and, in accordance with SFAS 159, carry the investment at fair value with changes in fair value recognized as realized gains or losses in our consolidated statements of operations. As a result of adopting the FVO for this investment, we recorded a cumulative adjustment of $1.5 million to reclassify foreign currency unrealized gains, net of tax, which had been included in accumulated other comprehensive income, to retained earnings as of January 1, 2008. In addition, SFAS 159 amended SFAS 95, “Statement of Cash Flows,” to allow cash payments and receipts related to trading securities to be classified according to the investment intent. As a result of the amendment to SFAS 95, as of January 1, 2008, we have classified our trading activity within the investing activities section of our consolidated statements of cash flows due to the investment nature of the transactions. For comparative purposes, prior period cash flows have been reclassified to conform with the current year’s presentation.
In December 2007, the FASB issued SFAS 141(R), “Business Combinations,” to replace SFAS 141, “Business Combinations.” While several items from SFAS 141 were retained, including the acquisition method of accounting
and the recognition of intangible assets separately from goodwill, SFAS 141(R) broadens its scope and establishes a definition of the acquirer and the acquisition date. SFAS 141(R) should be applied on a prospective basis in the first annual reporting period beginning on or after December 15, 2008. Earlier application is prohibited. The adoption of SFAS 141(R) will not have a material impact on our consolidated financial statements.
In November 2008, the FASB ratified EITF 08-6, “Equity Method Investment Accounting Considerations,” to clarify the equity method accounting method and questions regarding the changes from current practices due to the adoption of SFAS 141(R) and SFAS 160. EITF 08-6 is effective, on a prospective basis, for fiscal years beginning on or after December 15, 2008. As EITF 08-6 is effective, on a prospective basis, for new investments in fiscal years beginning on or after December 15, 2008.
In May 2008, the FASB issued SFAS 162, “The Hierarchy of Generally Accepted Accounting Principles,” which provides the framework necessary to determine the proper application of accounting principles in preparing financial statements in conformity with GAAP. SFAS 162 is effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board (“PCAOB”) amendments to AU Section 411, “The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles.” The amendments to AU Section 411 are still in deliberations. The adoption of SFAS 162 will not have a material impact on our consolidated financial statements.
The term “market risk” refers to the risk of loss arising from adverse changes in prices. We believe that we are principally exposed to four types of market risk related to our investment operations. These risks are interest rate risk, credit risk, equity price risk and foreign currency risk. Market sensitive instruments discussed in this section principally relate to our fixed income securities and common stocks carried at fair value which are classified as available for sale. As of December 31, 2008, our total investments and cash of $7.9 billion include $3.9 billion of fixed income securities that are subject to interest rate risk, foreign currency risk and credit risk.
The table below displays the potential impact (in millions) of fair value fluctuations on our fixed income securities portfolio as of December 31, 2008 and December 31, 2007, based on parallel 200 basis point shifts in interest rates, up and down, in 100 basis point increments. This analysis was performed on each security individually.
As of December 31, 2008, we were party to floating to fixed interest rate swap contracts with a notional amount of $140.0 million. As of December 31, 2008, the fair value of these contracts is reported in other liabilities at $32.6 thousand. Interest rate swaps had net realized losses of $32.6 thousand as of December 31, 2008.
As of December 31, 2008, our holdings of financial instruments without quoted prices, or “non-traded investments,” included a collateral loan, which was fully impaired during 2005. We periodically evaluate the carrying value of non-traded investments by reviewing the borrowers’ current financial positions, and the timeliness of their interest and principal payments.
In recent years, we have made investments in equity index and common stock total return swaps, as an “economic hedge” against a broad market downturn. During the fourth quarter of 2008, we removed this hedge on our equity portfolio by closing the swap contracts. The total return swaps had an aggregate notional amount of $691.0 million as of December 31, 2007. The margin maintenance requirement related to the total return swaps was $205.7 million as of December 31, 2007. As of December 31, 2007, we had provided $210.9 million of U.S. Treasury securities and municipal bonds as collateral for the swap transactions. The fair value of the equity index total return swaps, in the aggregate, was in a gain position as of December 31, 2007, and was recorded in other invested assets. We did not own common stock total return swaps as of December 31, 2007. Changes in the fair value of total return swaps are recorded as realized gains or losses in the consolidated statements of operations in the period in which they occur.
In connection with the short sales described above, we purchased a SPDR call option as protection against a decline in the value of short positions, which were closed out during the third quarter of 2008. The call option was also closed out in the third quarter of 2008. The call option was recorded at fair value in other invested assets in the consolidated balance sheet and changes in the fair value are recorded as realized gains or losses in the consolidated statements of operations in the period in which they occur. For the years ended December 31, 2008, 2007 and 2006, the call option had a net realized loss of $0.1 million, a net realized gain of $0.2 million and a net realized losses $0.1 million, respectively.
Through investment in securities denominated in foreign currencies, we are exposed to foreign (i.e., non-U.S.) currency risk. Foreign currency exchange risk exists because changes in the exchange rates of the underlying foreign currencies in which our investments are denominated affect the fair values of these investments when they are converted to the U.S. dollar. As of December 31, 2008 and December 31, 2007, our total exposure to foreign-denominated securities in U.S. dollar terms was approximately $1.9 billion and $2.1 billion, respectively, or 23.8% and 26.8%, respectively, of our total investments and cash. The primary foreign currency exposures were from securities denominated in the Euro, which represented 9.7% and 9.5% of our total investments and cash as of December 31, 2008 and December 31, 2007, respectively, the British pound, which represented 6.0% and 9.2% of our total investments and cash as of December 31, 2008 and December 31, 2007, respectively, and the Canadian dollar, which represented 3.5% and 4.2%, of our total investments and cash as of December 31, 2008 and December 31, 2007, respectively. As of December 31, 2008, the potential impact of a 10% decline in each of the foreign exchange rates on the valuation of investment assets denominated in those respective foreign currencies would result in a $188.1 million decline in the fair value of our total investments and cash, before taxes.
Through our international operations, we conduct our business in a variety of foreign (non-U.S.) currencies, with the primary exposures being the Euro, the British pound, and the Canadian dollar. Assets and liabilities denominated in foreign currencies are exposed to changes in currency exchange rates to the extent that they do not offset each other resulting in a natural hedge. Our reporting currency is the U.S. dollar, and exchange rate fluctuations relative to the U.S. dollar may materially impact our results and financial condition. We manage this risk on a macro basis by entering into forward currency contracts. As of December 31, 2008 and 2007, we were party to forward currency contracts with notional amounts of $533.9 million and $149.2 million, respectively. As of December 31, 2008 and 2007, the fair value of these contracts is reported in other invested assets and other liabilities at $28.2 million and $2.8 million, respectively. Forward currency contracts had net realized gains of $66.7 million and net realized losses of $2.8 million for the years ended December 31, 2008 and 2007, respectively.
Decisions regarding other-than-temporary impairments require an evaluation of facts and circumstances at a specific time. Should the facts and circumstances change such that an other-than-temporary impairment is considered appropriate, we will recognize the impairment, by reducing the cost, amortized cost or carrying value of the investment to its fair value, and recording the loss in our consolidated statements of operations. Upon the disposition of a security where an other-than-temporary impairment has been taken, we will record a gain or loss based on the adjusted cost or carrying value of the investment.
Risks and uncertainties are inherent in our other-than-temporary decline in value assessment methodology. Risks and uncertainties include, but are not limited to, incorrect or overly optimistic assumptions about financial condition or liquidity, incorrect or overly optimistic assumptions about future prospects, inadequacy of any
underlying collateral, unfavorable changes in economic or social conditions and unfavorable changes in interest rates.
For further detail on our long term debt principal and interest payments, see Note 13 to our consolidated financial statements included in this Annual Report on Form 10-K. For further detail on our operating lease payments, see Note 16 to our consolidated financial statements included in this Annual Report on Form 10-K. For further detail on our employee benefit plans, see Note 19 to our consolidated statements in this Annual Report on Form 10-K.
I. Summary of Investments - Other than Investments in Related Parties as of December 31, 2008
II. Condensed Financial Information of Registrant as of December 31, 2008 and 2007 and for the years ended December 31, 2008, 2007 and 2006
III. Supplementary Insurance Information as of December 31, 2008 and 2007 and for the years ended December 31, 2008, 2007 and 2006
VI. Supplementary Information (for Property-Casualty Insurance Underwriters) as of December 31, 2008, 2007, 2006 and for the years ended December 31, 2008, 2007 and 2006
In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Odyssey Re Holdings Corp. and its subsidiaries at December 31, 2008 and 2007, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2008 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedules listed in the accompanying index present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements and financial statement schedules, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on these financial statements, on the financial statement schedules, and on the Company’s internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
(b) Investments. The majority of the Company’s investments in fixed income securities and common stocks are categorized as “available for sale” and are recorded at their estimated fair value based on quoted market prices. Certain investments, including fixed income securities that contain embedded derivatives, are reflected in trading securities (see Note 3), while investments in common stocks of affiliates are carried at the Company’s proportionate share of the equity of those affiliates. Short-term investments, which have a maturity of one year or less from the date of purchase, are carried at fair value. The Company considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents. Investments in limited partnerships and investment funds have been reported in other invested assets. Other invested assets also include trust accounts relating to the Company’s benefit plans and derivative securities, which are each carried at fair value. The Company routinely evaluates the carrying value of its investments in common stocks of affiliates and in partnerships and investment funds. In the case of limited partnerships and investment funds, the carrying value is generally established on the basis of the net valuation criteria as determined by the managers of the investments. Such valuations could differ significantly from the values that would have been available had markets existed for the securities. Investment transactions are recorded on their trade date, with balances pending settlement reflected in the consolidated balance sheet as a component of other assets or other liabilities.
Investment income, which is reported net of applicable investment expenses, is recorded as earned. Realized investment gains or losses are determined on the basis of average cost. The Company records its proportionate share of income or loss from common stocks of affiliates, limited partnerships and investment funds in investment income in accordance with the equity method of accounting. Income from equity investees, including realized gains or losses, is recorded in net investment income. Due to the timing of when financial information is reported by equity investees and received by the Company, including limited partnerships and investment funds, results attributable to these investments are generally reported by the Company on a one month or one quarter lag. If the Company becomes aware of a significant event that would impact the value of these investments, it assesses the impact, if any,
on the carrying value of the investment. The unrealized appreciation and depreciation related to hedge funds and private equity investments is recorded in net investment income, while unrealized appreciation and depreciation related to trading securities is recorded as realized investment gains or losses in the consolidated statements of operations.
(c) Premium Revenue Recognition. Reinsurance assumed premiums written and related costs are based upon reports received from ceding companies. Where reinsurance assumed premiums written have not been reported by the ceding company, they are estimated, at the individual contract level, based on historical patterns and experience from the ceding company and judgments of the Company. Subsequent adjustments to premiums written, based on actual results or revised estimates from the ceding company, are recorded in the period in which they become known. Reinsurance assumed premiums written related to proportional treaty business are established on a basis that is consistent with the coverage periods under the terms of the underlying insurance contracts. Reinsurance assumed premiums written related to excess of loss and facultative reinsurance business are recorded over the coverage term of the contracts, which is generally one year. Unearned premium reserves are established for the portion of reinsurance assumed premiums written to be recognized over the remaining contract period. Unearned premium reserves related to proportional treaty contracts are computed based on reports received from ceding companies, which show premiums written but not yet earned. Premium adjustments made over the life of the contract are recognized as earned premiums based on the applicable contract period to which they apply. Insurance premiums are earned on a pro rata basis over the policy period, which is generally one year. A reserve for uncollectible premiums is established when deemed necessary.
The cost of reinsurance purchased by the Company (reinsurance premiums ceded) is reported as prepaid reinsurance premiums and amortized over the contract period in proportion to the amount of insurance protection provided. The ultimate amount of premiums, including adjustments, is recognized as premiums ceded, and amortized over the applicable contract period to which they apply. Reserves are established for the unexpired portion of premiums ceded and recorded as an asset in prepaid reinsurance premiums. Premiums earned are reported net of reinsurance ceded premiums earned in the consolidated statements of operations. Amounts paid by the Company for retroactive reinsurance that meets the conditions for reinsurance accounting are reported as reinsurance receivables to the extent those amounts do not exceed the associated liabilities. If the liabilities exceed the amounts paid, reinsurance receivables are increased to reflect the difference, and the resulting gain is deferred and amortized over the estimated settlement period. If the amounts paid for retroactive reinsurance exceed the liabilities, the Company will increase the related liabilities or reduce the reinsurance receivable, or both, at the time the reinsurance contract is effective, and the excess is charged to net income. Changes in the estimated amount of liabilities relating to the underlying reinsured contracts are recognized in net income in the period of the change.
Assumed and ceded reinstatement premiums represent additional premiums related to reinsurance coverages, principally catastrophe excess of loss contracts, which are paid when the incurred loss limits have been utilized under the reinsurance contract and such limits are reinstated. Premiums written and earned premiums related to a loss event are estimated and accrued as earned. The accrual is adjusted based upon any change to the ultimate losses incurred under the contract.
The reserve for unpaid losses and loss adjustment expenses is based on the Company’s evaluations of reported claims and individual case estimates received from ceding companies for reinsurance business or the estimates advised by the Company’s claims adjusters for insurance business. The Company utilizes generally accepted actuarial methodologies to determine reserves for losses and loss adjustment expenses on the basis of historical experience and other estimates. The reserves are reviewed continually during the year and changes in estimates in losses and loss adjustment expenses are reflected as an expense in the consolidated statements of operations in the period the adjustment is made. Reinsurance recoverables on unpaid losses and loss adjustment expenses are reported as assets. A reserve for uncollectible reinsurance recoverables is established based on an evaluation of each reinsurer or retrocessionaire and historical experience. The Company uses tabular reserving for workers’ compensation indemnity reserves, which are considered to be fixed and determinable, and discounts such reserves using an interest rate of 3.5%. Losses have been discounted using the Life Table for Total Population: United States, 2004.
Accounting for Insurance and Reinsurance Contracts That Do Not Transfer Risk” (“SOP 98-7”). Under the deposit method of accounting, revenues and expenses from reinsurance contracts are not recognized as written premium and incurred losses. Instead, the profits or losses from these contracts are recognized net, as other income or expense over the contract or contractual settlement periods. In accordance with SOP 98-7, these contracts are deemed as either transferring only significant timing risk or only significant underwriting risk or transferring neither significant timing nor underwriting risk.
For such contracts, the Company initially records the amount of consideration paid as a deposit asset or received as a deposit liability. Revenue or expense is recognized over the term of the contract, with any deferred amount recorded as a component of assets or liabilities until such time it is earned. The ultimate asset or liability under these contracts is estimated, and the asset or liability initially established, which represents consideration received, is increased or decreased over the term of the contract. The change during the period is recorded in the Company’s consolidated statements of operations, with increases and decreases in the ultimate asset or liability shown in other expense, net. As of December 31, 2008 and 2007, the Company had reflected in other assets $8.0 million and $8.5 million, respectively, and in other liabilities $1.1 million and $1.0 million, respectively, related to deposit contracts. In cases where cedants retain the consideration on a funds held basis, the Company records those assets in other assets, and records the related investment income on the assets in the Company’s consolidated statements of operations as investment income.
(h) Income Taxes. The Company records deferred income taxes to provide for the net tax effect of temporary differences between the carrying values of assets and liabilities in the Company’s consolidated financial statements and their tax bases. Such differences relate principally to deferred acquisition costs, unearned premiums, unpaid losses and loss adjustment expenses, investments and tax credits. Deferred tax assets are reduced by a valuation allowance when the Company believes it is more likely than not that all or a portion of deferred taxes will not be realized. As of December 31, 2008 and 2007, a valuation allowance was not required. During the third quarter of 2006, Fairfax reduced its ownership of the Company to below 80%, and as a result, the Company has been deconsolidated from the United States tax group of Fairfax. Accordingly, the Company has filed separate consolidated tax returns for the period August 29, 2006 to December 31, 2006, the year ended December 31, 2007 and will file a separate consolidated tax return for 2008. The deconsolidation has no effect on the Company’s tax position (see Note 15). The Company has elected to recognize accrued interest and penalties, associated with uncertain tax positions as part of the income tax provision. As of December 31, 2008 and 2007, the Company has not recorded any interest or penalties.
(i) Derivatives. The Company utilizes derivative instruments to manage against adverse changes in the value of its assets and liabilities. Derivatives include credit default swaps, call options and warrants, total return swaps, interest rate swaps, forward currency contracts and other equity and credit derivatives. In addition, the Company holds options on certain securities within its fixed income portfolio, which allows the Company to extend the maturity date on fixed income securities or convert fixed income securities to equity securities. Upon the adoption of SFAS 155, “Accounting for Certain Hybrid Financial Instruments - an amendment of SFAS 133 and 140,” on January 1, 2007 (see Note 3), the Company has categorized these investments as trading securities, and changes in fair value are recorded as realized investment gains or losses in the consolidated statements of operations. All derivative instruments are recognized as either assets or liabilities on the consolidated balance sheet and are measured at their fair value. Gains or losses from changes in the derivative values are reported based on how the derivative is used and whether it qualifies for hedge accounting. As the Company’s derivative instruments do not qualify for hedge accounting, changes in fair value are included in realized investment gains and losses in the consolidated statements of operations. Margin balances required by counterparties in support of derivative positions are included in cash and cash equivalents held as collateral.
(k) Foreign Currency. Foreign currency transaction gains or losses resulting from a change in exchange rates between the currency in which a transaction is denominated, or the original currency, and the functional currency are reflected in the consolidated statements of operations in the period in which they occur. The Company translates the financial statements of its foreign subsidiaries and branches, which have functional currencies other than the U.S. dollar, into U.S. dollars by translating balance sheet accounts at the balance sheet date exchange rate and income statement accounts at the average exchange rate for the year. Translation gains or losses are recorded, net of deferred income taxes as a component of accumulated other comprehensive income.
The following table presents the foreign exchange effect, net of tax, on certain line items in the Company’s financial statements for the years ended December 31, 2008, 2007 and 2006 (in thousands):
(l) Earnings Per Share. Basic earnings per common share are calculated by dividing net income available to common shareholders by the weighted average number of common shares outstanding, excluding those non-vested shares granted under the OdysseyRe Restricted Share Plan. Diluted earnings per common share are calculated by dividing net income available to common shareholders by the weighted average number of common shares outstanding, inclusive of: vested and non-vested shares granted under the OdysseyRe Restricted Share Plan, as determined using the treasury stock method; stock options that would be assumed to be exercised on the balance sheet date, as determined using the treasury stock method; and the effect of the conversion of the Company’s convertible debt to equity securities. Restricted shares, stock options or the effect of the conversion of the convertible debt and the related interest expense would not be included in the calculation of diluted earnings per common share if the effect would be anti-dilutive (see Note 5).
(o) Funds Held Balances. Funds held under reinsurance contracts is an account used to record a liability, in accordance with the contractual terms, arising from the Company’s receipt of a deposit from a reinsurer or the withholding of a portion of the premiums due as a guarantee that a reinsurer will meet its loss and other obligations. Interest generally accrues on withheld funds in accordance with contract terms. Funds held by reinsured is an account used to record an asset resulting from the ceding company, in accordance with the contractual terms, withholding a portion of the premium due the Company as a guarantee that the Company will meet its loss and other obligations.
The Company elected to recognize accrued interest and penalties, if any, associated with uncertain tax positions as part of the income tax provision. As of December 31, 2008 and 2007, the Company has not recorded any taxes, interest or penalties related to FIN 48.
On October 10, 2008, the FASB issued FSP FAS 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active,” to clarify the application of SFAS 157 to financial assets traded in inactive or distressed markets. FSP FAS 157-3 was effective upon issuance. FSP FAS 157-3 evaluates third party pricing quotes and the development of models, with a focus on discount rates, to determine the fair value of the investments. Entities are permitted to move financial assets and liabilities from Level 2 to Level 3 (see Note 6), if a market becomes inactive or distressed, making it difficult to determine the fair value. FSP FAS 157-3 did not have a material effect on the way in which the Company measures the fair value of its investments.
On January 1, 2008, the Company adopted SFAS 159, “The Fair Value Option for Financial Assets and Financial Liabilities - Including an Amendment of FASB Statement No. 115,” which provides a fair value option (“FVO”) to measure many financial instruments and certain other assets and liabilities at fair value on an instrument-by-instrument basis. The Company elected the FVO for one investment that previously has been recorded under the equity method of accounting. On January 1, 2008, the Company discontinued applying the equity method of accounting for this investment and, in accordance with SFAS 159, carries the investment at fair value with changes in fair value recognized as realized gains or losses in its consolidated statements of operations. As a result of adopting the FVO for this investment, the Company recorded a cumulative adjustment of $1.5 million to reclassify foreign currency unrealized gains, net of tax, which had been included in accumulated other comprehensive income, to retained earnings as of January 1, 2008. In addition, SFAS 159 amended SFAS 95, “Statement of Cash Flows,” to allow cash payments and receipts related to trading securities to be classified according to the investment intent. As a result of the amendment to SFAS 95, as of January 1, 2008, the Company has classified its trading activity within the investing activities section of its consolidated statements of cash flows
In December 2007, the FASB issued SFAS 160, “Non-controlling Interests in Consolidated Financial Statements,” which amends Accounting Research Bulletin 51, “Consolidated Financial Statements,” to establish accounting and reporting standards for the non-controlling interest in a subsidiary and for the deconsolidation of a subsidiary. SFAS 160 clarifies the definition of a non-controlling interest and the proper accounting for that entity. SFAS 160 is effective for fiscal years beginning on or after December 15, 2008. Earlier adoption is prohibited. The adoption of SFAS 160 will not have a material impact on the Company’s consolidated financial statements.
In November 2008, the FASB ratified EITF 08-6, “Equity Method Investment Accounting Considerations,” to clarify the equity method accounting method and questions regarding the changes from current practices due to the adoption of SFAS 141(R) and SFAS 160. EITF 08-6 is effective, on a prospective basis, for new investments in fiscal years beginning on or after December 15, 2008.
In March 2008, the FASB issued SFAS 161, “Disclosures About Derivative Instruments and Hedging Activities,” which requires additional disclosures for derivative and hedging activities. While earlier application is encouraged, SFAS 161 is effective for fiscal years and interim periods beginning after November 15, 2008. SFAS 161 does not require but encourages comparative application to prior periods at the initial adoption date. Upon adoption of SFAS 161, the Company will include additional disclosures within its future consolidated financial statements.
In May 2008, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position Accounting Principles Bulletin 14-1 (“FSP APB 14-1”), “Accounting for Convertible Debt Instruments That May Be Settled in Cash Upon Conversion (Including Partial Cash Settlement),” to clarify the guidance related to convertible debt with options to settle partially or fully in cash. This statement does not change the accounting for convertible debt that does not offer a cash settlement feature, nor does it apply if the conversion feature is accounted for as an embedded derivative or for convertible preferred stock. FSP APB 14-1 is applicable to annual and interim periods beginning after December 15, 2008, however it must be applied on a retrospective basis for comparative purposes, even if the convertible debt did not exist as of the date of application. The Company will apply the provisions of FSP APB 14-1, effective January 1, 2009, related to the convertible senior debentures issued by the Company in June 2002 (see Note 13). As of May 1, 2007, all of the convertible senior debentures had been converted to common stock of the Company. The adoption of FSP APB 14-1 will not have a material impact on the Company’s financial statements.
In December 2008, the FASB issued FSP FAS 132(R)-1, “Employers’ Disclosures about Postretirement Benefit Plan Assets,” to require enhanced disclosures regarding the major categories of plan assets, concentrations of risk, inputs and valuation techniques used to measure the fair value of plan assets and the effect of using unobservable inputs (Level 3 classification under SFAS 157). The disclosure requirements of FSP FAS 132(R)-1 are effective for fiscal years ending after December 15, 2009.
On June 9, 2008, Hudson Specialty purchased the remaining 60% of the outstanding shares of Hooghuis Group LLC (“Hooghuis”), an underwriting agency specializing in U.S. directors’ and officers’ liability insurance, at a cost of $5.3 million. Hudson Specialty had purchased 40% of Hooghuis in 2004. As a result of the acquisition, the Company acquired $9.9 million in assets (including $2.9 million in intangible assets, which will be amortized over the expected lives of such assets, and $1.0 million in goodwill) and $5.5 million in liabilities. As of December 31, 2008, the unamortized balance of the intangible assets was $2.5 million.
Basic earnings per common share is calculated by dividing net income available to common shareholders for the period by the weighted-average number of common shares outstanding during the period, excluding those non-vested shares granted under the Odyssey Re Holdings Corp. Restricted Share Plan (the “Restricted Share Plan”). Diluted earnings per common share is calculated by dividing net income available to common shareholders for the period, adjusted for interest expense on the Company’s previously outstanding 4.375% convertible senior debentures (the “Convertible Notes”), by the weighted-average number of common shares outstanding during the period, inclusive of: vested and non-vested shares granted under the Restricted Share Plan, as determined using the treasury stock method; stock options that would be assumed to be exercised as of the balance sheet date, as determined using the treasury stock method; and the effect of the conversion of the Convertible Notes to equity securities. Restricted shares, stock options or the effect of the conversion of the Convertible Notes and the related interest expense are not included in the calculation of diluted earnings per common share if the effect would be anti-dilutive.
Net income per common share for the years ended December 31, 2008, 2007 and 2006 as depicted in the following table has been computed based upon weighted average common shares outstanding (in thousands, except share and per share amounts):
SFAS 157 defines fair value, establishes a framework for measuring fair value, establishes a fair value hierarchy based on the quality of inputs used to measure fair value, and enhances disclosure requirements for fair value measurements. The Company accounts for a significant portion of its financial instruments at fair value under various accounting literature, including SFAS 155, “Accounting for Certain Hybrid Financial Instruments - an amendment of FASB Statements No. 133 and 140,” SFAS 133, “Accounting for Derivative Instruments and Hedging Activities,” SFAS 115, “Accounting for Certain Investments in Debt and Equity Securities,” and SFAS 159.
In accordance with SFAS 157, the Company has categorized its financial instruments, based on the priority of the inputs to the valuation technique, into a three-level fair value hierarchy. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). When the inputs used to measure fair value fall within different levels of the hierarchy, the level within which the fair value measurement is categorized is based on the lowest level input that is significant to the fair value measurement in its entirety. For example, a Level 3 fair value measurement may include inputs that are observable (Levels 1 and 2) and unobservable (Level 3). Therefore, gains and losses for such assets and liabilities categorized within the Level 3 table below may include changes in fair value that are attributable to both observable inputs (Levels 1 and 2) and unobservable inputs (Level 3). Financial assets and liabilities recorded in the consolidated balance sheets are categorized based on the inputs to the valuation techniques as follows:
Level 2: Level 2 financial instruments are financial assets and liabilities, the values of which are based on quoted prices in markets that are not active, or model inputs that are observable either directly or indirectly for substantially the full term of the asset or liability. Level 2 inputs include the following:
c) Pricing models, the inputs for which are observable for substantially the full term of the asset or liability; and
d) Pricing models, the inputs for which are derived principally from, or corroborated by, observable market data through correlation or other means, for substantially the full term of the asset or liability.
Level 3: Level 3 financial instruments are financial assets and liabilities, the values of which are based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement. These inputs reflect management’s own assumptions about the methodology and valuation techniques that a market participant would use in pricing the asset or liability.
The Company is responsible for determining the fair value of its investment portfolio by utilizing market driven fair value measurements obtained from active markets where available, by considering other observable and unobservable inputs and by employing valuation techniques which make use of current market data. For the majority of the Company’s investment portfolio, the Company uses quoted prices and other information from independent pricing sources in determining fair values.
For determining the fair value of its Level 1 investments, (approximately 40.2% of total invested assets and cash), the Company utilizes quoted market prices. The majority of the Company’s Level 1 investments are common stocks that are actively traded in a public market, and cash, cash equivalents and short-term investments, for which the cost basis approximates fair value.
The Company adopted the provisions of SFAS 159 as of January 1, 2008. SFAS 159 provides an FVO election that allows companies to irrevocably elect fair value as the initial and subsequent measurement attribute for certain financial assets and liabilities. Changes in the fair value of assets and liabilities for which the election is made will be recognized in net income as they occur. SFAS 159 permits the FVO election on an instrument-by-instrument basis at initial recognition of an asset or liability or upon the occurrence of an event that gives rise to a new basis of accounting for that instrument.
As of December 31, 2008, Advent is recorded at its fair value of $14.3 million and is included in other invested assets, with related changes in fair value recognized as realized investment gains or losses in the period in which they occur. As of December 31, 2007, under the equity method of accounting, Advent’s value was $16.1 million. For the year ended December 31, 2008, the change in fair value resulted in a realized investment loss of $9.0 million. During 2008, the Company purchased additional shares of Advent at a cost of $7.2 million. Advent’s value as of December 31, 2008, calculated in accordance with the equity method of accounting, would have been $27.1 million.
A summary of the Company’s investment portfolio as of December 31, 2008, excluding common stocks at equity, other invested assets and fixed income securities held as trading securities, is as follows (in thousands):
The amortized cost and fair value of fixed income securities as of December 31, 2008, by contractual maturity, are shown below (in thousands).
Actual maturities may differ from the contractual maturities shown in the table above due to the existence of call or put options. In the case of securities containing call options, the actual maturity will be the same as the contractual maturity if the issuer elects not to exercise its call option. Total securities subject to a call option represent approximately 56% of the total fair value. In the case of securities containing put options, the actual maturity will be the same as the contractual maturity if the Company elects not to exercise its put option. Total securities containing the put option represent approximately 3% of the total fair value.
Net income of common stocks, at equity includes an other-than-temporary impairment of $5.3 million for the year ended December 31, 2007 related to the Company’s investment in Advent.
Included in net realized investment gains for the year ended December 31, 2008, is a net decrease in fair value of $290.7 million, as compared to net increases for the years ended December 31, 2007 and 2006, respectively, of $259.0 million and $36.8 million, principally related to derivatives and investments designated as trading securities.
The Company reviews, on a quarterly basis, its investment portfolio for declines in value, and specifically considers securities with fair values that have declined to less than 80% of their cost or amortized cost at the time of review. Declines in the fair value of investments which are determined to be temporary are recorded as unrealized depreciation, net of tax, in accumulated other comprehensive income. If the Company determines that a decline is “other-than-temporary,” the cost or amortized cost of the investment will be written down to the fair value, and a realized loss will be recorded in the Company’s consolidated statements of operations.
Common stocks, at equity, totaled $141.5 million as of December 31, 2008, compared to $157.5 million as of December 31, 2007. The following table shows the components of common stocks, at equity, as of December 31, 2008 and 2007 (in thousands):
On June 23, 2008, the Company purchased additional shares of Fairfax Asia Limited at a cost of $9.1 million. The Company’s ownership in Fairfax Asia Limited remained at 26.2%.
As of January 1, 2008, Advent has been reclassified to other invested assets as a result of the Company’s election of the FVO under SFAS 159.
The Company sold its 13.2% ownership (5.3 million shares) of Hub International Limited (“Hub”) in June 2007 to a group of private equity firms for $41.50 per share in cash; accordingly, the Company had no equity interest in Hub as of December 31, 2007. The Company recognized a pre-tax realized investment gain of $119.2 million ($77.5 million, after tax) related to the sale of its ownership in Hub.
The Company’s equity in the net income of HWIC Asia is included in net investment income and is comprised of the following items for the years ended December 31, 2006 (in thousands):
Including pre-tax realized investment gains of $75.1 million for the year ended December 31, 2006, related to the redemption of HWIC Asia shares, total realized investment gains from the Company’s interest in HWIC Asia were $242.8 million, pre-tax for the year ended December 31, 2006.
The aggregate of the Company’s equity investees’ summarized financial information, and the Company’s proportionate share thereof, as of December 31, 2008 and 2007 and for the years ended December 31, 2008, 2007 and 2006, follows (in thousands):
As of December 31, 2008 and 2007, the Company held one collateral loan which constituted a financial instrument without a quoted price, or a “non-traded investment.” This collateral loan was fully impaired during 2005. The Company periodically evaluates the carrying values of non-traded investments by reviewing the borrowers’ current financial position and the timeliness of their interest and principal payments.
related changes in fair value recognized as realized investment gains or losses in the consolidated statements of operations in the period in which they occur.
The Company has investments in warrants, which are contracts that grant the holder the right to purchase (but not the obligation) an underlying financial instrument at a given price and time or at a series of prices and times. Warrants, which are included in other invested assets, are recorded at fair value, with the related changes in fair value recognized as realized investment gains or losses in the consolidated statements of operations in the period in which they occur.
The Company has entered into interest rate swaps to protect it from adverse movements in interest rates. Under its current interest rate swap contracts, the Company receives a floating interest rate and pays a fixed interest rate based on the notional amounts in the contracts. Interest rate swaps are recorded at fair value in other liabilities, with the related changes in fair value recognized as realized investment gains or losses in the period in which they occur.
The Company had purchased equity index and common stock total return swaps as an “economic hedge” against a broad market downturn. During the fourth quarter of 2008, the Company removed the hedge on its portfolio, closing the swap contracts for significant gains. The margin maintenance requirement related to the total return swaps was $207.5 million as of December 31, 2007. As of December 31, 2007, the Company provided $210.9 million of U.S. Treasury bills as collateral for the swap transactions. The swap transactions were recorded at fair value in other invested assets as of December 31, 2007, and changes in the fair value are recorded as realized investment gains or losses in the consolidated statements of operations in the period in which they occur.
The Company had short positions, primarily in equity securities, all of which were closed out during the second quarter of 2008. As of December 31, 2007, the Company recorded a liability equal to the underlying fair value of the securities. As of December 31, 2007, the Company had provided cash of $195.8 million as collateral for the borrowed securities. The short positions were recorded as realized investment gains or losses in the consolidated statements of operations in the period in which they occur. The Company did not have any short sales of securities as of December 31, 2008.
In connection with the short sales described above, the Company purchased a SPDR call option as protection against a decline in the value of the short positions. The call option was closed out on July 7, 2008. The call option was recorded at fair value in other invested assets in the consolidated balance sheets, and changes in the fair value were recorded as realized investment gains or losses in the consolidated statements of operations in the period in which they occurred.
The net realized investment gains or losses on disposal in the table below represent the total gain or loss from the purchase date of the investment. The following table sets forth the total net realized investment gains and losses on derivatives and short sales, which are included in net realized investment gains in the consolidated statements of operations, for the years ended December 31, 2008, 2007 and 2006 (in thousands):
The components of comprehensive income for the years ending December 31, 2008, 2007 and 2006 are shown in the following table (in thousands):
The following table sets forth the activity in the liability for unpaid losses and loss adjustment expenses for the years ended December 31, 2008, 2007 and 2006 (in thousands):
Estimates of reserves for unpaid losses and loss adjustment expenses are contingent on many events that may or may not occur in the future. These events include losses arising from a variety of catastrophic events, such as hurricanes, windstorms and floods. The eventual outcome of these events may be different from the assumptions underlying the Company’s reserve estimates. In the event that the business environment and loss trends diverge from expected trends, the Company may have to adjust its reserves accordingly, potentially resulting in adverse or favorable effects to the Company’s financial results. The Company believes that the recorded estimate represents the best estimate of unpaid losses and loss adjustment expenses based on the information available as of December 31, 2008. The estimate is reviewed on a quarterly basis and the ultimate liability may be more or less than the amounts provided, for which any adjustments will be reflected in the periods in which they become known.
respectively. For the year ended December 31, 2008, the current year catastrophe losses included $143.8 million related to Hurricane Ike, $45.9 million related to the China winter storm, $19.1 million related to Windstorm Emma and $11.3 million related to Hurricane Gustav. For the year ended December 31, 2007, the total catastrophe losses included $38.5 million for Windstorm Kyrill, $12.3 million for Cyclone Gonu and $10.0 million for the Mexico flood in Tabasco. For the year ended December 31, 2006, the total catastrophe losses did not include any significant loss events.
The effects of exchange rate changes on net unpaid losses and loss adjustment expenses resulted in a decrease of $143.2 million for the year ended December 31, 2008 and increases of $26.6 million and $46.6 million for the years ended December 31, 2007 and 2006, respectively. The effects of exchange rate changes were attributable to changes in foreign currency exchange rates for unpaid losses and loss adjustment expenses in the London Market division.
The Company uses tabular reserving for workers’ compensation indemnity reserves, which are considered to be fixed and determinable, and discounts such reserves using an interest rate of 3.5%. Losses have been discounted using the Life Table for Total Population: United States, 2004. Reserves reported at the discounted value were $118.2 million and $128.7 million as of December 31, 2008 and 2007, respectively. The amount of case reserve discount was $55.6 million and $62.4 million as of December 31, 2008 and 2007, respectively. The amount of incurred but not reported reserve discount was $24.0 million and $27.0 million as of December 31, 2008 and 2007, respectively.
Net losses and loss adjustment expenses incurred for asbestos claims increased $41.0 million, $63.0 million and $27.1 million for the years ended December 31, 2008, 2007 and 2006, respectively. The increases in net losses and loss adjustment expenses incurred were primarily attributable to the annual reviews of claim activity and loss emergence trend information obtained in the calendar periods from ceding companies and other industry sources. Upon consideration of this new loss emergence information received in 2008, 2007 and 2006, the Company revised its loss development assumptions used in its asbestos loss reserving analyses, which had the effect of increasing the asbestos loss estimates for these calendar periods. The increase in 2006 net losses and loss adjustment expenses incurred included a $17.3 million benefit resulting from the amortization of the deferred gain related to the 1995 Stop Loss Agreement and a loss of $3.8 million related to the commutation of this agreement in addition to a net reserve increase of $40.6 million. Also as a result of this commutation, net reserves were increased by $49.9 million and net paid losses were decreased by $63.4 million.
Net losses and loss adjustment expenses incurred for environmental claims increased $4.1 million and $14.5 million for the years ended December 31, 2008 and 2007, respectively and decreased $2.2 million for the year ended December 31, 2006. The increases in net losses and loss adjustment expenses incurred for the years ended December 31, 2008 and 2007 were attributable to the annual reviews of claim activity and loss emergence trend information obtained in the calendar year from ceding companies. The decrease in 2006 net losses and loss adjustment expenses incurred included a net reserve decrease of $0.3 million, a $3.1 million benefit resulting from the amortization of the deferred gain related to the 1995 Stop Loss Agreement and a loss of $1.2 million related to the commutation of this agreement. As a result of this commutation, net reserves were increased by $17.3 million and net paid losses were decreased by $19.2 million.
The Company’s survival ratio for asbestos and environmental related liabilities as of December 31, 2008 is eight years. The Company’s underlying survival ratio for asbestos related liabilities is eight years and for environmental related liabilities is five years. The asbestos and environmental related liability survival ratio represents the asbestos and environmental reserves, net of reinsurance, on December 31, 2008, divided by the average paid asbestos and environmental claims for the last three years of $34.2 million, which are net of reinsurance but prior to amounts subject to cession to the 1995 Stop Loss Agreement. Our survival ratios may fluctuate over time due to the variability of large payments and adjustments to liabilities.
The Company’s reinsurance protection covering certain amounts of its 1995 and prior unpaid losses and loss adjustment expenses (the “1995 Stop Loss Agreement”), provided by nSpire Re Limited (“nSpire Re”), a wholly-owned subsidiary of Fairfax, was commuted effective September 29, 2006, for consideration of $63.2 million. In accordance with the terms of the commutation agreement, the Company commuted ceded loss reserves of $71.8 million, resulting in a pre-tax commutation loss of $5.5 million for the year ended December 31, 2006. The 1995 Stop Loss Agreement had been accounted for as retroactive reinsurance. Accordingly, losses ceded under the contract in excess of premiums paid had been recorded as a deferred gain rather than as a benefit in the applicable periods. The deferred gain had been amortized into income over the estimated remaining settlement period of the underlying claims. Prior to commutation, on March 29, 2006, the Company received $78.0 million in cash from nSpire Re, which reduced the outstanding recoverable. As the $78.0 million was received in advance of the payment of the underlying claims, it was included as an adjustment to net unpaid losses and loss adjustment expenses, which increased by $78.0 million. In connection with the receipt of this cash, during 2006, the Company recognized $19.3 million ($12.5 million after tax) of the cumulative deferred gain, an increase of $17.9 million ($11.7 million after tax) over the anticipated deferred gain amortization for the period, as a reduction in losses and loss adjustment expenses.
For the years ending December 31, 2001 and prior, the Company utilized whole account aggregate excess of loss retrocessional coverage (“Whole Account Excess of Loss Agreements”) to manage its exposures, including catastrophic occurrences and the potential accumulation of exposures. As further discussed below, during the second quarter of 2006, the Company commuted certain whole account excess of loss agreements. In addition, Whole Account Excess of Loss Agreements were purchased covering underwriting years 2002 through 2004
though no losses were ceded to these coverages. In each calendar year, the Company has the ability to cede losses attributable to certain prior periods to the Whole Account Excess of Loss Agreements to the extent there are limits remaining for the period. These agreements cover business written or incepting during a defined period of time (underwriting year), which is typically twelve months, or in other cases, business earned during a defined period of time (accident year). The Whole Account Excess of Loss Agreements were purchased on an underwriting year basis for 1996 through 2004 and on an accident year basis for 1994 and 1995. Accident year agreements were also purchased to supplement the 1996 and 1997 underwriting year agreements. All of these Whole Account Excess of Loss Agreements covering underwriting and accident years have been commuted except for two agreements covering underwriting years 2000 and 2001. Loss cession limits on these two covers still outstanding have been fully utilized. Each agreement provides for recoveries from the retrocessionaires, subject to a limit, in the event that the net subject business results in a composite ratio (the sum of the commission and loss ratios), in excess of a specified attachment point. The attachment point is net of other inuring third party reinsurance. The premium paid, net of commission, by the Company is calculated based on a contractual fixed rate that is applied to the total premiums covered by the retrocession agreements. Each agreement includes a provision for additional premium, subject to a maximum, based on the amount of loss activity under the agreement. Reinsurance recoverables on paid and unpaid losses are fully secured by letters of credit or funds held by the Company.
In each calendar year, subject to certain limits, the Company has the ability to cede losses that are attributable to the covered period until all applicable losses are paid and settled, which is typically several years beyond the covered period, or until the contract is terminated by the Company. The ability of the Company to cede losses in any given calendar year that are attributable to prior periods will depend on the nature of the risks that generated the losses, the time periods from which the losses originate and whether there are limits remaining covering the subject period. Losses attributable to prior periods are ceded to the treaties and recorded in the period in which they are ceded. Additional premiums, if any, are determined and recorded in the period when losses are ceded. When additional premiums are due, the interest on the funds attributable to the additional premiums ceded is typically calculated based on the inception period of the contract and the cumulative interest expense is recognized in the period when additional premiums are due. As of December 31, 2008 and 2007, the limits for the Whole Account Excess of Loss Agreements have been fully utilized or commuted.
The Company has recorded interest expense associated with other ceded reinsurance agreements, and not reflected in the table above, of $439 thousand, $975 thousand and $571 thousand for the years ended December 31, 2008, 2007 and 2006, respectively.
The reinsurance recoverables on paid and unpaid losses related to the 2000 and 2001 underwriting years Whole Account Excess of Loss Agreements are $46.5 million and $74.0 million as of December 31, 2008 and 2007, respectively. Funds held under reinsurance contracts related to these agreements, shown as a liability on the Company’s consolidated balance sheets, reflect $34.8 million and $58.1 million as of December 31, 2008 and 2007, respectively. Other collateral related to these agreements is $12.3 million and $33.6 million as of December 31, 2008 and 2007, respectively.
Reinsurance recoverables were $726.6 million and collateral was $184.1 million, or 25.3% of the reinsurance recoverable balance, as of December 31, 2007.
The Company is the beneficiary of letters of credit, cash and other forms of collateral to secure certain amounts due from its reinsurers. The total amount of collateral held by the Company as of December 31, 2008 is
The components of the Company’s debt obligations as of December 31, 2008 and 2007 were as follows (in thousands):
During the second quarter of 2005, the Company issued $125.0 million aggregate principal amount of senior notes due May 1, 2015. The issue was sold at a discount of $0.8 million, which is being amortized over the life of the notes. Interest accrues on the senior notes at a fixed rate of 6.875% per annum, which is due semi-annually on May 1 and November 1.
In June 2002, the Company issued $110.0 million aggregate principal amount of convertible senior debentures, due 2022 (the “Convertible Notes”). Interest accrued on the Convertible Notes at a fixed rate of 4.375% per annum, due semi-annually on June 15 and December 15. The Convertible Notes became redeemable at the Company’s option on June 22, 2005. Under certain conditions specified in the indenture under which the Convertible Notes were issued (the “Indenture”), each Convertible Notes holder had the right to request conversion of its Convertible Notes into 46.9925 of the Company’s common shares for every $1,000 principal amount of the Convertible Notes held by such holder, which represented a conversion price of $21.28 per share. These conditions included the common stock of the Company trading at or above $25.54 per share for a specified period of time. Pursuant to the terms of the Indenture, the Company was permitted to satisfy the conversion obligations in stock or in cash, or in a combination thereof. The conversion conditions were first satisfied on August 9, 2006, and in accordance with the Indenture, the Convertible Notes became convertible, at the option of the holders, on August 14, 2006. As of March 31, 2007, 1.9 million shares of the Company’s common stock were issued to the Convertible Notes holders who elected to convert their Convertible Notes. In March 2007, the Company announced that it had called for the redemption of the remaining $22.5 million principal value of the outstanding Convertible Notes. At the close of business on April 30, 2007, all holders of the Convertible Notes had exercised their rights of conversion with respect to the Convertible Notes. Accordingly, on May 1, 2007, the Company issued 1,056,107 shares of its common stock related to the final conversion of $22.5 million principal value of the Convertible Notes, and no Convertible Notes remained outstanding as of such date.
During the year ended December 31, 2006, the Company repurchased portions of its Convertible Notes, as reflected in the following table (in thousands):
As of December 31, 2008 and 2007, the amortized cost of the Company’s debt obligations was $489.3 million and $489.2 million, respectively, as reflected in the consolidated balance sheets. As of December 31, 2008 and 2007, the estimated fair value of the Company’s debt obligations was $407.0 million and $506.2 million, respectively. The estimated fair value is based on quoted market prices for debt similar to the Company’s, and discounted cash flow calculations.
On each of March 28, 2008 and June 27, 2008, the Company paid dividends of $0.0625 per common share. On July 31, 2008, the Company announced that its Board of Directors had approved a 20% increase in its quarterly common stock dividend, and declared a quarterly cash dividend of $0.075, which was paid on September 26, 2008. The common share dividend of $0.075 for the fourth quarter was paid on December 30, 2008. These common share dividends resulted in an aggregate annual dividend in 2008 of $0.275 per common share, totaling $17.4 million. In each of the four quarters of 2007, the Company paid a dividend of $0.0625 per common share, resulting in an aggregate annual dividend of $0.25 per common share, totaling $17.8 million. The 2007 dividends were paid on March 30, 2007, June 29, 2007, September 28, 2007 and December 28, 2007.
Dividends on each series of preferred shares are deferrable on a non-cumulative basis, provided that no dividends or other distributions have been declared or paid or set apart for payment on any other class or series of the Company’s capital shares ranking junior to or equal with the preferred shares. Dividends on Series A and Series B preferred shares will each be payable when, as and if declared by the Company’s Board of Directors, quarterly in arrears on the 20th day of January, April, July, and October of each year. Deferred dividends on either series will not accrue interest prior to the date of redemption. On December 2, 2008, the Company’s Board of Directors declared quarterly dividends of $0.5078125 per share on the Company’s 8.125% Series A preferred shares and $0.4845313 per share on the Company’s floating rate Series B preferred shares. The total dividends of $1.9 million were paid on January 20, 2009 to Series A and Series B preferred shareholders of record on December 31, 2008.
The Company’s operations are managed through four operating segments: Americas, EuroAsia, London Market and U.S. Insurance. The Americas division is comprised of the Company’s reinsurance operations in the United States, Canada and Latin America, and writes property and casualty business on a treaty and facultative basis. The EuroAsia division writes treaty reinsurance. The London Market division operates through three distribution channels, Newline at Lloyd’s and NICL, which focus on casualty insurance, and the London branch, which focuses on worldwide property and casualty reinsurance. The U.S. Insurance division writes specialty insurance lines and classes of business, such as medical professional liability, professional liability and non-standard automobile.
The financial results of these divisions for the years ended December 31, 2008, 2007 and 2006 are as follows (in thousands):
Deferred federal and foreign income taxes reflect the tax impact of temporary differences between the amount of assets and liabilities for financial reporting purposes and such amounts as measured by tax laws and regulations. Components of federal and foreign income tax assets and liabilities as of December 31, 2008 and 2007 follow (in thousands):
Domestic pre-tax income was $642.4 million, $692.8 million and 513.2 million for the years ended December 31, 2008, 2007 and 2006, respectively. Foreign pre-tax income was $185.1 million, $220.4 million and $226.0 million for the years ended December 31, 2008, 2007 and 2006, respectively.
As a result of Fairfax reducing its ownership of the Company to below 80% during the third quarter of 2006, the Company was deconsolidated from the United States tax group of Fairfax, and, accordingly, the Company has filed a separate consolidated tax return for the period August 29, 2006 to December 31, 2006 and will file a separate consolidated tax return for 2007 and 2008. The deconsolidation has no effect on the Company’s tax position. Prior to August 29, 2006, the Company was a member of the United States tax group of Fairfax and made payments to Fairfax in accordance with its tax sharing agreements. The Company paid federal and foreign income taxes of $348.4 million, $224.6 million and $59.3 million for the years ended December 31, 2008, 2007 and 2006, respectively. As of December 31, 2008, the Company had a current tax payable of $238.1 million, which reflects $9.3 million payable to Fairfax and a net payable of $228.8 million to the U.S. federal government and various foreign governments. As of December 31, 2007, the Company had a current tax payable of $45.9 million, which reflects $33.1 million payable to Fairfax and a net payable of $12.8 million to the U.S. federal government and various foreign governments. The federal income tax provision is allocated to each of the Company’s subsidiaries in the consolidated group pursuant to a written agreement, on the basis of each subsidiary’s separate taxable income.
The Company does not have any material unrecognized tax benefits and, accordingly, has not recognized any accrued interest or penalties associated with uncertain tax positions.
On September 7, 2005, the Company announced that it had been advised by Fairfax that Fairfax had received a subpoena from the Securities and Exchange Commission (“SEC”) requesting documents regarding any non-traditional insurance and reinsurance transactions entered into or offered by Fairfax and any of its affiliates, which included OdysseyRe. The United States Attorney’s Office for the Southern District of New York is reviewing documents provided to the SEC in response to the subpoena, and has participated in the investigation into these matters. In addition, the Company provided information and made a presentation to the SEC and the U.S. Attorney’s office relating to the restatement of the Company’s financial results announced by it on February 9, 2006 and responded to questions with respect to transactions that were part of the restatement. This inquiry is ongoing, and the Company will continue to cooperate fully in addressing its obligations under this subpoena. At the present time, the Company cannot predict the outcome of these matters, or the ultimate effect on the Company’s consolidated financial statements, which effect could be material and adverse. No assurance can be made that the Company will not be subject to further requests or other regulatory proceedings of a similar kind.
On February 8, 2007, the Company was added as a co-defendant in an amended and consolidated complaint in an existing action against Fairfax, and certain of Fairfax’s officers and directors, who include certain of the Company’s current and former directors. The amended and consolidated complaint has been filed in the United States District Court for the Southern District of New York by the lead plaintiffs, who seek to represent a class of all purchasers and acquirers of securities of Fairfax between May 21, 2003 and March 22, 2006, inclusive, and allege, among other things, that the defendants violated U.S. federal securities laws by making material misstatements or failing to disclose certain material information. The amended and consolidated complaint seeks, among other things, certification of the putative class, unspecified compensatory damages, unspecified injunctive relief, reasonable costs and attorneys’ fees and other relief. These claims are at a preliminary stage. Pursuant to the scheduling stipulations, the various defendants filed their respective motions to dismiss the amended and consolidated complaint, the lead plaintiffs filed their opposition thereto, and the defendants filed their replies to those oppositions; the motions to dismiss were argued before the Court in December 2007. The Court has not yet issued a ruling on these motions. The Company intends to vigorously defend against the allegations. At this early stage of the proceedings, it is not possible to make any determination regarding the likely outcome of this matter.
During the second quarter of 2004, Odyssey America pledged U.S. Treasury Notes with a par value of $162.0 million (“the pledged assets”), or approximately £110.0 million equivalent, to the Society and Council of Lloyd’s on behalf of Advent to support Advent’s underwriting activities for the 2001 to 2005 underwriting years of account. Advent is 66.6% owned by Fairfax and its affiliates, which includes 14.4% held by OdysseyRe. nSpire Re Limited (“nSpire Re”), a wholly-owned subsidiary of Fairfax, had previously pledged assets at Lloyd’s on behalf of Advent pursuant to a November 2000 agreement with Advent. In consideration of Odyssey America pledging the assets, nSpire Re paid Odyssey America a fee equal to 2.0% per annum of the pledged assets, which the Company
considered to be representative of commercial market terms. The securities were carried at fair value and were included in investments and cash in OdysseyRe’s consolidated balance sheets. Interest earned on the securities was included in investment income. The placement of funds at Lloyd’s would have automatically terminated effective no later than December 31, 2008 and any remaining pledged assets would have reverted to Odyssey America at that time. In January 2006, September 2006, June 2007, July 2008 and December 2008, Odyssey America received assets with par values of $48.6 million, $10.7 million, $14.6 million, $63.9 million and $24.2 million, respectively, in each case representing a permanent reduction and unconditional release of such amount, prior to the stated termination date. Following these returns of assets, and as of December 31, 2008, Lloyd’s has returned all the pledged assets related to Advent to Odyssey America, and Odyssey America has received a deed of total release from Lloyd’s with respect thereto.
Odyssey America agreed, as of April 1, 2002, to guarantee the payment of all of the insurance contract obligations (the “Subject Contracts”), whether incurred before or after the agreement, of Falcon Insurance Company (Hong Kong) Limited (“Falcon”), a subsidiary of Fairfax Asia Limited (“Fairfax Asia”), in the event Falcon becomes insolvent. Fairfax Asia is 100% owned by Fairfax, which includes a 26.2% economic interest owned by the Company. The guarantee by Odyssey America was made to assist Falcon in writing business through access to Odyssey America’s financial strength ratings and capital resources. Odyssey America is paid a fee for this guarantee of one percent of all gross premiums earned associated with the Subject Contracts on a quarterly basis. For the years ended December 31, 2008, 2007 and 2006, Falcon paid $0.3 million, $0.5 million and $0.5 million, respectively, to Odyssey America in connection with this guarantee. Odyssey America’s potential exposure in connection with this agreement is estimated to be $48.7 million, based on Falcon’s loss reserves at December 31, 2008. Falcon’s shareholders’ equity on a U.S. GAAP basis is estimated to be $39.5 million as of December 31, 2008. Fairfax has agreed to indemnify Odyssey America for any obligation under this guarantee. The Company believes that the financial resources of Falcon provide adequate protection to support its liabilities in the ordinary course of business. The Company anticipates that Falcon will meet all of its obligations in the normal course of business and does not expect to make any payments under this guarantee. The Company does not consider its potential exposure under this guarantee to be material to its consolidated financial position.
The amounts above are reduced by an aggregate minimum rental recovery of $2.1 million resulting from the sublease of space to other companies.
Odyssey America, the Company’s principal operating subsidiary, is subject to state regulatory restrictions that limit the maximum amount of dividends payable. In any 12-month period, Odyssey America may pay dividends equal to the greater of (i) 10% of statutory capital and surplus as of the prior year end or (ii) net income for such prior year, without prior approval of the Insurance Commissioner of the State of Connecticut (the “Connecticut Commissioner”). The maximum amount of dividends which Odyssey America may pay in 2009, without such prior approval is $544.8 million, based on Odyssey America’s separate company statutory financial statements. Connecticut law further provides that (i) Odyssey America must report to the Connecticut Commissioner, for informational purposes, all dividends and other distributions within five business days after the declaration thereof and at least ten days prior to payment and (ii) Odyssey America may not pay any dividend or distribution in excess of its earned surplus, as reflected in its most recent statutory annual statement on file with the Connecticut Commissioner, without the Connecticut Commissioner’s approval.
The statutory provision for potentially uncollectible reinsurance recoverables due from unauthorized companies is reduced to the extent collateral is held by Clearwater or Hudson. Pursuant to indemnification agreements between the Company and Clearwater, and between the Company and Hudson, the Company provides letters of credit and/or cash in respect of uncollateralized balances due from unauthorized reinsurers. The use of such collateral provided by the Company is a permitted accounting practice approved by the Insurance Department of the State of Delaware, the domiciliary state of Clearwater and Hudson. The Company has provided a $20.5 million letter of credit to Clearwater and a $0.5 million letter of credit to Hudson as of December 31, 2008, which have been used as collateral in regard to the indemnification agreements. The indemnification agreements do not affect the accompanying consolidated financial statements.
The Company’s subsidiaries have entered into investment management agreements with Fairfax and its wholly-owned subsidiary, Hamblin Watsa Investment Counsel Ltd. These agreements provide for an annual base fee of 0.20% (20 basis points), calculated and paid quarterly based upon the subsidiary’s average invested assets for the preceding three months. The agreements also include incentive fees of 0.10% (10 basis points), which are payable if realized gains exceed 1% of the average investment portfolio in any given year, subject to cumulative realized gains on investments exceeding 1% of the average investment portfolio. Additional incentive fees are paid based upon the performance of the subsidiary’s equity portfolio equal to 10% of the return on equities (subject to an annual maximum) in excess of the Standard & Poor’s 500 index plus 200 basis points, provided that the equity portfolio has achieved such excess on a cumulative basis. If the performance of the equity portfolio does not equal or exceed this benchmark in a given year, the annual base fee is reduced to 0.18% (18 basis points). The aggregate annual investment management fee payable by each subsidiary, including incentive fees, is capped at 0.40% (40 basis points) of its investment portfolio, with any excess amounts carried into the following year. These agreements may be terminated by either party on 30 days’ notice. For the years ended December 31, 2008, 2007 and 2006, total fees, including incentive fees, of $21.4 million, $17.3 million and $17.6 million, respectively, are included in the consolidated statements of operations.
The OdysseyRe Foundation, a not-for-profit entity through which the Company provides funding to charitable organizations active in the communities in which the Company operates, was formed in February 2007. Prior to the formation of the OdysseyRe Foundation, the Company provided funding to charitable organizations through the Sixty-Four Foundation, a not-for-profit affiliate of Fairfax and the Company. Included in other expense, net for the years ended December 31, 2008, 2007 and 2006, are incurred charitable contributions of $3.7 million, $2.5 million and $1.7 million, respectively, related to these entities.
As of December 31, 2008, SFAS 158 requires employers to measure plan assets and liabilities as of the date of their financial statements. The Supplemental Employee Retirement Plan and the Postretirement Benefit Plan are not affected by this revision as the measurement date for these plans has historically been December 31. However, the measurement date for the Defined Benefit Pension Plan and the Supplemental Plan has been changed from October 1 to December 31. The Company elected to apply the “fifteen-month” approach to these two benefit plans to measure plan assets and liabilities from the plans’ previous measurement date of October 1, 2007, for a fifteen-month period through December 31, 2008. As of January 1, 2008, the net periodic benefit costs of $1.8 million ($1.2 million, after tax) and the change in the minimum benefit plan liabilities of $0.2 million ($0.1 million, after tax) for the period October 1 through December 31, 2007 related to the Defined Benefit Pension Plan and Supplemental Plan have been reflected as a direct charge to retained earnings and an increase to accumulated other comprehensive income, respectively.
As of December 31, 2006, SFAS 158 required the Company to recognize the overfunded or underfunded status of its defined benefit and postretirement plans, including pension plans, as assets or liabilities in its balance sheet and to recognize changes in that funded status, in the year in which the changes occur, through comprehensive income. The Company adopted the recognition provisions of SFAS 158, which resulted in a reduction of accumulated other comprehensive income of $10.2 million as of December 31, 2006.
As of December 31, 2008 and 2007, the fair value and percentage of fair value of the total Plan assets are as follows:
The Plan seeks to maximize the economic value of its investments, by applying a long-term, value-oriented approach to optimize the total investment returns of the Plan’s invested assets. Assets are transferred and allocated among various investment vehicles, when appropriate. During the fourth quarter of 2008, the Plan reallocated its invested assets from fixed income securities to equity securities and money market funds. The long-term rate of return assumption is based on this flexibility to adjust to market conditions. The actual return on assets has historically been in line with the Company’s assumptions of expected returns. During 2008, the Company contributed $3.8 million to the Plan. Based on the Company’s current expectations, it expects to make a contribution in 2009 of $4.0 million.
The weighted average assumptions used to calculate the benefit obligation as of December 31, 2008 and 2007 are as follows:
The accumulated benefit obligation for the Plan is $45.4 million and $52.5 million as of the December 31, 2008 and 2007 measurement dates, respectively.
As a result of the adoption of SFAS 158, the Company recognized an $8.3 million, after tax, reduction in accumulated other comprehensive income related to the Plan, as of December 31, 2006, of which, on an after tax basis, $8.0 million related to net losses, while $0.3 million related to prior service cost.
The Company recorded a one-time pension settlement charge of $1.6 million ($1.0 million after-tax), and a corresponding increase to other comprehensive income, during the second quarter of 2008 related to the settlement of retiree benefit obligations from the defined benefit pension plan. The settlement of those benefit obligations resulted in the immediate recognition of a portion of a previously unrecognized actuarial loss. The settlement of the retiree pension obligations had no effect on total shareholders’ equity. Annuities have been purchased for those individuals whose benefit obligations were settled under the defined benefit pension plan. Additionally, as a result of the settlement, the pension benefit obligation and the fair value of the plan assets decreased by $7.7 million.
The net amount recognized in the consolidated balance sheets related to the accrued pension cost of $16.4 million and $16.7 million, as of December 31, 2008 and 2007, respectively, is included in other liabilities. The net amount of accumulated other comprehensive loss recognized is $2.2 million and $3.7 million, before taxes, as of December 31, 2008 and 2007, respectively.
The Excess Plans’ expected benefit payments are shown below (in thousands):
A trust fund, which was established related to the Excess Plans, is included in other invested assets, and had a fair value of $5.6 million and $6.8 million as of December 31, 2008 and 2007, respectively. During 2008, the trust fund reallocated its invested assets from U.S. government securities to money market accounts. Plan benefits are paid by the Company as they are incurred by the participants, accordingly, there are no assets held directly by the Excess Plans.
As a result of the adoption of SFAS 158, the Company recognized a $1.4 million after-tax reduction in accumulated other comprehensive income related to the Excess Plans as of December 31, 2006, of which, on an after-tax basis, $1.7 million related to net losses, while $0.3 million related to net prior service credit.
The Company estimates that it will record a $1.8 million expense related to the net periodic benefit cost during the year ended December 31, 2009.
Company. The Company’s cost for providing postretirement benefits other than pensions is accounted for in accordance with SFAS 106 “Employers’ Accounting for Postretirement Benefits Other Than Pensions.” The following tables set forth the amounts recognized for the postretirement benefit plan, which has a measurement date of December 31, in the Company’s consolidated financial statements as of December 31, 2008 and 2007 (in thousands):
The net amount recognized in the consolidated balance sheets related to the accrued benefit cost of $14.2 million, as of both December 31, 2008 and 2007, is included in other liabilities. The net amount of accumulated other comprehensive income recognized is $2.3 million and less than $0.1 million, before taxes, as of December 31, 2008 and 2007, respectively.
The accumulated benefit obligation for the postretirement benefit plan was $14.2 million as both of December 31, 2008 and 2007, respectively.
The postretirement plan’s expected benefit payments are shown below (in thousands):
The Company estimates that it will record $2.4 million in benefit costs relating to this plan during the year ended December 31, 2009.
The Company also maintains a defined contribution profit sharing plan for all eligible employees. Each year, the Board of Directors may authorize payment of an amount equal to a percentage of each participant’s basic annual earnings based on the experience of the Company for that year. These amounts are credited to the employee’s account maintained by a third party, which has contracted to provide benefits under the plan. No contributions were authorized in 2008, 2007 or 2006.
The Company maintains a qualified deferred compensation plan pursuant to Section 401(k) of the Internal Revenue Code of 1986, as amended. Employees may contribute up to 50% of base salary on a pre-tax basis, subject to annual maximum contributions set by law ($15,500 in 2008). The Company contributes an amount equal to 100% of each employee’s pre-tax contribution up to certain limits. The maximum matching contribution is 4% of annual base salary, with certain government-mandated restrictions on contributions to highly compensated employees. The Company also maintains a non-qualified deferred compensation plan to allow for contributions in excess of qualified plan limitations. The Company contributed $1.8 million, $1.8 million and $1.6 million to these plans in 2008, 2007 and 2006, respectively, which is included in other underwriting expenses in the consolidated statements of operations.
The Company has established three stock incentive plans (the “Plans”), the Odyssey Re Holdings Corp. 2002 Stock Incentive Plan (the “2002 Option Plan”), the Odyssey Re Holdings Corp. Stock Option Plan (the “2001 Option Plan”) and the Odyssey Re Holdings Corp. Restricted Share Plan (the “Restricted Share Plan”). The Plans generally allow for the issuance of grants and exercises through newly issued shares, treasury stock, or any combination thereof.
The following table summarizes stock option activity for the 2002 Option Plan for the year ended December 31, 2008:
In 2001, the Company adopted the 2001 Option Plan, which provides for the grant of stock options with a grant price of zero to officers and key employees of the Company employed outside of the United States. Options granted under the 2001 Option Plan generally vest and become exercisable in equal installments over three or five years from the date of grant, although amounts granted in 2001 vest and become exercisable in two equal installments on the fifth and tenth anniversary of the grant dates. Awards under each of the 2001 Option Plan and the Restricted Share Plan (described below) may not exceed an aggregate of 10% of the Company’s issued and outstanding shares of common stock as of the last business day of the previous calendar year. The Company had 69,521,494 issued and outstanding shares of common stock as of December 31, 2007.
As of December 31, 2008, there was $2.6 million of unrecognized compensation cost related to unvested options granted from the 2001 Option Plan, which is expected to be recognized over a remaining weighted-average vesting period of 1.9 years. The total fair value of the options exercised from the 2001 Option Plan during the years ended December 31, 2008, 2007 and 2006 was $1.7 million, $0.8 million and $1.1 million, respectively.
The weighted-average remaining contractual term for options outstanding as of December 31, 2008, 2007 and 2006 was 7.5 years, 7.2 years and 7.4 years, respectively. The weighted-average remaining contractual term for options vested and exercisable as of December 31, 2008 was 6.3 years. As of December 31, 2008, the aggregate fair value was $8.9 million for options outstanding and $2.2 million for options vested and exercisable.
In 2001, the Company adopted the Restricted Share Plan, which provides for the grant of restricted shares of the Company’s common stock to directors, officers and key employees of the Company. Shares granted under the Restricted Share Plan generally vest and become exercisable in equal installments over three years or five years from the grant dates. Restricted shares granted in 2001 vest and become exercisable in two equal installments on the fifth and tenth anniversary of the grant dates. Awards under each of the Restricted Share Plan and the 2001 Option Plan (described above) may not exceed an aggregate of 10% of the Company’s issued and outstanding shares of common stock as of the last business day of the previous calendar year. The Company had 69,521,494 issued and outstanding shares of common stock as of December 31, 2007.
The following table summarizes restricted share activity for the Restricted Share Plan for the year ended December 31, 2008:
In 2001, the Company established the Employee Share Purchase Plan (the “ESPP”). Under the terms of the ESPP, eligible employees may elect to purchase Company common shares in an amount up to 10% of their annual base salary. The Company issues or purchases, on the employee’s behalf, the Company’s common shares equal to 30% of the employee’s contribution. In the event that the Company achieves a return on equity of at least 15% in any calendar year, additional shares are purchased by the Company for the employee’s benefit in an amount equal to 20% of the employee’s contribution during that year. During the years ended December 31, 2008, 2007 and 2006, the Company purchased 75,757 shares, 68,542 shares and 83,046 shares, respectively, on behalf of employees pursuant to the ESPP, at average purchase prices of $38.46, $38.67 and $27.58, respectively. The compensation expense recognized by the Company for purchases of the Company’s common shares under the ESPP was $0.9 million, $0.9 million and $0.5 million for the years ended December 31, 2008, 2007 and 2006, respectively.
For the years ended December 31 2008, 2007 and 2006, the Company received $3.6 million, $2.5 million and $2.7 million, respectively, in cash from employees for the exercise of stock options. For the years ended December 31, 2008, 2007 and 2006, the Company recognized an expense related to all stock based compensation of $9.5 million, $6.7 million and $5.6 million, respectively. The total tax benefit recognized for the years ended December 31, 2008, 2007 and 2006 was $3.3 million, $2.3 million and $2.0 million, respectively. Of the $9.5 million expense for the year ended December 31, 2008, less than $0.1 million relates to the adoption of SFAS 123(R).
Due to changes in the number of weighted average common shares outstanding during 2008 and 2007, the sum of quarterly earnings per common share amounts will not equal the total for the year.
(1) The registrant’s investment in Odyssey America is accounted for under the equity method of accounting.