Properties. We currently lease office space in Bermuda (our corporate headquarters) and the United States for the operation of our business. We also lease apartments for employee use in Bermuda. Our leases have remaining terms ranging from 7 months to approximately 3 years in length. We renew and enter into new leases in the ordinary course of business as needed. While we believe that the office space from these leased properties is sufficient for us to conduct our operations for the foreseeable future, we may need to expand into additional facilities to accommodate future growth. For more information on our leasing arrangements, please see Note 10(f) of the notes to the consolidated financial statements in the Form 10-K.
We executed an office space lease in Hamilton, Bermuda commencing January 1, 2008. The initial term of this agreement expires on December 31, 2010 with two options of three years each at the then market rent. We have an office space lease in Mt. Laurel, New Jersey expiring on May 31, 2010, with two options of three years to renew until 2016 at specified rents.
Management’s Discussion and Analysis of Financial Condition and Results of Operations. Some of the statements in this Form 10-K include forward-looking statements within the meaning of The Private Securities Litigation Reform Act of 1995 that involve inherent risks and uncertainties. These statements include in general forward-looking statements both with respect to us and the insurance industry. Statements that are not historical facts, including statements that use terms such as “anticipate,” “believe,” “expect,” “predict”, “estimate”, “intend,” “plan,” “project,” “seek,” “potential,” “possible,” “could,” “might,” “may,” “should,” “will,” “would”, “will be”, “will continue”, “will likely result” and that relate to our plans and objectives for future operations, are forward-looking statements. In light of the risks and uncertainties inherent in all forward-looking statements, the inclusion of such statements in this Form 10-K should not be considered as a representation by us or any other person that our objectives or plans will be achieved. These statements are based on current plans, estimates and expectations. Actual results may differ materially from those projected in such forward-looking statements and therefore you should not place undue reliance on them. Important factors that could cause actual results to differ materially from those in such forward-looking statements are set forth in Item 1.A “Risk Factors” in this Form 10-K. We undertake no obligation to release publicly the results of any future revisions we make to the forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events, except as may be required by law.
We offer our products to small specialty property and casualty insurance companies located in the United States and Europe that are seeking to efficiently manage their capital. We may also reinsure other reinsurers of U.S. and European specialty property and casualty insurance business that have similar objectives. We also conduct business with managing general agents in the United States and Europe that manage programs that fit our expertise in specialty insurance as well as Lloyd’s syndicates and program administrators. We may on occasion, make strategic investments in some of our clients in order to enable those clients to expand their business and therefore the amount of business they do with us. We do not currently hold any such investments.
On October 31, 2008, we acquired the reinsurance operations of GMACI, including its book of assumed reinsurance business. As part of the transaction, the Company’s wholly owned subsidiary, Maiden NA, acquired GMAC RE, the reinsurance managing general agent writing business on behalf of Motors and the renewal rights for the business written by GMAC RE. In connection with the transaction, Maiden NA also entered into an agreement to acquire two licensed insurance companies, GMAC Direct and Integon. The acquisition of GMAC Direct was consummated on December 23, 2008 upon receipt of regulatory approval, and it was renamed “Maiden Reinsurance Company” on February 2, 2009. Regulatory approval for the acquisition of Integon is pending.
To support the above transaction, on January 20, 2009, we completed the TRUPS Offering of 260,000 units, each Unit consisting of $1,000 principal amount of Trust Preferred Securities of Maiden Capital Financing Trust and 45 common shares, $.01 par value, of the Company for a purchase price of $1,000.45 per Unit. This resulted in gross proceeds to the Company of approximately $260.1 million in the form of junior subordinated debentures (“Debentures”) before approximately $4.1 million of placement agent fees and expenses. As part of the transaction, the Company issued 11,700,000 common shares to the purchasers of the Units. Approximately 62% of these securities were placed privately with the Founding Shareholders, and the remainder with several existing institutional investors.
Second, the recent economic turmoil has also impacted us, as well as others in the industry, in the ability to raise additional capital if necessary given the current market conditions. We believe it would be difficult to raise new capital in the current financial markets at reasonable prices.
Third, the turmoil in the financial markets has impacted the ability of reinsurance companies we compete with to retain business. Several major reinsurance companies have been severely impacted by the recent events in the financial markets. We believe that such events are likely to have a significant effect on competition and pricing in our industry, although the ultimate impact remains unclear. We continue to analyze how to best position our company to benefit from ongoing competitive developments.
Relevant Factors Revenues We derive our revenues primarily from premiums on our insurance policies and reinsurance contracts, net of any reinsurance or retrocessional coverage purchased. Insurance and reinsurance premiums are a function of the amounts and types of policies and contracts we write, as well as prevailing market prices. Our prices are determined before our ultimate costs, which may extend far into the future, are known. In addition, our revenues include income generated from our investment portfolio, consisting of net investment income and net realized investment gains or losses. Investment income is principally derived from interest and dividends earned on investments, partially offset by investment management fees and fees paid to our custodian bank.
• IBNR, which are reserves established by us for changes in the values of claims that have been reported to us but are not yet settled, as well as claims that have occurred but have not yet been reported. The portion recoverable from reinsurers is deducted from the gross estimated loss.
General and administrative expenses include personnel expenses including share-based compensation charges, rent expense, professional fees, information technology costs and other general operating expenses. We are experiencing increases in general and administrative expenses resulting from additional staff, increased share-based compensation expense, increased rent expense for our offices and increased professional fees. We believe this trend will continue into 2009 as we continue to hire additional staff and build our infrastructure, including additional expenses related to the GMAC RE business for the full year 2009.
Ratios Management measures results for each segment on the basis of the “loss and loss expense ratio,” “acquisition cost ratio,” “general and administrative expense ratio,” “expense ratio” and the “combined ratio.” Because we do not manage our assets by segment, investment income, interest expense and total assets are not allocated to individual reportable segments. General and administrative expenses are allocated to segments based on various factors, including staff count and each segment’s proportional share of gross premiums written. The “loss and loss expense ratio” is derived by dividing net losses and loss expenses by net premiums earned. The “acquisition cost ratio” is derived by dividing acquisition costs by net premiums earned. The “general and administrative expense ratio” is derived by dividing general and administrative expenses by net premiums earned. The “expense ratio” is the sum of the acquisition cost ratio and the general and administrative expense ratio. The “combined ratio” is the sum of the loss and loss expense ratio, the acquisition cost ratio and the general and administrative expense ratio.
We record the individual case reserves sent to us by the cedents through the reinsurance intermediaries. The loss data received from the intermediaries is checked for reasonableness and for known events. The loss listings are reviewed during routine claim audits.
The RLD method is a common reserving method in which ultimate losses are estimated by applying a loss development factor to actual loss experience. This method fully utilizes actual experience. Multiplication of underwriting year actual reported (or paid) losses by its respective development factor produces the estimated ultimate losses. The RLD method is based upon the assumption that the relative change in a given underwriting year’s losses from one evaluation point to the next is similar to the relative change in prior underwriting years’ losses at similar evaluation points. In addition, this method is based on the assumption
The key assumptions used to arrive at our best estimate of loss reserves are the expected loss ratios, rate of loss cost inflation, selection of benchmarks and reported and paid loss emergence patterns. Our reporting factors and expected loss ratios are based on a blend of our own experience and industry benchmarks for longer-tailed business and primarily our own experience for shorter-tail business. The benchmarks selected were those that we believe are most similar to our underwriting business.
costs and believes they are fully recoverable. A premium deficiency is recognized if the sum of anticipated losses and loss adjustment expenses, unamortized acquisition costs and anticipated investment income exceed unearned premium.
• Level 1: Observable inputs to the valuation methodology that are quoted prices (unadjusted) for identical assets or liabilities in active markets.
• Level 3: Inputs to the valuation methodology that are unobservable for the asset or liability.
(i) the significance of the decline in value and the resulting unrealized loss position; (ii) the time period for which there has been a significant decline in value; (iii) an analysis of the issuer of the investment, including its liquidity, business prospects and overall financial position; and (iv) our intent and ability to hold the investment for a sufficient period of time for the value to recover. For certain investments, our investment portfolio managers have the discretion to sell those investments at any time. As such, we recognized an other-than-temporary impairment charge for those securities in an unrealized loss position each quarter as we cannot assert that we have the intent to hold those investments until anticipated recovery. The identification of potentially impaired investments involves significant management judgment that includes the determination of their fair value and the assessment of whether any decline in value is other than temporary. If the decline in value is determined to be other than temporary, then we record a realized loss in the statements of operations and comprehensive income in the period that it is determined, and the cost basis of that investment is reduced.
The following shows the other-than-temporary impairment charges during the year ended December 31, 2008 and the period from May 31 (inception) to December 31, 2007 for our fixed maturity investments by category:
• Full twelve months of premium for the Reinsurance - AmTrust Quota Share segment. This contract incepted on July 1, 2007. In 2008 our net premiums written were $438.7 million compared to $247.3 million of unearned premium transferred on the inception of the contract and net premium written for the period from July 1, 2007 to December 31, 2007.
• In our Reinsurance - Other segment - the GMAC Acquisition effective November 1, 2008 and the unearned premium transfer resulted in net premiums written increasing by $252.9 million.
We evaluate our business by segment, distinguishing between Reinsurance - AmTrust Quota Share and Reinsurance - Other. The following chart illustrates the mix of our business on both a net premiums written and net premiums earned basis.
Net Investment Income and Net Realized Losses Net investment income increased by $22.0 million, or 144.5%, for the year ended December 31, 2008 compared to the period from May 31 (inception) to December 31, 2007. The increase was primarily the result of an increase in average invested assets and the change in average yield on the assets of 3.3% in 2008 versus 6.1% in 2007. The decrease is due to a decrease in interest rates and the fact that 2007 was a partial year the average yield is not as meaningful as that for a full year. Average invested assets were approximately $1.1 billion for the year ended December 31, 2008 compared to approximately $0.3 billion to the period from May 31 (inception) to December 31, 2007. Interest on the loan to AmTrust amounted to $5.2 million compared to $0.2 million for the period from May 31 (inception) to December 31, 2007, respectively. Investment management fees of $1.5 million and $1.0 million were incurred during the year ended December 31, 2008 and the period from May 31 (inception) to December 31, 2007, respectively.
The increase was the result of the increase in gross premiums and acquired GMAC RE business having a higher loss ratio. The loss ratios were 62.8% and 59.0% for the year ended December 31, 2008 and the period from May 31 (inception) to December 31, 2007, respectively.
The following table shows the components of the increase in net losses and loss expenses of $198.7 million for the year ended December 31, 2008 from the period from May 31 (inception) December 31, 2007.
Net Income Net income for the year ended December 31, 2008 was $18.8 million compared to net income of $22.1 million for the period from May 31 (inception) to December 31, 2007. The decrease was the result of net realized investment losses, and increased general and administrative expenses partially offset by increased investment income and underwriting income due the inclusion of a full twelve months in 2008 and the GMAC Acquisition on October 31, 2008. Net income for the year ended December 31, 2008 included a net foreign exchange loss of $1.4 million and amortization of intangible assets of $1.2 million.
Underwriting Results by Operating Segments The results of operations for our segments are disclosed below.
The table below illustrates net premiums written by line of business for the year ended December 31, 2008 and the period from May 31 (inception) to December 31, 2007.
The increase in Small Commercial Business included one time unearned premium transfer of $82.2 million as a result of the Company’s reinsurance of premiums and losses assumed by AmTrust pursuant to its acquisition of Unitrin Business Insurance (“UBI”) business in 2008.
General and Administrative Expenses. General and administrative expenses increased by $1.3 million, or 650.0%, for the year ended December 31, 2008 compared to the period from May 31 (inception) to December 31, 2007. This increase resulted from a full years activity in 2008 compared to 2007, the general and administrative expense ratios were 0.45% and 0.21% for the year ended December 31, 2008 and the period from May 31 (inception) to December 31, 2007, respectively.
Reinsurance - Other Segment The following table summarizes the underwriting results and associated ratios for the Reinsurance - Other segment for the year ended December 31, 2008 and the period from May 31 (inception) to December 31, 2007.
Comparison of Year Ended December 31, 2008 and the Period from May 31 (Inception) to December 31, 2007 Premiums. Gross premiums written increased by $288.6 million, for the year ended December 31, 2008 compared to the period from May 31 (inception) to December 31, 2007. The increase primarily resulted from the GMAC Acquisition.
Despite the ongoing turmoil in the financial and credit markets, we believe our Company’s capital position continues to remain well within the range needed for our business requirements and we have sufficient liquidity to fund our ongoing operations.
On January 20, 2009, we completed the TRUPS Offering. The net proceeds are being used to support the North American business, principally the operations recently acquired in the GMAC Acquisition. The gross proceeds to the Company were approximately $260.1 million in the form of junior subordinated debentures (“Debentures”) before approximately $4.1 million of placement agent fees and expenses. As part of the transaction, the Company issued 11,700,000 shares of its common stock to the purchasers of the Trust Preferred Securities. The Debentures mature in 2039 and carry an interest rate of 14%.
The payment of dividends from Maiden Holdings’ Bermuda domiciled operating subsidiary is, under certain circumstances, limited under Bermuda law, which requires our Bermuda operating subsidiary to maintain certain measures of solvency and liquidity. Maiden Holdings’ U.S. domiciled operating subsidiaries are subject to significant regulatory restrictions limiting their ability to declare and pay dividends. The inability of the subsidiaries of Maiden Holdings to pay dividends and other permitted distributions could have a material adverse effect on Maiden Holdings’ cash requirements and ability to make principal, interest and dividend payments on its senior notes and common shares.
At this time, Maiden Insurance uses trust accounts primarily to meet collateral requirements - cash equivalents and investments pledged in favor of ceding companies in order to comply with relevant insurance regulations. As of December 31, 2008, total trust account deposits were $1.07 billion compared to $0 as of December 31, 2007. For the Quota Share Agreement with AII, Maiden Insurance has also loaned funds totaling $168.0 million and $113.5 million as of December 31, 2008 and 2007, respectively, to AmTrust’s Bermuda reinsurance subsidiary to satisfy collateral requirements.
In addition, Maiden Insurance has outstanding letters of credit totaling $12.2 million and $0 as of December 31, 2008 and 2007, respectively.
Sources and Uses of Funds Our sources of funds primarily consist of premium receipts net of commissions, investment income, net proceeds from capital raising activities, which may include the issuance of common shares, and proceeds from sales and redemption of investments. Cash is used primarily to pay losses and loss expenses, general and administrative expenses and dividends, with the remainder made available to our investment managers for investment in accordance with our investment policy.
Investing cash flows consist primarily of proceeds on the sale of investments and payments for investments acquired. We used $716.9 million in net cash for investing activities during the year ended December 31, 2008 compared to $617.2 million for the period from May 31 (inception) to December 31, 2007 The increase in cash flows used in investing activities for the year ended December 31, 2008 compared to the period from May 31 (inception) to December 31, 2007 was primarily due to cash used to fund the GMAC Acquisition.
Cash flows provided by financing activities were $223.7 million for the year ended December 31, 2008 compared to $528.4 million for the period from May 31 (inception) to December 31, 2007 Included in cash flows provided by financing activities for the year ended December 31, 2008 were dividends paid of $8.9 million and $232.6 million of proceeds from the securities sold under agreements to repurchase, at contract value. During the year ended December 31, 2007, we raised $529.9 million from the initial issuance of our common shares (net of offering expenses) offset by dividends paid of $1.5 million.
Our funds are primarily invested in liquid, high-grade fixed income securities. As of December 31, 2008 and December 31, 2007, 99% and 100%, respectively, of our fixed income portfolio consisted of investment grade securities. As of December 31, 2008 and 2007, net accumulated unrealized losses were $44.5 million and $13.5 million, respectively. The change in unrealized gains or losses during 2008 reflected movements in interest rates and credit spread widening partially offset by the recognition of approximately $43.3 million of realized losses on securities that were considered to be impaired on an other-than-temporary basis. We have the ability and intent to hold onto these positions until maturity. The maturity distribution of our fixed income portfolio (on a market value basis) as of December 31, 2008 was as follows:
On March 23, 2009 the Company repaid from existing cash resources all of the liabilities relating to securities sold under agreements to repurchase which as of December 31, 2008 the balance outstanding was $232.6 million.
Aggregate Contractual Obligations The following table shows our aggregate contractual obligations by time period remaining until due date as of December 31, 2008:
The amounts included for reserve for losses and loss expenses reflect the estimated timing of expected loss payments on known claims and anticipated future claims as of December 31, 2008. Both the amount and timing of cash flows are uncertain and do not have contractual payout terms. For a discussion of these uncertainties, refer to “- Critical Accounting Policies - Reserve for Losses and Loss Expenses.” Due to the inherent uncertainty in the process of estimating the timing of these payments, there is a risk that the amounts paid in any period will differ significantly from those disclosed. Total estimated obligations will be funded by existing cash and investments.