W. R. Berkley and its subsidiaries own or lease office buildings or office space suitable to conduct their operations. At December 31, 2011, the Company had aggregate office space of 3,663,698 square feet, of which 1,121,546 were owned and 2,542,152 were leased.
In examining reserve adequacy, several factors are considered in estimating the ultimate economic value of losses. These factors include, among other things, historical data, legal developments, changes in social attitudes and economic conditions, including the effects of inflation. The actuarial process relies on the basic assumption that past experience, adjusted judgmentally for the effects of current developments and anticipated trends, is an appropriate basis for predicting future outcomes. Reserve amounts are based on management’s informed estimates and judgments using currently available data. As additional experience and other data become available and are reviewed, these estimates and judgments may be revised. This may result in reserve increases or decreases that would be reflected in our results in periods in which such estimates and assumptions are changed.
The key assumptions used to arrive at the best estimate of loss reserves are the expected loss ratios, rate of loss cost inflation, and reported and paid loss emergence patterns. Expected loss ratios represent management’s expectation of losses at the time the business is written, before any actual claims experience has emerged. This expectation is a significant determinant of the estimate of loss reserves for recently written business where there is little paid or incurred loss data to consider. Expected loss ratios are generally derived from historical loss ratios adjusted for the impact of rate changes, loss cost trends and known changes in the type of risks underwritten. Expected loss ratios are estimated for each key line of business within each operating unit. Expected loss cost inflation is particularly important for the long-tail lines, such as excess casualty, and claims with a high medical component, such as workers’ compensation. Reported and paid loss emergence patterns are used to project current reported or paid loss amounts to their ultimate settlement value. Loss development factors are based on the historical emergence patterns of paid and incurred losses, and are derived from the Company’s own experience and industry data. The paid loss emergence pattern is also significant to excess and assumed workers’ compensation reserves because those reserves are discounted to their estimated present value based upon such estimated payout patterns. Management believes the estimates
The key assumptions used in calculating the most recent estimate of the loss reserves are reviewed each quarter and adjusted, to the extent necessary, to reflect historical changes, current trends and other factors observed. If the actual level of loss frequency and severity are higher or lower than expected, the ultimate losses will be different than management’s estimate. The following table reflects the impact of changes (which could be favorable or unfavorable) in frequency and severity, relative to our assumptions, on our loss estimate for claims occurring in 2011 (dollars in thousands):
Approximately $1.4 billion, or 19%, of the Company’s net loss reserves as of December 31, 2011 relate to assumed reinsurance business. There is a higher degree of uncertainty and greater variability regarding estimates of assumed loss reserves because those estimates are based, in part, upon information received from ceding companies. If information received from ceding companies is not timely or correct, the Company’s estimate of ultimate losses may not be accurate. Furthermore, due to delayed reporting of claim information by ceding companies, the claim settlement tail for assumed reinsurance is extended. Management considers the impact of delayed reporting in its selection of assumed loss development factors.
Reserves for excess and assumed workers’ compensation business are net of an aggregate net discount of $892 million and $898 million as of December 31, 2011 and December 31, 2010, respectively.
The following table presents development in our estimate of claims occurring in prior years:
For the year ended December 31, 2011, estimates for claims occurring in prior years decreased by $182 million. The favorable reserve development in 2011 was primarily attributable to accident years 2007 through 2009. The changes in prior year loss reserve estimates are generally the result of ongoing analysis of recent loss development trends. Original estimates are increased or decreased as additional information becomes known regarding individual claims and aggregate claim trends.
Specialty - The majority of the favorable reserve development for the specialty segment during 2011 and 2010 was associated with excess and surplus (“E&S”) casualty business. E&S insurers are free from rate and form regulation and generally charge higher rates for business than those that are charged in the “standard” market. Beginning in 2002, the E&S business began to experience improved claim frequency (i.e., a lower number of reported claims per unit of exposure). One reason for the lower number of claims was the Company’s introduction of more restrictive policy language which included additional exclusions that eliminated claims that would have previously been covered, particularly for the Company’s building contractor business. In addition, as standard carriers tightened their underwriting criteria, the Company benefited from an influx of accounts from the standard market to the E&S market during these years. The more restrictive policy language and the influx of standard market business resulted in an improved risk profile within the E&S business and a reduction in loss costs that was not expected at the time loss reserves were initially established. In addition, loss severity trends for E&S casualty business have been lower than we had initially expected for the 2005 to 2009 period. We began to recognize these trends in 2007 and have continued to reduce our estimates of ultimate claim costs since then as the magnitude of the frequency trends has become more evident. The favorable reserve development in 2011 was primarily attributable to accident years 2007 through 2009.
Regional - The favorable reserve development for the regional segment during 2011 was primarily related to the general liability portion of commercial multi-peril business and to commercial automobile liability business. The favorable reserve development resulted mainly from lower loss emergence on known case reserves relative to historical levels. The favorable reserve development was primarily attributable to accident years 2007 through 2009.
Alternative Markets - The favorable reserve development for the alternative markets segment during 2011 was related to a decrease in prior year reserves for primary workers’ compensation business and, to a lesser extent, for medical excess business, partially offset by an increase in prior year reserves for excess workers’ compensation business. The majority of favorable reserve development for primary workers’ compensation was related to California business, where the impact of legislative reforms continues to be reflected in improved loss trends. The increase in loss reserves for excess workers’ compensation business was related primarily to increased medical and pharmaceutical costs associated with certain long-term disability claims.
International - The favorable reserve development for the international segment during 2011 was primarily related to property business written in 2010 by our Lloyd's syndicate and Asia-Pacific reinsurance business.
Assumed Reinsurance Premiums. The Company estimates the amount of assumed reinsurance premiums that it will receive under treaty reinsurance agreements at the inception of the contracts. These premium estimates are revised as the actual amount of assumed premiums is reported to the Company by the ceding companies. As estimates of assumed premiums are made or revised, the related amount of earned premiums, commissions and incurred losses associated with those premiums are recorded. Estimated assumed premiums receivable were approximately $64 million and $58 million at December 31, 2011 and December 31, 2010, respectively. The assumed premium estimates are based upon terms set forth in reinsurance agreements, information received from ceding companies during the underwriting and negotiation of agreements, reports received from ceding companies and discussions and correspondence with reinsurance intermediaries. The Company also considers its own view of market conditions, economic trends and experience with similar lines of business. These premium estimates represent management’s best estimate of the ultimate amount of premiums to be received under its assumed reinsurance agreements.
A summary of the Company’s non-investment grade fixed maturity securities that were in an unrealized loss position at December 31, 2011 is presented in the table below.
(1) This investment is a residential mortgage-backed security that was evaluated based on the performance of the underlying collateral under various economic and default scenarios. The security has met its contractual obligations and the Company expects that it will continue to meet those contractual payment obligations as they become due. Based on this evaluation, the Company does not consider the investment to be OTTI.
Loans Receivable - The Company monitors the performance of its loans receivable, including current market conditions for each loan and the ability to collect principal and interest. For loans where the Company determines it is probable that the contractual terms will not be met, an analysis is performed and a valuation reserve is established, if necessary, with a charge to earnings. Loans receivable are reported net of a valuation reserve of $20 million at December 31, 2011 and 2010.
The Company monitors the performance of its loans receivable and assesses the ability of the borrower to pay principal and interest based upon loan structure, underlying property values, cash flow and related financial and operating performance of the property and market conditions. Loans receivable with a potential for default are further assessed using discounted cash
Fair Value Measurements. The Company’s fixed maturity and equity securities available for sale and its trading account securities are carried at fair value. Fair value is defined as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.” The Company utilizes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date. Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for similar assets in active markets. Level 3 inputs are unobservable inputs for the asset or liability. Unobservable inputs may only be used to measure fair value to the extent that observable inputs are not available. The fair value of the vast majority of the Company’s portfolio is based on observable data (other than quoted prices) and, accordingly, is classified as Level 2.
Independent pricing services - The vast majority of the Company’s fixed maturity securities available for sale were priced by independent pricing services (generally one U.S. pricing service plus additional pricing services with respect to a limited number of foreign securities held by the Company). The prices provided by the independent pricing services are generally based on observable market data in active markets (e.g., broker quotes and prices observed for comparable securities). The determination of whether markets are active or inactive is based upon the volume and level of activity for a particular asset class. The Company reviews the prices provided by pricing services for reasonableness based upon current trading levels for similar securities. If the prices appear unusual to the Company, they are re-examined and the value is either confirmed or revised. In addition, the Company periodically performs independent price tests of a sample of securities to ensure proper valuation and to verify our understanding of how securities are priced. As of December 31, 2011, the Company did not make any adjustments to the prices provided by the pricing services. Based upon the Company’s review of the methodologies used by the independent pricing services, these securities were classified as Level 2.
Premiums. Gross premiums written were $5,077 million in 2011, an increase of 15% from $4,416 million in 2010. The increase in gross premiums written was primarily due to growth in our specialty and international business segments as a result of expansion into new geographic and product markets. Approximately 80% of policies expiring in 2011 were renewed, compared with a 77% renewal retention rate for policies expiring in 2010. The average rate (i.e., average premium adjusted for change in exposures) for policies that renewed in 2011 increased by approximately 2.3%. Audit premiums were $53 million in 2011 compared with $18 million in 2010.
Beginning in 2005, the property casualty insurance market became more competitive and insurance rates decreased across most business lines. While prices increased in 2011, overall loss costs are also generally increasing and current market price levels for certain lines of business remain below the prices required for the Company to achieve its return objectives. A summary of gross premiums written in 2011 compared with 2010 by line of business within each business segment follows:
Regional gross premiums decreased 1% to $1,149 million in 2011 from $1,160 million in 2010. Gross premiums increased $14 million (3%) for commercial multiple peril, $11 million (5%) for workers’ compensation and $7 million (4%) for other lines. Gross premiums decreased $7 million (2%) for commercial automobile. Gross premiums written decreased $36 million as a result of the transfer of fully reinsured assigned risk plan premiums to the alternative markets segment in 2011.
Alternative Markets gross premiums increased 18% to $827 million in 2011 from $703 million in 2010. Excluding assigned risk plans, which are fully reinsured, gross premiums increased 6% to $676 million in 2011 from $636 million in 2010. Gross premiums increased $51 million (68%) for accident and health products, $29 million (11%) for primary workers’ compensation and $13 million (38%) for other liability and decreased $4 million (7%) for other lines. Gross premiums decreased $48 million (24%) for excess workers’ compensation. Fully reinsured assigned risk premiums increased $84 million (including the $36 million transferred from the regional segment) to $151 million in 2011.
Net premiums written were $4,357 million in 2011, an increase of 13% from $3,851 million in 2010. Ceded reinsurance premiums as a percentage of gross written premiums increased to 14% in 2011 from 13% in 2010. The increase in the percentage of business ceded was due to the increase in premiums written by new companies, which cede a higher portion of their gross premiums, and to growth in premiums written by assigned risk plans, which cede 100% of their gross premiums.
Alternative Markets - The loss ratio of 72.3% in 2011 was 4.7 points higher than the loss ratio of 67.6% in 2010. Catastrophe losses were $2 million in 2011 compared with none in 2010, an increase of 0.3 loss ratio points. Favorable prior year reserve development was $3 million in 2011 compared with $24 million in 2010, a difference of 3.4 loss ratio points. The loss ratio excluding catastrophe losses and favorable prior year reserve development increased 1.0 points to 72.5% in 2011 from 71.5% in 2010.
Underwriting expenses are comprised of commissions paid to agents and brokers, premium taxes and other assessments and internal underwriting costs. The expense ratio (underwriting expenses expressed as a percentage of premiums earned) was 34.4% in 2011 compared with 34.3% in 2010 due to increases in internal underwriting costs, largely offset by an increase in earned premiums.
Expenses from Wholly-Owned Investees. These expenses represent costs associated with aviation-related businesses that include cost of goods sold related to aircraft and other sales, labor and equipment costs related to repairs and other services and general and administrative expenses. Expenses from wholly-owned investees were $245 million in 2011 compared to $208 million in 2010 due to higher cost of aircraft sold as a result of higher sales volume.
Interest Expense. Interest expense was $113 million in 2011 compared with $107 million in 2010 due to the issuance of $300 million of 5.375% senior notes in September 2010, partially offset by repayment of $150 million 5.125% senior notes in September 2010.
Net Income to Common Stockholders. The following table presents the Company's net income to common stockholders and net income per diluted share for the years ended December 31, 2010 and 2009 (amounts in thousands, except per share data):
The Company reported net income of $449 million in 2010 compared to $309 million in 2009. The increase in net income was primarily due to lower losses from investment funds ($6 million in 2010 compared with $164 million in 2009) and lower other-than-temporary investment impairments ($9 million in 2010 compared with $152 million in 2009). The number of weighted average diluted shares decreased as a result of the Company's repurchases of its common stock in 2010 and 2009.
Specialty gross premiums increased 4% to $1,526 million in 2010 from $1,464 million in 2009. Gross premiums increased 12% for property lines, 6% for professional liability and 2% for other liability. Gross premiums decreased 18% for commercial automobile and 17% for products liability.
Regional gross premiums decreased 6% to $1,160 million in 2010 from $1,230 million in 2009. Gross premiums decreased 6% for workers' compensation, 6% for commercial automobile and 3% for commercial multiple peril. Gross premiums include assigned risk premiums, which are fully reinsured, of $36 million in 2010 and $66 million in 2009. The decrease in assigned risk premiums was due to the transfer of certain assigned risk premiums from the regional segment to the alternative markets segment in 2010.
Alternative Markets gross premiums increased 6% to $703 million in 2010 from $665 million in 2009. Gross premiums decreased 16% for excess workers' compensation and increased 1% for primary workers' compensation. Gross premiums include fully reinsured assigned risk premiums of $67 million in 2010 and $24 million in 2009. The increase is primarily due to the transfer from the regional segment described above.
Reinsurance gross premiums decreased 7% to $425 million in 2010 from $456 million in 2009. Gross premiums decreased 10% to $288 million for casualty business and increased 1% to $137 million for property business.
International gross premiums increased 37% to $602 million in 2010 from $439 million in 2009. The increase is primarily due to an increase in business written by our recently started operations in Canada, Norway and Brazil and our Lloyd's syndicate. Gross premiums increased 144% for property lines, 30% for liability lines, 24% for workers' compensation, 20% for reinsurance assumed, 6% for automobile and 1% for professional liability.
Net premiums written were $3,851 million in 2010, an increase of 3% from $3,730 million in 2009. Ceded reinsurance premiums as a percentage of gross written premiums increased to 13% in 2010 from 12% in 2009. The increase in the percentage of business ceded was due to the increase in premiums written by new companies, which cede a higher portion of their gross premiums, and to growth in premiums written by assigned risk plans, which cede 100% of their gross premiums.
Premiums earned increased 1% to $3,836 million in 2010 from $3,806 million in 2009. Insurance premiums (including the impact of rate changes) are generally earned evenly over the policy term. Premiums earned in 2010 are related to business written during both 2010 and 2009.
Insurance Service Fees. Insurance service fees consist of fee-based services to help clients develop and administer self-insurance programs, primarily for workers' compensation coverage. Service fees decreased to $85 million in 2010 from $93 million in 2009 due to a decline in fees received for claims administration services.
Other-Than-Temporary Impairments. Other-than-temporary impairments were $9 million in 2010 compared with $143 million in 2009. The impairment charge in 2009 was primarily related to debt and preferred stock of major financial institutions that experienced adverse credit events and ratings downgrades during the period, including write-downs of debt issued by Thornburg Mortgage, Inc. and preferred stock issued by Citibank and Bank of America.
Losses and Loss Expenses. Losses and loss expenses decreased to $2,310 million in 2010 from $2,337 million in 2009. The consolidated loss ratio of 60.2% in 2010 was 1.2 points lower than the loss ratio of 61.4% in 2009. Catastrophe losses, net of reinsurance recoveries and reinstatement premiums, were $81 million in 2010 (including $8 million for the earthquake in Chile) compared with $63 million in 2009, an increase of 0.5 loss ratio points. Favorable prior year reserve development was $234 million in 2010 compared with $190 million in 2009, a difference of 1.2 loss ratio points. The loss ratio excluding catastrophe losses and favorable prior year reserve development decreased 0.5 points to 64.2% in 2010 from 64.7% in 2009. A summary of loss ratios in 2010 compared with 2009 by business segment follows:
points to 61.7% in 2010 from 60.5% in 2009 due to earned pricing and loss cost trends.
Alternative Markets - The loss ratio of 67.6% in 2010 was 4.2 points higher than the loss ratio of 63.4% in 2009. Favorable prior year development was $24 million in 2011 compared with $45 million in 2010, a difference of 3.7 loss ratio points. The loss ratio excluding favorable prior year reserve development increased 0.5 points to 71.5% in 2011 from 71.0% in 2010.
Reinsurance - The loss ratio of 52.5% in 2010 was 5.4 points lower than the loss ratio of 57.9% in 2009. Catastrophe losses were $4 million, or 1.0 loss ratio points, in 2010 compared with none in 2009. Favorable prior year reserve development was $26 million in 2010 compared with $16 million in 2009, a difference of 2.4 loss ratio points. The loss ratio excluding catastrophe losses and favorable prior year reserve development decreased 4.0 points to 57.8% in 2010 from 61.8% in 2009.
International - The loss ratio of 61.8% in 2010 was 1.9 points higher than the loss ratio of 59.9% in 2009. Catastrophe losses were $4 million, or 0.9 loss ratio points, in 2010 compared with none in 2009. Favorable prior year reserve development was $1 million in 2010 and $8 million in 2009, a difference of 2.1 loss ratio points. The loss ratio excluding catastrophe losses and favorable prior year reserve development decreased 1.1 points to 61.2% in 2010 from 62.3% in 2009.
Service expenses, which represent the costs associated with the fee-based businesses, decreased 8% to $72 million. The decrease was due to lower employment costs and was in line with the rate of decrease in insurance service fees.
Net foreign currency gains and losses result from transactions denominated in a currency other than the operating unit's functional currency. The loss in 2010 was primarily attributable to operating units in the U.K. and resulted from transactions denominated in Australian and Norwegian currencies.
Other costs and expenses, which represent general and administrative expenses that are not allocated to business segments, decreased 2% to $107 million.
At December 31, 2011, investments in foreign fixed maturity securities were as follows:
Investment Funds. At December 31, 2011, the carrying value of investment funds was $681 million, including investments in real estate funds of $373 million and investments in energy funds of $99 million.
Real Estate. Real estate is directly owned property held for investment. At December 31, 2011, real estate consists of two office buildings in London, including one in operation and one under development, and a long-term ground lease in Washington D. C.
Loans Receivable. Loans receivable, which are carried at amortized cost, have an aggregate cost of $263 million and an aggregate fair value of $245 million at December 31, 2011. Amortized cost of these loans is net of a valuation allowance of $20 million as of December 31, 2011. The six largest loans have an aggregate amortized cost of $187 million and an aggregate fair value of $166 million as of such date and are secured by commercial real estate. These loans earn interest at floating LIBOR-based interest rates and have maturities (inclusive of extension options) through March 2016. The loans are secured by office buildings (86%) and hotels (14%) located primarily in New York City, California, Hawaii and Boston.
The Company's insurance subsidiaries' principal sources of cash are premiums, investment income, service fees and proceeds from sales and maturities of portfolio investments. The principal uses of cash are payments for claims, taxes, operating expenses and dividends. The Company expects its insurance subsidiaries to fund the payment of losses with cash received from premiums, investment income and fees. The Company targets an average duration for its investment portfolio that is within one year of the average duration of its liabilities so that portions of its investment portfolio mature throughout the claim cycle and are available for the payment of claims if necessary. In the event operating cash flow and proceeds from maturities and prepayments of fixed income securities are not sufficient to fund claim payments and other cash requirements, the remainder of the Company's cash and investments is available to pay claims and other obligations as they become due. The Company's investment portfolio is highly liquid, with approximately 85% invested in cash, cash equivalents and marketable fixed income securities as of December 31, 2011. If the sale of fixed maturity securities were to become necessary, a realized gain or loss equal to the difference between the cost and sales price of securities sold would be recognized.
As further described in Note 1(Q) to the consolidated financial statements for the years ended December 31, 2011, 2010 and 2009, the Company plans to apply new FASB guidance regarding deferred acquisition costs as of January 1, 2012. The Company estimates that the effect of adopting this guidance will be a reduction in common stockholders' equity of between $50 million and $60 million as of January 1, 2012.
The Company files a consolidated income tax return in the U.S. and foreign tax returns in each of the countries in which it has overseas operations. At December 31, 2011, the Company had a deferred gross tax asset of $433 million (which primarily relates to loss and loss expense reserves and unearned premium reserves) and a gross deferred tax liability of $464 million (which primarily relates to deferred policy acquisition costs and unrealized investment gains). The realization of the deferred tax asset is dependent upon the Company's ability to generate sufficient taxable income in future periods. Based on historical results and the prospects for future operations, management anticipates that it is more likely than not that future taxable income will be sufficient for the realization of this asset.
The Company has not provided U.S. deferred income taxes on the undistributed earnings of approximately $66 million of its non-U.S. subsidiaries since these earnings are intended to be permanently reinvested in the non-U.S. subsidiaries. However, in the future, if such earnings were distributed to the Company, taxes of approximately $5.0 million, assuming all tax credits are realized, would be payable on such undistributed earnings and would be reflected in the tax provision for the year in which these earnings are no longer intended to be permanently reinvested in the foreign subsidiary.
(1)Rating represents S&P rating, or if not rated by S&P, A.M. Best rating.
The majority of "non-rated and other" consists of amounts due from government sponsored reinsurers and amounts that are secured by letters of credit or other forms of collateral.
Many states require licensed insurers that provide workers' compensation insurance to participate in programs that provide workers' compensation to employers that cannot procure coverage from an insurer on a voluntary basis. Insurers can fulfill this residual market obligation by participating in pools where results are shared by the participating companies. The Company acts as a servicing carrier for workers' compensation pools in 18 states. As a servicing carrier, the Company writes residual market business directly and then cedes 100% of this business to the respective pool. As a servicing carrier, the Company receives fee income for its services. The Company does not retain underwriting risk, and credit risk is limited as ceded balances are jointly shared by all the pool members.
Following is a summary of the Company's contractual obligations as of December 31, 2011 (dollars in thousands):
The estimated payments for reserves for losses and loss expenses in the above table represent the projected (undiscounted) payments for gross loss and loss expense reserves related to losses incurred as of December 31, 2011. The estimated payments in the above table do not consider payments for losses to be incurred in future periods. These amounts include reserves for reported losses and reserves for incurred but not reported losses. Estimated amounts recoverable from reinsurers are not reflected. The estimated payments by year are based on historical loss payment patterns. The actual payments may differ from the estimated amounts due to changes in ultimate loss reserves and in the timing of the settlement of those reserves.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2011 and 2010, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2011, in conformity with U.S. generally accepted accounting principles.
Fair value is generally determined based on quoted market prices. For publicly traded securities for which quoted prices are unavailable, the Company determines fair value based on independent broker quotations and other observable market data. For securities traded only in private negotiations, the Company determines fair value based primarily on the cost of such securities, which is adjusted to reflect prices of recent placements of securities of the same issuer, financial data, projections and business developments of the issuer and other relevant information.
Acquisition costs incurred in writing insurance and reinsurance business (primarily commissions and premium taxes) are deferred and amortized ratably over the terms of the related contracts. Ceding commissions received on reinsurance contracts are netted against acquisition costs and are recognized ratably over the life of the contract. Deferred policy acquisition costs are presented net of unearned ceding commissions. Deferred policy acquisition costs are reviewed to determine if they are recoverable from future income and, if not, are charged to expense. The recoverability of deferred policy acquisition costs is evaluated separately by each of our operating companies for each of their major lines of business. Future investment income is taken into account in measuring the recoverability of deferred policy acquisition costs.
Contracts that do not meet the risk transfer requirements of GAAP are accounted for using the deposit accounting method. Under this method, an asset or liability is recognized at the inception of the contract based on consideration paid or received. The amount of the deposit asset or liability is adjusted at subsequent reporting dates using the interest method with a corresponding credit or charge to interest income or expense. Deposit liabilities for assumed reinsurance contracts were $80 million and $95 million at December 31, 2011 and 2010, respectively.
Goodwill and other intangibles assets are tested for impairment on an annual basis and at interim periods where circumstances require. The Company's impairment test as of December 31, 2011 indicated that there were minimal impairment losses related to goodwill and other intangible assets. Intangible assets of $29 million are included in other assets as of December 31, 2011 and 2010.
In October 2010, the FASB (Financial Accounting Standards Board) issued guidance regarding the treatment of costs associated with acquiring or renewing insurance contracts. This guidance modifies the definition of the types of costs that can be capitalized and specifies that the costs must be directly related to the successful acquisition of a new or renewed insurance contract. This guidance is effective for the quarter ending March 31, 2012. The Company plans to apply this guidance retrospectively and estimates that the effect of adopting this guidance will be a reduction in common stockholders' equity of between $50 million and $60 million as of January 1, 2012.
Gross unrealized losses for mortgage-backed securities include $7,668,000 and $4,064,000, as of December 31, 2011 and 2010, respectively, related to the non-credit portion of OTTI recognized in other comprehensive income.
At December 31, 2011 and 2010, investments in equity securities available for sale were as follows:
The Company uses put options, call options and swap contracts in order to mitigate the impact of potential changes in market conditions on the merger arbitrage trading account. These options and contracts are reported at fair value. As of December 31, 2011, the fair value of long option contracts outstanding was $8 million (notional amount of $86 million) and the fair value of short option contracts outstanding was $4 million (notional amount of $107 million). Other than with respect to the use of these trading account securities, the Company does not make use of derivatives.
Real estate is directly owned property held for investment. At December 31, 2011, real estate consists of two office buildings in London, including one in operation and one under development, and a long-term ground lease in Washington D. C. Future minimum rental income expected on operating leases relating to real estate held for investment is $1,421,000 in 2012, $1,464,000 in 2013, $1,508,000 in 2014, $1,553,000 in 2015, $1,600,000 in 2016 and $331,476,000 thereafter.
This investment is a residential mortgage-backed security that was evaluated based on the performance of the underlying collateral under various economic and default scenarios. The security has met its contractual obligations and the Company expects that it will continue to meet those contractual payment obligations as they become due. Based on this evaluation, the Company does not consider the investment to be OTTI.
Common Stocks - At December 31, 2011, there were four common stocks in an unrealized loss position with an aggregate fair value of $47 million and an aggregate unrealized loss of $3 million. The Company does not consider any of these securities to be OTTI.
The following tables summarize changes in Level 3 assets and liabilities for the years ended December 31, 2011 and 2010:
For the year ended December 31, 2011, estimates for claims occurring in prior years (net of additional and return premiums) decreased by $182 million. The favorable reserve development in 2011 was primarily attributable to accident years 2007 through 2009. The changes in prior year loss reserve estimates are generally the result of ongoing analysis of recent loss development trends. Original estimates are increased or decreased as additional information becomes known regarding individual claims and aggregate claim trends.
The Company’s net reserves for losses and loss adjustment expenses relating to asbestos and environmental claims were $34 million and $36 million at December 31, 2011 and 2010, respectively. The Company’s gross reserves for losses and loss adjustment expenses relating to asbestos and environmental claims were $59 million and $51 million at December 31, 2011 and 2010, respectively. Increases (decreases) in net incurred losses and loss expenses for reported asbestos and environmental claims were approximately $1 million, $2 million and $(0.6) million in 2011, 2010 and 2009, respectively. Net paid losses and loss expenses for asbestos and environmental claims were approximately $3 million in 2011, $3 million in 2010 and $3 million in 2009. The estimation of these liabilities is subject to significantly greater than normal variation and uncertainty because it is difficult to make an actuarial estimate of these liabilities due to the absence of a generally accepted actuarial methodology for these exposures and the potential effect of significant unresolved legal matters, including coverage issues, as well as the cost of litigating the legal issues. Additionally, the determination of ultimate damages and the final allocation of such damages to financially responsible parties are highly uncertain.
Discounting - The Company discounts its liabilities for excess and assumed workers’ compensation business because of the long period of time over which losses are paid. Discounting is intended to appropriately match losses and loss expenses to
income earned on investment securities supporting the liabilities. The expected losses and loss expense payout pattern subject to discounting was derived from the Company’s loss payout experience. For non-proportional business, reserves for losses and loss expenses have been discounted using risk-free discount rates determined by reference to the U.S. Treasury yield curve. These discount rates range from 2.3% to 6.5% with a weighted average discount rate of 4.3%. For proportional business, reserves for losses and loss expenses have been discounted at the statutory rate permitted by the Department of Insurance of the State of Delaware of 2.3%. The aggregate net discount, after reflecting the effects of ceded reinsurance, was $892 million, $898 million and $877 million at December 31, 2011, 2010 and 2009, respectively.
Senior notes and other debt consist of the following (the difference between the face value and the carrying value is unamortized discount):
In 2005, the Company issued $250,000,000 aggregate principal amount of 6.75% Junior Subordinated Debentures due July 26, 2045 (the “Debentures”) to W. R. Berkley Capital Trust II (the “Trust”). At December 31, 2011, the carrying value of the Debentures, net of unamortized discount, was $243,000,000. The Trust simultaneously issued an equal amount of 6.75% mandatorily redeemable preferred securities (the “Trust Preferred Securities”), which are fully and unconditionally guaranteed by the Company to the extent the Trust has funds available for payment of distributions. The Trust Preferred Securities are subject to mandatory redemption in a like amount (i) in whole but not in part upon repayment of the Debentures at maturity, (ii) in whole but not in part, at any time contemporaneously with the optional prepayment of the Debentures by the Company upon the occurrence and continuation of certain events.
The Company had current tax receivables of $9,670,000 and $23,605,000 at December 31, 2011 and 2010, respectively. At December 31, 2011, the Company had foreign net operating loss carryforwards of $420,000, which expire beginning in 2014. The Company had provided a valuation allowance against the unutilized foreign tax credits which were fully utilized in the 2010 federal tax return. The reduction in the valuation relates primarily to the full utilization of the foreign tax credit carryforward. At December 31, 2011, the Company had no deferred tax assets for which a valuation allowance is required. The statute of limitations has closed for the Company’s tax returns through December 31, 2004. The 2005 calendar year statute of limitations remains open as a result of the carry back of capital losses from the 2008 tax year, and the 2006 calendar year statue of limitations remains open as a result of the carry back of capital losses from the 2008 and 2009 tax years.
The Company’s insurance subsidiaries are restricted by law as to the amount of dividends they may pay without the approval of regulatory authorities. During 2012, the maximum amount of dividends which can be paid without such approval is approximately $417 million. Combined net income and policyholders’ surplus of the Company’s consolidated insurance subsidiaries, as determined in accordance with statutory accounting practices, are as follows:
The significant variances between statutory accounting practices and GAAP are that for statutory purposes bonds are carried at amortized cost, acquisition costs are charged to income as incurred, deferred Federal income taxes are subject to limitations, excess and assumed workers’ compensation reserves are discounted at different discount rates and certain assets designated as “non-admitted assets” are charged against surplus.
The Company and its subsidiaries use office space and equipment under leases expiring at various dates. These leases are considered operating leases for financial reporting purposes. Some of these leases have options to extend the length of the leases and contain clauses for cost of living, operating expense and real estate tax adjustments. The Company also has an investment in a commercial office building that has a long-term land lease. Future minimum lease payments, without provision for sublease income, are: $34,635,000 in 2012; $31,177,000 in 2013; $26,808,000 in 2014; $22,646,000 in 2015 and $173,015,000 thereafter. Rental expense was $33,003,000, $29,936,000 and $28,067,000 for 2011, 2010 and 2009, respectively.
At December 31, 2011, the Company had commitments to invest up to $328 million in certain investment funds.
The Company has not issued any stock options under its stock incentive plan since 2004. All outstanding options are vested and exercisable. The following table summarizes stock option information:
The following table summarizes information about stock options outstanding at December 31, 2011:
Upon vesting, shares of the Company’s common stock equal to the number of vested RSUs are issued or deferred to a later date, depending on the terms of the specific award agreement. As of December 31, 2011, 2,641,177 shares related to vested RSUs had been deferred.
The fair value of RSUs at the date of grant are recorded as unearned compensation, a component of stockholders’ equity, and expensed over the vesting period. Following is a summary of changes in unearned compensation for the three years ended December 31, 2011:
The Company and its subsidiaries have profit sharing plans in which substantially all employees participate. The plans provide for minimum annual contributions of 5% of eligible compensation; contributions above the minimum are discretionary and vary with each participating subsidiary’s profitability. Employees become eligible to participate in the profit sharing plans on the first day of the month following the first full three months in which they are employed. The plans provide that 40% of the contributions vest immediately and that the remaining 60% vest at varying percentages based upon years of service. The Company’s foreign subsidiaries provide pension benefits in accordance with local regulations. Profit sharing expense was $27 million, $29 million, and $25 million in 2011, 2010 and 2009, respectively.
The following table summarizes the LTIP expense for the three years ended December 31, 2011:
Following is a summary of the amounts recognized in accumulated other comprehensive income (loss) as of December 31, 2011 and 2010:
The components of net periodic pension benefit cost are as follows:
The changes in plan assets and projected benefit obligation recognized in other comprehensive income (loss) are as follows:
Our Specialty lines companies underwrite risks within the excess and surplus lines market and on an admitted basis. The risks are highly complex, often unique exposures that typically fall outside the underwriting guidelines of the standard insurance market or are best served by specialized knowledge of a particular industry. The Specialty lines of business include premises operations, commercial automobile, property, products liability and professional liability lines. The customers in this segment are highly diverse. Business is conducted through 20 operating units, each delivering their products through a variety of distribution channels, depending on the customer base and particular risks insured.
Our Reinsurance companies provide other insurance companies and self-insureds with assistance in managing their net risk through reinsurance on either a portfolio basis, through treaty reinsurance, or on an individual basis, through facultative reinsurance.
Our International operating units write business in almost 40 countries worldwide, with branches or offices in 15 locations outside the United States, including the United Kingdom, Continental Europe, South America, Australia, the Asia Pacific region, Scandinavia and Canada. In each of our international operating territories, we have built decentralized structures that allow products and services to be tailored to each regional customer base. Our international businesses are managed by teams of professionals with expertise in local markets and knowledge of regional environments.
Net premiums earned by major line of business are as follows: