The Company leases office space in Bermuda where the Company’s principal executive offices are located. Additionally, the Company leases office space in various locations, including Beijing, Dublin, Greenwich (Connecticut), Hong Kong, Mexico City, Paris, Santiago, Sao Paulo, Seoul, Singapore, Tokyo, Toronto and Zurich.
The Company is a leading global reinsurer, with a broadly diversified and balanced portfolio of traditional reinsurance risks and capital markets risks. Successful risk management is the foundation of the Company’s value proposition, with diversification of risks at the core of its risk management strategy.
The Company’s economic objective is to manage a portfolio of risks that will generate compound annual diluted book value per share growth of 10 percent and an average operating return on beginning shareholders’ equity of 13 percent over a reinsurance cycle.
The Company generates its reinsurance revenue from premiums. Premium rates and terms and conditions vary by line of business depending on market conditions. Pricing cycles are driven by supply of capital in the industry and demand for reinsurance and other risk transfer products. The reinsurance business is also influenced by several other factors, including variations in interest rates and financial markets, changes in legal, regulatory and judicial environments, loss trends, inflation and general economic conditions.
In 2008, pricing declined in most major markets and most lines of business. There was a continuation of the trend toward increasing risk retention by cedants, and restructuring proportional coverages to non-proportional treaties, which led to the reduction in the amount of premiums in the reinsurance marketplace. The second half of 2008 was highly unusual on many levels: severity of losses, such as Hurricane Ike, the third largest natural catastrophe in history, frequency of losses and severe and widespread financial turmoil stemming from the sub-prime mortgage and resulting global credit and financial crisis. The financial markets have experienced severe dislocation and unprecedented events during 2008, including extreme volatility in foreign exchange markets and worldwide equity markets, significant declines in risk-free interest rates and increases in credit spreads, risk assets under-performing risk-free assets and several financial institutions being subject to government bail-out packages both in the U.S. and Europe. The ongoing financial and capital markets crises are likely to be a transforming event for the reinsurance industry, given a new sense of risk and exposure and continued volatility. This will not only impact the normal reinsurance pricing and profit cycle, but also the capital markets, given continued volatility, increased regulation and certain investment products and strategies that have been largely discredited.
The January 1, 2009 renewal saw market conditions beginning to stabilize overall, and improve significantly in catastrophe-exposed lines. U.S. casualty lines remained uncertain at the January 1, 2009 renewals, with no indication of improving pricing or terms and conditions, despite growing evidence of increasing loss trends. The Company grew in markets with the most attractive risk and return opportunities, and maintained its position in lines where priced profitability has stabilized, but not yet improved. Management believes it has maintained the diversification in its risk portfolio and maintained a similarly priced technical ratio (defined below) to that of the January 1, 2008 renewal.
impacted by the Company’s net income and external factors such as foreign exchange, interest rates and equity markets, which can drive changes in unrealized gains or losses on its investment portfolio. Over the past six years, since December 31, 2002, the Company has generated a compound annual growth rate in diluted book value per share in excess of 11%.
ROE: Management uses operating return on beginning shareholders’ equity (ROE) as a measure of profitability that focuses on the return to common shareholders. It is calculated using operating earnings (loss) available to common shareholders (net income or loss excluding net after-tax realized gains or losses on investments, net after-tax interest in earnings or losses of equity investments and preferred share dividends) divided by beginning common shareholders’ equity. Management has set an average 13% ROE target over the reinsurance cycle, which Management believes provides an attractive return to shareholders for the risk assumed. Each business unit and support department throughout the Company is focused on seeking to ensure that the Company meets the 13% return objective. This means that most economic decisions, including capital allocation and underwriting pricing decisions, incorporate an ROE impact analysis. For the purpose of that analysis, an appropriate amount of capital (equity) is allocated to each transaction for determining the transaction’s priced return on deployed capital. Subject to an adequate return for the risk level as well as other factors, such as the contribution of each risk to the overall risk level and risk diversification, capital is allocated to the transactions generating the highest priced return on deployed capital. Management’s challenge consists of (i) allocating an appropriate amount of capital to each transaction based on the incremental risk created by the transaction, (ii) properly estimating the Company’s overall risk level and the impact of each transaction on the overall risk level, and (iii) assessing the diversification benefit, if any, of each transaction. The risk for the Company lies in mis-estimating any one of these factors, which are critical in calculating a meaningful priced return on deployed capital, and entering into transactions that do not contribute to the Company’s 13% ROE objective.
Combined Ratio: The combined ratio is used industry-wide as a measure of underwriting profitability for Non-life business. The combined ratio is the sum of the technical ratio (losses and loss expenses and acquisition costs divided by net premiums earned) and the other operating expense ratio (other operating expenses divided by net premiums earned). A combined ratio under 100% indicates underwriting profitability, as the total losses and loss expenses, acquisition costs and other operating expenses are less than the premiums earned on that business. While an important metric of success, the combined ratio does not reflect all components of profitability, as it does not recognize the impact of interest income earned on premiums between the time premiums are received and the time loss payments are ultimately made to clients. Since 2001, the Company had six years of underwriting profitability reflected in combined ratios of less than 100% for its Non-life segment. In 2005, when the industry recorded its worst year in history in terms of catastrophe losses, with Hurricane Katrina being the largest insured event ever, the Company recorded a net underwriting loss and Non-life combined ratio of 116.3%. In 2008, the Company maintained a Non-life combined ratio of 94.1% for the year, after incurring large catastrophic losses for Hurricane Ike. The key challenges in managing the combined ratio metric consist of (i) focusing on underwriting profitable business even in the weaker part of the reinsurance cycle, as opposed to growing the book of business at the cost of profitability, (ii) diversifying the portfolio to achieve a good balance of business, with the expectation that underwriting losses in certain lines or markets may potentially be offset by underwriting profits in other lines or markets, and (iii) maintaining control over expenses.
The Company aims to be a reliable and financially secure partner to its cedants. This means that the Company must maintain sufficient liquidity at all times so that it can support its cedants by settling claims quickly. The Company generates cash flows primarily from its underwriting and investment operations. Management believes that a profitable, well-run reinsurance organization will generate sufficient cash from premium receipts to pay claims, acquisition costs and operating expenses in most years. To the extent that underwriting cash flows are not sufficient to cover operating cash outflows in any year, the Company may utilize cash flows generated from investments and may ultimately liquidate assets from its investment portfolio. Management ensures that its liquidity requirements are supported by maintaining a high-quality, well-balanced and liquid investment portfolio, and by matching the duration of its investments with that of its net reinsurance liabilities. In 2009, the Company expects to continue to generate positive operating cash flows, absent a series of unusual catastrophic events. Management also maintains credit facilities with banks that can provide efficient access to cash in the event of an unforeseen cash requirement.
The Company has a clearly defined governance structure for risk management. Executive Management and the Board are responsible for setting the vision and goals including risk appetite and return expectations. Strategy and principles are recommended by Executive Management and approved by the Board. Key policies and Group policies are established by the Chief Executive Officer and policies at the next level down are established by Business Unit and functional management. Risk management policies and processes are audited by Internal Audit and the results of audits are monitored by the Audit Committee of the Board.
PartnerRe Ltd. (the Company) provides reinsurance on a worldwide basis through its principal wholly owned subsidiaries, Partner Reinsurance Company Ltd. (Partner Reinsurance), Partner Reinsurance Company of the U.S. (PartnerRe U.S.) and Partner Reinsurance Europe Limited (PartnerRe Europe). Risks reinsured include, but are not limited to property, casualty, motor, agriculture, aviation/space, catastrophe, credit/surety, engineering, energy, marine, specialty property, specialty casualty, multiline and other lines, life/annuity and health and alternative risk products. The Company’s alternative risk products include weather and credit protection to financial, industrial and service companies on a worldwide basis.
The preparation of financial statements in conformity with U.S. GAAP requires Management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. While Management believes that the amounts included in the Consolidated Financial Statements reflect its best estimates and assumptions, actual results could differ from those estimates. The Company’s principal estimates include:
In the normal course of its operations, the Company enters into certain contracts that do not meet the risk transfer provisions of SFAS No. 113 “Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts” (SFAS 113). While these contracts do not meet the risk transfer provisions of SFAS 113, there is a remote possibility that the Company will suffer a loss. These contracts are accounted for using the deposit accounting method in accordance with Statement of Position 98-7 “Deposit Accounting: Accounting for Insurance and Reinsurance Contracts That Do Not Transfer Insurance Risk”. For these contracts, the Company originally records deposit liabilities for an amount equivalent to the consideration received. The consideration to be retained by the Company, irrespective of the experience of the contracts, is earned over the expected settlement period of the contracts, with any unearned portion recorded as a component of deposit liabilities. Actuarial studies are used to estimate the final liabilities under these contracts and the appropriate accretion rates to increase or decrease the liabilities over the term of the contracts. The change for the period is recorded in other income or loss in the Consolidated Statements of Operations.
The adoption of SFAS 157 and FSP SFAS 157-3 did not have a material impact on the Company’s consolidated shareholders’ equity or net income. See Note 3 for additional information on fair value.
Under the provisions of SFAS 159, the Company elected the fair value option for all of its fixed maturities, short-term investments, equities and certain other invested assets (including swaps and derivatives but excluding certain other invested assets, such as those that are accounted for using the equity method of accounting or investment company accounting).
On adoption of SFAS 159, the Company recorded a cumulative effect adjustment of $106.0 million, net of taxes, which decreased accumulated other comprehensive income and increased opening retained earnings as of January 1, 2008. The adoption of SFAS 159 did not have any impact on the Company’s consolidated net income, shareholders’ equity nor its comprehensive income.
Short-term investments comprise securities with a maturity greater than three months but less than one year from the date of purchase.
Other invested assets consist primarily of investments in non-publicly traded companies, private placement equity investments, derivative financial instruments and other specialty asset classes. Entities in which the Company has an ownership of more than 20% and less than 50% of the voting shares, and limited partnerships in which the Company has more than a minor interest, are accounted for using the equity method. Other invested
Net investment income includes interest and dividend income, amortization of premiums and discounts on fixed maturities and short-term investments and investment income on funds held, and is net of investment expenses and withholding taxes. Investment income is recognized when earned. Realized gains and losses on the disposal of investments are determined on a first-in, first-out basis. Investment purchases and sales are recorded on a trade-date basis.
Goodwill represents the excess of the purchase price over the fair value of the net assets acquired of PartnerRe SA and Winterthur Re. SFAS No. 142 “Goodwill and Other Intangible Assets”, requires that the Company perform, at a minimum, an annual valuation of its goodwill asset to test it for impairment. The Company has established September 30 as the date for performing its annual impairment test. If, as a result of the assessment, the Company determines that the value of its goodwill asset is impaired, goodwill will be written down in the period in which the determination is made. Neither the Company’s initial valuation nor its subsequent valuations has indicated any impairment of the Company’s goodwill asset.
The reporting currency of the Company is the U.S. dollar. The national currencies of the Company’s subsidiaries and branches are generally their functional currencies, except for the Bermuda subsidiaries and the Company’s Swiss branch, whose functional currencies are the U.S. dollar. In translating the financial statements of those subsidiaries or branches whose functional currency is other than the U.S. dollar, assets and liabilities are converted into U.S. dollars using the rates of exchange in effect at the balance sheet dates, and revenues and expenses are converted using the average foreign exchange rates for the period. The effect of translation adjustments are reported in the Consolidated Balance Sheets as currency translation adjustment, a separate component of accumulated other comprehensive income.
Following the adoption of SFAS 159, derivatives employed by the Company to hedge currency exposure related to fixed income securities and derivatives employed by the Company to hedge currency exposure related to other reinsurance assets and liabilities, except for the hedge of the Company’s net investment in non-U.S. dollar functional currency subsidiaries and branches, are no longer designated as hedges under SFAS 133. The changes in fair value of the non-designated hedges are recognized in net foreign exchange gains and losses in the Consolidated Statements of Operations.
The Company will discontinue hedge accounting prospectively if it is determined that the derivative is no longer effective in offsetting changes in the fair value of a hedged item. To the extent that the Company discontinues hedge accounting related to its net investment in non-U.S. dollar functional currency subsidiaries and branches, because, based on Management’s assessment, the derivative no longer qualifies as an effective hedge, the derivative will continue to be carried in the Consolidated Balance Sheets at its fair value, with changes in its fair value recognized in current period net income through net foreign exchange (gains) losses.
The Company’s investment strategy allows for the use of derivative instruments, subject to strict limitations. The Company utilizes various derivative instruments such as futures contracts, credit default swaps, foreign currency option contracts, foreign exchange forward contracts and written covered call options for the purpose of replicating investment positions, managing market exposure and duration risks, or enhancing investment performance. These instruments are recorded at fair value as assets and liabilities in the Consolidated Balance Sheets and changes in fair value are included in net realized and unrealized investment gains and losses in the Consolidated Statements of Operations, and changes in the fair value of foreign currency option contracts and foreign exchange forward contracts are included in net foreign exchange gains and losses in the Consolidated Statements of Operations. The fair value of these derivatives are based on quoted market prices, or internal valuation models where quoted market prices are not available. Margin balances required by counterparties, which are equal to a percentage of the total value of open futures contracts, are included in cash and cash equivalents.
Common shares repurchased by the Company and not cancelled are classified as treasury shares, and are recorded at cost. This results in a reduction of shareholders’ equity in the Consolidated Balance Sheets. When shares are reissued from treasury, the Company uses the average cost method to determine the cost of the reissued shares. Gains on sales of treasury stock are credited to additional paid-in capital, while losses are charged to additional paid-in capital to the extent that previous net gains from sales or retirements of treasury shares are included therein, otherwise losses are charged to retained earnings.
The Company adopted SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans-an amendment of FASB Statements No. 87, 88, 106, and 132(R)” (SFAS 158) as of December 31, 2006. The Company recognizes an asset or a liability in the Consolidated Balance Sheets for the funded status of defined benefit plans that are overfunded or underfunded, respectively, measured as the difference between the fair value of plan assets and the pension obligation and recognizes changes in the funded status of defined benefit plans in the year in which the changes occur as a component of accumulated other comprehensive income, net of tax.
FASB Interpretation No. 46 (revised December 2003) “Consolidation of Variable Interest Entities-an interpretation of ARB No. 51” (FIN 46(R)) requires a variable interest entity (VIE) to be consolidated by a company if that company is determined to be the primary beneficiary of the VIE, such that it is subject to a majority of the risk of loss from the VIE’s activities or is entitled to receive a majority of the VIE’s residual returns or both. A VIE is a corporation, partnership, trust or any other legal structure used for business purposes that either (a) does not have equity investors with voting rights or (b) has equity investors that do not provide sufficient financial resources for the entity to support its activities. The Company has determined that PartnerRe Finance A, which issued the Senior Notes, and PartnerRe Finance II, which issued the capital efficient notes (CENts), do not meet the consolidation requirements of FIN 46(R). As a result, the Company has not consolidated PartnerRe Finance A and PartnerRe Finance II and has reflected the debt issued by the Company related to the Senior Notes and CENts as liabilities in the Consolidated Balance Sheets (see Note 13). The interest on the debt related to the Senior Notes and CENts is reported as interest expense in the Consolidated Statements of Operations.
The Company monitors the performance of its operations in three segments, Non-life, Life and Corporate & Other. The Non-life segment is further divided into four sub-segments: U.S., Global (Non-U.S.) Property and Casualty (Global (Non-U.S.) P&C), Global (Non-U.S.) Specialty, and Catastrophe.
In June 2008, the FASB’s Emerging Issues Task Force reached a consensus regarding EITF Issue No. 07-5, “Determining Whether an Instrument (or Embedded Feature) Is Indexed to an Entity’s Own Stock” (EITF 07-5). EITF 07-5 outlines a two-step approach to evaluate the instrument’s contingent exercise provisions, if any, and to
The SFAS 157 fair value hierarchy prioritizes the inputs to valuation techniques used to measure fair value by maximizing the use of observable inputs and minimizing the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are inputs that market participants would use in pricing an asset or liability based on market data obtained from sources independent of the Company. Unobservable inputs are inputs that reflect the Company’s assumptions about what market participants would use in pricing the asset or liability based on the best information available in the circumstances. The level in the hierarchy within which a given fair value measurement falls is determined based on the lowest level input that is significant to the measurement.
Level 1 inputs-Unadjusted, quoted prices in active markets for identical assets or liabilities that the Company has the ability to access.
The Company’s financial instruments that it measures at fair value using Level 2 inputs generally include: U.S. Treasury bonds; U.S. Government Sponsored Entities; Organization for Economic Co-operation and Development Sovereign Treasury bonds; investment grade and high yield corporate bonds; catastrophe bonds; mortgage-backed securities; asset-backed securities (“ABS”); foreign exchange forward contracts and over-the-counter derivatives such as foreign currency option contracts, equity put and call options, interest rate swaps and credit default swaps.
At December 31, 2008, the Company’s financial instruments measured at fair value were categorized between Levels 1, 2 and 3 as follows (in thousands of U.S. dollars):
At December 31, 2008, the aggregate carrying amounts of items included in Other invested assets that the Company did not measure at fair value were $91.5 million, which primarily related to the Company’s investments that are accounted for using the equity method of accounting or investment company accounting.
Substantially all of the accrued investment income in the Consolidated Balance Sheet as of December 31, 2008 related to the Company’s fixed maturities, short-term investments and equities for which the fair value option was elected.
The following methods and assumptions were used by the Company in estimating the fair value of each class of financial asset recorded in the Consolidated Balance Sheets. Following the adoption of SFAS 157 and FSP SFAS 157-3, there have been no material changes in the Company’s valuation techniques.
Substantially all of the Company’s fixed maturities and short-term investments are categorized as Level 2 within the SFAS 157 hierarchy. The Company receives prices from independent pricing sources to measure the fair values of its fixed maturity investments. The independent pricing sources obtain market quotations and actual transaction prices for securities that have quoted prices in active markets. Each source has its own proprietary method for determining the fair value of securities that are not actively traded. In general, these methods involve the use of “matrix pricing” in which the independent pricing source applies the credit spread for a comparable security that has traded recently to the current yield curve to determine a reasonable fair value. The Company uses a pricing service ranking to consistently select the most appropriate pricing service in instances where it receives multiple quotes on the same security. When fair values are unavailable from these independent pricing sources, quotes are obtained directly from broker-dealers who are active in the corresponding markets. Most of the Company’s fixed maturities are priced from the pricing services or dealer quotes. The Company will typically not make adjustments to prices received from pricing services or dealer quotes; however, in instances where the quoted external price for a security uses significant unobservable inputs, the Company will categorize that security as Level 3. The Company’s private ABS are classified as Level 3. For all fixed maturity investments, the bid price is used for estimating fair value.
To validate prices, the Company compares the fair value estimates to its knowledge of the current market and will investigate prices that it considers not to be representative of fair value. The Company also reviews an internally generated fixed maturity price validation report which converts prices received for fixed maturity investments from the independent pricing sources and from broker-dealers quotes and plots option adjusted spreads (OAS) and duration on a sector and rating basis. The OAS is calculated using established algorithms developed by an independent risk analytics platform vendor. The OAS on the fixed maturity price validation report are compared for securities in a similar sector and having a similar rating, and outliers are identified and investigated for price reasonableness. In addition, the Company completes quantitative analyses to compare the performance of each fixed maturity investment portfolio to the performance of an appropriate benchmark, with significant differences identified and investigated.
Substantially all of the Company’s equities are categorized as either Level 1 or Level 2 within the SFAS 157 hierarchy. For equities categorized as Level 1, the Company receives prices based on closing exchange prices from independent pricing sources to measure fair value. Equities categorized as Level 2 are generally mutual funds invested in securities other than the common stock of publicly traded companies (such as emerging market debt funds or bank loan funds). These funds provide daily net asset values which the Company uses in determining fair value for these investments. For funds where the net asset value is not provided on a daily basis, the asset is classified as Level 3.
To validate prices, the Company will compare them to benchmarks, where appropriate, or to the business results generally within that asset class and specifically to those particular assets. In addition, the fair value measurements of all investments categorized as Level 3 within the SFAS 157 hierarchy are presented to, and peer reviewed by, an internal valuation committee that the Company has established.
There were no material differences in the Company’s valuation techniques for financial instrument assets described above prior to the adoption of SFAS 157 and the carrying value of the Company’s financial instrument assets equaled their fair value. At December 31, 2007, included in other invested assets were financial instruments with negative carrying and fair values of $15.8 million. The negative fair value of these other invested assets reflects fair value adjustments on derivative financial instruments. In accordance with SFAS No. 107 “Disclosures about Fair Value of Financial Instruments” (SFAS 107), the Company’s investments accounted for under the equity method were excluded for the purpose of the fair value disclosure.
The following methods and assumptions were used by the Company in estimating the fair value of each class of financial instrument liability recorded in the Consolidated Balance Sheets for which the Company does not measure that instrument at fair value. SFAS 107 excludes insurance contracts (other than financial guarantees), investment contracts and certain other financial instruments.
(3) PartnerRe Finance II, the issuer of the capital efficient notes, does not meet the consolidation requirements of FIN 46(R). Accordingly, the Company shows the related intercompany debt of $257.6 million in its Consolidated Balance Sheets. The fair value of the capital efficient notes was based on the initial issuance of $250.0 million from PartnerRe Finance II.
The components of the net realized and unrealized investment (losses) gains for the years ended December 31, 2008, 2007 and 2006 are as follows (in thousands of U.S. dollars):
The components of net investment income for the years ended December 31, 2008, 2007 and 2006 were as follows (in thousands of U.S. dollars):
At December 31, 2008 and 2007, approximately $15.7 million and $27.5 million, respectively, of cash and cash equivalents and approximately $1,119.3 million and $1,410.6 million, respectively, of securities were deposited, pledged or held in escrow accounts in favor of ceding companies and other counterparties or government authorities to comply with reinsurance contract provisions and insurance laws or to support long-term debt.
Unpaid losses and loss expenses are categorized into three types of reserves: reported outstanding loss reserves (case reserves), additional case reserves (ACRs) and incurred but not reported (IBNR) reserves. Case reserves represent unpaid losses reported by the Company’s cedants and recorded by the Company. ACRs are established for particular circumstances where, on the basis of individual loss reports, the Company estimates that the particular loss or collection of losses covered by a treaty may be greater than those advised by the cedant. IBNR reserves represent a provision for claims that have been incurred but not yet reported to the Company, as well as future loss development on losses already reported, in excess of the case reserves and ACRs. The
The table below is a reconciliation of the beginning and ending liability for unpaid losses and loss expenses, excluding policy benefits for life and annuity contracts, for the years ended December 31, 2008, 2007 and 2006 (in thousands of U.S. dollars):
The following table summarizes the net prior year (favorable) adverse development of loss reserves for each of the Company’s Non-life sub-segments for the years ended December 31, 2008, 2007 and 2006 (in millions of U.S. dollars):
For the Global (Non-U.S.) P&C sub-segment, the Company reported net favorable development for prior accident years in 2008, 2007 and 2006. The net favorable development in 2008 included net favorable development in all lines of business, but was most pronounced in the property line, and was primarily due to favorable loss emergence, as losses reported by cedants in 2008 for prior accident years were lower than the Company expected. Losses reported by cedants in 2007 regarding prior accident years were also lower than expected in all lines of business, which led the Company to decrease its expected ultimate loss ratios and loss estimates. The Company observed an improvement in loss experience in the property and casualty lines, and deterioration in the motor line in 2006. Loss information provided by cedants during each of these years for prior accident years included no individually significant losses or reductions but a series of attritional losses or reductions.
Ultimate losses for lines impacted by the rapidly deteriorating financial condition of the world economies in 2008, particularly in the fourth quarter of 2008, cannot be estimated by standard actuarial techniques alone. The majority of the Company’s underwriting exposure related to this issue arises from business written in U.S. and Global (Non-U.S.) specialty casualty, primarily directors and officers exposures, Global (Non-U.S.) credit/surety, and to a lesser extent, U.S. surety during the underwriting years 2006, 2007, and 2008. The potential ultimate liability for these exposures was evaluated through an analysis of the Company’s exposure to these risks, which include but are not limited to, sub-prime mortgage related exposures. For specialty casualty, the analysis was based on information received from cedants both at the time the exposed business was written and supplemented by discussions with cedants, evaluation of known securities class action filings, current industry data regarding the likelihood of securities class actions and other potential suits against companies exposed to the effects of financial stress, estimates of exposed industry premium, estimates of the Company’s market share of exposed industry premium and estimates of industry-wide insured losses. For credit/surety, the analysis was based on information received from cedants both at the time the exposed business was written supplemented by discussions with cedants, historical experience in times of similar financial stress, reported claim information and internal modeling.
The Company’s net reserve for unpaid losses and loss expenses at December 31, 2008 and 2007 included $82.5 million and $87.7 million, respectively, that represents estimates of its net ultimate liability for asbestos and environmental claims. The gross liability for such claims at December 31, 2008 and 2007 was $92.2 million and $97.8 million, respectively, of which $85.6 million and $89.1 million, respectively, relate to U.S. casualty exposures arising from business written by PartnerRe SA and PartnerRe U.S. Ultimate loss estimates for such claims cannot be estimated using traditional reserving techniques and there are significant uncertainties in estimating the amount of the Company’s potential losses for these claims. In view of the legal and tort environment that affect the development of such claims, the uncertainties inherent in estimating asbestos and environmental claims are not likely to be resolved in the near future. There can be no assurance that the reserves established by the Company will not be adversely affected by development of other latent exposures, and further, there can be no assurance that the reserves established by the Company will be adequate. The Company does, however, actively evaluate potential exposure to asbestos and environmental claims and establishes additional reserves as appropriate. The Company believes that it has made a reasonable provision for these exposures and is unaware of any specific issues that would materially affect its unpaid losses and loss expense reserves related to this exposure.
The Company uses retrocessional agreements to reduce its exposure to risk of loss on reinsurance assumed. These agreements provide for recovery from retrocessionaires of a portion of losses and loss expenses. The Company remains liable to its cedants to the extent that the retrocessionaires do not meet their obligations under these agreements, and therefore the Company evaluates the financial condition of its reinsurers and monitors concentration of credit risk on an ongoing basis. Provisions are made for amounts considered potentially uncollectible. The allowance for uncollectible reinsurance recoverable was $5.8 million and $9.4 million at December 31, 2008 and 2007, respectively.
The following table is a reconciliation of the actual income tax rate for the years ended December 31, 2008, 2007 and 2006 to the amount computed by applying the effective rate of 0% under Bermuda law to income or loss before income taxes (in thousands of U.S. dollars):
For the year ended December 31, 2007, there were no interest and penalties recognized on such temporary difference.
The total unrecognized tax benefits of $39.8 million and $24.8 million at December 31, 2008 and 2007, respectively, were recorded in net current tax liabilities (2008, $0.1 million; 2007, $1.4 million), net deferred tax liabilities (2008, $nil; 2007, $16.1 million) and net FIN 48 unrecognized tax benefit (2008, $39.7 million; 2007, $7.3 million). The Company recognizes interest and penalties as income tax expense in its Consolidated Statements of Operations.
Included in the Consolidated Balance Sheets at December 31, 2008 and 2007 were the following balances related to Atradius N.V. (in thousands of U.S. dollars):
At December 31, 2008 and 2007, the funded status at the end of the year was included in accounts payable, accrued expenses and other in the Consolidated Balance Sheets. The total amounts recognized in accumulated other comprehensive income at December 31, 2008 and 2007 were $14.7 million (net of $4.0 million of taxes) and $2.9 million (net of $0.8 million of taxes), respectively.
Of the $6.9 million transition adjustment recorded under SFAS 158 in 2006, $5.5 million remains in accumulated other comprehensive income at December 31, 2008. Of this transition adjustment, $0.6 million (pre-tax) is expected to be recognized in net periodic benefit cost in 2009. The Company expects to recognize $0.3 million amortization of actuarial loss in net periodic benefit cost in 2009.
The components of net periodic benefit cost for the years ended December 31, 2008, 2007 and 2006 consisted of (in thousands of U.S. dollars):
At December 31, 2008 and 2007, the Zurich Plan’s asset allocation was as follows:
The investment strategy of the Zurich Plan’s Pension Committee is to achieve a consistent long-term return which will provide sufficient funding for future pension obligations while limiting risk. The majority of the Zurich Plan’s assets are invested in insured funds and the remainder are invested in equities. The investment strategy is reviewed regularly.
Prior to June 1999, the Company had defined benefit plans in place covering substantially all of its employees. All active employees previously enrolled in defined benefit plans have been transferred to defined contribution plans or the Zurich Plan. Benefit accruals under the former defined benefit plans were either frozen, except for certain disabled participants, or rolled into defined contribution plans or the Zurich Plan. At December 31, 2008 and 2007, the frozen defined benefit plan had plan assets of $6.1 million and $7.5 million, respectively, with a pension obligation of $5.9 million and $6.4 million, respectively, resulting in the defined benefit plan being overfunded by $0.2 million and $1.1 million, respectively. The total amounts recognized in accumulated other comprehensive income at December 31, 2008 and 2007 were $1.4 million (net of $0.7 million of taxes) and $0.4 million (net of $0.2 million of taxes), respectively.
The Non-Employee Directors’ Stock Plan (Directors’ Stock Plan), which is shareholder-approved, permits the grant of up to 0.5 million stock options, RS, RSU, alternative awards and other share-based awards. Under the Directors’ Stock Plan, the exercise price of the stock options will be equivalent to the fair value of the stock
The Swiss Share Purchase Plan (the SSPP) has two offering periods per year with two purchase periods of six months. All full-time Swiss employees are eligible to participate in the SSPP and can contribute between 1% and 8% of their base salary toward the purchase of the Company’s shares up to a maximum of 5,000 Swiss francs per annum. Employees who enroll in the SSPP may purchase the Company’s shares at a 40% discount of the fair value. There is a restriction on transfer or sale of these shares for a period of two years following purchase. Participants in the SSPP are eligible to receive dividends on their shares as of the purchase date. A total of 0.1 million common shares may be issued under the SSPP.
In 2008 and 2007, the Company’s U.S. subsidiaries deducted $1.2 million and $5.2 million from their taxable income upon exercises of stock options with a corresponding tax benefit realized on options exercised of $0.4 million and $1.8 million, respectively. Shareholders’ equity at December 31, 2008 and 2007, reflects a tax benefit of $1.9 million and $1.8 million, respectively, related to compensation expense deductions for stock options exercised by employees of the Company’s U.S. subsidiaries.
Stock options vested and expected to vest and the weighted average exercise price for these stock options was 2,386,008 stock options and $55.98, respectively, at December 31, 2008. The aggregate intrinsic value and weighted average remaining contractual term of stock options vested and expected to vest at December 31, 2008 was $36.9 million and 4.6 years, respectively. The aggregate intrinsic value and weighted average remaining contractual term of stock options exercisable at December 31, 2008 was $36.8 million and 4.5 years, respectively.
The Company values stock options issued with a Black-Scholes valuation model and used the following assumptions for the years ended December 31, 2008, 2007 and 2006:
Of the 751,735 RSU outstanding at December 31, 2008, 118,766 are subject to a five year delivery date restriction from the grant date and were not released for conversion into shares.
Total unrecognized share-based compensation expense related to unvested RSU was approximately $16.1 million at December 31, 2008, which is expected to be recognized over a weighted-average period of 1.7 years.
Total unrecognized share-based compensation expense related to unvested SAR was approximately $4.4 million at December 31, 2008, which is expected to be recognized over a weighted-average period of 1.8 years.
In determining the weighted average assumptions used, the Company used the same methodology as described in stock options above.
The Company’s ability to pay common and preferred shareholders’ dividends and its expenses is dependent mainly on cash dividends from Partner Reinsurance, PartnerRe Europe and PartnerRe U.S. (collectively the reinsurance subsidiaries). The payment of such dividends by the reinsurance subsidiaries to the Company is limited under Bermuda and Irish laws and certain statutes of various U.S. states in which PartnerRe U.S. is licensed to transact business. The restrictions are generally based on net income and/or certain levels of policyholders’ earned surplus as determined in accordance with the relevant statutory accounting practices. As of December 31, 2008, there were no significant restrictions on the payment of dividends by Partner Reinsurance. However, PartnerRe Europe is currently restricted from paying dividends under Irish company law given it has negative retained earnings due to transactions undertaken as part of the reorganization (see Note 1), and PartnerRe U.S is currently restricted from paying dividends under New York law given it has negative earned surplus.
The reinsurance subsidiaries are required to file annual statements with insurance regulatory authorities prepared on an accounting basis prescribed or permitted by such authorities (statutory basis), maintain minimum levels of solvency and liquidity and comply with risk-based capital requirements and licensing rules. As of December 31, 2008, the reinsurance subsidiaries’ solvency, liquidity and risk-based capital amounts were in excess of the minimum levels required. The typical adjustments to insurance statutory basis amounts to convert to U.S. GAAP include elimination of certain statutory reserves, deferral of certain acquisition costs, recognition of goodwill and deferred income taxes, valuation of bonds at fair value and presentation of ceded reinsurance balances gross of assumed balances.
The following table summarizes the statutory shareholders’ equity of the Company’s reinsurance subsidiaries as of December 31, 2008 and 2007 (in thousands of U.S. dollars):
PartnerRe Europe’s statutory net income and shareholders’ equity for 2007 and 2006 are prior to its reorganization (see Note 1). At December 31, 2008, the Company’s Swiss and French operations are branches of PartnerRe Europe and are regulated by the Irish Financial Regulatory Authority as prescribed by the EU Reinsurance Directive.
In connection with the acquisition of the reinsurance operations of Winterthur Re in 1998, the Company’s subsidiary, PartnerRe U.S. Corporation (PartnerRe U.S. Holdings) obtained a $220.0 million, 5.81% fixed rate bank loan. The loan, which was fully collaterized, was repaid in 2008 using the proceeds from the issuance of the Senior Notes (see Note 13). PartnerRe U.S. Holdings incurred interest expense of $8.7 million and paid interest of $9.6 million for the year ended December 31, 2008 and incurred interest expense and paid interest of $13.0 million in each of the years ended December 31, 2007 and 2006 in relation to this loan.
On July 31, 2008, the Company entered into an amendment (Loan Amendment) to the loan agreement with Citibank N.A. Under the terms of the Loan Amendment, the maturity of half of the original $400.0 million loan was extended to July 12, 2010. The remaining half of the original loan retained its original maturity of April 27, 2009. Under the Loan Amendment, the amended half of the loan will bear interest quarterly at a floating rate of 3-month LIBOR plus 0.50% through April 27, 2009 and at a rate of 3-month LIBOR plus 0.85% thereafter. The interest rate on the unamended half of the loan remained unchanged at 3-month LIBOR plus 0.50%.
The Company incurred interest expense of $15.2 million, $23.5 million and $22.7 million and paid interest of $16.1 million, $23.7 million and $2l.8 million for the years ended December 31, 2008, 2007 and 2006, respectively, in relation to this loan.
The Senior Notes are ranked as senior unsecured obligations of PartnerRe Finance A. The Company has fully and unconditionally guaranteed all obligations of PartnerRe Finance A under the Senior Notes. The Company’s obligations under this guarantee are senior and unsecured and rank equally with all other senior unsecured indebtedness of the Company. The proceeds from the Senior Notes were used to redeem the $220.0 million, 5.81% fixed rate bank loan owed by PartnerRe U.S. Holdings and the remaining net proceeds were used for general corporate purposes (see Note 12).
Contemporaneously, PartnerRe U.S. Holdings issued a 6.875% promissory note, with a principal amount of $250.0 million to PartnerRe Finance A. Under the term of the promissory note, PartnerRe U.S. Holdings promises to pay to PartnerRe Finance A the principal amount on June 1, 2018, unless previously paid. Interest on the promissory note is payable semi-annually commencing on December 1, 2008 at an annual fixed rate of 6.875%, and cannot be deferred. For the year ended December 31, 2008, the Company incurred interest expense of $10.2 million and paid interest of $8.8 million.
In November 2006, PartnerRe Finance II Inc. (PartnerRe Finance II), an indirect wholly-owned subsidiary of the Company, issued $250.0 million aggregate principal amount of 6.440% Fixed-to-Floating Rate Junior Subordinated CENts. The CENts will mature on December 1, 2066 and may be redeemed at the option of the issuer, in whole or in part, after December 1, 2016 or earlier upon occurrence of specific rating agency or tax events. Interest on the CENts is payable semi-annually commencing on June 1, 2007 to December 1, 2016 at an annual fixed rate of 6.440% and will be payable quarterly thereafter until maturity at an annual rate of 3-month LIBOR plus a margin equal to 2.325%.
The Company does not consolidate PartnerRe Finance A, which issued the Senior Notes, or PartnerRe Finance II, which issued the CENts, as they do not meet the consolidation requirements under FIN 46(R). The Company has reflected the debt related to the Senior Notes and the CENts in its Consolidated Balance Sheets.
At December 31, 2008 and 2007, the total authorized shares of the Company were 200 million shares, par value $1.00 per share, as follows (in millions of shares):
During 2008, the Company repurchased 1.5 million of its common shares pursuant to its repurchase program at a total cost of $110.0 million, representing an average cost of $71.79 per share. During 2007, the Company repurchased in the open market 3.6 million of its common shares pursuant to its share repurchase program at a total cost of $275.0 million, representing an average cost of $76.06 per share. During 2006, the Company did not repurchase any common shares.
On July 31, 2008, the Company amended its existing forward sale agreement (see Note 15). Under the terms of the amendment, half the contract matured according to its original term beginning on September 26, 2008, while the remaining half is extended to April 2010. Under the maturing forward sale agreement, the Company delivered 3,366,295 common shares to the forward counterparty over the 40 day valuation period for total proceeds of $211.6 million. The value received per share was the average daily market price per share over the valuation period, subject to a minimum price per share of $59.37.
At December 31, 2008, approximately 1.3 million common shares are held in treasury and available for reissuance.
In May 2003, the Company issued 11.6 million of 6.75% Series C cumulative redeemable preferred shares (Series C preferred shares) for a total consideration of $280.9 million after underwriting discounts and commissions totaling $9.1 million. Beginning May 8, 2008, the Company may redeem the Series C preferred shares at $25.00 per share plus accrued and unpaid dividends without interest. Dividends on the Series C preferred shares are cumulative from the date of issuance and are payable quarterly in arrears. In the event of
liquidation of the Company, the holders of outstanding preferred shares would have preference over the common shareholders and would receive a distribution of $25.00 per share, or an aggregate value of $290 million, plus accrued and unpaid dividends.
The reconciliation of basic and diluted net income per share for the years ended December 31, 2008, 2007 and 2006 is as follows (in thousands of U.S. dollars or shares, except per share amounts):
(1) At December 31, 2008, 2007 and 2006, stock options to purchase 870.1 thousand, 4.7 thousand and nil common shares, respectively, were excluded from the calculation of diluted weighted average number of common and common share equivalents outstanding because their exercise prices were greater than the average market price of the common shares.
Under the terms of the unamended half of the forward sale agreement, in 2008 the Company delivered 3,366,295 common shares to the forward counterparty for total proceeds of $211.6 million (see Note 14).
On July 31, 2008, the Company amended the existing forward sale agreement. Under the terms of the amendment, half the contract matured according to its original term beginning on September 26, 2008, while the remaining half is extended to April 2010.
The extension with the forward counterparty allows the Company to deliver 3,366,295 of the 6,732,590 common shares subject to the original contract to the forward counterparty at any time during the remaining term of the agreement, which will mature beginning on April 28, 2010. The future sale price of the Company’s common shares under the amended half of the forward sale agreement will vary depending upon the market price of its common shares over a 40 trading day period surrounding the maturity of the forward sale agreement in April 2010, subject to a minimum price per share of $59.33 and a maximum price per share of $84.43 at December 31, 2008. If the Company elects to settle all or a portion of the forward sale agreement prior to its maturity, the Company will deliver common shares to the forward counterparty and will initially receive the present value of the minimum price per share, and the remaining payment, if any, due to the Company will be made at maturity of the agreement based on the excess of the market price of the Company’s common shares over the minimum price per share at maturity of the contract. Settlement of the forward sale agreement may be accelerated by the forward counterparty upon the occurrence of certain events, and the maximum and minimum purchase prices will be reduced or increased quarterly depending on the amount of the Company’s dividends.
For the fourth quarter of 2007, the diluted net income per share included the dilutive effect of 115,350 shares related to this agreement, as the Company’s average share price exceeded the maximum price per share during the fourth quarter of 2007. The 2008 and 2006 diluted net income per share did not include any dilutive effect related to this agreement.
The Company is also exposed to credit risk in its underwriting operations, most notably in the credit/surety line and for different life and alternative risk products. Loss experience in these lines of business is cyclical and is affected by the state of the general economic environment. The Company provides its clients in these lines of business with reinsurance protection against credit deterioration, defaults or other types of financial non-performance of or by the underlying credits that are the subject of the reinsurance provided and, accordingly, the Company is exposed to the credit risk of those credits. The Company mitigates the risks associated with these credit-sensitive lines of business through the use of risk management techniques such as risk diversification, careful monitoring of risk aggregations and accumulations and, at times, through the use of retrocessional reinsurance protection and the purchase of credit default swaps and total return and interest rate swaps.
The Company is also subject to the credit risk of its cedants in the event of insolvency or the cedant’s failure to honor the value of funds held balances for any other reason. However, the Company’s credit risk is mitigated, to some extent, by the fact that the Company generally has the contractual ability to offset any shortfall in the payment of the premiums receivable or funds held balances with amounts owed by the Company to the cedant for losses payable and other amounts contractually due.
The Company leases office space under operating leases expiring in various years through 2019. The leases are renewable at the option of the lessee under certain circumstances. The following is a schedule of future minimum rental payments, exclusive of escalation clauses, on non-cancelable leases as of December 31, 2008 (in thousands of U.S. dollars):
Under the terms of the Company’s extended forward sale agreement (see Note 15), the Company will pay approximately $8.1 million, including interest, in contract fees through 2010.
In January 2007, PartnerRe U.S. received a subpoena from the Attorney General for the State of Connecticut requesting information relating to the Company’s participation in certain underwriting agreements that existed in 2002 and prior. The Company has responded promptly to all requests for information.
Foreign exchange forward contracts outstanding with a notional value of $1,323.9 million had a net unrealized gain of $20.3 million as of December 31, 2007.
The Company also utilizes foreign exchange forward contracts to hedge a portion of its net investment exposure resulting from the translation of its foreign subsidiaries and branches whose functional currency is other than the U.S. dollar. During the fourth quarter of 2008, the Company entered into foreign exchange forward contracts with notional amounts of Euro 250 million and Canadian $125 million. A portion of these contracts have been designated as fair value hedges under SFAS 133.
Exchange traded treasury note futures are used by the Company for the purposes of managing portfolio duration. The notional value of the treasury futures was a long position of $485 million at December 31, 2007. The fair value of futures contracts was a net unrealized gain of $0.9 million at December 31, 2007.
The Company purchases protection through credit default swaps to mitigate the risk associated with its underwriting operations, most notably in the credit/surety line and to manage market exposures. These credit default swaps are recorded at fair value and the Company uses externally modeled quoted prices that use observable market inputs to estimate the fair value. The fair value of protection purchased through credit default swaps was a net unrealized gain of $0.3 million and a notional value of $498 million at December 31, 2007.
The Company assumes credit risk through credit default swaps to replicate investment positions. The original term of these credit default swaps is generally five years or less and there are no recourse provisions associated with these swaps. While the Company would be required to perform under exposure assumed through
The Company has entered into total return swaps referencing various project and principal finance obligations. The Company has also entered into interest rate swaps to mitigate interest rate risk on certain total return swaps. The fair value of those derivatives (the Company’s net liabilities) was a net unrealized loss of $33.7 million at December 31, 2007. The notional value of the Company’s total return swaps was $273 million at December 31, 2007.
Pursuant to the Company’s adoption of the disclosure requirements of SFAS 161 “Disclosures about Derivative Instruments and Hedging Activities-an amendment of FASB Statement No. 133” (SFAS 161), the fair values and notional values of derivatives included in the Company’s Consolidated Balance Sheet at December 31, 2008 were as follows (in thousands of U.S. dollars):
In the normal course of its operations, the Company enters into agreements with financial institutions to obtain unsecured credit facilities. As of December 31, 2008, the total amount of such credit facilities available to the Company was $794.1 million. These facilities are used primarily for the issuance of letters of credit, although a portion of these facilities may also be used for liquidity purposes. Under the terms of certain reinsurance agreements, irrevocable letters of credit were issued on an unsecured basis in the amount of $570.4 million at December 31, 2008, in respect of reported loss and unearned premium reserves.
Included in the total credit facilities available to the Company at December 31, 2008 is a $700 million five-year syndicated, unsecured credit facility. In February 2009, the Company and its lenders agreed to release one of the participants from its obligations under the syndicated facility. As such, the facility has been reduced from $700 million to $660 million. All other terms and conditions remain unchanged. This unsecured credit facility has the following terms: (i) a maturity date of September 30, 2010, (ii) a $300 million accordion feature, which enables the Company to potentially increase its available credit from $660 million to $960 million, and (iii) a minimum consolidated tangible net worth requirement as defined below. The ability of the Company to increase its available credit to $960 million is subject to the agreement of the credit facility participants and, given the current financial crisis and related credit environment, this may be limited.
ii. a maximum ratio of total debt to total capitalization of 35% (for the purposes of this covenant, debt does not include the CENts); and
The Company’s breach of any of the covenants would result in an event of default, upon which the Company may be required to repay any outstanding borrowings and replace or cash collateralize letters of credit issued under these facilities. At December 31, 2008 and 2007, the Company was not in breach of any of the covenants and no conditions of default existed under its facilities. Its total debt to total capitalization ratio was 12.7% and 11.9%, respectively, and its consolidated tangible net worth was $4,019.6 million and $4,142.1 million, at December 31, 2008 and 2007, respectively.
The Company monitors the performance of its operations in three segments, Non-life, Life and Corporate & Other. The Non-life segment is further divided into four sub-segments: U.S., Global (Non-U.S.) P&C, Global (Non-U.S.) Specialty and Catastrophe.
The U.S. sub-segment includes property, casualty, motor, multiline, agriculture, surety and other risks generally originating in the United States. The Global (Non-U.S.) P&C sub-segment includes property, casualty and motor business generally originating outside of the United States. The Global (Non-U.S.) Specialty sub-segment is comprised of business that is generally considered to be specialized due to the sophisticated technical underwriting required to analyze risks, and is global in nature. This sub-segment consists of several lines of business for which the Company believes it has developed specialized knowledge and underwriting capabilities. These lines of business include agriculture, aviation/space, credit/surety, engineering, energy, marine, specialty property, specialty casualty and other lines. The Catastrophe sub-segment is comprised of the Company’s catastrophe line of business. The Life segment includes life, health and annuity lines of business. Corporate and Other is comprised of the Company’s capital markets and investment related activities, including principal finance transactions, insurance-linked securities and strategic investments, and its corporate activities, including other operating expenses.
(A) The Company reports the results of ChannelRe Holdings on a one-quarter lag. The 2007 period includes the Company’s share of ChannelRe Holdings’ net loss and a charge which represents the write-down of its total investment in ChannelRe Holdings due to anticipated unrealized mark-to-market losses on Channel Reinsurance Ltd’s credit derivative portfolio, which it expected to incur during the three months ended December 31, 2007, for a total of $92.8 million (see Note 21).
(B) The 2006 period includes the Company’s share of ChannelRe Holdings’ net income in the amount of $11.7 million for the period from October 2005 to September 2006, as the Company reports the results of ChannelRe Holdings on a one-quarter lag.
The Company produces its business both through brokers and through direct relationships with insurance company clients. None of the Company’s cedants accounted for more than 7% of total gross premiums written during the years ended December 31, 2008, 2007 and 2006.
(1) Following the adoption of SFAS 159 on January 1, 2008, net realized and unrealized investment gains (losses) include both realized and unrealized gains (losses) on investments. Prior to the adoption of SFAS 159, net realized investment gains (losses) included realized gains (losses) on investments and other-than-temporary impairment charges.
On January 8, 2009, the Company entered into a second amendment to the loan agreement, dated as of October 25, 2005, among the Company, as borrower, Citibank, N.A., as administrative agent, and Citibank, N.A., as lender, which originally evidenced a three-and-a-half year term loan agreement with Citibank, N.A. Under the terms of the second loan amendment, the Company has a right to prepay the half of the original $400.0 million loan that has a maturity of April 27, 2009. Any such prepayment under the terms of the second loan amendment will be accompanied by payment of accrued and unpaid interest on the prepayment amount. The remaining half of the loan will have a maturity of July 12, 2010 and the Company will not have a right to prepay this amount. The loan is otherwise unchanged.
On January 14, 2009, the Company repaid the half of the original $400.0 million loan that was due April 27, 2009.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of PartnerRe Ltd. and subsidiaries as of December 31, 2008 and 2007, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2008, in conformity with accounting principles generally accepted in the United States of America.