Everest Re’s corporate offices are located in approximately 230,500 square feet of leased office space in Liberty Corner, New Jersey. Bermuda Re’s corporate offices are located in approximately 3,600 total square feet of leased office space in Hamilton, Bermuda. The Company’s other sixteen locations occupy a total of approximately 96,300 square feet, all of which are leased. Management believes that the above-described office space is adequate for its current and anticipated needs.
Starting in the latter part of 2007, throughout 2008 and 2009, there has been a significant slowdown in the global economy, which has negatively impacted the financial resources of the industry. Excessive availability and use of credit, particularly by individuals, led to increased defaults on sub-prime mortgages in the U.S. and elsewhere, falling values for houses and many commodities and contracting consumer spending. The significant increase in default rates negatively impacted the value of asset-backed securities held by both foreign and domestic institutions. The defaults have led to a corresponding increase in foreclosures, which have driven down housing values, resulting in additional losses on asset-backed securities. During the third and fourth quarters of 2008, credit markets deteriorated dramatically, evidenced by widening credit spreads and dramatically reduced availability of credit. Many financial institutions, including some insurance entities, experienced liquidity crises due to immediate demands for funds for withdrawals or collateral, combined with falling asset values and their inability to sell assets to meet the increased demands. As a result, several financial institutions have failed or been acquired at distressed prices, while others have received loans from the U.S. government to continue operations. The liquidity crisis significantly increased the spreads on fixed maturity securities and, at the same time, had a dramatic and negative impact on the stock markets around the world. The combination of losses on securities from failed or impaired companies combined with the decline in values of fixed maturity and equity securities resulted in significant declines in the capital bases of most insurance and reinsurance companies. While there was significant improvement in the financial markets during 2009, it is too early to predict the timing and extent of impact the capital deterioration and subsequent partial recovery will have on insurance and reinsurance market conditions.
Rates in the international markets have generally been more adequate than in the U.S., and we have seen some increases, particularly for catastrophe exposed business. We have grown our business in the Middle East, Latin America and Asia. We are expanding our international reach with the opening of a new office in Brazil to capitalize on the recently expanded opportunity for professional reinsurers in that market and on the economic growth expected for Brazil in the future.
Net Realized Capital (Losses) Gains. Net realized capital losses were $2.3 million and $695.8 million in 2009 and 2008, respectively, while 2007 had net realized capital gains of $86.3 million. In 2009, we recorded $29.3 million of net realized capital losses from sales and $13.2 million in other-than-temporary impairments on our available for sale fixed maturity securities, partially offset by $40.2 million gain in fair value re-measurements. The net realized capital losses in 2008 were primarily the result of the credit crisis impacting the global financial markets, which drove down the values of equity and fixed income securities. As such, our equity security portfolio decreased $277.5 million as a result of fair value adjustments and our fixed maturities decreased $176.5 million due to other-than-temporary impairments. In addition, we recognized $243.3 million of net realized capital losses, principally from the sale of equity securities we owned as we realigned our investment portfolios. The net realized gains in 2007 consisted of $76.6 million in fair value re-measurements of equity securities and $18.1 million from sales of equity securities and fixed maturity securities, partially offset by $8.4 million of other-than-temporary impairments of the fixed maturity securities.
Net Derivative Gain (Loss). In 2005 and prior, we sold seven equity index put option contracts, which are outstanding. These contracts meet the definition of a derivative in accordance with FASB guidance and as such, are fair valued each quarter with the change recorded as net derivative gain or loss in the consolidated statements of operations and comprehensive income (loss). As a result of these adjustments in value, we recognized net derivative gain of $3.2 million in 2009 and net derivative loss of $20.9 million and $2.1 million in 2008 and 2007, respectively. The change in the fair value of these equity index put option contracts is indicative of the change in the financial markets over the same periods.
Catastrophe losses, at $364.3 million, were $204.3 million higher than in 2007, driven by Hurricanes Gustav and Ike and a major snowstorm in China. While 2008 ranks as one of the costliest years on record for insured natural catastrophe losses, our losses were generally in line with our modeled expected annual aggregate catastrophe losses as developed through our enterprise risk and catastrophe exposure management processes.
We strengthened our asbestos reserves by $387.5 million in 2007, and had no gross development in 2009 or 2008 as loss activity was in line with expected as per the reserves established at December 31, 2007.
Commission, Brokerage, Taxes and Fees. Commission, brokerage, taxes and fees decreased by $2.4 million, or 0.3%, in 2009 compared to the same period in 2008. The change in this directly variable expense was influenced by reduction in contingent commissions and changes in the mix of business.
Other underwriting expenses were $162.3 million and $152.6 million in 2008 and 2007, respectively. The increase was primarily due to higher compensation and benefits expense resulting from increased staff, primarily in the U.S. Insurance segment. Included in other underwriting expenses were corporate expenses of $13.8 million and $13.1 million in 2008 and 2007, respectively.
Interest, Fees and Bond Issue Cost Amortization Expense. Interest and other expense was $72.1 million and $79.2 million in 2009 and 2008, respectively. The decrease, period over period, was primarily due to the partial repurchase of our long term subordinated notes in March 2009.
Income Tax Expense (Benefit). We had income tax expense of $132.3 million in 2009 compared to an income tax benefit of $64.8 million 2008. The period over period increases were primarily due to the increase in pre-tax net income in 2009 versus pre-tax net losses in 2008. We had an income tax expense of $188.7 million in 2007, primarily due to income from operations and net realized gains for the period. Our income tax is primarily a function of the statutory tax rates and corresponding pre-tax income in the jurisdictions where we operate, coupled with the impact from tax-preferenced investment income. Variations in our effective tax rate generally result from changes in the relative levels of pre-tax income among jurisdictions with different tax rates.
Our net loss was $18.8 million in 2008 compared to a net income of $839.3 million in 2007. This decrease was primarily driven by after-tax net realized capital losses and increased catastrophe losses in 2008 compared to after-tax net realized capital gains and fewer catastrophe losses in 2007.
Net investment income decreased 17.1% to $565.9 million in 2008 from $682.4 million in 2007, primarily due to losses incurred on our limited partnership investments, particularly those that invested in public equity securities, in 2008 compared to limited partnership investment income in 2007.
The following table shows a comparison of various investment yields for the periods indicated.
The pre-tax equivalent total return for the bond portfolio was approximately 10.1%, 1.0% and 5.7%, respectively, in 2009, 2008 and 2007. The pre-tax equivalent return adjusts the yield on tax-exempt bonds to the fully taxable equivalent.
The following table presents the composition of our net realized capital (losses) gains for the periods indicated.
Gross written premiums decreased by 12.9% to $771.8 million in 2008 compared to $885.6 million in 2007. Conditions for workers’ compensation, contractors and public entity business have gotten increasingly competitive, which reduced the volume of business that met our underwriting and pricing criteria. A little less than half of the shortfall compared to last year was from the C.V. Starr program, where we lost public entity accounts because we did not match market pricing and terms. In addition, the $76.3 million of gross written premium we assumed on a new program in 2007 did not recur in 2008. Net written premiums decreased by 17.1% to $617.0 million in 2008 compared to $744.3 million in 2007. The decrease in net written premiums was larger than the decline in gross written premiums primarily due to increased reinsurance cessions. Net premiums earned decreased 4.1% to $705.5 million in 2008 compared to $735.9 million in 2007, as a result of timing.
Incurred losses and LAE decreased by 2.0% to $538.6 million in 2009 compared to $549.9 million in 2008. This decrease was due to the decrease in net earned premiums, partially offset by the increase in the loss ratio, period over period. Prior years’ attritional losses were $10.1 million less unfavorable in 2009 compared to 2008. The 2009 unfavorable development of $59.0 million was primarily the result of reserve strengthening on contractors’ liability programs, package policy business and workers’ compensation business. The 2008 unfavorable development of $69.1 million was primarily the result of $85.3 million reserve strengthening for an auto loan credit insurance program, partially offset by $16.2 million in favorable prior years’ reserve development.
Incurred losses and LAE decreased by 4.3% to $165.9 million in 2008 compared to $173.3 million in 2007, as both attritional losses and catastrophe losses were similar for the two periods. The bulk of the 2008 catastrophe losses emanated from Hurricanes Gustav and Ike, while the 2007 losses were primarily caused by late reported marine losses from Hurricane Rita.
Segment Expenses. Commission and brokerage increased 2.5% to $72.6 million in 2009 compared to $70.8 million in 2008 as commissions increased on the A&H business. Segment other underwriting expenses for 2009 increased slightly to $8.7 million compared to $8.1 million for 2008.
Premiums. Gross written premiums increased by 19.9% to $1,084.5 million in 2009 compared to $904.7 million in 2008. As a result of our strong financial strength ratings, we continue to see increased participations on treaties in most regions, new business writings and preferential signings, including preferential terms and conditions. In addition, rates, in some markets, also contributed to the increased written premiums. Premiums written through the Brazil, Miami and New Jersey offices increased by $122.9 million (21.3%), the Asian branch increased by $32.4 million (17.1%) and the Canadian branch premiums increased by $24.5 million (17.7%). Net written premiums increased by 19.9% to $1,081.3 million in 2009 compared to $902.1 million in 2008, principally as a result of the increase in gross written premiums. Premiums earned increased 19.0% to $1,053.5 million in 2009 compared to $885.5 million in 2008, consistent with the increase in net written premiums.
Gross written premiums increased by 12.3% to $904.7 million in 2008 compared to $805.9 million in 2007. Due to the strong financial strength ratings in 2008, we obtained increased participations on treaties in most regions. As well, we benefited from new business writings as some insurers sought to increase the financial strength ratings of their reinsurance panels. In addition, we obtained some preferential signings including preferential terms and conditions, and benefited from higher rates in some markets. Premiums written through the Miami and New Jersey offices increased by $106.0 million (22.5%); the Asian branch increased by $24.2 million (14.6%), while premiums for the Canadian branch decreased by $31.8 million (18.7%). Net written premiums increased by 11.9% to $902.1 million in 2008 compared to $806.0 million in 2007, principally as a result of the increase in gross written premiums. Net premiums earned increased 10.2% to $885.5 million in 2008 compared to $803.8 million in 2007, generally consistent with the increase in net written premiums.
Incurred losses and LAE increased 21.5% to $613.3 million in 2009 compared to $504.8 million in 2008. The increase was primarily due to reserve strengthening of prior years’ non-catastrophe attritional losses in 2009 of $19.4 million compared to 2008’s favorable prior years’ non-catastrophe attritional development of $33.5 million. Current year attritional losses were higher primarily due to the increase in earned premiums. Current year catastrophe losses were flat year over year.
Incurred losses and LAE increased slightly 0.6% to $504.8 million in 2008 compared to $501.9 million in 2007. The segment loss ratio decreased by 5.4 points in 2008 compared to 2007 due to lower current year catastrophe losses in 2008 compared to 2007. The 2008 current year catastrophe losses included a large snowstorm in China and Hurricanes Gustav and Ike. In addition, increased favorable development on prior years’ reserves period over period contributed to the lower loss ratio.
Gross written premiums decreased 15.1% to $783.4 million in 2008 compared to $922.5 million in 2007. The Bermuda home office premiums decreased in 2008 compared to 2007 by $69.7 million, principally due to a discontinued account and conversion of a large casualty quota share to excess of loss coverage. The U.K. branch premiums also decreased by $69.1 million due to the non-renewal of two casualty proportional contracts. Net written premiums decreased 15.1% to $783.1 million in 2008 compared to $922.3 million in 2007. Premiums earned decreased 12.2% to $801.2 million in 2008 compared to $912.9 million in 2007, commensurate with the decrease in gross written premiums.
Incurred losses and LAE increased 15.2% to $484.0 million in 2009 compared to $420.3 million in 2008. The increase was primarily due to the change in prior years’ attritional reserve development to unfavorable development of $19.4 million in 2009 from favorable development of $56.6 million in 2008, principally generated by the UK branch business. A portion of this change, $39.3 million, is strengthening of reserves on our sub-prime exposure. Partially offsetting the increase was a $10.8 million reduction in catastrophes, period over period.
It is more difficult to accurately estimate loss reserves for reinsurance liabilities than for insurance liabilities. At December 31, 2009, we had reinsurance reserves of $6,754.8 million and insurance loss reserves of $2,183.1 million, of which $502.6 million and $136.1 million, respectively, were loss reserves for A&E liabilities. A detailed discussion of additional considerations related to A&E exposures follows later in this section.
Asbestos and Environmental Exposures. We continue to receive claims under expired insurance and reinsurance contracts, asserting injuries and/or damages relating to or resulting from environmental pollution and hazardous substances, including asbestos. Environmental claims typically assert liability for (a) the mitigation or remediation of environmental contamination or (b) bodily injury or property damage caused by the release of hazardous substances into the land, air or water. Asbestos claims typically assert liability for bodily injury from exposure to asbestos or for property damage resulting from asbestos or products containing asbestos.
Reinsurance Receivables. We have purchased reinsurance to reduce our exposure to adverse claim experience, large claims and catastrophic loss occurrences. Our ceded reinsurance provides for recovery from reinsurers of a portion of losses and loss expenses under certain circumstances. Such reinsurance does not relieve us of our obligation to our policyholders. In the event our reinsurers are unable to meet their obligations under these agreements or are able to successfully challenge losses ceded by us under the contracts, we will not be able to realize the full value of the reinsurance receivable balance. To minimize exposure from uncollectible reinsurance receivables, we have a reinsurance security committee that evaluates the financial strength of each reinsurer prior to our entering into a reinsurance arrangement. In some cases, we may hold full or partial collateral for the receivable, including letters of credit, trust assets and cash. Additionally, creditworthy foreign reinsurers of business written in the U.S. are generally required to secure their obligations. We have established reserves for uncollectible balances based on our assessment of the collectibility of the outstanding balances. As of December 31, 2009 and 2008, the reserve for uncollectible balances was $51.6 million and $247.9 million, respectively. Actual uncollectible amounts may vary, perhaps substantially, from such reserves, impacting income in the period in which the change in reserves is made. See also ITEM 8, “Financial Statements and Supplementary Data” - Note 13 of Notes to the Consolidated Financial Statements and “Financial Condition - Reinsurance Receivables” below.
Premiums Written and Earned. Premiums written by us are earned ratably over the coverage periods of the related insurance and reinsurance contracts. We establish unearned premium reserves to cover the unexpired portion of each contract. Such reserves are computed using pro rata methods based on statistical data received from ceding companies. Premiums earned, and the related costs, which have not yet been reported to us, are estimated and accrued. Because of the inherent lag in the reporting of written and earned premiums by our ceding companies, we use standard accepted actuarial methodologies to estimate earned but not reported premium at each financial reporting date. These earned but not reported premiums are combined with reported earned premiums to comprise our total premiums earned for determination of our incurred losses and loss and LAE reserves. Commission expense and incurred losses related to the change in earned but not reported premium are included in current period company and segment financial results. See also ITEM 8, “Financial Statements and Supplementary Data” - Note 1 of Notes to the Consolidated Financial Statements.
Investment Valuation. Our fixed income investments are classified for accounting purposes as available for sale and are carried at market value or fair value in our consolidated balance sheets. Our equity securities are also held as available for sale and are carried at market or fair value. Most securities we own are traded on national exchanges where market values are readily available. Some of our commercial mortgage-backed securities (“CMBS”) are valued using cash flow models and risk-adjusted discount rates. We hold some privately placed securities, less than 0.2% of the portfolio, that are either valued by brokers or an investment advisor. At December 31, 2009 and 2008, our investment portfolio included $504.3 million and $644.8 million, respectively, of limited partnership investments whose values are reported pursuant to the equity method of accounting. We carry these investments at values provided by the managements of the limited partnerships and due to inherent reporting lags, the carrying values are based on values with “as of” dates from one month to one quarter prior to our financial statement date.
At December 31, 2009, we had net unrealized gains, net of tax, of $309.3 million compared to net unrealized losses, net of tax, of $163.4 million at December 31, 2008. Gains and losses from market fluctuations for investments held at market value are reflected as comprehensive income in the consolidated balance sheets. Gains and losses from market fluctuations for investments held at fair value are reflected as net realized capital gains and losses in the consolidated statements of operations and comprehensive income (loss) in accordance with FASB guidance. Market value declines for the fixed income portfolio, which are considered credit other-than-temporary impairments, are reflected in our consolidated statements of operations and comprehensive income (loss), as realized capital losses. We consider many factors when determining whether a market value decline is other-than-temporary, including: (1) we have no intent to sell and, more likely than not, will not be required to sell prior to recovery, (2) the length of time the market value has been below book value, (3) the credit strength of the issuer, (4) the issuer’s market sector, (5) the length of time to maturity and (6) for asset-backed securities, increases in prepayments, credit enhancements and underlying default rates. If management’s assessments change in the future, we may ultimately record a realized loss after management originally concluded that the decline in value was temporary. See also ITEM 8, “Financial Statements and Supplementary Data” - Note 1 of Notes to the Consolidated Financial Statements.
Cash and Invested Assets. Aggregate invested assets, including cash and short-term investments, were $14,918.8 million at December 31, 2009, an increase of $1,204.5 million compared to $13,714.3 million at December 31, 2008. This increase was primarily the result of $784.7 million of cash flows from operations, $636.7 million of unrealized appreciation and $211.6 million in foreign exchange gains on our portfolio securities, partially offset by the repurchase of common shares of $190.6 million, $116.9 million paid out in dividends to shareholders and $83.0 million in debt repurchase.
Our principal investment objectives are to ensure funds are available to meet our insurance and reinsurance obligations and to maximize after-tax investment income while maintaining a high quality diversified investment portfolio. Considering these objectives, we view our investment portfolio as having two components: 1) the investments needed to satisfy outstanding liabilities and 2) investments funded by our shareholders’ equity.
The Company’s limited partnership investments are comprised of limited partnerships that invest in public equities and limited partnerships that invest in private equities. Generally, the public equity limited partnerships are reported on a one month lag while the private equity partnerships are included in the financials on a quarter lag. All of the limited partnerships are required to report using fair value accounting in accordance with FASB guidance. We receive annual audited financial statements for all of the limited partnerships and for the quarterly reports; the Company staff performs reviews of the financial reports for any unusual changes in carrying value. If the Company becomes aware of a significant decline in value during the lag reporting period, the loss will be recorded in the period in which the Company identifies the decline.
The pre-tax equivalent total return for the bond portfolio was approximately 10.1%, 1.0% and 5.7%, respectively, for 2009, 2008 and 2007. The pre-tax equivalent return adjusts the yield on tax-exempt bonds to the fully taxable equivalent.
Reinsurance Receivables. Reinsurance receivables for both paid and unpaid losses totaled $636.4 million and $657.2 million at December 31, 2009 and 2008, respectively. At December 31, 2009, $131.4 million, or 20.6%, was receivable from Transatlantic; $100.0 million, or 15.7%, was receivable from Continental; $87.6 million, or 13.8% was receivable from C.V. Starr; $53.4 million, or 8.4%, was receivable from Munich Re; $49.1 million, or 7.7%, was receivable from Berkley and $32.9 million, or 5.2%, was receivable from ACE. The receivable from Continental is collateralized by a funds held arrangement under which we have retained the premiums earned by the retrocessionaire to secure obligations of the retrocessionaire, recorded
Loss and LAE Reserves. Gross loss and LAE reserves totaled $8,937.9 million at December 31, 2009 and $8,840.7 million at December 31, 2008.
Our loss and LAE reserves represent our best estimate of our ultimate liability for unpaid claims. We continuously re-evaluate our reserves, including re-estimates of prior period reserves, taking into consideration all available information and, in particular, newly reported loss and claim experience. Changes in reserves resulting from such re-evaluations are reflected in incurred losses in the period when the re-evaluation is made. Our analytical methods and processes operate at multiple levels including individual contracts, groupings of like contracts, classes and lines of business, internal business units, segments, legal entities, and in the aggregate. In order to set appropriate reserves, we make qualitative and quantitative analyses and judgments at these various levels. Additionally, the attribution of reserves, changes in reserves and incurred losses among accident years requires qualitative and quantitative adjustments and allocations at these various levels. We utilize actuarial science, business expertise and management judgment in a manner intended to assure the accuracy and consistency of our reserving practices. Nevertheless, our reserves are estimates, which are subject to variation, which may be significant.
Depending on the specific segment, the range derived for the loss reserves, excluding reserves for A&E exposures, ranges from minus 8.5% to minus 21.5% for the low range and from plus 8.5% to plus 21.5% for the high range. Both the higher and lower ranges are associated with the U.S. Insurance segment. The size of the range is dependent upon the level of confidence associated with the outcome. Within each range, our best estimate of loss reserves is based upon the point estimate derived by our actuaries in detailed reserve studies. Such ranges are necessarily subjective due to the lack of generally accepted actuarial standards with respect to their development. For the above presentation, we have assumed what we believe is a reasonable confidence level but note that there can be no assurance that our claim obligations will not vary outside of these ranges.
At December 31, 2009, the gross reserves for A&E losses were comprised of $141.5 million representing case reserves reported by ceding companies, $150.2 million representing additional case reserves established by us on assumed reinsurance claims, $63.0 million representing case reserves established by us on direct excess insurance claims, including Mt. McKinley, and $283.9 million representing IBNR reserves.
Ultimate loss projections for A&E liabilities cannot be accomplished using standard actuarial techniques. In 2007, we completed a detailed study of our asbestos experience and our cedants’ asbestos exposures and also considered industry trends. Our Claims Department undertook a contract by contract analysis of our direct business and projected those findings to our assumed reinsurance business. Our actuaries utilized nine methodologies to project our potential ultimate liabilities including projections based on internal data and assessments, extrapolations of non-public and publicly available data for our cedants and benchmarking against industry data and experience. As a result of the study, we increased our gross reinsurance asbestos reserves by $250.0 million and our gross direct asbestos reserves by $75.0 million. Subsequent to the study, we have not experienced significant claims activity related to asbestos. We believe that our A&E reserves represent our best estimate of the ultimate liability, however, there can be no assurance that ultimate loss payments will not exceed such reserves, perhaps by a significant amount. No additional gross reserve strengthening was made in 2008 and 2009.
Shareholders’ Equity. Our shareholders’ equity increased to $6,101.7 million as of December 31, 2009 from $4,960.4 million as of December 31, 2008. This increase was the result of $807.0 million in net income, unrealized appreciation on investments, net of tax, of $529.9 million, $83.8 million of foreign currency translation adjustment and $22.5 million of share-based compensation transactions, partially offset by the repurchase of 2.4 million common shares for $190.6 million and $116.9 million of shareholder dividends.
Capital Our business operations are in part dependent on our financial strength and financial strength ratings, and the market’s perception of our financial strength, as measured by shareholders’ equity, which was $6,101.7 million at December 31, 2009 and $4,960.4 million at December 31, 2008. On March 13, 2009, Everest Re and Everest National, wholly owned indirect subsidiaries of the Company, received notification of a one level ratings downgrade by Standard & Poor’s. We continue to possess significant financial flexibility and access to the debt and equity markets as a result of our perceived financial strength, as evidenced by the financial strength ratings as assigned by independent rating agencies. During the last six months of 2008 and into 2009, the capital markets were illiquid in reaction to the deepening credit crisis which led to bank and other financial institution failures and effective failures. Credit spreads widened and
From time to time, we have used open market share repurchases to adjust our capital position and enhance long term expected returns to our shareholders. On July 21, 2008, our existing authorization to purchase up to 5 million of our shares was amended to authorize the purchase of up to 10 million shares. On February 24, 2010, our existing authorization to purchase up to 10 million of our shares was amended to authorize the purchase of up to 15 million shares. As of December 31, 2009, we had repurchased 6.5 million shares under this authorization.
Liquidity. Our principal investment objectives are to ensure funds are available to meet our insurance and reinsurance obligations and to maximize after-tax investment income while maintaining a high quality diversified investment portfolio. Considering these objectives, we view our investment portfolio as having two components: 1) the investments needed to satisfy outstanding liabilities and 2) investments funded by our shareholders’ equity.
The Group Credit Facility requires Group to maintain a debt to capital ratio of not greater than 0.35 to 1 and to maintain a minimum net worth. Minimum net worth is an amount equal to the sum of $3,575.4 million plus 25% of consolidated net income for each of Group’s fiscal quarters, for which statements are available ending on or after January 1, 2007 and for which consolidated net income is positive, plus 25% of any increase in consolidated net worth during such period attributable to the issuance of ordinary and preferred shares, which at December 31, 2009, was $4,063.4 million. As of December 31, 2009, the Company was in compliance with all Group Credit Facility covenants.
Effective August 23, 2006, Holdings entered into a five year, $150.0 million senior revolving credit facility with a syndicate of lenders referred to as the “Holdings Credit Facility”. Citibank N.A. is the administrative agent for the Holdings Credit Facility. The Holdings Credit Facility may be used for liquidity and general corporate purposes. The Holdings Credit Facility provides for the borrowing of up to $150.0 million with interest at a rate selected by Holdings equal to either, (1) the Base Rate (as defined below) or (2) a periodic fixed rate equal to the Eurodollar Rate plus an applicable margin. The Base Rate means a fluctuating interest rate per annum in effect from time to time to be equal to the higher of (a) the rate of interest publicly announced by Citibank as its prime rate or (b) 0.5% per annum above the Federal Funds Rate, in each case
At December 31, 2009 and 2008, the Holdings Credit Facility had outstanding letters of credit of $28.0 million.
Projected catastrophe losses are generally summarized in terms of the PML. We define PML as our anticipated loss, taking into account contract terms and limits, caused by a single catastrophe affecting a broad contiguous geographic area, such as that caused by a hurricane or earthquake. The PML will vary depending upon the modeled simulated losses and the make-up of the in force book of business. The projected severity levels are described in terms of “return periods”, such as “100-year events” and “250-year events”. For example, a 100-year PML is the estimated loss from a single event which has a 1% probability of being exceeded in a twelve month period. Conversely, it corresponds to a 99% probability that the loss from a single event will fall below the indicated PML. It is important to note that PMLs are estimates. Modeled events are hypothetical events produced by a stochastic model. As a result, there can be no assurance that any actual event will align with the modeled event or that actual losses from events similar to the modeled events will not vary materially from the modeled event PML.
Management estimated that the projected economic loss from its largest 100-year event in a given zone does not exceed 10% of its projected 2010 shareholders’ equity. Economic loss is the gross PML reduced by estimated reinstatement premiums to renew coverage and income taxes. The impact of income taxes on the PML depends on the distribution of the losses by corporate entity, which is also affected by inter-affiliate reinsurance. Management also monitors and controls its largest PMLs at multiple points along the loss distribution curve, such as loss amounts at the 20, 50, 100, 250, 500 and 1,000 year return periods. This process enables management to identify and control exposure accumulations and to integrate such exposures into enterprise risk, underwriting and capital management decisions.
We believe that our greatest worldwide 1 in 100 year exposure to a single catastrophic event is to a hurricane affecting the U.S. southeast coast, where we estimate we have a gross PML exposure of $864 million. See also table under ITEM 1, “Business - Risk Management of Underwriting and Retrocession Arrangements”.
Interest rate risk is the potential change in value of the fixed maturity portfolio, including short-term investments, from a change in market interest rates. In a declining interest rate environment, it includes prepayment risk on the $2,971.7 million of mortgage-backed securities in the $13,056.5 million fixed maturity portfolio. Prepayment risk results from potential accelerated principal payments that shorten the average life and thus the expected yield of the security.
Equity Risk. Equity risk is the potential change in fair and/or market value of the common stock and preferred stock portfolios arising from changing equity prices. Our equity investments consist of a diversified portfolio of individual securities and mutual funds, which invest principally in high quality common and preferred stocks that are traded on the major exchanges. The primary objective of the equity portfolio is to obtain greater total return relative to bonds over time through market appreciation and income.
We sold six equity index put option contracts based on the S&P 500 index, for total consideration, net of commissions, of $22.5 million. At December 31, 2009, fair value for these equity index put option contracts was $51.2 million. These equity index put option contracts each have a single exercise date, with maturities ranging from 12 to 30 years and strike prices ranging from $1,141.21 to $1,540.63. No amounts will be payable under these equity index put option contracts if the S&P 500 index is at or above the strike prices on the exercise dates, which fall between June 2017 and March 2031. If the S&P 500 index is lower than the strike price on the applicable exercise date, the amount due would vary proportionately with the percentage by which the index is below the strike price. Based on historical index volatilities and trends and the December 31, 2009 index value, we estimate the probability for each equity index put option contract, of the S&P 500 index falling below the strike price on the exercise date, to be less than 36%. The theoretical maximum payouts under the equity index put option contracts would occur if on each of the exercise dates the S&P 500 index value were zero. At December 31, 2009, the present value of these theoretical maximum payouts using a 6% discount factor was $254.0 million.