The following table sets forth our selected historical financial information for the periods ended and as of the dates indicated. The summary income statement data for the twelve months ended December 31, 2009, 2008, 2007, 2006 and 2005 and the balance sheet data as of December 31, 2009, 2008, 2007, 2006 and 2005 are derived from our audited consolidated financial statements. The consolidated financial statements as of December 31, 2009, and for each of the twelve months ended December 31, 2009, 2008 and 2007, and the report thereon of KPMG Audit Plc, an independent registered public accounting firm, are included elsewhere in this report. These historical results, including the ratios presented below, are not necessarily indicative of results to be expected from any future period. You should read the following selected consolidated financial information along with the information contained in this report, including Item 8, “Financial Statements and Supplementary Data” and Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the audited consolidated financial statements, condensed consolidated financial statements and related notes included elsewhere in this report.
The expense ratio is calculated by dividing policy acquisition expenses and general and administrative expenses by net premiums earned.
The following is a discussion and analysis of the results of our operations for the twelve months ended December 31, 2009, 2008 and 2007 and of our financial condition at December 31, 2009. This discussion and analysis should be read in conjunction with our audited consolidated financial statements and accompanying Notes included in this report. This discussion contains forward-looking statements that involve risks and uncertainties and that are not historical facts, including statements about our beliefs and expectations. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those discussed below and particularly under the headings “Risk Factors,” “Business” and “Forward-Looking Statements” contained in Item 1A, Item 1, and Part I of this report, respectively.
On January 14, 2010, we announced a new organizational structure where we intend to manage our insurance and reinsurance businesses as two underwriting segments, Aspen Insurance and Aspen Reinsurance, to enhance and better serve our global customer base. For additional details, see “- Recent Developments” below.
Cartesian Iris 2009A L.P. Cartesian Iris 2009A L.P. is a variable interest entity under the guidance contained in ASC 820 Consolidations. On May 19, 2009, we invested $25.0 million with Cartesian Iris 2009A L.P. through our wholly-owned subsidiary, Acorn Limited. Cartesian Iris 2009A L.P. is a Delaware Limited Partnership formed to provide capital to Iris Re, a newly formed Class 3 Bermuda reinsurer focusing on insurance-linked securities. In addition to returns on our investment, we provide services on risk selection, pricing and portfolio design in return for a percentage of profits from Iris Re.
In the twelve months ended December 31, 2009, a fee of $0.1 million was payable to us. For more information, please see Notes 6 and 18 to the audited financial statements for the twelve months ended December 31, 2009 included elsewhere in this report.
Gross written premiums for 2009 have increased to $2,067.1 million from $2,001.7 million in 2008 due mainly to increased contributions from our property reinsurance and U.S. insurance segments, which were offset by declines in our international insurance and casualty reinsurance segments. The property reinsurance segment has benefited from a $48.8 million contribution from the newly established credit and surety reinsurance business written in our Zurich office. Our U.S. insurance segment has also experienced growth in the year, predominantly in the property line where gross written premiums increased from $53.2 million in 2008 to $82.5 million in 2009 due to new business growth and increased prices for catastrophe-exposed business. Gross written premiums in the international insurance segment have decreased marginally by 2.3% to $847.7 million when compared to 2008 due to a lack of demand for Gulf of Mexico energy cover, the repositioning of the financial institutions book and the U.K. liability book as we actively manage the cycle, compensating for an increase in premiums written in some of the other business lines. We have seen a small decrease of 2.0% in gross written premiums in the casualty reinsurance segment in response to the softening market.
established lines, in particular property treaty catastrophe, property treaty risk excess, international casualty treaty reinsurance and U.K. commercial liability insurance.
Reinsurance. Total reinsurance ceded in the year ended December 31, 2009 of $230.3 million was $64.1 million higher than in the corresponding period in 2008. The overall increase was due to an unusually low level in 2008 as we took advantage of favorable pricing conditions in 2007 which enabled us to purchase a number of reinsurance contracts covering a period of greater than 12 months, effectively covering the 2008 windstorm season. Costs in 2008 were impacted, however, by the recognition of $13.0 million of additional reinsurance premiums to reinstate cover from our reinsurance program following Hurricane Ike.
The U.S. insurance segment had a loss ratio in 2009 of 88.3% up from 62.9% in 2008. The increase in the loss ratio is due to deterioration from our casualty insurance business line which has recorded a net reserve strengthening of $20.4 million in 2009 due to adverse experience from our New York contractors’ business.
years. The amounts of these reductions and their effects on the loss ratio in each year are shown in the following table:
Although total reserve releases for 2009 are in line with 2008, an increase in property reinsurance reserve releases has offset smaller reserve releases from our casualty reinsurance segment. Total reserve releases in 2009 are marginally higher than 2008 but have a lower impact on the loss ratio due to an increase in net earned premium. The reserve releases in 2008 were $23.9 million lower than in 2007 due predominantly to reserve strengthening in our international insurance segment compared to reserve releases in prior years.
Expense ratio. We monitor the ratio of expenses to net earned premium (the “expense ratio”) as a measure of the cost effectiveness of our business acquisition, operating and administrative processes. The table below presents the contribution of the policy acquisition expenses and operating and administrative expenses to the expense ratio and the total expense ratios for the twelve months ended December 31, 2009, 2008 and 2007:
Operating and administrative expenses increased by $44.3 million to $252.4 million in 2009 when compared to 2008 due predominantly to performance-related remuneration linked to our improved performance during the year. Operating and administrative expenses increased by $3.3 million in 2008 when compared to 2007, due mainly to a $6.8 million rise in costs in our international insurance segment resulting from our entry into new business lines, which was partially offset by a reduction in performance-related remuneration and a weakening of the British Pound against the U.S. Dollar.
Net investment income. In 2009, we generated net investment income of $248.5 million, up 78.5% on the prior year (2008 - $139.2 million, 2007 - $299.0 million). The increase was mainly due to our investments in funds of hedge funds which contributed $19.8 million to net investment income in 2009 compared to a loss of $97.3 million in 2008. Our fixed income portfolio book yield reduced to 4.2% at December 31, 2009 from 4.6% at December 31, 2008 (2007 - 5.1%). Total cash and investments (including accrued interest and receivables for investments sold) increased from $6.0 billion at the end of 2008 to $6.8 billion at December 31, 2009 (2007 - $5.9 billion). The fixed income portfolio duration increased from 3.1 years in 2008 to 3.3 years in 2009 (2007 - 3.4 years) and the average credit quality of our fixed income book is “AA+”, with 74% of the portfolio being graded “AA” or higher. The average
Change in fair value of derivatives. In the twelve months ended December 31, 2009, we recorded a reduction in the fair value of derivatives of $8.0 million (2008 - $7.8 million; 2007 - $11.4 million). This included a reduction of $8.0 million (2008 - $7.8 million; 2007 - $9.0 million) in the estimated fair value of our credit insurance contract. In the twelve months ended December 31, 2007, a charge of $2.4 million for a catastrophe swap which expired on August 20, 2007 was also included.
Taxes. We incurred a tax expense in 2009 of $60.8 million (2008 - $36.4 million), equivalent to a consolidated rate on income before tax of 11.4% compared to 26.0% in 2008 and 14.8% in 2007. The reduction in the effective tax rate from 26.0% in 2008 to 11.4% in 2009 is due to strong underwriting results in Bermuda and the distribution of investment returns biased towards jurisdictions with lower tax rates.
As at December 31, 2009, the remainder of our total shareholders’ equity was funded by two classes of preference shares with a total value as measured by their respective liquidation preferences of $363.2 million (2008 - $430 million) less issue costs of $9.6 million (2008 - $10.8 million).
Tangible book value per ordinary share is based on total shareholders’ equity, less intangible assets and preference shares (liquidation preference less issue expenses), divided by the number of ordinary shares in issue at the end of the period. Balances as at December 31, 2009 and December 31, 2008 were:
dividend payments and to provide financial support to the Insurance Subsidiaries. During the period ended December 31, 2009, Aspen Holdings received a $36.5 million payment of inter-company interest in respect of an inter-company loan from Aspen U.K. Holdings and also recognized a $401.0 million dividend from Aspen U.K. Holdings.
As at December 31, 2009, Aspen Holdings held $33.5 million in cash and cash equivalents which, taken together with our credit facilities and expected levels of future inter-company dividends, management considered sufficient to provide us with an appropriate level of liquidity.
Casualty Reinsurance. Pricing conditions within the casualty reinsurance market continue to be challenging with mixed results depending on line of business and the location of business. In the U.S., rates are mostly flat with some single digit declines. The outlook for our international casualty reinsurance line is more positive with some rate increases in professional lines and continued strengthening of financial institutions rates, while elsewhere, reinsurance rates were flat.
International Insurance. The international insurance segment covers a broad range of business although January is not a significant renewal date for this segment. However, our marine, energy and construction liability and energy property rates increased by 10% on the part of the portfolio that was renewed in January. Gulf of Mexico business is not renewed in January, and therefore no comment can be made on rate conditions for Gulf of Mexico-exposed energy property business. Aviation renews principally in October, however we have seen rate increases of over 20% for airline business with loss events being a major catalyst producing the increase. Our political and financial risk insurance line is not heavily reliant on renewals due to the nature of the business, however, in respect of the business that is subject to renewal, we have seen small rate reductions of up to 5%. January is not a significant renewal
date for our financial institutions and professional liability lines, however at this early stage in the year we are seeing double digit rate increases in our financial institutions line and more modest rate insurances in our professional liability account.
U.S. Insurance. In our U.S. insurance segment we are seeing some rate reductions in catastrophe-exposed property risks, however this business continues to remain attractive. Elsewhere, the market continues to be challenging in property and casualty lines.
Treaty pro rata made a significant contribution to our property reinsurance segment where we wrote $181.4 million in gross written premium in 2009 (2008 - $174.7 million) or 28.0% of our property reinsurance segment, of which $15.7 million was estimated (2008 - $26.0 million) and $165.7 million was reported by the cedants (2008 - $148.7 million). We estimate that the impact of a $1 million change in our estimated gross premiums written in our property treaty pro rata business would have an impact of $0.2 million on our net income before tax for our property reinsurance segment at December 31, 2009 (2008 - $0.1 million), excluding the impact of fixed costs such as reinsurance premiums and operating expenses.
Catastrophe swap. On August 17, 2004, Aspen Bermuda entered into a risk transfer swap (“cat swap”) with a non-insurance counterparty. During the cat swap’s 3 year term, which ended on August 17, 2007, Aspen Bermuda made quarterly payments based on an initial notional amount of $100 million. In return, Aspen Bermuda was entitled to receive payments of up to $100 million in total if hurricanes made landfall in Florida and caused damage in excess of $39 billion or earthquakes in California caused insured damage in excess of $23 billion. The latest estimate of the insured loss arising from Hurricane Katrina published by Property Claims Services (“PCS”) on June 8, 2007 was $41.1 billion, which entitled us to a recovery of approximately $26.3 million which has been paid to us. We have decided not to extend the development period under the cat swap and will not be making any further recoveries.
a reserve for the expense associated with settling claims, including legal and other fees and the general expenses of administering the claims adjustment process, known as Loss Adjustment Expenses (“LAE”).
Exposure-based method: This method is used for specific large typically catastrophic events such as a major hurricane. All exposure is identified and we work with known market information and information from our cedants to determine a percentage of the exposure to be taken as the ultimate loss.
In general terms, the IELR method is most appropriate for lines of business and/or accident years where the actual paid or reported loss experience is not yet mature enough to modify our initial expectations of the ultimate loss ratios. Typical examples would be recent accident years for lines of business in the casualty reinsurance segment. The BF method is generally appropriate where there are few reported claims and a relatively less stable pattern of reported losses. Typical examples would be our treaty risk excess line of business in our property reinsurance segment and marine hull line of business in
Lines of business where claims are typically reported relatively quickly after the claim event tend to display lower levels of volatility between initial estimates and final outcomes. Reinsurance claims are subject to a longer time lag both in their reporting and in their time to final settlement. The time lag is a factor which is included in the projections to ultimate claims within the actuarial analyses and helps to explain why in general a higher proportion of the initial reinsurance reserves are represented by IBNR than for insurance reserves for business in the same class. Delays in receiving information from cedants are an expected part of normal business operations and are included within the statistical estimate of IBNR to the extent that current levels of backlog are consistent with historical data. Currently, there are no processing backlogs which would materially affect our financial statements.
These factors are incorporated in the recommended reserve range from which management selects its best point estimate. As at December 31, 2009, a 5% change in the gross reserve for IBNR losses would have equated to a change of approximately $97.3 million in loss reserves which would represent 18.2% of net income before income tax for the twelve months ended December 31, 2009. As at December 31, 2008, a 5% change in the gross reserve for IBNR losses would have equated to a change of approximately $89.5 million in loss reserves which would represent 63.8% of net income before income tax for the twelve months ended December 31, 2008.
There are specific areas of our selected reserves which have additional uncertainty associated with them. In the property reinsurance segment there is still the potential for adverse development from litigation associated with Hurricane Katrina. In the casualty reinsurance segment, there are additional uncertainties associated with claims emanating from the global financial crisis and the collapse of the Madoff investment funds. There is also a potential for new areas of claims to emerge as underlying this segment are many long-tail lines of business. In the international insurance segment, we wrote a book of financial institutions risks which have a number of notifications relating to the financial crisis in 2008 and 2009. In the U.S. insurance segment a specific area of uncertainty relates to a book of New York Contractor business. In each case, management believe that they have selected an appropriate best estimate based on current information and current analyses.
The above represents a distribution from our internal capital model for reserving risk based upon our current state of knowledge and application of actuarial principles. The model itself has many explicit and implicit assumptions relating to the incurred pattern of claims, the expected ultimate settlement amount, inflation and dependencies between lines of business. If any of these assumptions underlying the model were to prove incorrect then a materially different reserving distribution may result.
Changes in loss reserve estimates would not have an immediate effect on our liquidity as settlement of insurance liabilities typically can take a number of years. However, please see Item 7, “Management’s Discussion and Analysis - Liquidity” for a discussion of liquidity risks.
Other-Than-Temporary Impairment in Investments. Our process for identifying declines in the fair value of investments that are other-than-temporary involves consideration of several factors. These primary factors include (i) the time period during which there has been a significant decline in value, (ii) an analysis of the liquidity, business prospects and financial condition of the issuer, (iii) the significance of the decline, (iv) an analysis of the collateral structure and other credit support, as applicable, of the securities in question, (v) expected future interest rate movements, and (vi) our intent and ability to hold the investment for a sufficient period of time for the value to recover. In addition, accounting standards require that other-than-temporary impairments for certain asset-backed and mortgage-backed securities are recognized if the fair value of the security is less than its cost or amortized cost and there has been a decrease in the present value of the expected cash flows since the last reporting period. Where our analysis of the above factors results in our conclusion that declines in fair values are other-than-temporary, the cost of the security is written down to fair value and the previously unrealized loss is therefore considered realized in the period such determination is made.
Our financial statements are prepared in accordance with U.S. GAAP. The discussions that follow include tables and discussions relating to our consolidated income statement and our segmental operating results for the twelve months ended December 31, 2009, 2008 and 2007.
Gross written premiums in 2009 increased by 3.3% to $2,067.1 million when compared to the twelve months ended December 31, 2008 due mainly to a $48.9 million contribution from the newly established credit and surety reinsurance business and favorable market conditions in our U.S. property business. The increase in gross written premium in 2008 compared to 2007 was due to several factors including the contribution from new underwriting teams established in the international insurance segment and favorable premium adjustments in our property and casualty reinsurance segments. Gross written premiums in our casualty reinsurance segment were also reduced in 2007 due to the closure of our Marlton, New Jersey office and relocation of our facultative business to Rocky Hill, Connecticut, and a change in our underwriting approach.
Net premiums written. Although total gross written premiums have increased by 3.3%, net premiums written have increased by only 0.1% in 2009 compared to 2008 as a result of the $64.1 million increase in ceded written premiums when compared to 2008. The lower ceded written premium in 2008 reflects the purchase of catastrophe cover in 2007 which protected both the 2007 and 2008 wind seasons.
Net premiums earned. Net premiums earned in 2009 increased by 7.1% compared to 2008 mainly as a result of the increase in gross earned premium. Net premiums earned in 2008 reduced by 1.8% compared to 2007 mainly as a result of the reduction in gross earned premium offset by the recognition of $13.0 million of additional reinstatement premiums associated with Hurricane Ike losses. The changes in net premiums earned for each of our segments were as follows:
Losses and loss adjustment expenses. In 2009, we had no significant catastrophe loss events, with the only notable loss events being the recognition of $13.4 million of European and Canadian storm losses and $11.4 million of net losses from the Air France disaster. In 2008, we suffered $200.2 million of losses from Hurricanes Ike and Gustav before reinstatements and tax, a $49.7 million provision against potential losses as a result of the ongoing financial crisis, a $15.7 million loss from a French pollution claim and a deterioration of $15.3 million related to California wildfires occurring in 2007. In 2007, we suffered total losses of a smaller magnitude with a $30.1 million loss from windstorm Kyrill, a $35.0 million loss from sub-prime related exposures, a $28.7 million loss from the June and July U.K. floods, an $18.1 million loss from the California wildfires, a $14.0 million marine loss resulting from a shipping collision and a $10.1 million loss from an air crash in Brazil. Further information relating to movements in prior year reserves can be found below under “Reserves for Loss and Loss Adjustment Expenses.” Our insurance losses and loss adjustment expenses included paid claims of $808.6 million in 2009, $739.4 million in 2008 and $695.6 million in 2007.
The prior year adjustment for our international insurance segment in 2007 was attributable mainly to reserve releases in the U.K. liability line of business.
Changes in the acquisition and operating expense ratios to gross earned premiums, and the impact of reinsurance on net earned premiums by segment for each of the twelve months ended December 31, 2009, 2008 and 2007 are shown in the following tables:
Investment funds represented our investments in funds of hedge funds which were recorded using the equity method of accounting. Adjustments to the carrying value of these investments were made based on the net asset values reported by the fund managers, resulting in a carrying value that approximated fair value. Realized and unrealized gains of $19.8 million (2008 - loss of $97.3 million) were recognized through the statement of operations in the twelve months ended December 31, 2009. We invested $150.0 million in the share capital of two funds in 2006, a further $247.5 million in one of these funds and $112.5 million in the share capital of a third fund in 2007. In 2008, we sold share capital in the funds that cost $198.6 million for proceeds of $177.2 million realizing a loss of $21.4 million. In February 2009, we gave notice to redeem the balance of the funds in June 2009. The outstanding balance of $11.5 million is expected to be received subsequent to the completion of the audited financial statements for the funds.
Cartesian Iris 2009A. On May 19, 2009, we invested $25 million in Cartesian Iris 2009A L.P. through our wholly-owned subsidiary, Acorn Limited. Cartesian Iris 2009A L.P. is a Delaware Limited Partnership formed to provide capital to Iris Re, a newly formed Class 3 Bermudian reinsurer focusing on insurance-linked securities. In addition to returns on our investment, we provide services on risk selection, pricing and portfolio design in return for a percentage of profits from Iris Re. In the twelve months ended December 31, 2009, a fee of $0.1 million was payable to us.
Other-than-temporary impairments. In the twelve months ended December 31, 2009 realized investments losses include a $23.2 million charge for investments we believe to be other-than-temporarily impaired (2008 - $59.6 million). Other-than-temporary impairment losses of $23.2 million for 2009 were considered to be credit related and therefore are included in the income statement. The other-than-temporary impairment charge of $59.6 million in 2008 was attributable mainly to the write-down of Lehman Brothers bonds subsequent to that company’s collapse in September 2008.
Net income/(loss). In 2009, we had net income of $473.9 million, equivalent to diluted earnings per ordinary share of $5.64 based on the weighted average number of shares in issue during the period. In 2008, we had net income of $103.8 million, equivalent to diluted earnings per ordinary share of $0.89 based on the weighted average number of shares in issue during the period. In 2007, we had net income of $489.0 million, equivalent to diluted earnings per ordinary share of $5.11 based on the weighted average number of shares in issue during the period. Preference share dividends are deducted from net income for the purpose of calculating earnings per ordinary share.
Not Meaningful - This line of business was not operational at December 31, 2008.
The reduction in gross written premiums in the property reinsurance segment in 2007 was principally due to softening rates, in particular in our risk excess line of business, unfavorable pricing and market conditions and the non-renewal of several large contracts which did not meet our pricing conditions.
Reinsurance ceded. We purchased $57.6 million of reinsurance contracts during 2009 which is a 131.3% increase over 2008 with the increase attributable to a combination of specific reinsurance purchased to cover our newly established lines of business, some higher renewal rates on existing reinsurance. The 2008 year benefited from the purchase in 2007 of a number of reinsurance contracts covering us for a period of greater than 12 months, effectively covering the 2008 windstorm season.
Our casualty reinsurance segment is written on both a treaty and facultative basis and consists of the following principal lines of business: U.S. treaty, international treaty, and casualty facultative. The casualty treaty reinsurance business we write includes excess of loss and pro rata reinsurance which are applied to portfolios of primary insurance policies. We also write casualty facultative reinsurance, both U.S. and international. Our excess of loss positions come most commonly from layered reinsurance structures with underlying ceding company retentions.
Policy acquisition, operating and administrative expenses. Total expenses were $125.5 million for 2009 equivalent to 28.8% of net premiums earned (2008 - 26.2%). The acquisition expense ratio has increased by 3.2 percentage points driven mainly by a $2.3 million increase in U.S. federal excise tax on our U.S. emanating business and by profit commission accruals in 2009 but also due to 2008 including an adjustment to brokerage which resulted in a lower expense. Operating costs have reduced by $0.4 million year on year due to favorable movements in the exchange rate between the U.S. Dollar and British Pound applied to Sterling denominated expenses.
Not Meaningful - These lines of business were not operational as at December 31, 2008 and/or December 31, 2007.
Overall premiums have reduced by $20.1 million in 2009 mainly due to reduced market demand for Gulf of Mexico energy cover, the repositioning of our financial institutions account, our U.K. liability line reducing written premiums in the soft market and adverse exchange rate movements between the British Pound and the U.S. Dollar. These have been partially offset by an increase in premiums written by the new specie and management and technology business lines and additional premiums from our marine, energy and construction liability line. The increase in gross written premiums in 2008 of 30.9% over 2007 was mainly due to the contribution by our newer lines of business at the time. Written premium for existing lines decreased by $3.1 million mainly due to energy property insurance which experienced reducing rates until the September hurricanes and U.K. commercial liability insurance due to continuing rate pressure.
Policy acquisition, operating and administrative expenses. The 2009 acquisition expense ratio has improved marginally from 17.1% to 16.9% due to changes in the mix of business written and the addition of new business lines. The 2008 acquisition expense ratio improved by 0.6 percentage points compared to 2007 due to an $8.0 million reduction in profit commissions and changes to the business mix following the introduction of new teams.
Operating and administrative expenses have increased by $23.9 million compared to 2008 mainly due to profit-related staff costs as underwriting profit moves from $0.5 million to $61.6 million, a $1.2 million increase in U.S. federal excise tax on our U.S. emanating business, an additional $1.7 million provision for claims handling costs and increases in personnel costs associated with the establishment of our new underwriting teams.
Gross written premiums. Gross written premiums increased by 26.4% in 2009 to $162.6 million compared to 2008 due to increased contribution from the property business following the repositioning of the risks written in that account, an increase in rates for catastrophe-exposed business following Hurricanes Ike and Gustav in 2008 and the program property business written by the new risk solutions team. Gross written premium for casualty insurance increased slightly despite competition and business being declined due to rate inadequacy.
Gross written premiums increased by 5.0% in 2008 compared to 2007 due to increased contribution from the property business following the repositioning of the risks written in that account. Gross written premium for casualty insurance decreased as a result of competition and business being declined due to rate inadequacy.
Losses and loss adjustment expenses. Losses in 2009 increased by $30.3 million compared to 2008 due to reserve strengthening of $19.3 million compared to a reserve release of $8.1 in 2008. This strengthening was mainly due to adverse loss development on our casualty line where incurred development has been greater than expected on our New York contractors’ accounts.
Policy acquisition, operating and administrative expenses. Policy acquisition expenses have increased from 16.5% in 2008 to 16.8% in 2009 due to an increase in the proportion of premiums ceded which impacts the ratio. The increase in operating and administrative expenses in 2009 was attributable mainly to an increase in profit-related staff costs and reorganization costs. The additional costs were partly offset by favorable movements in the exchange rates between the U.S. Dollar and the British Pound, which reduced the dollar value of recharged costs.
At December 31, 2009 and December 31, 2008, total cash and investments, including accrued interest receivable, were $6.8 billion and $6.0 billion, respectively. The composition of our investment portfolio is summarized below:
Fixed maturities. At December 31, 2009, the average credit quality of our fixed income book is “AA+,” with 96% of the portfolio being graded “A” or higher. At December 31, 2008, the average credit quality of our fixed income book was “AA+,” with 96% of the portfolio being graded “A” or higher.
Mortgage-Backed Securities. The following tables summarize the fair value of our Mortgage-Backed Securities (“MBS”) by rating and class at December 31, 2009:
Sub-prime securities. We define sub-prime related investments as those supported by, or contain, sub-prime collateral based on creditworthiness. We do not invest directly in sub-prime related securities.
Other investments. Other investments as at December 31, 2009 and 2008 are as follows:
Our involvement with the funds of hedge funds ceased at June 30, 2009. The carrying value of the receivables represents our maximum exposure to loss at the balance sheet date. The remaining $11.6 million receivable at December 31, 2009 is due by the third quarter of 2010.
Our active investments and other obligations with the funds ceased at June 30, 2009. The carrying value of the receivables represents our maximum exposure to loss at the balance sheet date. Of the $16.3 million receivable at September 30, 2009, $4.8 million was received by October 31, 2009 with the remaining balance of $11.5 million to be received subsequent to the completion of the audited financial statements for the funds.
hierarchy prioritizes pricing services based on availability and reliability and assigns the highest priority to index providers.
To validate the techniques or models used by third-party pricing sources, we review process, in conjunction with the processes completed by the third-party accounting service provider, include, but are not limited to:
The value of our investment in Cartesian Iris 2009A L.P. is based on our shares of the capital position of the partnership which includes income and expenses reported by the limited partnership as provided in its quarterly management accounts. Cartesian Iris 2009A L.P. is subject to annual audit evaluating the financial statements of the partnership. We periodically review the management accounts of Cartesian Iris 2009A L.P. and evaluate the reasonableness of the valuation of our investment.
Our exposure to mono-line insurers was limited to 1 municipal holding (2008 - 2 holdings) as at December 31, 2009 with a market value of $0.1 million (2008 - $7.1 million). Our exposure to other third-party guaranteed debt is primarily to investments backed by the Federal Depository Insurance Corporation (FDIC) and non-U.S. government guaranteed issuers.”
Other-than-temporary impairment. We review all of our fixed maturities for potential impairment each quarter based on criteria including issuer-specific circumstances, credit ratings actions and general macro-economic conditions. The process of determining whether a decline in value is “other-than-temporary” requires considerable judgment. As part of the assessment process we also evaluate whether it is more likely than not that we will sell any fixed maturity security in an unrealized loss position before its market value recovers to amortized cost. Once a security has been identified as other-than-temporarily impaired, the amount of any impairment included in net income is determined by reference to that portion of the unrealized loss that is considered to be credit related. Non-credit related unrealized losses are included in other comprehensive income.
For a discussion of our valuation techniques within the fair value hierarchy please see Note 6 of the audited financial statements for the twelve months ended December 31, 2009 included elsewhere in this report.
Reserves by segment. The following presents our loss reserves by business segment as at December 31, 2009 and 2008:
The increase in reinsurance recoverables in 2009 is due to increased recoveries in our international insurance segment related mainly to losses from Hurricane Ike, the Air France disaster and the global financial crisis. This has been offset by the continued settlement of losses associated with Hurricanes Katrina, Rita and Wilma.
Gross reserves for the property reinsurance segment in 2009 reflect the continued settlement of 2004 and 2005 related hurricane losses and claims settlements associated with 2008 Hurricanes Ike and Gustav. Gross reserves for the casualty reinsurance segment have continued to increase reflecting the build up of long-tail exposures. International insurance reserves have increased by 9.2% due to the recognition of reserves associated with the global financial crisis, aviation losses and the reserves associated with new business lines. The reserves for U.S. insurance have increased reflecting additional Hurricane Wilma losses and deterioration on the New York contractors’ liability account.
Prior year loss reserves. In the twelve months ended December 31, 2009, 2008 and 2007, there was an overall reduction of our estimate of the ultimate claims to be paid. An analysis of this reduction by segment is as follows:
Casualty Reinsurance. The $67.2 million of reserve releases in our casualty reinsurance segment are mainly attributable to favorable development in our U.S. casualty treaty and international casualty treaty reinsurance business which contributed $33.2 million and $31.0 million, respectively. For both U.S. and international casualty, where claims may take several years to emerge, the experience to date compared with starting loss ratios and expected patterns has generally been better than expected at the aggregate level. Additional releases occurred from commutations of certain contracts.
International Insurance. The international insurance segment has been impacted by $3.9 million of net reserve strengthening during 2008. The reserve strengthening was attributable to deterioration in respect of a loss related to the 2007 California wildfires and also from shipowners’ liability losses, both written in our marine, energy and construction liability account. This was partially offset by favorable development in our U.K. commercial property and liability lines.
Property Reinsurance. Property reinsurance deteriorated by $11.5 million in 2007, approximately $10.0 million of which was attributable to Hurricanes Katrina, Rita and Wilma. The methodology used to determine the hurricanes’ ultimate losses was to review each cedant’s position with respect to its reported claims and establish an expected IBNR utilizing information from that client. In setting our loss estimates for Hurricane Katrina, we had taken account of evolving litigation relating to coverage and quantum issues and included additional provisions where appropriate. Because of ongoing litigation, there remains uncertainty as to our ultimate costs of Hurricane Katrina.
Other than the matters described above, we did not make any significant changes in assumptions used in our reserving process. However, because the period of time we have been in operation is relatively short, our loss experience is limited and reliable evidence of changes in trends of numbers of claims incurred, average settlement amounts, numbers of claims outstanding and average losses per claim will necessarily take years to develop.
The following table shows our capital structure at December 31, 2009 compared to December 31, 2008.
Our preference shares are classified in our balance sheet as equity but may receive a different treatment in some cases under the capital adequacy assessments made by certain rating agencies. Such securities are often referred to as ‘hybrids’ as they have certain attributes of both debt and equity. We also monitor the ratio of the total of debt and hybrids to total capital and this stands at 17.0% as of December 31, 2009 (2008 - 22.1%).
The principal capital management transactions during 2009 and early 2010 were as follows:
During the period ended December 31, 2009, Aspen U.K. Holdings paid Aspen Holdings dividends of $401.0 million. In the twelve months ended December 31, 2008, Aspen Bermuda and Aspen U.K. Holdings paid Aspen Holdings dividends of $25.0 million and $45.0 million, respectively. Aspen Holdings also received interest of $36.5 million (2008 - $36.5 million) from Aspen U.K. Holdings in respect of an inter-company loan.
Cash is used primarily to pay reinsurance premiums, losses and loss adjustment expenses, brokerage commissions, general and administrative expenses, taxes, interest, dividends and to purchase new investments.
As of December 31, 2009, the Company had funds on deposit of $667.1 million and £18.8 million (December 31, 2008 - $604.6 million and £25.3 million) as collateral for the secured letters of credit.
Canadian trust fund. Aspen U.K. has established a Canadian trust fund with a Canadian bank to secure a Canadian insurance license. As at December 31, 2009, the balance held in trust was Can$276.5 million (2008 - Can$203.6 million).
Consolidated cash flows for the twelve months ended December 31, 2008. Total net cash flow from operating activities in 2008 was $530.5 million, a reduction of $243.5 million from 2007 due largely to an increase in claims payments. For the twelve months ended December 31, 2008, our cash flows from operations provided us with sufficient liquidity to meet our operating requirements. We paid net claims of $739.4 million in 2008 and made net investments in the amount of $255.3 million in market securities and equipment during the period. We paid ordinary and preference share dividends of $77.9 million, and $100.3 million was used to repurchase ordinary shares. At December 31, 2008, we
had a cash and cash equivalents balance of $809.1 million. The increase in cash is in response to volatile market conditions allowing increased flexibility to deploy cash to longer duration portfolios as we expect yields to rise and spreads to remain wide over the short-term.
Letters of Credit Facility. On April 29, 2009, Aspen Bermuda replaced its existing letter of credit facility with Citibank Europe dated October 29, 2008 in a maximum aggregate amount of up to $450 million with a new letter of credit facility in a maximum aggregate amount of up to $550 million.
As at December 31, 2009 we had $415.4 million of outstanding collateralized letters of credit under this facility.
We entered into an agreement in July 2004 to lease three floors comprising a total of approximately 15,000 square feet in Hamilton, Bermuda for our holding company and Bermuda operations. The term of the rental lease agreement is for six years, and we have agreed to pay approximately a total of $1 million per year in rent for the three floors for the first three years. We moved into these premises on January 30, 2006. Beginning in 2009, we will pay $1.3 million in rent annually. We have also leased additional premises in London covering 9,800 square feet for a period of five years.
Ajax Re was a variable interest entity under the guidance contained in ASC 820 Consolidations. We had a variable interest in the entity, however we were not the primary beneficiary of the entity and therefore we were not required to consolidate its results into our consolidated financial statements. For further details on the Ajax Re transactions please see Note 8 to the audited financial statements for the twelve months ended December 31, 2009 included elsewhere in this report.
On September 15, 2008, Lehman Brothers filed for bankruptcy, which is a termination event under the swap. Ajax Re terminated the swap on September 16, 2008. As a result, without the benefit of the total return swap, the extent of the actual reinsurance cover in the event of a California earthquake provided by Ajax Re will be limited to the market value of the collateral held by Ajax Re, that in light of current financial market conditions, we expect the market value of this collateral is substantially less than the $100 million of original reinsurance cover. Nevertheless, we remained within our risk tolerances without the benefit of this reinsurance cover.
We also seek to take into account the projected impact of inflation on the likely actions of central banks in the setting of short-term interest rates and consequent effects on the yields and prices of fixed interest securities. As of February 2010, we consider that although inflation is currently low, in the medium-term there is a risk that inflation, interest rates and bond yields will rise with the result that the market value of certain of our fixed interest investments may reduce.