(6) Book value per share is based on total shareholders' equity, excluding for 2005 Perpetual PIERS, divided by the number of shares outstanding of 58,876,360, 69,179,303, 69,315,099 and 95,209,008 at December 31, 2002, 2003, 2004 and 2005 respectively.
(7) Fully diluted book value per share is calculated based on total shareholders' equity, excluding for 2005 Perpetual PIERS, at December 31, 2002, 2003, 2004 and 2005, divided by the number of dilutive equivalent shares outstanding of 58,876,360, 71,481,906, 71,271,170 and 98,126,046 at December 31, 2002, 2003, 2004 and 2005, respectively. There were no dilutive options at December 31, 2002. At December 31, 2003, 2004, and 2005, there were 2,302,603, 1,956,071 and 2,917,038 dilutive options, respectively. Potentially dilutive shares outstanding are calculated using the treasury method.
We continued to grow in 2005, both in our number of employees, which increased by approximately 38% over 2004, and in our gross written premiums, which increased by 31.9%. In the fourth quarter of 2004, we took steps to enhance our presence in Bermuda by transferring the majority of our London-based property reinsurance underwriting team to Bermuda. In 2005, we also expanded our underwriting capacity in the United States.
The following overview of our 2003, 2004 and 2005 operating results and financial condition is intended to identify important themes and should be read in conjunction with the more detailed discussion further below.
Our losses before taxation from Hurricanes Katrina, Rita and Wilma as of December 31, 2005 were $594.6 million net of reinsurance and taking into account additional premiums receivable and payable. After allowing for tax and our estimate of the fair value of a potential recovery from our derivative catastrophe risk contract, this results in a net impact on our income after tax of $507 million. These losses severely impacted our results for the year, including as follows:
• an increase in our combined ratio from 83.4% in 2004 to 117.2% in 2005;
• a net loss of $177.8 million compared to net income of $195.1 million in 2004; and
• a significant increase in our reinsurance recoverables from $197.7 million in 2004 to $1,192.7 million in 2005.
The loss ratios take into account any changes in our assessments of reserves for unpaid claims and loss adjustment expenses arising from earlier years. In each of the years ended December 31, 2005, 2004 and 2003, we recorded a reduction in the level of reserves for prior years. The amounts of these reductions and their effect on the loss ratio in each year is shown in the following table:
Further information relating to the release of reserves can be found below under ‘‘-Critical Accounting Policies’’ below.
The increase in expense ratio by 2.4% in 2005 was mainly due to the effect of reinstatement premiums reducing net earned premiums by $71.3 million which has the effect of increasing the expense ratio by 1.2%. The remaining increase was due to a number of factors including higher acquisition costs on new lines of business and increases in staff costs to support the new business lines.
Beginning in the first quarter of 2005, we increased our quarterly dividends from $0.03 to $0.15 per ordinary share, and we paid such dividends on our outstanding shares in each quarter, notwithstanding our losses from the 2005 hurricanes.
Total shareholders' equity increased from $1,481.5 million at the end of 2004 to $2,039.8 million as of December 31, 2005. The most significant movements were:
• capital increase in 2005 of approximately $790 million after expenses as a result of our issuance and sale of:
(1) 17,551,558 ordinary shares in our public offering in October 2005;
Our Perpetual PIERS 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 19.4% as of December 31, 2005 (2004-14.4%; 2003-3.0%).
Management monitors the liquidity of Aspen Holdings and of each of its Insurance Subsidiaries. With respect to Aspen Holdings, management monitors its ability to service debt, to finance dividend payments and to provide financial support to the Insurance Subsidiaries. During 2005, Aspen Holdings received $17.0 million in dividends from Aspen (UK) Holdings and $26.0 million in interest payments under our intercompany loan. As at December 31, 2005, Aspen Holdings held $203.7 million in cash and cash equivalents which, taken together with our credit facilities, management considered sufficient to provide us liquidity at such time.
As of December 31, 2005, we had issued $411.0 million and £63.9 million in letters of credit to cedents, of which $121.3 million and £65.1 million were collateralized. Our reinsurance receivables increased substantially, and as of December 31, 2005, we had $1,192.7 million in reinsurance receivables. Our premium receivables have increased by £47.2 million due to increases in total business written and the timing of reinstatement premiums following the 2005 hurricanes.
Specialty Insurance and Reinsurance. In our specialty insurance and reinsurance segment, prices increased by 18% on average for business written in January. The specialty lines segment is expected to increase to in excess of 20% of our gross premium earned in 2006. The most rapidly improving class is, as we expected, our offshore energy physical damage account. While we achieved rate increases outside the Gulf of Mexico of about 20% on average, the actual rates increased by approximately four and a half to more than six times for risks situated in the Gulf of Mexico. In addition to these rate increases there has also been a dramatic reduction in aggregate limits for named windstorms in the Gulf of Mexico. As a result, the rate for each unit of exposure underwritten has increased significantly. Partly as a consequence of the hardening energy market, we have also achieved increases in our marine liability lines of about 15% and marine hull has also performed well with increases of about 4%.
Property and Casualty Insurance. Our insurance segment is expected to comprise approximately 18% of our anticipated planned gross earned premiums in 2006. Our insurance account does not typically experience a great deal of renewal business during January with the first major insurance renewal date expected at the end of March. U.K. commercial property insurance rates have come under some pressure, decreasing approximately 4% in our book which has been much better than the market as a whole. U.K. liability insurance saw average rate reductions on renewed business of approximately 7%. Our U.S. excess and surplus property lines business has seen catastrophe-exposed business increase by 24% in December and we expect further increases as the year progresses. Casualty excess and surplus rates, on the other hand, continue to register modest single digit reductions.
Property Reinsurance. The property reinsurance market is still coming to terms with the impact of the 2004 and 2005 hurricane seasons. We expect the proportion of gross earned premiums in this segment in relation to the whole business to decrease in 2006. In respect of January 1 renewals, prices increased varying significantly, from less than 15% to highs of over 100% depending upon loss experience, terms, data quality and the nature of the original business. The upper limit of rate increases was achieved on programs covering commercial exposures which had sustained hurricane losses in 2005. We expected that this phenomenon would have a knock-on effect to pricing for U.S. regional programs and this occurred although with more muted price increases of 10% to 15%. Rate increases in Europe were driven mainly by losses from European floods with loss affected programs seeing increases of 15% to 30% and programs without losses experiencing single digit percentage increases. During the second quarter of this year we expect a sharp correction in market pricing. We believe there will be four drivers of this. First, new versions of catastrophe models expected to be released by the vendors will demand more price per unit of risk. Second, many sellers of reinsurance will recognize that a unit of risk carries more exposure than they thought and we expect that they will become more risk averse, i.e. accept less risk despite higher prices. Third, the buyers of reinsurance will find that they need to buy more dollars of protection for the same amount of exposure to meet both the demands of the new pricing models as well as the constraints placed on them by the new rating agency models. Finally, retrocession cover, which at times has effectively operated as a "disguised subsidy" to reinsurance pricing, will become scarcer and more expensive and hence will have the opposite effect and thereby drive prices up still further.
Business developments. We have hired a new team operating within Aspen Re which writes international property facultative reinsurance business. This account will be developed during 2006 once the whole team is in place.
• the amount and type of contracts written and the premiums we are able to charge to policyholders, which are influenced by multiple factors, including prevailing market prices;
• the distribution of the renewal dates of the business we write, which is fairly evenly distributed through the year for our insurance business but is concentrated at the beginning of quarters (particularly January 1st) for our reinsurance business; and
Our expenses are classified under four headings as set out below.
Losses and loss adjustment expenses. These expenses include claims paid and payable under our insurance and reinsurance contracts and the internal and external costs of settling these claims (‘‘loss adjustment expenses’’).
Operating and administrative expenses. These expenses consist primarily of staff compensation, payroll taxes, accommodation costs, information technology and other operating expenses and professional fees. This heading also includes depreciation of tangible assets. Staff compensation includes salaries, bonuses, share-related compensation and benefits such as medical insurance and pension contributions.
We believe that the following critical accounting policies affect the more significant estimates used in the preparation of our consolidated financial statements. A statement of all the significant
All premium estimates are reviewed regularly, comparing actual reported premiums to expected ultimate premiums along with a review of the collectability of premiums receivable. Based on management's review, the appropriateness of the premium estimates is evaluated, and any adjustments to these estimates are recorded in the periods in which they become known. Adjustments to original premium estimates could be material and these adjustments may directly and significantly impact earnings in the period they are determined because the subject premium may be fully or substantially earned.
Non-proportional treaties. A large number of the contracts we write are written on a non-proportional or excess of loss treaty basis. As the ultimate level of business written by each cedent can only be estimated at the time the reinsurance is placed, the reinsurance contracts generally stipulate a minimum and deposit premium payable under the contract with an adjustable premium based on variables such as: the number of contracts covered by the reinsurance; the total premium received by the cedent; and the nature of the exposures assumed. Minimum and deposit premiums generally cover the majority of premiums due under such treaty reinsurance contracts and the adjustable portion of the premium is usually a small portion of the total premium receivable. For excess of loss contracts, the minimum and deposit premium, as defined in the contract, is generally considered to be the best estimate of the contract's written premium at inception. Accordingly, this is the amount we generally record as written premium in the period the underlying risks incept. During the life of a contract, notifications from cedents and brokers may affect the estimate of ultimate premium and result in either increases or reductions in reported revenue. Changes in estimated adjustable premiums will have less of an impact on short term liquidity as the payment of adjustment premiums generally occurs after the expiration of a contract.
Reinstatement premiums are accrued as provided for in the provisions of assumed reinsurance contracts, based on loss experience under such contracts. Reinstatement premiums are the premiums charged for the restoration of the reinsurance limit of an excess of loss contract to its full amount after payment by the reinsurer of losses as a result of an occurrence. These premiums relate to the future coverage obtained during the remainder of the initial policy term.
Proportional treaties ("treaty pro-rata"). Estimates of premiums assumed under treaty pro-rata reinsurance contracts are recorded in the period in which the underlying risks are expected to incept and are based on information provided by brokers and ceding companies and estimates of the underlying economic conditions at the time the risk is underwritten. We estimate premium receivable initially and update our estimates regularly throughout the contract term based on treaty statements received from the ceding company.
The segment for which treaty pro rata is most relevant is our property reinsurance segment in which we wrote $168.1 million in gross written premium in 2005 or 20.7% of our property reinsurance segment, of which $49.2 million was estimated, and $118.9 million was reported by the cedents. 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 $466,000 on our net income before tax for our property reinsurance segment, excluding the impact of fixed costs such as reinsurance premiums and operating expenses.
We anticipate that ultimate premiums might reasonably be expected to vary by up to 5% as a result of variations in one or more of the assumptions described above, although larger variations are possible. Based on gross written premiums of $168.1 million in our property reinsurance treaty pro rata account as of December 31, 2005, a variation of 5% could increase or reduce net income before taxation by approximately $4 million.
Earned premiums and premiums receivable. Premiums are recognized as earned evenly over the policy periods using the daily pro rata method.
Gross reserves for our property reinsurance lines were $1,266.7 million in 2005 compared to $341.2 million in 2004, of which 37.6% and 46.9% were IBNR for 2005 and 2004, respectively. The increase in property reserves was due to the recognition of $1,018.0 million of losses associated with the 2005 hurricanes. IBNR has reduced as a percentage of total reserves as the majority of 2005 hurricane losses have been recorded in outstandings and due to 2004 hurricane losses moving from IBNR to case reserves. In addition, the property reinsurance segment was affected by material claims incurred during 2004 from Hurricanes Charley, Frances, Ivan and Jeanne and by Typhoon Songda totalling $298.7 million.
Gross reserves for our casualty reinsurance segment were $683.4 million in 2005 compared to $377.8 million in 2004, of which 81.8% and 84.5% were IBNR for 2005 and 2004, respectively. The increase in reserves was due to the reinsurance portfolio maturing as a book of business. 2005 was only the third full year of operation for the Company, and an increase in reserves would be expected as reserves build up over time, particularly in this longer tail business.
Gross reserves for our specialty insurance and reinsurance segment were $526.5 million in 2005 compared to $187.1 million in 2004, of which 57.1% and 80.9% were IBNR for 2005 and 2004, respectively. The significant increase in reserves was due to the recognition of reserves for the new marine and aviation business written combined with $266.7 million of 2005 hurricane losses in this segment.
For IBNR claims that are statistically determined, reserves are estimated using established actuarial methods including available historical data. Both case and IBNR reserve estimates consider such variables as past loss experience, changes in legislative conditions and changes in judicial interpretation of legal liability policy coverages and inflation. Historical loss information is included in selecting our best estimates of the reserves for each line of business. We take into account the quality of the historical information available and where appropriate historical trends are used to validate information received from cedents.
For classes of business where early claims experience may not provide a sound statistical basis to estimate the loss reserves, our approach is to establish an initial expected loss and loss expense ratio. This is based on one or more of (a) an analysis of our own claims experience to date on our portfolio, (b) market benchmark data, (c) a contract by contract analysis, and (d) an analysis of a portfolio of similar business written by Syndicate 2020, as available, adjusted by an index reflecting how insurance rates, terms and conditions have changed. This initial expected loss and loss expense ratio is then modified in light of the actual experience to date measured against the expected experience. Loss reserves for known catastrophic events are based upon a detailed analysis of our reported losses and potential exposures conducted in conjunction with our underwriters.
While the reported reserves make a reasonable provision for unpaid loss and loss adjustment expense obligations, we note that the process of estimating required reserves does, by its very nature, involve uncertainty and therefore the ultimate claims may fall outside this range. The level of uncertainty can be influenced by such factors as the existence of coverage with long duration payment patterns and changes in claims handling practices, as well as the factors described above.
proportional reinsurance programs and so movements in gross reserves resulted in an equivalent movement in the net reserves. For excess of loss recoveries, if the upper and lower estimates of gross losses are contained within our reinsurance program then there will be minimal movement in the net losses; if gross losses were to reduce to a level below the attachment point of the excess of loss program then movements in gross losses would be replicated as movements in the net loss. The net actuarial range for reserves for losses and loss expenses established at December 31, 2005 was between $1,604 million and $1,956 million. The actual net reserves established as at December 31, 2005 were $1,848.9 million.
For 2005, the actuarial range has been set to include a wider range of possible outcomes which includes possible outcomes that we consider possible but less likely. The amounts shown for the lower and upper ends of the actuarial range are different from the sums of the corresponding amounts for the four segments due to variation, which takes into account the fact that at the higher end of the actuarial range we do not expect all segments to deteriorate at the same time (hence the variation credit) and, conversely, at the lower end of the actuarial range not all segments will improve simultaneously (hence the debit).
Loss reserves presented on an ‘‘underwriting year’’ basis represent claims related to all policies incepting in a given year. In contrast, ‘‘accident year’’ loss reserves represent claims for events that occurred during a given calendar year, regardless of when the policy was written. Loss reserves on an underwriting year basis may include claims from different accident years. For example, a policy written during 2004 may have losses in accident year 2004 and in accident year 2005. Therefore, underwriting year data as of a particular evaluation date is less mature than accident year data.
Estimates of IBNR are generally subject to a greater degree of uncertainty than estimates of the cost of settling claims already notified to the Company, where more information about the claim event is generally available. IBNR claims often may not be apparent to the insured until many years after the event giving rise to the claims has happened. Lines of business where the IBNR proportion of the total reserve is high, such as liability insurance, will typically display greater variations between initial estimates and final outcomes because of the greater degree of difficulty of estimating these reserves.
Prior year loss reserves. In the twelve months ended December 31, 2005, 2004 and 2003, there was a reduction of our estimate of the ultimate claims to be paid. An analysis of this reduction by segment is as follows:
For the twelve months ended December 31, 2005. The analysis of the development by each segment is as follows:
Property Reinsurance: The net reserves of the property reinsurance segment as at December 31, 2004 were $222.9 million which included specific case reserves in relation to Hurricanes Charley, Frances, Ivan and Jeanne and Typhoon Sondga. Further claims information received in
relation to Hurricane Ivan and Typhoon Songda windstorms has given rise to a $7.8 million increase in reserves in the period. In addition, further claims notifications in respect of certain treaty risk excess contracts received during the twelve months to December 31, 2005 highlighted deterioration in claims development resulting in a strengthening in claims reserves of $6.1 million.
Property and Casualty Insurance: The net reserves of the insurance segment as at December 31, 2004 were $ 326.2 million. Development in the shorter-tail property insurance lines has seen a lower claim development than had been expected and the liability insurance class has to date seen a lower level of incurred claims than projected giving rise to a release in net reserves of $26.2 million across these two classes.
Casualty Reinsurance: The net reserves of the casualty reinsurance segment as at December 31, 2003 were $125.6 million. We do not receive notice of most of the claims in this segment until a considerable time has passed, however incurred claims development in the twelve months ended December 31, 2004 resulted in a small increase in the projected loss ratio for this class of business giving rise to a strengthening of reserves of $0.6 million.
For the twelve months ended December 31, 2003. The analysis of the favorable development on a segmental basis for the period is as follows:
Property Reinsurance: The net reserves of the property reinsurance segment as at December 31, 2002 were $24 million, of which $9 million related to the Wellington quota share
Specialty Insurance and Reinsurance: The net reserves of the specialty segment as at December 31, 2002 were $30.9 million. All of the specialty business as at December 31, 2002 was derived through the Wellington quota share arrangements. The reserves established as at December 31, 2002 were based upon the cedents' underwriting year estimates. Management assessed these estimates and, with the data provided, determined the accident year loss ratio. Premiums and claims information received from the cedent during the twelve months ended December 31, 2003 has enabled us to refine our accident year assessment. This has resulted in a release in reserves of $4.2 million.
Property and Casualty Insurance: The net reserves of the property insurance line of business as at December 31, 2002 were $2.4 million. This account had only two years of Syndicates history prior to its being written by us. The reserves established as at December 31, 2002 were partly based upon the historical performance experienced in those two years. During the course of 2003, the historical information improved due in particular to the settlement of one claim significantly below its case reserve. This improvement enabled us to reassess the likely level of IBNR claims in respect of the 2002 accident year, resulting in a reduction in reserves of $1.2 million.
Gross premiums written. Gross premiums written increased by 31.9% in 2005 compared to 2004. This was largely due to the growth in our marine and energy and aviation insurance lines which increased by 508% and property reinsurance which increased by 25.2%. The increase in property reinsurance included $71.0 million attributable to inwards reinstatement premium from the 2005 hurricanes (2004-$16.7 million; 2003-nil). Gross premiums written increased by 21.4% in 2004 compared to 2003. The increases included $154.5 million from net new business and rate increases in casualty reinsurance, $47.1 million from new property reinsurance business written through Aspen Re America, $43.6 million from our new marine lines of business and $60.3 million of new business written by Aspen Specialty and reported under property insurance ($30.0 million) and liability insurance ($30.3 million).
Net premiums written. Net premiums written increased by approximately 22% in 2005 compared to 2004, at a slightly slower pace than the growth in 2004 of approximately 24%. Each year we arrange reinsurance in respect of certain of our exposures and the amounts paid and payable under these arrangements are shown as reinsurance ceded and deducted in arriving at net premiums written. As a result of the hurricanes in 2005 we expect to make significant recoveries. Under the terms of the
The growth rate in net premiums written is less than the growth rate in our gross premiums written largely due to our outwards reinstatement premiums of $149.7 million as a result of the 2005 hurricanes being greater than our inwards reinstatement premiums of $78.7 million.
Gross premiums earned. Gross premiums earned reflect the portion of gross premiums written which are recorded as revenues over the policy periods of the risks we write. Therefore, the earned premium recorded in any year includes premium from policies incepting in prior years and excludes premium to be earned subsequent to the balance sheet date. Gross premiums earned in 2005 increased by 31.6% compared to 2004, and represented 92.4% of gross premiums written in the year. The growth in gross premiums earned is primarily as a result of the new business written in our marine and aviation insurance lines, which increased by $156.3 million, as 2005 was the first full year writing these lines of business. The ratios of gross premiums earned to gross premiums written in 2005 and 2004 were substantially the same. Gross premiums earned increased significantly in 2004 by 48.7% compared to 2003 as a result of growth in gross written premiums.
Net premiums earned. Net premiums earned increased by 22.4% in 2005 compared to 2004 and by 51.8% in 2004 compared to 2003. The increases for each of our segments were as follows:
The largest percentage increase in 2005 relates to new marine and aviation insurance business written in our specialty segment and increases in our casualty reinsurance account, driven primarily by $55.7 million of structured risks written in the year. The net premiums earned in 2005 represented 91.3% of net premiums written (2004-90.8%; 2003-74.3%).
Insurance losses and loss adjustment expenses. Our losses and loss adjustment expenses increased significantly year-on-year (2005-87.7% increase; 2004-68.9% increase), mainly as a result of our hurricane losses in both 2004 ($196.1 million net of reinsurance from Hurricanes Charley, Frances, Ivan, Jeanne and Typhoon Songda) and 2005 ($594.6 million net of reinsurance from Hurricanes Katrina, Rita and Wilma and before potential receipts under our cat swap) and our growth in gross premiums written. Our insurance losses and loss adjustment expenses included paid claims of $551.9 million in 2005, $164.6 million in 2004, and $53.9 million in 2003.
Income tax expense. Income tax expense decreased to $17.4 million in 2005 from $68.1 million in 2004 and $54.5 million in 2003. Even though in 2005 we had net losses before tax of $160.4 million, we still incurred a tax expense because Aspen Re was profitable in 2005. Our tax rate in 2005 was (10.8)%, and is not indicative of future tax rates as 2005 was a loss-making year. Our consolidated tax rate for 2004 was 25.9%, whereas in 2003 it was 26.4%. The tax rate decreased in 2004 due to a greater proportion of the Company's profit being derived from our Bermudian operations.
Our business segments are based on how we monitor the performance of our underwriting operations. Management measures segment results on the basis of the combined ratio, which is obtained by dividing the sum of the losses and loss expenses, acquisition expenses and operating and administrative expenses which cannot be attributed directly to any one segment by net premiums earned. As a relatively new company, our historical combined ratio may not be indicative of future underwriting performance. We do not manage our assets by segment; accordingly, investment income and total assets are not allocated to the individual segments. Operating and administrative expenses are allocated to segments based on each segment's proportional share of gross premiums written.
Gross premiums written. Gross premiums written in this segment increased by 25.2% compared to 2004. The table below shows our gross premiums written for each line of business for each of 2005, 2004 and 2003, and the percentage increase in gross premiums written for each line:
The increases in respect of catastrophe and risk excess of loss treaties include reinstatement premiums and other similar revenues, totaling $71.0 million and $14.7 million arising as a result of the hurricane losses in 2005 and 2004 respectively. The annual increases in risk excess and proportional treaties include $74.6 million in 2005 (2004-$47.1 million) in respect of business produced by Aspen Re America. The increase in proportional treaty also includes the property component of our reinsurance of a quota share of a participant in Lloyd’s Syndicate 958 (managed by Omega Underwriting Agents). In 2004, gross premiums written increased by 16.3% compared to 2003. The increases in 2004 included $47.1 million from new property reinsurance business written through Aspen Re America, which consisted mostly of risk excess, treaty catastrophe and treaty pro rata.
The balance of losses, excluding the losses described above, were $185.7 million in 2005 (2004- $82.8 million; 2003-$75.2 million) representing 37.3% of net premiums earned (2004-17.6%, 2003 -24.3%). In 2005, we also recorded a $13.9 million reserve strengthening which represented 2.8% of net premiums, earned whereas in 2004, we recognized a $17.1 million reserve release and in 2003, a $3.8 million reserve release (3.6% and 1.2% of net earned premiums respectively). In 2004, we suffered from a very low level of reported losses, whereas in 2005, we experienced a higher than expected level of attritional losses.
As a result of the 2005 hurricanes, our loss ratio in this segment increased significantly to 140.9% as net premiums earned in the year were substantially less than the losses incurred. Losses and loss adjustment expenses for 2005 are stated after deduction of $605.0 million in reinsurance recoveries received or receivable (2004-$104.4 million, 2003-$9.0 million). Any failure to collect these amounts as a result of the inability of our reinsures to pay or as a result of disputes which are not resolved in our favor could result in charges in future years. See Part I, Item 1, ‘‘Business-Reinsurance.’’
Gross premiums written. Gross premiums written increased by 17.9% in 2005 compared to 2004. The table below shows our gross premiums written for each line of business for each of 2005, 2004 and 2003, and the percentage increase in gross premiums written for each line:
Losses and loss adjustment expenses. Our losses and loss adjustment expenses increased by $76.1 million from $252.2 million in 2004, which was in line with the increase in the gross premiums earned. The substantial increase in loss expenses in 2004 was primarily due to the increase in business written in 2004 compared to 2003. Our loss ratio in this segment was profitable for the year, and continues to improve year-on-year (2005-69.7%; 2004-71.4%; 2003-72.9%).
Policy acquisition, operating and administrative expenses. Total expenses increased by 59.1% in 2005 and the expense ratio for 2005 increased by approximately 3.9%. Because U.S. treaty is making up a greater proportion of the business written year-on-year in this segment and as it incurs higher commission rates than other lines of business, the average expense ratio has increased. Also, our structured risks written in this segment incur higher acquisition costs. In addition, a greater proportion of central administrative costs were allocated to this segment commensurate with the proportional increase of the business written by this segment. The expense ratio was the same in both 2004 and 2003.
The following table summarizes gross and net premiums written and earned, underwriting results and combined ratios for specialty insurance and specialty reinsurance separately for the twelve months ended December 31, 2005, 2004 and 2003:
Gross premiums written. Gross premiums written increased significantly in 2005 by 193.9% in the period. The table below shows our gross premiums written for each line of business for each of 2005, 2004 and 2003, and the percentage increase in gross premiums written for each line:
The loss ratio for 2005 increased substantially compared to 2004, as a result of the 2005 hurricane losses and marine and aviation insurance business being reserved at a generally higher rate than our specialty reinsurance lines. However, the year also benefited from a release of $27.4 million from prior year reserves as discussed above under ‘‘-Critical Accounting Policies-Prior Year Loss Reserves.’’
We write both commercial property and commercial liability insurance. Our commercial property line of business is primarily composed of U.K. commercial property insurance and U.S. excess and surplus lines property business written through Aspen Specialty. Our commercial liability line of business consists of U.K. employers' and public liability insurance, and casualty insurance in the U.S. on a surplus lines basis. For a more detailed description of this segment, see Part I, Item 1, ‘‘Business-Business Segments-Property and Casualty Insurance.’’
Losses and loss adjustment expenses. Losses and loss adjustment expenses increased by 10.7% in 2005 due to both the increase in business written in this segment and losses associated with the 2005 hurricanes of $13.7 million. However, the year also benefited from a release of $26.2 million of prior year reserves in the period largely due to slower than expected development of incurred claims, as further described above under ‘‘-Critical Accounting Policies-Prior Year Loss Reserves.’’
As a holding company, our assets primarily consist of our share ownership in our subsidiaries as well as cash balances and investment assets. In addition to net investment income, our cash flows depend on dividend and interest payments from our Insurance Subsidiaries. As of December 31, 2005, the maximum amount of distributions that our Insurance Subsidiaries could have paid to us under applicable laws and regulations without prior regulatory approval was approximately $151.1 million.
In 2005, Aspen (UK) Holdings paid us a dividend of $17.0 million. No other dividends were paid to us in 2005. We also received interest of $26.0 million from Aspen (UK) Holdings in respect of an intercompany loan.
Our aggregate invested assets as of December 31, 2005 totaled $3.69 billion compared to aggregate invested assets of $2.74 billion as of December 31, 2004. The increase in invested assets since December 31, 2004 resulted from capital raisings, collections of premiums on insurance policies and reinsurance contracts and investment income, offset by policy acquisition expenses paid, reinsurance premiums paid, payment of losses and loss adjustment expenses, operating and administrative expenses paid and repayment of short-term borrowings.
Cash flows for the twelve months ended December 31, 2004. Total net cash flow from operating activities in 2004 was approximately $961.3 million, an increase of $324.7 million from 2003. For the twelve months ended December 31, 2004, our cash flows from operations provided us with sufficient liquidity to meet our operating requirements. We paid net claims of $164.6 million in 2004 and made net investments in the amount of $1,104.3 million in market securities during the period. We paid dividends of $8.3 million, and raised $249.3 million from our senior notes offering. At December 31, 2004, we had a cash balance of $284.9 million.
Cash is used primarily to pay reinsurance premiums, losses and loss adjustment expenses, brokerage commissions, general and administrative expenses and taxes and to purchase new investments. We may also use cash to pay for any authorized share repurchases and dividends.
Our cash flows from operations represent the difference between premiums collected and the losses and loss adjustment expenses paid, underwriting and other expenses paid. The potential for a large claim under one of our reinsurance contracts means that substantial and unpredictable payments may need to be made within relatively short periods of time.
Aspen Re is regulated by the FSA and is subject to the FSA's Handbook of Rules and Guidance with respect to solvency requirements. See Part I, Item 1, ‘‘Business-Regulatory Matters-U.K. and
E.U. Regulation’’ elsewhere in this report. Aspen Re has maintained the required margin of solvency throughout 2005 and 2004 and the value of its shareholders' equity as of December 31, 2005 and 2004 was $886.4 million and $870.9 million respectively as measured under U.S. GAAP.
We are obliged by the terms of our contractual obligations to U.S policyholders and by undertakings to certain U.S. regulatory authorities to facilitate the issue of letters of credit or maintain certain balances in trust funds for the benefit of policyholders. Our current arrangements with our bankers for the issue of letters of credit require us to provide cash collateral for the full amount of all secured and undrawn letters of credit that are outstanding. We monitor the proportion of our otherwise liquid assets that are committed to trust funds or to the collateralization of letters of credit. As at December 31, 2005 and 2004, these funds amounted to approximately 32% of the $4.4 billion and approximately 20% of the $3.0 billion of cash and investments held by the Company, respectively. We do not consider that this unduly restricts our liquidity at this time.
For these purposes, we have specifically established facilities for the issuance of letters of credit in the amount of $50 million with Citibank, N.A. and can also issue secured and unsecured letters of credit under our $400 million credit facility. As of December 31, 2005 and December 31, 2004, letters of credit totaling $411.0 million and $48.4 million, respectively, had been issued. In addition, in 2002, Barclays Bank plc issued letters of credit totaling £47.4 million to policyholders of the Company which remained in place as of December 31, 2005. At that date we provided $121.3 million and £65.1 million as collateral for the letters of credit issued on our behalf with the balance of the letters of credit having been issued on an unsecured basis.
On June 23, 2003, we established a trust fund at the Bank of New York which is used as an alternative to letters of credit to satisfy the obligations of Aspen Re to provide security to certain U.S.-domiciled cedents. As of December 31, 2005 and December 31, 2004, the balances on this fund were $1,072.9 million and $415.9 million, respectively. On July 16, 2003 we established an additional trust fund at the Bank of New York, with a balance of $5.4 million, which served a similar purpose with respect to certain U.S. insurance clients of Aspen Re for whom we provide surplus lines insurance. As at December 31, 2005, the balance in the trust was $8.1 million.
In December 2005, Aspen Bermuda set up a Regulation 114 trust fund to collateralize its obligations to an individual U.S. cedent. The balance on this fund at December 31, 2005 was $48.3 million.
• on December 12, 2005, we issued 8,333,333 ordinary shares which generated approximately $195 million in net proceeds; and
$1,481.5 million at December 31, 2005 and 2004, respectively. We believe our financial strength provides us with the flexibility and capacity to obtain funds through debt or equity financing. Our ability to access the capital markets is dependent on, among other things, market conditions and our perceived financial strength. We continuously monitor our capital and financial position, as well as investment and security market conditions, both in general and with respect to Aspen Holdings’ securities. We have accessed both the debt and equity markets from time to time.
We have no material commitments for capital expenditures as at December 31, 2005.
The following table summarizes our contractual obligations other than our obligations to employees, under long-term debt, our Perpetual PIERS, operating leases and reserves relating to insurance and reinsurance contracts as of December 31, 2005: