The following is a discussion and analysis of our results of operations for the year ended December 31, 2004 compared to the year ended December 31, 2003 and for the year ended December 31, 2003 compared to the year ended December 31, 2002, and also a discussion of our financial condition as of December 31, 2004. This discussion and analysis should be read in conjunction with the audited consolidated financial statements and related notes that are included in this annual report.
To manage reinsurance and insurance liability exposure, make investment decisions and assess overall enterprise risk, we model our underwriting and investing activities on an integrated basis. Our integrated risk management, as well as terms and conditions of our products, provides flexibility in making decisions regarding investments. Our investments are currently comprised of a high grade fixed maturities portfolio and an alternative investment portfolio that currently employs 12 strategies invested in approximately 50 underlying trading entities and two strategic reinsurance private equity investments. Our investment portfolio is designed to provide diversification and to generate positive returns while attempting to reduce the frequency and severity of loss outcomes. Based on fair value at December 31, 2004, the allocation of invested assets was approximately 68.2% in cash and fixed maturities and 31.8% in alternative investments.
The Company continued to perform well in the year ended December 31, 2004. Our overall property and casualty underwriting results improved to produce a 93.2% combined ratio (total losses and expenses as a percentage of net premiums earned) compared to 99.8% in the year ended December 31, 2003. This reflects the realization of the benefits associated with our shift in property and casualty product mix toward traditional reinsurance and insurance business over the past two years and achievement of expected loss results. In addition, our alternative investments produced strong results in the three months ended December 31, 2004 enabling the annual return for these investments to reach 8.23%, slightly ahead of our annual target return of 8%. We faced some challenges in 2004, including losses associated with catastrophes in the three months ended September 30, 2004 and a difficult investment environment for alternative assets in the six months ended September 30, 2004. A combination of good returns from our increasingly diversified underwriting portfolio and alternative investment portfolio allowed the Company to produce record net income of $133.7 million and a solid return on average equity of 15.35%.
We continued to actively pursue property and casualty traditional reinsurance and insurance opportunities during the year ended December 31, 2004. Overall we produced a 3.3% increase in gross premiums written during the year ended December 31, 2004 compared to the year ended December 31, 2003. Gross premiums written for the traditional reinsurance and traditional insurance product lines increased by 20.9% to $582.6 million for the year ended December 31, 2004 compared to $481.8 million for the year ended December 31, 2003. Although overall production of gross premiums written increased, gross premiums written in our alternative risk transfer product line decreased 40.7%, principally due to the non-renewal of one large alternative risk transfer contract that accounted for $110.0 million of gross premiums written in the year ended December 31, 2003 and the termination of an accident and health alternative risk transfer contract during its
term, which resulted in us writing $50.0 million less premium in the current year compared to the same period in 2003. In addition, we placed greater emphasis on selling traditional products during the year ended December 31, 2004, which resulted in lower alternative risk transfer premium volume. Conditions in the life and annuity market improved and we closed two life and annuity reinsurance transactions during the year ended December 31, 2004, resulting in gross written premium of $212.3 million compared to $108.3 million during the same period in 2003.
The increased premium volume in traditional reinsurance and traditional insurance resulted in improved underwriting performance in 2004 due to the lower loss ratios incurred on these products. Our traditional reinsurance and traditional insurance products generated lower combined ratios than our alternative risk transfer products. Consequently, our property and casualty combined ratio improved to 93.2% for the year ended December 31, 2004, compared to 99.8% for the year ended December 31, 2003.
Losses, benefits and experience refunds represented our largest expense and accounted for 61.8% of total liabilities at December 31, 2004. We established loss expenses and reserves using a combination of loss reserving techniques and actuarial methods. Loss expenses and reserves are reviewed regularly to reflect new information that we receive. We conduct regular quarterly internal reviews of reserves and, in addition, the adequacy of our reserves is reviewed annually, during the fourth quarter of the year, by outside actuaries to support management’s estimates. Overall, we did not have any significant adjustment to reserves relating to prior periods during the year ended December 31, 2004. An analysis of property and casualty loss development may be found in Note 4 to our audited consolidated financial statements attached hereto.
The New York State Attorney General filed suit against an insurance broker alleging illegal conduct including the manipulation of the insurance market. In addition, other regulatory authorities have also launched investigations. We are not a party to any of the litigation and have not received any subpoena or information requests. We have reviewed the allegations contained in the filed complaint and have conducted an internal review of our business arrangements. We have discovered no evidence that we were involved in the type of conduct that is the subject of the complaint. It is not possible to predict the ultimate effect of the current litigation or its impact on the reinsurance industry and our business.
We have entered into a limited number of Placement Service Agreements (PSAs) with insurance brokers. The fees incurred under these PSAs are accounted for as acquisition costs. We terminated our PSAs with effect from September 30, 2004. We do not believe that the termination of our PSAs will have a material adverse effect on our business or financial condition.
During the year ended December 31, 2004, our alternative investments generated a 8.23% rate of return compared to a 16.57% rate of return for the same period in 2003. The Max Re Diversified portfolio has performed at a level consistent with our annual targeted return, which is based on our expectations of long term average return. The return of the alternative investment portfolio was negatively impacted by our private equity reinsurance investments that have produced negative returns for the year largely due to our investment in DaVinci Re Holdings Ltd. and its operating subsidiary DaVinci Reinsurance Ltd. (“DaVinci”), which experienced losses from hurricanes Charley, Frances, Ivan and Jeanne.
We continually assess our liquidity needs by monitoring and evaluating new business prospects and opportunities and the development of our existing operations. During the year ended December 31, 2004, we generated $598 million of cash from operations and invested $557 million in fixed maturities. We expect to continue to generate positive operating cash flow during 2005 through premium receipts and investment returns, which will be partially offset by paid losses on reinsurance and insurance obligations, as well as operating expenses.
We derive operating revenues from premiums from our reinsurance and insurance business. Additionally, we recognize returns from our investment portfolio.
Our principal expenses are losses, benefits and experience refunds, acquisition costs, interest expense and general and administrative expenses. Losses, benefits and experience refunds are based on the amount and type of reinsurance and insurance contracts written by us during the current reporting period and information received during the current reporting period from clients pertaining to contracts written in prior years. We record losses, benefits and experience refunds based on actuarial estimates of the expected losses, benefits and experience refunds to be incurred on each contract written. The ultimate losses, benefits and experience refunds depend on
Interest expense principally reflects the net interest charge on funds withheld from reinsurers under reinsurance and retrocessional contracts. Interest is recorded on the funds withheld balances based on various contractual and negotiated rates. The interest expense attributable to the funds withheld under a variable quota share retrocession agreement with Grand Central Re, our largest funds withheld balance, is based on the average of two total return interest rate indices. A charge or credit may be recorded in interest expense on this contract in any given period. As a result, interest expense is expected to vary from period to period with a corresponding entry to funds withheld. Interest expense on the remaining balance of funds withheld from other reinsurers under reinsurance and retrocessional contracts will vary due only to changes in the balance of funds withheld. In addition, interest expense also includes interest on deposit contracts and interest on the bank loan at a rate based on LIBOR plus a spread.
We follow SFAS No. 60, “Accounting and Reporting by Insurance Enterprises,” SFAS No. 97, “Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and Realized Gains and Losses from the Sale of Investments,” and SFAS No. 113, “Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts,” in determining the accounting for our reinsurance and insurance products. Assessing whether or not the contracts we write meet the conditions for risk transfer requires judgment. The determination of risk transfer is fundamental to our determination of gross premiums written and is based, in part, on the use of actuarial and pricing models and assumptions.
We also accrue for reinstatement and additional premiums resulting from losses. Such accruals are based upon contractual terms, and the only element of management judgment involved is with respect to the amount of losses. Reinstatement and additional premiums are recognized at the time we receive and book loss notifications. Reinstatement premiums are the premiums for the restoration of the insurance limit of a contract to its full amount after a loss occurrence by the insured. Additional premiums are premiums based on loss experience during the policy term or coverage period.
Our property and casualty reinsurance premiums are recorded at the inception of each contract, based upon contract terms and information received from ceding clients and their brokers. For excess of loss contracts, the amount of minimum and/or deposit premium is usually contractually documented at inception, and variances between deposit premium and final premium are generally small. An adjustment is posted to amend the minimum and/or deposit premium as data regarding the underlying exposure is provided to us by our ceding clients. For quota share or proportional property and casualty reinsurance contracts, gross premiums written are normally estimated at inception by the ceding client. We generally account for such premiums using the client’s initial estimates, and then adjust them as advised by our ceding clients. We believe that the ceding clients’ estimate of the volume of business they expect to cede to us represents the best estimate of gross premium written at the beginning of the contract. As the contract progresses, we monitor actual premium received in conjunction with correspondence from the ceding client in order to refine our estimate. Variances from original premium estimates can be greater for quota share contracts than excess of loss contracts. Premiums are earned on a pro rata basis over the coverage period.
We also accrue for reinstatement and additional premiums resulting from losses. Such accruals are based upon contractual terms, and the only element of management judgment involved is with respect to the amount of losses. Reinstatement and additional premiums are recognized at the time we re-estimate losses. Reinstatement premiums are the premiums for the restoration of the reinsurance limit of a contract to its full amount after a loss occurrence by the reinsured. Additional premiums are premiums based on loss experience during the policy term or coverage period.
For quota share or proportional contracts we are entitled to receive premium as the ceding client collects the premium under contractual reporting and payment terms, which are usually quarterly. Premiums are usually collected over a two year period on our quota share or proportional contracts. For excess of loss contracts, premium is generally paid in contractually stipulated installments with payment terms ranging from payment at the inception of the contract to four quarterly payments. As a result of recognizing the estimated gross premium written at the inception of the policy and collecting that premium over an extended period, we include a premium receivable asset on our balance sheet. We actively monitor our premium receivable asset to consider whether we need an allowance for doubtful accounts. As part of this process we consider the credit quality of our cedants and monitor premium receipts versus expectations. We also seek to include a right of offset in the contract terms. We have not written off any premiums receivable since our inception, and no premiums receivables are significantly beyond their due dates or in dispute.
Setting appropriate reserves for losses, benefits and experience refunds is an inherently uncertain process. Losses, benefits and experience refunds reserves represent estimates, at a given point in time, of the ultimate settlement costs of losses incurred (including IBNR losses, which are losses that have been incurred but not yet
reported to us). Our IBNR reserves are largely comprised of casualty exposures and therefore these claims are subject to a higher degree of estimation volatility as a result of changes in the legal environment, jury awards, medical cost trends and general cost inflation. We regularly review and update these estimates using the most current information available and employing various actuarial methods. The ultimate liability for a loss is likely to differ from the original estimate due to the factors discussed above. Whenever we determine that an existing reserve for losses, benefits and experience refunds needs adjustment, we are required to record a change in estimate, increasing or decreasing the reserve with a corresponding reduction or increase, which could be material, in our operating results in the period in which the deficiency or redundancy is identified. Adjustments resulting from changes in our estimates are recorded in the period such adjustments are determined. The establishment of reserves, or the adjustment of reserves for reported losses, could result in significant upward or downward changes to our financial condition or results of our operations in the period such amounts are reported.
lower aggregate loss cap and occurrences limits, relative to the premium received, compared to our traditional products. Within the life and annuity segment, we currently offer reinsurance products focusing on existing blocks of business, which take the form of co-insurance transactions. In co-insurance transactions, risks are reinsured on the same basis as the original policies. We also have a corporate segment that includes our investment and financing functions. We do not allocate assets by segment and accordingly, we evaluate performance of underwriting operations without the allocation of investment income.
The combined ratio (“combined ratio”) is calculated by dividing total losses and expenses (shown as (c)) by net premiums earned (shown as (a)).
Reinsurance premiums ceded. Reinsurance premiums ceded for traditional reinsurance products for the year ended December 31, 2004 were $20.8 million compared to $17.5 million for the year ended December 31, 2003, an increase of 18.9%. Reinsurance premiums ceded were principally related to our purchase of specific reinsurance to manage the risks associated with traditional reinsurance and to manage the exposure retained by us on certain transactions. Prior to the year ended December 31, 2003, we did not cede any premiums related to traditional reinsurance as the product line was relatively new and we had not written a sufficient volume of premium to warrant a reinsurance program.
Losses and experience refunds. Losses and experience refunds relating to the traditional reinsurance product line were $174.2 million for the year ended December 31, 2004 compared to $125.3 million for the year ended December 31, 2003, an increase of 39.0%, which is comparable to the increase in our premiums earned for this product line. The loss ratio for our traditional reinsurance product line for the year ended December 31, 2004 was 63.8% compared to 63.9% for the year ended December 31, 2003. There has been a shift in the type of business written from aviation business, which produced a lower loss ratio in past periods, to casualty products, which typically have higher loss ratios. However the effect of this shift was offset by the final settlement of loss reserves incurred in prior periods for amounts lower than previously reserved. During the year ended December 31, 2004, incurred losses relating to prior year traditional reinsurance contracts decreased by $11.2 million, largely as a result of the final settlement of certain loss reserves incurred in prior periods through commutation agreements with clients.
Acquisition costs. Acquisition costs were $51.3 million for the year ended December 31, 2004 compared to $41.3 million for the year ended December 31, 2003, an increase of 24.2%. The increase in acquisition costs is less than the 39.3% increase in premiums earned for the year ended December 31, 2004 due to lower average acquisition costs on premiums earned. Acquisition costs during each of the years ended December 31, 2004 and 2003 consisted primarily of amortization of deferred policy acquisition costs incurred in connection with writing traditional reinsurance business. Acquisition costs are customarily associated with the type of premium that we write. A significant component of deferred policy acquisition costs are ceding commissions paid to the buyer of our reinsurance products. Acquisition costs for the year ended December 31, 2003 were $41.3 million, an increase of 348.9% over the same period in 2002, principally the result of increased operations in 2003 compared to the prior year.
Net underwriting income. Net underwriting income attributable to traditional reinsurance products for the year ended December 31, 2004 was $42.5 million compared to $26.2 million for the year ended December 31, 2003. The results for the year ended December 31, 2004 were principally attributable to increased traditional reinsurance premiums earned at an improved combined ratio. Net underwriting income attributable to traditional reinsurance products for the year ended December 31, 2002 was $0.1 million.
Gross premiums written for alternative risk transfer products for the year ended December 31, 2003 were $419.7 million compared to $494.8 million for the year ended December 31, 2002, a decrease of 15.2%. This decrease is net of $43.7 million of increases in premium estimates relating to contracts written in prior periods. The increase in premium estimate principally relates to additional premium volume written by one client on a whole account coverage, which was advised to the Company in 2003. Our first full year of offering traditional reinsurance products was 2003 and the decrease in alternative risk transfer premium is a reflection of our shift away from alternative risk transfer products.
Net premiums earned. Net premiums earned for alternative risk transfer products for the year ended December 31, 2004 were $309.2 million compared to $398.7 million for 2003, a decrease of 22.5%. The decrease is attributed to the decreased production of our alternative risk transfer insurance and reinsurance. Net alternative risk transfer premiums earned for the year ended December 31, 2003 were $398.7 million, an increase of 18.4% over the same period in 2002.
Losses and experience refunds. Losses and experience refunds relating to our alternative risk transfer products were $261.2 million for the year ended December 31, 2004 compared to $317.4 million for the year ended December 31, 2003, a decrease of 17.7%. The loss ratio for our alternative risk transfer products for the
Reinsurance premiums ceded. Reinsurance premiums ceded for traditional insurance products for the year ended December 31, 2004 were $114.2 million compared to $57.0 million for the year ended December 31, 2003, an increase of 100.4%. Reinsurance premiums ceded were principally related to our quota share treaties that are utilized to manage our retained exposure, and line sizes on our insurance products, which were put in place in the latter half of 2003.
Net underwriting income. Net underwriting income attributable to the traditional insurance products for the year ended December 31, 2004 was $24.1 million compared to $3.3 million for the year ended December 31, 2003. The results for the year ended December 31, 2004 were principally attributable to increased traditional insurance premium earned as well as an improved combined ratio.
The nature of life and annuity transactions that we consider results in a limited number of transactions actually bound with potentially large variations in quarterly and annual premium volume. Consequently, components of our underwriting results, such as premiums written, premiums earned and benefits and experience refunds can be volatile and, accordingly, period to period comparisons are not representative of future trends.
Net premiums earned. Life and annuity business written in each respective year was fully earned in that year.
Net investment income. Net investment income, excluding realized and unrealized gains and losses, for the year ended December 31, 2004 increased $22.7 million to $82.8 million compared to $60.1 million for the year ended December 31, 2003, an increase of 37.8%. The increase was principally attributable to the growth in the fixed maturities portfolio from $1,604.4 million to $2,156.0 million, resulting from cash flow from operations since December 31, 2003. The average investment yield on the cash, fixed maturities investments and funds withheld by clients for the year ended December 31, 2004 was 4.2% compared to an average yield of 3.8% for the year ended December 31, 2003.
500 Index rose 28.67% in 2003 after falling each of the three prior years. Credit spreads tightened dramatically in 2003 as the U.S. and worldwide economies improved and concerns over the 2002 corporate scandals subsided. Interest rates rose in 2003 as inflation concerns replaced deflation concerns.
Net realized gains on sale of fixed maturities. Our fixed maturities investment strategy is not intended to generate realized gains and losses as more fully discussed below. The realized gains in the year ended December 31, 2004 of $10.4 million are the result of the sale of fixed maturities in order to realign the investment portfolio in relation to the early settlement of a contract through commutation. The realized gains in the year ended December 31, 2003 of $19.3 million are the result of hiring two additional fixed maturities managers and the resulting changes to the portfolio based on individual manager recommendations.
We own a portfolio of investment grade fixed maturity investments that are available for sale and, as a result, we record the investments at fair value in our balance sheet. The unrealized gain or loss associated with the difference between the fair value and the amortized cost of the investments is recorded in other comprehensive income in the equity section of our balance sheet. Fixed maturity investments are subject to fluctuations in fair value due to changes in the interest rates, changes in issuer specific circumstances such as credit rating and changes in industry specific circumstances such as movements in credit spreads based on the markets perception of industry risks. As a result of these potential fluctuations, it is possible to have significant unrealized gains or losses on a security. Our strategy for our fixed maturities portfolio is to tailor the maturities of the portfolio to the timing of expected loss payments. At maturity, a fixed maturity’s amortized cost will equal its fair value and no realized gain or loss will be recognized in income. If, due to an unforseen change in loss payment patterns, we need to sell investments before maturity, we could realize significant gains or losses in any period, which could result in a meaningful effect on reported net income for such period.
General and administrative costs. The increase in general and administrative costs over the last three years resulted principally from expenses associated with the expansion of our corporate staff. Our total general and administrative expenses to net premiums earned ratio was 5.3% for the year ended December 31, 2004 compared to 5.5% for the years ended December 31, 2003 and December 31, 2002.
Net income (loss) including underwriting results. Net income for the year ended December 31, 2004 was $133.7 million compared to $120.6 million for the year ended December 31, 2003. The results for the year ended December 31, 2004 were principally attributable to increased underwriting income generated from our property and casualty business partially offset by lower income from our alternative investments compared to the year ended December 31, 2003. Net income for the year ended December 31, 2003 was significantly higher than the income for the year ended December 31, 2002 due to the increased income from our alternative investments and underwriting income generated from our property and casualty business.
Cash and invested assets. Aggregate invested assets, comprising cash and cash equivalents, fixed maturities and alternative investments, were $3,514.2 million at December 31, 2004 compared to $2,637.3 million at December 31, 2003, an increase of 33.2%. The increase in cash and invested assets resulted principally from $597.7 million in cash flows from operations generated in the year ended December 31, 2004, which is net of
Life and annuity benefits and experience refunds. Life and annuity benefits and experience refunds totaled $666.1 million at December 31, 2004 compared to $480.1 million at December 31, 2003. The increase in the year ended December 31, 2004 was principally attributable to the two reinsurance transactions written and earned during the year ended December 31, 2004, partially offset by benefit payments on existing contracts in force.
Bank loans. In February 2003, Max Re completed a $150.0 million sale of shares of Max Re Diversified to a third party financial institution. Simultaneous with the sale, Max Re entered into a total return swap with the purchaser of these shares whereby Max Re receives the return earned on the Max Re Diversified shares in exchange for a variable rate of interest based on LIBOR plus a spread. Max Re Diversified shares owned by Max Re with a fair value of $94.7 million at December 31, 2004 were pledged as collateral to which we are exposed to credit risk. Under GAAP, these transactions are viewed on a combined basis and are accounted for as a financing transaction, which results in the recording of a $150.0 million bank loan. The swap termination date is February 2005 and we anticipate renewing the swap in a similar amount with terms largely unchanged from those obtained on the current facility.
Liquidity. We generated $597.7 million of cash from operations during the year ended December 31, 2004 compared to $397.2 million for the year ended December 31, 2003, an increase of 50.5%, principally reflecting the expansion of our traditional reinsurance and traditional insurance operations, which generated increased gross premiums written during the year, combined with increased life and annuity reinsurance transactions written and earned during the year. The two principal factors related to our operating cash flow are premium collections and timing of loss payments. We write casualty business, which generally has a long claim-tail and it is expected that we will generate significant operating cash flow while we build a portfolio of reserves on our balance sheet. We believe that our reserves currently have an average duration of approximately four years and we expect to see increases in the amount of expected loss payments in future years with a resulting decrease in operating cash flow. We do not expect loss payments to exceed the premiums generated and therefore expect to have continued
positive cash flow. However, actual premiums written and collected and losses paid in any period could vary from our expectations and could have a meaningful effect on operating cash flow. If required, our investments in fixed maturities and our alternative assets will be sold to provide cash in order to settle our liabilities.
While we tailor our fixed maturities portfolio to expected loss payments, increased loss amounts or settlement of losses earlier than anticipated can result in greater cash needs. We maintain a meaningful working cash balance (typically greater than $100.0 million), have generated positive cash flow from operations in each of our 5 years of operating history and have access to bank credit facilities and the debt capital markets. Nonetheless, it is possible that significant deviations in expected loss payments can occur, potentially requiring us to liquidate a portion of our fixed maturities portfolio at a gain or loss.
As a holding company, Max Re Capital’s principal assets are its investments in the common shares of its principal subsidiary, Max Re, and its other subsidiaries. Max Re Capital’s principal source of funds is from interest income on cash balances and cash dividends from its subsidiaries, including Max Re. The payment of dividends is limited under Bermuda insurance laws. In particular, Max Re may not declare or pay any dividends if it is in breach of its minimum solvency or liquidity levels under Bermuda law or if the declaration or payment of the dividends would cause it to fail to meet the minimum solvency or liquidity levels under Bermuda law. At December 31, 2004, Max Re, which is required to have approximately $335.0 million in statutory capital and surplus in order to pay dividends, had approximately $850.0 million in statutory capital and surplus.
Capital resources. At December 31, 2004, our capital structure consisted of common equity. Total capitalization after deducting loans to employees and including retained earnings and accumulated other comprehensive income amounted to $937.0 million as compared to $805.2 million at December 31, 2003, an increase of 16.4%. We have flexibility with respect to capitalization as a result of our access to the debt and equity markets. We regularly review our capital adequacy and evaluate various capital alternatives and believe our current level of capital is sufficient to support our current reinsurance and insurance operations.
On each of January 30, 2004, April 30, 2004, July 30, 2004 and October 28, 2004, Max Re Capital’s board of directors declared a shareholder dividend of $0.03 per share payable to shareholders of record on February 13, 2004, May 14, 2004, August 13, 2004 and November 12, 2004, respectively. Continuation of cash dividends in the future will be at the discretion of the board of directors and will be dependent upon our results of operations and cash flows, and our financial position and capital requirements, general business conditions, legal, tax, regulatory and any contractual restrictions on the payment of dividends and other factors the board of directors deems relevant. On February 4, 2005, Max Re Capital’s board of directors declared a dividend of $0.03 per share to be paid on February 28, 2005 to shareholders of record on February 14, 2005.
We have been assigned an insurer financial strength rating of “A- (Excellent)” by A.M. Best Company, Inc. and an insurer financial strength rating of “A (Strong)” by Fitch, Inc. These ratings reflect each rating agency’s
The reserves for losses, benefits and experience refunds together with deposit liabilities represent management’s estimate of the ultimate cost of settling losses, benefits, experience refunds and deposit liabilities. As more fully discussed in our “Critical Accounting Policies-Losses, benefits and experience refunds” above, the estimation of losses, benefits and experience refunds is based on various complex and subjective judgments. Actual losses, benefits and experience refunds paid may differ, perhaps significantly from the reserve estimates reflected in our financial statements. Similarly, the timing of payment of our estimated losses, benefits and experience refunds is not fixed and there may be significant changes in actual payment activity. The assumptions used in estimating the likely payments due by period are based on our historical claims payment experience and industry payment patterns, but due to the inherent uncertainty in the process of estimating the timing of such payments, there is a risk that the amounts paid in any such period can be significantly different than the amounts disclosed above.
Furthermore, life and annuity benefits and experience refunds recorded in the financial statements at December 31, 2004 are computed on a discounted basis, whereas the expected payments by period in the table above are the estimated payments at a future time and do not reflect a discount of the amount payable.
In December 2004, the Financial Accounting Standards Board issued SFAS 123(R)-Share-Based Payment (SFAS 123(R)), a revision of SFAS No. 123-Accounting for Stock-Based Compensation (SFAS 123). Both statements supersede APB Opinion No. 25, Accounting for Stock Issued to Employees. SFAS 123(R) requires
companies to recognize the cost of employee services received in share-based payment transactions, thereby reflecting the economic effect of those transactions in the financial statements. SFAS 123(R) also eliminates alternative methods of accounting for stock-based compensation in order to allow for greater comparability between companies. We are required to adopt the new standard using a modified prospective method and may elect to restate prior periods using the modified retrospective method. Under the modified prospective method, we are required to record compensation costs for new and modified awards over the related vesting period of such awards prospectively and record compensation cost prospectively for the unvested portion, at the date of adoption, of previously issued and outstanding awards over the remaining vesting period of such awards. On January 1, 2003 we adopted the expense recognition provision of SFAS 123 for all stock options granted on or after January 1, 2003. The calculation of fair value is similar under SFAS 123 and SFAS 123(R), but the revised statement requires among other things; estimates of the number of awards that are expected to vest, no decrease in recognition of compensation cost if vested awards expire without being exercised and the adjustment of future expense based on revisions to fair value due to award modifications after grant date. SFAS 123(R) is effective for periods beginning after June 15, 2005. We believe that the amount of additional share-based compensation expense to be recognized by us under the provisions of SFAS 123(R) will not be material.