We entered into an agreement in July 2004 to lease three floors comprising a total of approximately 15,000 square feet in Hamilton, Bermuda for our holding company and Bermuda operations. The term of the rental lease agreement is for six years, and we have agreed to pay approximately a total of $1 million per year in rent for the three floors for the first three years. We moved into these premises on January 30, 2006. Beginning in 2009, we will pay $1.3 million in rent annually.
For our U.K.-based reinsurance and insurance operations, on April 1, 2005, Aspen U.K. signed an agreement for under leases (following our entry in October 2004 into a heads of terms agreement) with B.L.C.T. (29038) Limited (the landlord), Tamagon Limited and Cleartest Limited in connection with leasing office space in London of approximately a total of 49,500 square feet covering three floors. The term of each lease for each floor commenced in November 2004 and runs for 15 years. In 2007, the building was sold to Tishman International. The terms of the lease remain unchanged. We began paying the yearly basic rent of approximately £2.7 million per annum in November 2007. The basic annual rent for each of the leases will each be subject to 5-yearly upwards-only rent reviews. We also license office space within the Lloyd’s building on the basis of a renewable twelve-month lease. We have also leased additional premises in London covering 9,800 square feet for a period of five years.
Book value per ordinary share is based on total shareholders’ equity excluding the aggregate value of the liquidation preferences of our preference shares, divided by the number of shares outstanding of 95,209,008, 87,788,375, 85,510,673, 81,506,503 and 83,327,594 at December 31, 2005, 2006, 2007, 2008 and 2009, respectively. In calculating the number of shares outstanding as at December 31, 2007 for this purpose, we have deducted shares delivered to us and canceled on January 22, 2008 pursuant to our accelerated share repurchase agreement.
Diluted book value per share is calculated based on total shareholders’ equity excluding the aggregate value of the liquidation preferences of our preference shares, at December 31, 2005, 2006, 2007, 2008 and 2009, divided by the number of dilutive equivalent shares outstanding of 98,126,046, 89,876,459, 88,268,968, 83,705,984 and 86,465,357 at December 31, 2005, 2006, 2007, 2008 and 2009, respectively. At December 31, 2005, 2006, 2007, 2008 and 2009, there were 2,917,038, 2,088,084, 2,758,295, 2,199,481 and 3,137,763 of dilutive equivalent shares, respectively. Potentially dilutive shares outstanding are calculated using the treasury method and all relate to employee, director and investor options. In calculating the number of shares outstanding as at December 31, 2007 for this purpose, we have deducted shares delivered to us and canceled on January 22, 2008 pursuant to our accelerated share repurchase agreement.
Our principal objective in 2009 was to continue to proactively manage our insurance and reinsurance portfolios in line with market conditions, while identifying opportunities to further diversify into profitable lines of business that have an appropriate strategic fit, financial prospects based on a strong track record and fit within our risk profile. We maintained a high quality investment portfolio, while exiting our alternative investments in funds of hedge funds during 2009.
Capital management. During 2009, we continued to execute our strategy to optimize our capital structure, repurchasing 2.7 million of our 7.401% $25 liquidation value preference shares (NYSE:AHL-PA) at a price of $12.50 per share. In conjunction with that transaction, we issued 1.2 million ordinary shares with this being the primary driver of the increase in our total shares outstanding from 81.5 million at the end of 2008 to 83.3 million at December 31, 2009.
Diversification. During 2009, we entered the credit and surety reinsurance and specie insurance markets, through our offices in Zurich, London and Connecticut.
Investment management. In February 2009, we gave notice to redeem the balance of our involvement in the funds of hedge funds with effect on June 30, 2009. As a result, we recognized proceeds receivable from the redemption of funds of $307.1 million at June 30, 2009.
Our active investment and other obligations with the funds ceased at June 30, 2009. The carrying value of the receivables represents our maximum exposure to loss at the balance sheet date. The outstanding balance of $11.6 million is expected to be received subsequent to the completion of the audited financial statements for the funds.
The duration of our fixed income portfolio has increased from approximately 3.1 years at December 31, 2008 to 3.3 years at December 31, 2009 and the book yield on our fixed income portfolio has reduced from 4.6% at December 31, 2008 to 4.2% at December 31, 2009. In 2009, we also recognized other-than-temporary impairment charges of $23.2 million. At December 31, 2009, approximately 27.7% of our fixed income securities comprised asset-backed and mortgage-backed securities, none of which we believe fall into the sub-prime category. We had negligible direct exposure to hybrid and preferred securities.
The following overview of our 2007, 2008 and 2009 operating results and financial condition is intended to identify important themes and should be read in conjunction with the more detailed discussion further below.
Net income. For 2009, we reported income after taxes of $473.9 million, a $370.1 million increase over the prior year. The increase is due to a combination of improved underwriting performance mainly arising from an absence of catastrophe losses, higher earned premium from teams established in 2008 and 2009 and a 78.5% increase in investment income from $139.2 million in 2008 to $248.5 million in 2009. This contrasts with 2008 which was impacted by adverse underwriting performance mainly arising from losses of $171.4 million, net of reinsurance recoveries, reinstatement premiums and tax following Hurricanes Ike and Gustav and adverse investment performance due to the turmoil in the financial markets which resulted in losses of $97.3 million from our investment in funds of hedge funds and $59.6 million of investment impairment charges. Net income after taxes of $489.0 million in 2007 included underwriting income of $295.1 million, reflecting a benign catastrophe season, and investment income of $299.0 million including a $44.5 million contribution from our investments in funds of hedge funds.
Gross written premiums. Total gross written premiums increased by 3.3% in 2009 compared to 2008, and by 10.1% in 2008 compared to 2007. The changes in gross written premiums in each of our segments for the twelve months ended December 31, 2009 and 2008 are as follows, with reductions shown as negative percentages.
The increase in gross written premiums in 2008, when compared with 2007, was driven by a $207.9 million contribution from new underwriting teams in international insurance established in the final quarter of 2007 and during 2008. This was offset by premium reductions in a number of our
Loss ratio. We monitor the ratio of losses and loss adjustment expenses to net earned premium (the “loss ratio”) as a measure of relative underwriting performance where a lower ratio represents a better result than a higher ratio. The loss ratios for our four business segments for the twelve months ended December 31, 2009, 2008 and 2007 were as follows:
The reduction in the property reinsurance loss ratio in 2009 was due mainly to an absence of major catastrophes when compared to $128.3 million of losses, net of reinsurance recoveries and reinstatement costs, associated with Hurricanes Ike and Gustav in 2008. The decrease in the loss ratio can also be attributed to reserve releases which increased to $58.5 million in 2009 compared to $12.1 million in 2008.
The loss ratio for casualty reinsurance increased to 67.3% from 65.8% in 2008 mainly as a result of less favorable development on prior accident years, particularly in our international casualty treaty line. Reserve releases reduced from $67.2 million in 2008 to $27.5 million in 2009. In 2007, we recognized $31.8 million of reserve releases emanating mainly from our U.S. casualty treaty account.
The loss ratio for the international insurance segment has reduced to 61.1% in 2009 from 71.5% in 2008 mainly due to the 2008 results being impacted by $45.7 million of net losses and $9.9 million of net additional reinstatement costs following Hurricanes Ike and Gustav. The 2008 loss ratio was also impacted by a net reserve strengthening of $3.9 million whereas in 2009, we have released $17.7 million from reserves due to favorable prior year development. In 2007, there was an absence of catastrophe losses and reserve releases of $80.8 million which had a favorable impact on the loss ratio.
Prior year reserve movements. 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, 2009, 2008 and 2007, we recorded a reduction in the level of reserves for prior
Policy acquisition expenses have increased from $299.3 million in 2008 to $334.1 million in 2009, due primarily to commissions associated with the $146.3 million increase in gross earned premium but also due to the impact of profit-related commissions. The 2008 ratio benefited from $15.3 million of reinstatement and profit-related premium increases which incurred no additional acquisition costs in addition to lower profit commission accruals in a catastrophe-affected year. The higher policy acquisition expenses in 2007 were largely due to the impact from profit-related commissions.
credit quality of our fixed income investment portfolio was “AA+” at the end of 2008 and “AA+” at the end of 2007.
Cartesian Iris 2009A L.P. Cartesian Iris 2009A L.P. is a variable interest entity under the guidance contained in ASC 820 Consolidations. On May 19, 2009 we invested $25.0 million with Cartesian Iris 2009A L.P. through our wholly-owned subsidiary, Acorn Limited. Cartesian Iris 2009A L.P. is a Delaware Limited Partnership formed to provide capital to Iris Re, a newly formed Class 3 Bermuda reinsurer focusing on insurance-linked securities. In addition to returns on our investment, we provide services on risk selection, pricing and portfolio design in return for a percentage of profits from Iris Re. In the twelve months ended December 31, 2009, a fee of $0.1 million was payable to us. For more information please see Notes 6 and 18 to the audited financial statements for the twelve months ended December 31, 2009 included elsewhere in this report.
At December 31, 2009, there were no outstanding foreign currency contracts. At December 31, 2008, we held foreign currency derivative contracts to purchase $18.8 million of U.S. and foreign currencies. The foreign currency contracts are recorded as derivatives at fair value with changes recorded as a realized foreign exchange gain or loss in our statement of operations. For the twelve months ended December 31, 2009, the impact of foreign currency contracts on net income was $1.8 million. For the twelve months ended December 31, 2008, the impact of foreign currency contracts on net income was a loss of $0.8 million (2007 - loss of $2.4 million). Further information on these contracts can be found in Note 9 to the financial statements.
Other revenues and expenses. Other revenues and expenses in 2009 included $2.0 million of foreign currency exchange gains (2008 - $8.2 million losses; 2007 - $20.6 million gains) and $11.4 million of realized investment gains (2008 - $47.9 million losses; 2007 - $13.1 million gains). The increase in realized investment gains in 2009 was due to a significant reduction in charges associated with investments we believe to be other-than-temporarily impaired from $59.6 million in 2008 to $23.2 million in 2009 (2007 - $Nil). Interest payable was $15.6 million in 2009 (2008 - $15.6 million; 2007 - $15.7 million).
Other-than-temporary impairments. We review all of our fixed maturities for potential impairment each quarter based on criteria including issuer-specific circumstances, credit ratings actions and general macro-economic conditions. The process of determining whether a decline in value is “other-than-temporary” requires considerable judgment. As part of the assessment process we also evaluate whether it is more likely than not that we will sell any fixed maturity security in an unrealized loss position before its market value recovers to amortized cost. Once a security has been identified as other-than-temporarily impaired, the amount of any impairment included in net income is determined by reference to the portion of the unrealized loss that is considered credit-related. Non-credit related unrealized losses are included in other comprehensive income. In the twelve months ended December 31, 2009, realized investments losses include a $23.2 million charge for investments we believe to be other-than-temporarily impaired (2008 - $59.6 million). Other-than-temporary impairment losses of $23.2 million for the year were considered to be credit-related and therefore are included in the income statement. The other-than-temporary impairment charge of $59.6 million in 2008 was attributable mainly to the write-down of Lehman Brothers bonds subsequent to that company’s collapse in September 2008.
Dividends. The quarterly dividend has been maintained at $0.15 per ordinary share for 2007, 2008 and 2009. Dividends paid on the preference shares in each of 2007 and 2008 were $27.7 million while in 2009, payments reduced to $23.8 million as a result of repurchasing 2.7 million of our 7.401% $25 liquidation value preference shares (NYSE:AHL-PA) at a price of $12.50 per share.
Shareholders’ equity and financial leverage. Total shareholders’ equity increased from $2,779.1 million at the end of December 31, 2008 to $3,305.4 million as at December 31, 2009. The most significant movements were:
dividend payments to ordinary and preference shareholders totaling $73.6 million in 2009.
As at December 31, 2009, total ordinary shareholders’ equity was $2,951.8 million compared to $2,359.9 million at December 31, 2008.
Diluted tangible book value per ordinary share at December 31, 2009 was $34.04, an increase of 21.1% compared to $28.10 at December 31, 2008.
At December 31, 2009, the Insurance Subsidiaries held $701.5 million in cash and cash equivalents that are readily realizable securities. Management monitors the value, currency and duration of the cash and investments within its Insurance Subsidiaries to ensure that they are individually able to meet their insurance and other liabilities as they become due and was satisfied that there was a comfortable margin of liquidity as at December 31, 2009 and for the foreseeable future.
As of December 31, 2009, we had in issue $496.5 million and £19.6 million in letters of credit to cedants, against which we held $667.1 million and £18.8 million of collateral. Our reinsurance receivables increased by 13.5% from $283.3 million at December 31, 2008 to $321.5 million at December 31, 2009, mainly as a result of an increase in the estimated receivables from our reinsurers in respect of 2005 hurricane claims, additional recoveries associated with financial institutions and U.S. casualty insurance claims.
In summary, there is a general climate of poor rate levels and soft market conditions and we believe this trend will continue as 2010 progresses. We will continue actively to seek out pockets of opportunity and it is core to our diversified strategy to take advantage of such opportunities as they arise. Good progress has been made in our political and financial risk insurance and credit and surety reinsurance lines, both relatively new additions to our portfolio. The reshaping and restructuring of our U.S. excess and surplus casualty insurance unit evidences our determination to address areas which are not performing as well, and our appetite to continue to refine and invest in our chosen business lines through the recruitment of quality underwriters.
Property Reinsurance. Within our property reinsurance segment, given the relatively benign catastrophe season and industry balance sheet recovery, the January renewal season proved to be very competitive. There were modest rate reductions of up to 5% for U.S. peak zone exposures. We expect that the property reinsurance market may well soften further in 2010 and as a result we deployed more of our catastrophic event capacity during the January renewal season than we had first anticipated. Our newly established credit and surety reinsurance team has also performed well during the January renewal season.
On January 5, 2010, we entered into an accelerated share repurchase program with Goldman, Sachs & Co. (“Goldman Sachs”) to repurchase $200 million of our ordinary shares. A substantial majority of the ordinary shares will be received and cancelled within the first quarter of 2010. We may be entitled to receive additional ordinary shares from Goldman Sachs based on the average of the daily market prices of our ordinary shares during the term of the agreement. The program is expected to be completed within ten months. Based on our closing share price on January 4, 2010, the $200 million share repurchase represents approximately 9.3% of our total market capitalization. The repurchase was made under the terms of our share repurchase program authorized by the Board of Directors and announced on February 6, 2008 and will complete the full amount of that program. The purchase has been funded with cash available and the sale of investment assets. An initial amount of 4,875,195 ordinary shares were retired on January 12, 2010.
On January 14, 2010, we announced a new organizational structure where we will manage our insurance and reinsurance businesses under two separate brands, Aspen Insurance and Aspen Reinsurance, to enhance and better serve our global customer base. As a result of our organizational changes, in 2010 we intend to manage our business along two operating segments: Insurance and Reinsurance. Under the new organizational structure, our insurance segment will comprise primarily of the existing international insurance and U.S. insurance segments, with Rupert Villers, Global Head of Financial and Professional Lines Insurance, acting as CEO of Aspen Insurance. William Murray will continue to lead our U.S. Insurance business forming part of our newly established insurance segment. Our reinsurance segment will comprise three divisions, property reinsurance, casualty reinsurance and specialty reinsurance (previously part of international insurance). Brian Boornazian has been appointed CEO of Aspen Reinsurance and James Few has been appointed as President of Aspen Reinsurance.
On January 22, 2010, we entered into a sale and purchase agreement to purchase APJ Continuation Limited (“APJ”) and its subsidiaries for an aggregate consideration of $4.0 million. The business writes a specialist account of kidnap and ransom insurance which will complement our existing political and financial risk line of business. Mr. Villers, one of our executive officers, was previously a director of APJ and is a 30% shareholder. This transaction is subject to regulatory approval and other closing conditions.
On February 4, 2010, we entered into a stock purchase agreement to purchase a U.S. insurance company with licenses to write insurance business on an admitted basis in the U.S. We will pay an amount in cash equal to $10.0 million plus the amount of the target company’s closing surplus. The company is currently licensed to write business in 50 states and the District of Columbia. This transaction is subject to regulatory approval and other closing conditions.
Premiums receivable. Premiums receivable are recorded as amounts due less any required provision for doubtful accounts. A significant portion of amounts included as premiums receivable, which represent estimated premiums written, net of commissions, is not currently due based on the terms of the underlying contracts. In determining whether or not any bad debt provision is necessary, we consider the financial security of the policyholder, past payment history and any collateral held. We have not made a provision for doubtful accounts in relation to assumed premium estimates. In addition, based on the above process, management believes that the premium estimates included in premiums receivable will be collectable and, therefore, we have not maintained a bad debt provision for doubtful accounts on the premiums at December 31, 2009.
This cat swap fell within the scope of ASC 815 Derivatives and Hedging Activities (“ASC 815”) and was therefore measured in the balance sheet at fair value with any changes in the fair value shown on the consolidated statement of operations.
The contract expired on August 20, 2007 and has no impact on net income in the twelve months ended December 31, 2009. The impact of this contract on net income at December 31, 2007 was $2.4 million.
As a result of the application of derivative accounting rules under ASC 815, the contract is treated as an asset and measured at the directors’ estimate of its fair value. Changes in the estimated fair value from time to time will be included in the consolidated statement of operations. The contract is for a maximum of five years and provides 90% cover for a named panel of reinsurers up to individual defined sub-limits. The contract does allow, subject to certain conditions, for substitution and replacement of panel members if our panel of reinsurers changes. Payments are made on a quarterly basis throughout the period of the contract based on the aggregate limit, which was set initially at $477.0 million but is subject to adjustment. As at December 31, 2009, the contract’s aggregate limit was $452.0 million.
reserves for incurred but not reported (“IBNR”) claims to cover the anticipated cost of claims incurred but not reported; and
Case Reserves. For reported claims, reserves are established on a case-by-case basis within the parameters of coverage provided in the insurance policy or reinsurance agreement. In estimating the cost of these claims, we consider circumstances related to the claims as reported, any information available from cedants, lawyers and loss adjustors and information on the cost of settling claims with similar characteristics in previous periods. In addition, for significant events such as the 2005 and 2008
hurricanes, for example, the detailed analysis of our potential exposures includes information obtained directly from cedants which has yet to be processed through market systems enabling us to reduce the time lag between a significant event occurring and establishing case reserves. This additional information is also incorporated into the analysis used to determine the actuarial IBNR. Reinsurance intermediaries are used to assist in obtaining and validating information from cedants but we establish all reserves. In addition, we may engage loss adjusters and perform on site cedant audits to validate the information provided. Disputes do occur with cedants, but the number and frequency are generally low. In the event of a dispute, intermediaries are used to try to resolve the dispute. If a resolution cannot be reached, then the contracts typically provide for binding arbitration.
Bornhuetter-Ferguson method: The BF method uses as a starting point an assumed IELR and blends in the loss ratio, which is implied by the claims experience to date using benchmark loss development patterns on paid claims data (“Paid BF”) or reported claims data (“Reported BF”). Although the method tends to provide less volatile indications at early stages of development and reflects changes in the external environment, it can be slow to react to emerging loss development and can, if the IELR proves to be inaccurate, produce loss estimates which take longer to converge with the final settlement value of loss.
our international insurance segment. The Chain Ladder method is appropriate when there are relatively stable patterns of loss emergence and a relatively large number of reported claims. Typical examples are the U.K. commercial property and U.K. commercial liability lines of business in the international insurance segment.
Reserving Procedures and Process. Our actuaries calculate the IELR, BF and Chain Ladder methods for each line of business and each accident year. They then provide a range of ultimates within which management’s best estimate is most likely to fall. This range will usually reflect a blend of the various methodologies. These methodologies do involve significant subjective judgments reflecting many factors such as changes in legislative conditions, changes in judicial interpretation of legal liability policy coverages and inflation. Our actuaries collaborate with underwriting, claims, legal and finance in identifying factors which are incorporated in their range of ultimates in which management’s best estimate is most likely to fall. The actuarial ranges are not intended to include the minimum or maximum amount that the claims may ultimately settle at, but are designed to provide management with ranges from which it is reasonable to select a single best estimate for inclusion in our financial statements.
Selection of reported gross reserves. Management, through its Reserve Committee, then reviews the range of actuarial estimates, which to date it has not adjusted, and any other evidence before selecting its best estimate of reserves for each line of business and accident year. Management can select its best estimate outside the range provided by the actuaries. This provides the basis for the recommendation made by management to the Audit Committee and Board of Directors regarding the reserve amounts to be recorded in the Company’s financial statements. The Reserve Committee is a management committee consisting of the Group Chief Risk Officer, the Group Chief Actuary, the Group Chief Financial Officer and senior members of our Underwriting and Claims staff.
changes in our processes which might accelerate or slow down the development and/or recording of paid or incurred claims;
The selected best estimate of reserves is typically in excess of the mean of the actuarial reserve estimates. The Company believes that there is potentially significant risk in estimating loss reserves for long-tail lines of business and for immature accident years that may not be adequately captured through traditional actuarial projection methodologies. As discussed above, these methodologies usually rely heavily on projections of prior year trends into the future. In selecting its best estimate of future
In order to show the potential variability in the Company’s estimate of loss reserves, the internal actuaries use stochastic modeling techniques around their mean estimate. We believe that stochastic modeling provides a distribution against which selected reserves can be assessed for which we show the probability of various outcomes relative to the actuarial mean estimate. Stochastic modeling provides a range of potential outcomes as reserve movements will be caused by any number of factors, and as such it is unlikely that only one factor will change in a given period; stochastic modeling techniques will reflect the impact from many factors. The output from the stochastic modeling is more meaningful at a segmental level and is therefore not provided at a line of business level. We show in the following table, the 10th percentile, 25th percentile, actuarial mean estimate, 75th percentile and 90th percentile together with the actual percentile that the selected loss reserves represent.
Actuarial range of gross reserves. The following table sets out the actuarial range of gross reserves for each of our segments and compares it to management’s selected best estimate as at December 31, 2009.
The 10th percentile represents a 1 in 10 chance that, for example, the property reinsurance reserves will be at or lower than $289.4 million. The 90th percentile represents a 1 in 10 chance that reserves will be at or greater than $450.9 million. Diversification reflects the fact that not all the segments are perfectly correlated; that is, we would not expect all lines of business to run off better than or worse than the mean at the same time.
If the ultimate liabilities equate to the mean actuarial estimate, then the impact from the change in loss reserves would be to increase net income before tax by $247.7 million (being the difference above between the selected loss reserves of $3,331.1 million and the mean value of $3,083.4 million), although the impact of such a change is unlikely to be recognized in one calendar year due to the unwinding of experience against expectations taking many years.
Actuarial range of net reserves. In determining the range of net reserves, we estimate recoveries due under our proportional and excess of loss reinsurance programs. For proportional reinsurance we apply the appropriate cession percentages to estimate how much of the gross reserves will be collectable. For excess of loss recoveries, individual large losses are modeled through our reinsurance program. An assessment is also made of the collectability of reinsurance recoveries taking into account market data on the financial strength of each of the reinsurance companies. The net actuarial range for reserves for losses and loss expenses assuming that net reserves move in proportion to gross would be between $2,320.7 million at the 10th percentile and $3,067.8 million at the 90th percentile. The actual net reserves established as at December 31, 2009 were $3,009.6 million.
Investments. We currently classify all except $348.1 million of our fixed maturity investments and short-term investments as “available for sale” and, accordingly, they are carried at estimated fair value. The Company uses quoted values and other data provided by internationally recognized independent pricing sources as inputs into its process for determining the fair value of its fixed income investments. Where multiple quotes or prices are obtained, a price source hierarchy is maintained in order to determine which price source provides the fair value (i.e., a price obtained from a pricing service with more seniority in the hierarchy will be used over a less senior one in all cases). The hierarchy prioritizes pricing services based on availability and reliability and assigns the highest priority to index providers. For mortgage-backed and other asset-backed debt securities, fair value includes estimates regarding prepayment assumptions, which are based on current market conditions. Amortized cost in relation to these securities is calculated using a constant effective yield based on anticipated prepayments and estimated economic lives of the securities. When actual prepayments differ significantly from anticipated prepayments, the effective yield is recalculated to reflect actual payments to date. Changes in estimated yield are recorded on a retrospective basis, which result in future cash flows being used to determine current book value. See additional information below under “Valuation of Investments.”
Gross written premiums. The following table analyzes the overall change in gross written premiums in the twelve months ended December 31, 2009, 2008 and 2007. The amounts shown as ‘underlying premiums’ exclude reinstatement premiums and other premiums receivable directly related to losses arising from Hurricanes Katrina, Rita and Wilma (“KRW”) in 2005 or Hurricanes Ike and Gustav (“IG”) in 2008.
Gross premiums earned. Gross premiums earned reflect the portion of gross written premiums 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 2009 were $146.3 million higher than in 2008 reflecting the increase in written premiums in our property reinsurance and U.S. insurance segments and due to the gross premium written by the new underwriting
The decrease in net premiums earned in 2008 in casualty reinsurance and U.S. insurance compared to 2007 was due to challenging market conditions and the repositioning of our U.S. property insurance line. These reductions were partially compensated by an increase of $99.3 million in gross earned premiums in our international insurance segment due to the contribution from new underwriting teams.
The underlying changes in net loss ratios by segment for the twelve months ended December 31, 2009, 2008 and 2007 are shown in the following tables:
The prior year adjustment for our property reinsurance segment was due to favorable loss development on all business lines, particularly in our property catastrophe account which saw favorable development on losses associated with the 2007 U.K. floods and Hurricanes Ike and Gustav. Reserve releases in the casualty reinsurance segment were generated mainly by our U.S treaty business. The prior year adjustment for the U.S. insurance segment was attributable mainly to reserve strengthening for the casualty line of business which experienced deterioration particularly in our New York contractors’ business. Prior year adjustments are discussed further in the “Reserves for Losses and Loss Adjustment Expenses” below.
The prior year adjustment in 2008 for our international insurance segment was attributable mainly to reserve strengthening for the marine liability line of business and the reserve releases in casualty reinsurance were due to favorable development in U.S. and international treaty business. Losses from Hurricanes Ike and Gustav (“IG”) contributed 25.6 percentage points to the loss ratio in property reinsurance.
Expenses. We monitor the ratio of expenses to gross earned premium (the “gross expense ratio”) as a measure of the cost effectiveness of our business acquisition, operating and administrative processes. The table below presents the contribution of the policy acquisition expenses and operating and administrative expenses to the gross expense ratios and the total net expense ratios for the twelve months ended December 31, 2009, 2008 and 2007. We also show the effect of reinsurance purchased which impacts the reported net expense ratio by expressing the expenses as a proportion of net earned premiums.
The gross expense ratio in 2009 increased by 2.0 percentage points when compared to 2008, due in part to a small increase in profit commissions payable to policyholders. The increase in operating and administrative expenses was attributable to our continued investment in new business lines, an increase in accruals for bonus and long-term incentive charges and some restructuring costs.
Net investment income. In the twelve months ended December 31, 2009, we generated net investment income of $248.5 million (2008 - $139.2 million). The increase was mainly due to our investments in funds of hedge funds which contributed $19.8 million to net investment income in 2009 compared to a loss of $97.3 million in 2008. Our fixed income portfolio book yield reduced to 4.2% at December 31, 2009 from 4.6% at December 31, 2008 (2007 - 5.1%). Total cash and investments (including accrued interest and receivables for investments sold) increased from $6.0 billion at the end of 2008 to $6.8 billion at December 31, 2009 (2007 - $5.9 billion). The fixed income portfolio duration increased marginally from 3.1 years to 3.3 years (2007 - 3.4 years) and the average credit quality of our fixed income book is “AA+”, with 74% of the portfolio being graded “AA” or higher. The average credit
quality of our fixed income investment portfolio was “AA+” at the end of 2008 and “AA+” at the end of 2007.
In the twelve months ended December 31, 2009, our share of gains and losses increased the value of our investment by $2.3 million to $27.3 million (2008-$Nil). The increase in value has been recognized in realized and unrealized gains and losses in the condensed consolidated statement of operations.
Change in fair value of derivatives. In the twelve months ended December 31, 2009, we recorded a reduction in the fair value of derivatives of $8.0 million (2008 - $7.8 million). This included a reduction of $8.0 million (2008 - $7.8 million) in the estimated fair value of our credit insurance contract. In the twelve months ended December 31, 2007, a charge of $2.4 million for a catastrophe swap which expired on August 20, 2007 was also included. In addition, we held foreign currency derivative contracts to purchase $18.8 million of U.S. and foreign currencies during 2009. The foreign currency contracts are recorded as derivatives at fair value with changes recorded as a realized foreign exchange gain or loss in our statement of operations. For the twelve months ended December 31, 2009, the impact of foreign currency contracts on net income is a gain of $1.8 million (2008 - loss of $0.8 million). Further information on these contracts can be found in Note 9 to the financial statements.
Income/(loss) before tax. In 2009, income before tax was $534.7 million and comprised $288.4 million of underwriting profit, $248.5 million in net investment income, $2.0 million of net exchange gains, $15.6 million of interest payable, $11.4 million of realized investment gains and $8.0 million of expenses associated with changes in the fair value of derivatives and $8.0 million of other income. In 2008, income before tax was $140.2 million and comprised $74.8 million of underwriting profit, $139.2 million in net investment income, $8.2 million of net exchange losses, $15.6 million of interest payable, $47.9 million of realized investment losses and $2.1 million of changes in the fair value of derivatives and other expenses. The increase in income in 2009 compared to 2008 was due principally to an absence of catastrophes and improved investment performance. Further, 2008 was adversely impacted as a result of the financial crisis which contributed to lower investment income and a smaller underwriting profit due to greater losses incurred in the year, including losses from Hurricane Ike. In 2007, income before tax was $574.0 million and comprised $295.1 million of underwriting profit,
$299.0 million in net investment income, $20.6 million of net exchange gains, $15.7 million of interest payable, $13.1 million of realized investment losses and $11.9 million of changes in the value of derivatives and other expenses.
Income tax expense. Income tax expense increased to $60.8 million in 2009 from $36.4 million in 2008 and $85.0 million in 2007. The effective tax rate in 2009 was 11.4% compared to 26.0% in 2008 and 14.8% in 2007. The reduction in tax rate for 2009 was mainly driven by the distribution of insurance and investment-related losses within the group in the fourth quarter of 2009. The increase in effective tax rate for 2008 compared to 2007 was due to a greater portion of our profits being derived from our non-Bermudian operations, which are subject to higher rates of tax.
The following tables summarize gross and net premiums written and earned, underwriting results, and combined ratios and reserves for each of our four business segments for the twelve months ended December 31, 2009, 2008 and 2007.
Our property reinsurance segment is written on both a treaty and facultative basis and consists of the following principal lines of business: treaty catastrophe, treaty risk excess, treaty pro rata and property facultative (U.S. and international). We also include within this segment credit and surety reinsurance contracts written by the Zurich branch of Aspen U.K. This portfolio is written primarily on a treaty basis. Treaty reinsurance contracts provide for automatic coverage of a type or category of risk underwritten by our ceding clients. In facultative reinsurance, the reinsurer assumes all or part of a risk written by the insurer in a single insurance contract. Facultative reinsurance is negotiated separately for each contract.
Gross written premiums. Gross written premiums in this segment increased by 10.1% compared to 2008 and reduced by 2.1% in 2008 when compared to 2007. The table below shows our gross written premiums for each line of business for the twelve months ended December 31, 2009, 2008 and 2007, and the percentage change in gross written premiums for each line:
The increase in gross written premium of $59.7 million in 2009 compared to 2008 is due to the $48.8 million contribution from our new credit and surety reinsurance team and favorable market conditions in the U.S. following the 2008 hurricanes. The reduction in gross written premium in 2008 compared to 2007 reflected the softening market conditions for this segment through the period prior to the September 2008 hurricanes, increased competition and the non-renewal of a number of accounts that no longer met our internal profitability requirements. These premium reductions were partially offset by the recognition of $12.2 million of reinstatement premiums following Hurricanes Ike and Gustav and favorable prior year estimated premium adjustments for the treaty risk excess, treaty pro rata and property facultative business lines.
Losses and loss adjustment expenses. The net loss ratio for 2009 was 21.7% compared to 59.1% in 2008 due to a lack of catastrophic losses in 2009. The $13.2 million of European and Canadian storm losses experienced in 2009 compare favorably to 2008, which recognized losses of $140.5 million (gross and net of recoveries) from Hurricanes Ike and Gustav. Another factor in the loss ratio reduction between 2009 and 2008 is the increase in reserve releases from $12.1 million in 2008 to $58.5 million in 2009 due to favorable development on prior year experience.
In 2007, the property reinsurance segment suffered from a series of modest catastrophe losses, including $25.5 million from windstorm Kyrill, $28.7 million from the June and July U.K. floods and $18.1 million of losses from the California wildfires. Prior year reserve strengthening increased the 2007 loss ratio by 2.2 percentage points to 39.7%.
Policy acquisition, operating and administrative expenses. Total expenses were $189.9 million in 2009, which was equivalent to 33.9% of net premiums earned (2008 - 32.0%). The policy acquisition expense ratio is broadly in line with 2008, while the operating and administrative expense ratio increased from 12.3% to 13.9%. The increase in the operating and administrative expenses to $111.8 million from $105.0 million for the comparative period in 2008 was mainly attributable to an increase in bonus-related accruals and long term incentive charges linked to our improved performance during the year.
Policy acquisition expenses reduced by $12.4 million in 2008 compared to 2007 due to the reduction in written premiums. The acquisition expense ratio also decreased in 2008 compared to 2007 due to the reduction in ceded earned premiums in the year as we continued to reduce our reliance on reinsurance in such year. Our underlying cost base in 2008 increased due to the operating costs of our Zurich branch and through incremental salary increases which were offset by reductions in performance-related compensation. Total expenses in 2007 were $182.7 million and were higher than in 2008 mainly as a result of the increase in operating and administrative expenses associated with personnel costs related to increased bonuses and long-term incentive charges and the weakening of the U.S. Dollar against the British Pound.
Casualty reinsurance is written by Aspen U.K. and our reinsurance intermediary in the U.S., Aspen Re America, on behalf of Aspen U.K. We also write some structured casualty reinsurance contracts out of Aspen Bermuda.
Losses and loss adjustment expenses. Losses and loss adjustment expenses increased by $21.2 million in 2009 compared to 2008, due primarily to a $39.7 million decrease in prior year reserve releases. The change in reserve releases is mainly due to the international casualty treaty line which experienced a reserve strengthening of $5.6 million in 2009 due to adverse development on our auto and general liability accounts and general uncertainty surrounding the impact of the global financial crisis, compared to a $31.0 million reserve release in the twelve months ended December 31, 2008.
Losses and loss adjustment expenses decreased by 18.0% in 2008 compared to 2007, due to a $35.4 million increase in prior year reserve releases and a 13.4% reduction in gross earned premium. The reserve releases reflected favorable loss experience from the international casualty and U.S. casualty reinsurance business lines. The 2008 year was affected by an additional $35.0 million provision against potential losses as a result of the ongoing financial crisis.
Our international insurance segment comprises marine hull, marine, energy and construction liability, energy property, specie, aviation, global excess casualty (including non-marine and transportation liability), professional liability, U.K. commercial property (including construction), U.K. commercial liability, financial and political risk, financial institutions, management and technology liability and specialty reinsurance. The commercial liability line of business consists of U.K. employers’ and public liability insurance. Our specialty reinsurance line of business includes aviation, marine and other specialty reinsurance. Our insurance business is written on a primary, quota share and facultative basis and our reinsurance business is mainly written on a treaty pro rata and excess of loss basis with some on a facultative basis. For a more detailed description of this segment, see Part I, Item 1, “Business - Business Segments - International Insurance.”
Gross written premiums. The table below shows our gross written premiums for each line of business for the twelve months ended December 31, 2009, 2008 and 2007, and the percentage change in gross written premiums for each line:
Losses and loss adjustment expenses. The net loss ratio for the twelve months ended December 31, 2009 was 61.1% compared to 71.5% in 2008. The improvement in the loss ratio in 2009 was due mainly to 2008 experiencing a greater frequency and severity of losses including a $45.7 million of losses from Hurricanes Ike and Gustav, a $5.7 million satellite loss, a $15.9 million pollution loss in France, a $3.9 million airline loss and a net $3.9 million reserve strengthening following adverse experience from the marine, energy and construction liability line in connection with California wildfire losses in 2007 and increased provisions for those lines affected by the global financial crisis. The 2009 year experienced losses from our aviation and specialty reinsurance lines which have suffered from an $11.7 million net loss associated with the Air France disaster and a $7.1 million satellite loss. Favorable development on a number of lines has resulted in a net $17.7 million reserve release in 2009.
The loss ratio in 2007 was 51.7% and benefited from an $80.8 million reserve release and a low level of loss activity, with a $14.0 million loss following a shipping collision and a $10.1 million loss from an air crash in Brazil being the only losses of note. Prior year reserve releases are further discussed under “Reserves for Losses and Loss Expenses.”
Operating and administrative expenses increased by $7.2 million in 2008 compared to 2007 mainly due to increases in personnel costs associated with the establishment of our Dublin branch, direct costs of the new underwriting teams and our entry into Lloyd’s. This was partially offset by a reduction in accruals for performance-related compensation and favorable movements in the exchange rate between the U.S. Dollar and British Pound applied to Sterling denominated expenses.
Our U.S. insurance segment consists of U.S. property and casualty insurance written on an excess and surplus lines basis. We also write property insurance that underwrites risk to a select group of U.S. program managers. We refer to this as our risk solutions business. For a more detailed description of this segment, see Part I, Item 1, “Business - Business Segments - U.S. Insurance.”
The table below shows our gross written premiums for each line of business in this segment for the twelve months ended December 31, 2009, 2008 and 2007, and the percentage change in gross written premiums for each line:
Not Meaningful - This line of business was not operational as at December 31, 2008.
Losses increased only marginally to $59.1 million in 2008 from $58.1 million in 2007 despite 2008 experiencing $14.0 million of losses associated with Hurricanes Ike and Gustav. The smaller than expected increase in 2008 loss was attributable to a prior period reserve release of $8.1 million compared to a release of $6.3 million in 2007 and low claims activity on our casualty accounts.
Policy acquisition expenses in 2008 decreased by $5.7 million due mainly to a reduction in earned premiums and a change in business mix between property and casualty insurance. Operating and administrative expenses were broadly in line with 2007 despite 2008 being impacted by costs associated with the repositioning of the property account.
Investment funds. Investment funds have historically represented our investments in funds of hedge funds which were recorded using the equity method of accounting. Adjustments to the carrying value of these investments were made based on the net asset values reported by the fund managers, resulting in a carrying value that approximated fair value. Realized and unrealized gains of $19.8 million (2008 - loss of $97.3 million) were recognized through net investment income in the statement of operations in the year ended December 31, 2009. We invested $150.0 million in the share capital of two funds in 2006, a further $247.5 million in one of these funds and $112.5 million in the share capital of a third fund in 2007. In 2008, we sold share capital in the funds that cost $198.6 million for proceeds of $177.2 million realizing a loss of $21.4 million. In February 2009, we gave notice to redeem the balance of the funds with effect at June 30, 2009. As a result, we recognized proceeds from the redemption of funds of $307.1 million at June 30, 2009.
Valuation of Fixed Income and Short Term Available for Sale Investments and Fixed Income and Short-Term Trading Investments. We use quoted values and other data provided by internationally recognized independent pricing sources as inputs into our process for determining the fair value of our fixed income investments. Where multiple quotes or prices are obtained, a price source hierarchy is maintained in order to determine which price source provides the fair value (i.e., a price obtained from a pricing service with more seniority in the hierarchy will be used over a less senior one in all cases). The
We consider prices for actively traded Treasury securities to be derived based on quoted prices in active markets for identical assets, which are Level 1 inputs in the fair value hierarchy. We consider prices for other securities priced via vendors, indices, or broker-dealers to be derived based on inputs that are observable for the asset, either directly or indirectly, which are Level 2 inputs in the fair value hierarchy.
We consider securities, other financial instruments and derivative insurance contracts subject to fair value measurement whose valuation is derived by internal valuation models to be based largely on unobservable inputs, which are Level 3 inputs in the fair value hierarchy. There have been no changes in our use of valuation techniques during the year.
Pricing Services and Index Providers. Pricing services provide pricing for less complex, liquid securities based on market quotations in active markets. For securities that do not trade on a listed exchange, these pricing services may use matrix pricing consisting of observable market inputs to estimate the fair value of a security. These observable market inputs include: reported trades, benchmark yields, broker-dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, reference data, and industry and economic factors. Additionally, pricing services may use a valuation model such as an option adjusted spread model commonly used for estimating fair values of mortgage-backed and asset-backed securities.
Prices obtained from brokers and pricing services are not adjusted by us; however, prices provided by a broker or pricing service in certain instances may be challenged based on market or information available from internal sources, including those available to our third-party investment accounting service provider. Subsequent to any challenge, revisions made by the broker or pricing service to the quotes are supplied to our investment accounting service provider.
At December 31, 2009, we obtained an average of 3.4 quotes per investment, compared to 2.8 quotes at December 31, 2008. Pricing sources used in pricing our fixed income investments at December 31, 2009 and December 31, 2008, respectively, were as follows:
Valuation of Other Investments. The value of our investments in funds of hedge funds was based upon monthly net asset values reported by the underlying funds to our funds of hedge fund managers. The financial statements of our funds of hedge funds were subject to annual audits evaluating the net asset positions of the underlying investments. We periodically reviewed the performance of our funds of hedge funds and evaluated the reasonableness of the valuations.
The gross reserves may be further analyzed between outstanding or reported claims and IBNR as at December 31, 2009 and 2008, as follows:
Property Reinsurance: The reserve release in the year were as a result of better than expected incurred development on all lines in the segment spread across several accident years and including settlement of Hurricane Ike and Gustav claims. Because of ongoing litigation, there remains significant uncertainty as to our ultimate costs of Hurricane Katrina.
Casualty Reinsurance: The $27.5 million of reserve releases in our casualty reinsurance segment were mainly attributable to favorable development in our U.S. casualty treaty reinsurance business line where the experience to year end compared with starting loss ratios and expected patterns has generally been better than expected at the aggregate level.
International Insurance: The $17.7 million release in the year was the result of reserve releases across the majority of lines compensating for reserve strengthening from the financial institutions and marine, energy and construction liability lines. The reserve strengthening was attributable to increased reserves on the financial institutions line in response to the global financial crisis and a deterioration on the 2007 accident year due to worse than expected incurred claims development in our marine, energy and construction liability line of business.
U.S. Insurance. The $19.3 million deterioration was due to worse than expected experience from the casualty insurance line particularly in relation to New York contractors’ liability business.
U.S. Insurance. The $8.1 million prior year release was due to better than expected experience primarily in the property line of business.
Casualty Reinsurance. The lines contributing to the casualty reinsurance reserves release of $31.8 million were $12.1 million attributed to international casualty, $31.4 million to U.S. casualty offset by $11.7 million of reserve strengthening for casualty facultative and structured business. Although claims in these lines may take several years to emerge, the experience to date compared with our starting loss ratios and expected patterns have generally been better than expected at the aggregate level for the U.S. and international casualty lines.
International Insurance. The international insurance reserves release was $80.8 million, spread across several lines of which the largest contributor was U.K. commercial liability which accounted for $58.3 million of releases. This reduction was attributable mainly to a reduction in the uncertainty surrounding the initial case reserving methodology and continued favorable loss experience. Most other lines exhibited releases of between $3 million and $8 million with the exception of marine, energy and construction liability which deteriorated by $4.9 million.
Access to capital. Our business operations are in part dependent on our financial strength and the market’s perception thereof, as measured by shareholders’ equity, which was $3,305.4 million at December 31, 2009 (2008 - $2,779.1 million). We believe our financial strength provides us with the flexibility and capacity to obtain funds through debt or equity financing. However, our continuing ability to access the capital markets is dependent on, among other things, market conditions, our operating results and our perceived financial strength. We regularly monitor our capital and financial position, as well as investment and security market conditions, both in general and with respect to Aspen Holdings’ securities. Our ordinary shares and all our preference shares are listed on the New York Stock Exchange.
On December 21, 2007, we filed an unlimited shelf registration statement for the issuance and sale of securities from time to time.
For a more detailed discussion of our Insurance Subsidiaries’ ability to pay dividends, see Note 14 of our financial statements.
Insurance subsidiaries. As of December 31, 2009, the Insurance Subsidiaries held approximately $701.5 million (2008 - $777.2 million) in cash and short-term investments that are readily realizable securities. Management monitors the value, currency and duration of cash and investments held by its Insurance Subsidiaries to ensure that they are able to meet their insurance and other liabilities as they become due and was satisfied that there was a comfortable margin of liquidity as at December 31, 2009 and for the foreseeable future.
The liquidity of the Insurance Subsidiaries is also affected by the terms of contractual obligations to U.S. policyholders and by undertakings to certain regulatory authorities to facilitate the issue of letters of credit or maintain certain balances in trust funds for the benefit of policyholders. The following table shows the forms of collateral or other security provided to policyholders as at December 31, 2009 and 2008:
These letters of credit are not secured by cash or securities, though we have the ability to issue secured letters of credit under the revolving credit facility.
Funds at Lloyd’s. AUL operates in Lloyd’s as the corporate member for Syndicate 4711. Lloyd’s determines Syndicate 4711’s required regulatory capital principally through the syndicate’s annual business plan. Such capital, called Funds at Lloyd’s, comprises cash, investments and a fully collateralized letter of credit. The amounts of cash, investments and letter of credit at December 31, 2009 amount to $219.8 million (December 31, 2008 - $200.3 million).
The amounts provided as Funds at Lloyd’s will be drawn upon and become a liability of the Company in the event of the syndicate declaring a loss at a level that cannot be funded from other resources, or if the syndicate requires funds to cover a short term liquidity gap. The amount which the Company provides as Funds at Lloyd’s is not available for distribution to the Company for the payment of dividends. AMAL is also required by Lloyd’s to maintain a minimum level of capital. As at December 31, 2009, the minimum amount was $646,000 (December 31, 2008 - $584,000). This is not available for distribution by the Company for the payment of dividends.
U.S. reinsurance trust fund. For its U.S. reinsurance activities, Aspen U.K. has established and must retain a multi-beneficiary U.S. trust fund for the benefit of its U.S. cedants so that they are able to take financial statement credit without the need to post cedant-specific security. The minimum trust fund amount is $20 million plus a minimum amount equal to 100% of Aspen U.K.’s U.S. reinsurance liabilities, which were $937.1 million at December 31, 2009 and $939.3 million at December 31, 2008. At December 31, 2009, the total value of assets held in the trust was $1,096.6 million (2008 - $1,092.5 million).
U.S. surplus lines trust fund. Aspen U.K. has also established a U.S. surplus lines trust fund with a U.S. bank to secure liabilities under U.S. surplus lines policies. The balance held in the trust at December 31, 2009 was $80.4 million (2008 - $78.8 million).
U.S. regulatory deposits. As at December 31, 2009, Aspen Specialty had a total of $6.6 million (2008 - $6.8 million) on deposit with U.S. states in order to satisfy state regulations for writing business in those states.
Consolidated cash flows for the twelve months ended December 31, 2009. Total net cash flow from operating activities in 2009 was $646.6 million, an increase of $116.1 million from 2008. For the twelve months ended December 31, 2009, our cash flows from operations provided us with sufficient liquidity to meet our operating requirements. We paid net claims of $808.6 million in 2009 and made net investments in the amount of $682.4 million in market securities and equipment during the period. We paid ordinary and preference share dividends of $73.6 million, and $100.3 million was used to repurchase ordinary shares. At December 31, 2009, we had a balance of cash and cash equivalents of $748.4 million. The balance of cash and cash equivalents has decreased during the year as opportunities have arisen to increase our holdings of high quality corporate bonds.
Consolidated cash flows for the twelve months ended December 31, 2007. Total net cash flow from operating activities in 2007 was $774.0 million, an increase of $50.8 million from 2006. For the twelve months ended December 31, 2007, our cash flows from operations provided us with sufficient liquidity to meet our operating requirements. We paid net claims of $695.6 million in 2007 and made net investments in the amount of $426.1 million in market securities and equipment during the period. We paid ordinary and preference share dividends of $80.7 million, and $100.3 million was used to repurchase ordinary shares. At December 31, 2007, we had a cash and cash equivalents balance of $651.4 million.
Credit Facility. On August 2, 2005, we entered into a five-year $400 million revolving credit facility pursuant to a credit agreement dated as of August 2, 2005 (the “credit facilities”) by and among the Company, certain of our direct and indirect subsidiaries, including the Insurance Subsidiaries (collectively, the “Borrowers”) the lenders party thereto, Barclays Bank plc, as administrative agent and letter of credit issuer, Bank of America, N.A. and Calyon, New York Branch, as co-syndication agents, Credit Suisse, Cayman Islands Branch and Deutsche Bank AG, New York Branch, as co-documentation agents and The Bank of New York, as collateral agent. On September 1, 2006, the aggregate limit available under the credit facility was increased to $450 million.
The facility can be used by any of the Borrowers to provide funding for our Insurance Subsidiaries, to finance the working capital needs of the Company and our subsidiaries and for general corporate purposes of the Company and our subsidiaries. The revolving credit facility provides for a $250 million sub-facility for collateralized letters of credit. The facility will expire on August 2, 2010 and prior to the facility’s expiration, we intend to enter into a new facility. As of December 31, 2009, no borrowings were outstanding under the credit facilities and we had no outstanding collateralized or uncollateralized letters of credit. The fees and interest rates on the loans and the fees on the letters of credit payable by the Borrowers increase based on the consolidated leverage ratio of the Company.
The following table summarizes our contractual obligations (other than our obligations to employees, our Perpetual PIERS and our Perpetual Preference Shares) under long-term debt, operating leases and reserves relating to insurance and reinsurance contracts as of December 31, 2009:
For a discussion of our commitments and contingencies, please see Note 18 to the audited financial statements for the twelve months ended December 31, 2009 included elsewhere in this report.
Ajax Re provides us with California earthquake coverage based on modified industry losses, or indexed-based losses, with an attachment level of $23.1 billion and an exhaustion level of $25.9 billion. The indexed-based losses are derived from industry personal lines losses, commercial lines losses and automobile losses, each as calculated by PCS. We would recover up to $100 million on a linear basis if we incurred losses in such earthquake. The insurance cover expires on May 1, 2009.
In order to ensure that Ajax Re had sufficient funding to service the LIBOR portion of interest due on the bonds issued by Ajax Re, Ajax Re entered into a total return swap with Lehman Financing, whereby Lehman Financing directed Ajax Re to invest the proceeds from the bonds into permitted investments. Lehman Brothers also provided a guarantee of Lehman Financing’s obligations under the swap.
Cartesian Iris 2009A L.P. Cartesian Iris 2009A L.P. is a variable interest entity under the guidance contained in ASC 820 Consolidations. On May 19, 2009, we invested $25.0 million with Cartesian Iris 2009A L.P. through our wholly-owned subsidiary, Acorn Limited. Cartesian Iris 2009A L.P. is a Delaware Limited Partnership formed to provide capital to Iris Re, a newly formed Class 3 Bermuda reinsurer focusing on insurance-linked securities. In addition to returns on our investment, we provide services on risk selection, pricing and portfolio design in return for a percentage of profits from Iris Re. In the twelve months ended December 31, 2009, a fee of $0.1 million was payable to us. For more information, please see Notes 6 and 18 to the audited financial statements for the twelve months ended December 31, 2009 included elsewhere in this report.
Inflation may have a material effect on our consolidated results of operations by its effect on interest rates and on the cost of settling claims. The potential exists, after a catastrophe or other large property loss, for the development of inflationary pressures in a local economy as the demand for services such as construction typically surges. We believe this had an impact on the cost of claims arising from the 2005 hurricanes. The cost of settling claims may also be increased by global commodity price inflation. We
In addition to general price inflation we are exposed to a persisting long-term upwards trend in the cost of judicial awards for damages. We seek to take this into account in our pricing and reserving of casualty business.
Operating income, a non-GAAP financial measure, is an internal performance measure used by us in the management of our operations and represents after-tax operational results excluding, as applicable, after-tax net realized capital gains or losses, after-tax net foreign exchange gains or losses and after-tax
gains or losses from our investments in funds of hedge funds. We exclude after-tax net realized capital gains or losses and after-tax net foreign exchange gains or losses and after-tax gains from our calculation of operating income because the amount of these gains or losses is heavily influenced by, and fluctuates in part, according to the availability of market opportunities. We believe these amounts are largely independent of its business and underwriting process and including them distorts the analysis of trends in its operations. In addition to presenting net income determined in accordance with GAAP, we believe that showing operating income enables investors, analysts, rating agencies and other users of our financial information to more easily analyze our results of operations in a manner similar to how management analyzes our underlying business performance. Operating income should not be viewed as a substitute for GAAP net income.