Selected consolidated statement of operations data, ending balance sheet data and share data for each of the five years ended December 31, 2009, follows:
As of January 1, 2007, we adopted a new accounting pronouncement whereby substantially all of our investments are now carried at fair value with changes in fair value being reported as net realized and unrealized investment gains (losses) in our statement of operations. Prior to adoption, substantially all of our investments were carried at fair value with changes in fair value being reported as a separate component of our shareholders’ equity, with changes therein reported as a component of other comprehensive income (loss).
During 2008, we incurred $177.1 million in net catastrophe losses associated with Hurricanes Ike and Gustav. During 2005, we incurred catastrophe losses associated with Hurricanes Katrina, Wilma and Rita. These events significantly increased our expenses in those years.
During 2009, we repurchased and retired $21.0 million of our senior unsecured debt. During 2008, Blue Ocean fully repaid $75.0 million of its debt that was issued in 2006. During 2006, we issued $103.1 million of our junior subordinated debt.
During 2005, we publicly sold 25,850,926 Common Shares for $600.0 million.
Our underwriting results for 2009 were devoid of any individually significant catastrophe losses and included $75.7 million of prior year favorable loss reserve development. Our investment results for 2009 included $181.8 million of net realized and unrealized investment gains which were comprised of $104.2 million in net gains from fixed maturities, $74.6 million in net gains from equity securities and $3.0 million in net gains from other investments.
We believe that our computations of our fully converted tangible book value per share and our change in fully converted tangible book value per share, as adjusted for dividends, are non-GAAP measures which are important to our investors, analysts and other interested parties who benefit from having an objective and consistent basis for comparison with other companies within our industry.
Pricing in most insurance and reinsurance markets is cyclical in nature. During 2009 we observed adequate to strong pricing levels in the majority of our business lines, ending broad price reductions experienced over the previous two years. Pricing strength has also affected the cost of ceded reinsurance protection, with the overall impact being a reduction in both our gross exposure and our reinsurance purchases.
At the same time, reinsurers appear to have maintained pricing discipline and have generally exhibited a selective approach to capacity expansion, which has set the stage for fairly orderly pricing concessions. With some exceptions, pricing reductions are mostly coming off of healthy levels, leading to a low level of renewal attrition on our book. Additionally, we have found opportunities to write new business and expand our participations on existing accounts, which has offset some of the pricing pressure.
Syndicate 5151’s newly formed Coverholder, PUAL, recently commenced underwriting business on behalf of both Syndicate 5151 and third parties with a focus on specialist contractors, recycling and crime classes of business. This business is also is largely uncorrelated with Syndicate 5151’s peak exposures. Due to the timing of its formation, PUAL wrote no business that incepted during 2009.
In January 2010, MUSIC received its authorization as an excess and surplus line insurer in California, a substantial market for that business. During 2009, MUSIC wrote $24.3 million in net premiums, $8.3 million of which was written during the fourth quarter, and our outlook for this business remains positive.
For 2010 we plan to continue to optimize the use of our catastrophe capacity and to look for selective growth opportunities across our broader underwriting platform in order to improve our operating and capital efficiency. We believe our business mix, which is overweight short-tail lines, matches well with the current pricing cycle as pricing for these lines of business continues to be relatively strong. Looking forward, absent a major market event, we see no catalyst for a general market upturn in the near future, though we remain satisfied with the expected profit potential in the markets we target.
It is difficult to predict the amount of annual premiums we will write in 2010 and how attractive overall pricing, terms and conditions will be. To the extent that the pricing environment does not merit the deployment of any excess capital we might have towards new underwriting opportunities, we will continue to consider the use of capital management tools such as share repurchases.
For certain defined natural catastrophe region and peril combinations, we assess the probability and likely magnitude of losses using a combination of industry third-party vendor models, CATM and underwriting judgment. We attempt to model the projected net impact from a single event, taking into account contributions from our inward portfolio of property, aviation, workers’ compensation, marine, casualty, and personal accident insurance policies, reinsurance policies, and event-linked derivative securities offset by the net benefit of any reinsurance or derivative protections we purchase and the net benefit of reinstatement premiums. The table below details our estimated average net impact market share for selected natural catastrophe events of various industry loss magnitudes:
We currently operate through three reportable segments: Montpelier Bermuda, Montpelier Syndicate 5151 and MUSIC. Prior to its liquidation and dissolution in 2009, Blue Ocean constituted a fourth reportable segment. Each reportable segment represents a separate underwriting platform through which we write insurance and reinsurance business. The activities of the Company, certain of its intermediate holding and service companies and intercompany eliminations relating to inter-segment reinsurance and support services, collectively referred to as “Corporate and Other”, are also presented below.
· Pricing levels decreased, particularly in our Property Catastrophe - Treaty and Property Specialty Individual Risk lines of business. This deterioration in pricing had the dual effect of: (i) reducing the premium written on many contract renewals, and (ii) causing Montpelier Bermuda not to renew other contracts.
· Loss-sensitive premium adjustments were made during the year within some retrospectively rated casualty contracts written in our Other Specialty - Treaty line of business. Montpelier Bermuda reduced its estimate of casualty losses incurred on these contracts, and consequently reduced the associated premium written.
In the normal course of its business, Montpelier Bermuda purchases reinsurance in order to manage its exposures. The amount and type of reinsurance that it purchases is dependent on a variety of factors, including the cost of a particular reinsurance cover and the nature of its gross premiums written during a particular period. Pricing strength has affected Montpelier Bermuda’s utilization of ceded reinsurance protection with the overall impact being a steady reduction in both its gross exposure and the level of its reinsurance purchases since 2007.
During 2009, net premiums written within our Montpelier Bermuda segment were consistent with those written in 2008. Net premiums written in 2008 decreased by approximately 13% as compared to 2007. Various factors will continue to affect Montpelier Bermuda’s appetite and capacity to write and retain risk. These include, but are not limited to the impact of changes in frequency and severity assumptions used in our models and the corresponding pricing required to meet our return targets, evolving industry-wide capital requirements and increased competition. The level of reinstatement premiums received in future periods is also dependent upon the occurrence of catastrophic losses.
Net premiums earned during 2009, 2008 and 2007 were $426.0 million, $459.7 million and $491.3 million, respectively, representing decreases of 7% and 6% during 2009 and 2008, respectively. Net premiums earned are a function of the amount and timing of net premiums written.
The following tables summarize Montpelier Bermuda’s loss and LAE reserve activities for the years ended December 31, 2009, 2008 and 2007:
As of December 31, 2009 and 2008, Montpelier Bermuda’s IBNR reserves represented 64% and 51% of its total gross loss and LAE reserves, respectively. With the exception of periods immediately following a natural catastrophe or other large loss event, the portion of loss reserves represented by IBNR tends to be lower for large loss events than it does for other business we write. During 2009, a year with a low level of large losses and sizable payments of existing reserves, our case reserves associated with such events decreased relative to total reserves.
We estimated Montpelier Bermuda’s gross and net loss and LAE reserves using the methodology outlined in our “Summary of Critical Accounting Estimates” contained in Item 7 herein. We did not make any significant changes in the assumptions or methodology used in our reserving process during the year ended December 31, 2009.
During 2009, Montpelier Bermuda incurred $47.7 million of net loss and LAE from catastrophe losses, including European windstorm Klaus and hail storms in Europe and Canada.
During 2008, Montpelier Bermuda incurred catastrophic losses from European Windstorm Emma and Hurricanes Ike and Gustav, representing a combined net loss of $181.2 million. Additionally, Montpelier Bermuda incurred $49.2 million of net losses as a result of four individual risk losses within our Other Specialty line of business.
Loss and LAE development regarding the 2005 explosion and 2007 mining event was driven by the resolution of legal proceedings in 2009. The development associated with the 2006 furnace collapse was the result of new information provided to us by the ceding company in 2009.
· A reduction in losses reported to us during 2008 in connection with several individual risk claims, resulted in a decrease in estimated losses and LAE of $11.0 million.
During the year ended December 31, 2007, Montpelier Bermuda experienced $36.4 million in favorable development on net loss and LAE reserves relating to prior year losses. This decrease in loss and LAE was the result of relatively small adjustments across several classes of business. None of these adjustments was individually significant.
The following table presents Montpelier Bermuda’s underwriting expenses for the years ended December 31, 2009, 2008 and 2007:
The decrease in fixed expenses incurred in 2008, as compared to 2007, is primarily the result of a reduction in the marketing efforts of MMSL and lower intercompany allocations of information technology and risk modeling expenses to the Montpelier Bermuda segment, as our newer operations gained significance and began to bear a greater proportion of such costs. In addition, during 2008 Montpelier Bermuda received a $1.2 million U.K. Value Added Tax refund.
The significant increase in Montpelier Bermuda’s share-based and other incentive compensation recognized during 2009 versus 2008 is the result of an increase in accrued incentive compensation to above-target levels in response to stronger operating results achieved by the Company during 2009. Expenses incurred in 2008 reflected below-target incentive compensation costs, mainly as a result of the significant storm losses we incurred during the third quarter of that year. The 2008 losses were also the primary driver of the decrease in share-based and other incentive compensation from 2007, a year with significantly stronger operating results and few significant loss events.
The following table summarizes Montpelier Syndicate 5151’s gross premiums, by line of business, for the years ended December 31, 2009, 2008 and 2007:
(1) Represents an inter-segment reinsurance cover with Montpelier Bermuda. This intercompany arrangement is eliminated in consolidation.
Montpelier Syndicate 5151 wrote $167.3 million of gross premiums during 2009, which represents a 44% increase over the $116.2 million in total gross premiums written during 2008. The majority of the increase was generated by our U.K.-based underwriters who wrote $119.1 million of gross premiums during 2009, as compared to $79.9 million during 2008. The largest drivers of this increase related to marine business (within our Property and Specialty Individual Risk line of business) and to excess-of-loss and proportional contracts written within our Other Specialty - Treaty line of business. Our U.S.-based underwriters, who wrote $48.2 million of gross premiums during 2009, wrote $36.3 million during 2008. The biggest portion of this increase was written within our Property Specialty - Treaty line of business.
Montpelier Syndicate 5151 also experienced significant growth from 2007, the year in which the segment was established, compared to 2008. The largest drivers of the increase were new business production in engineering, individual and treaty property coverage and U.S. casualty lines, written on both a proportional and non-proportional basis.
Net premiums earned at Montpelier Syndicate 5151 during years ended December 31, 2009, 2008 and 2007 were $133.1 million, $63.6 million and $4.2 million, respectively. Net premiums earned are a function of the timing of net premiums written.
During 2008, Montpelier Syndicate 5151 incurred $46.7 million of net loss and LAE from current year losses which related to several individual risk losses, as well as $6.8 million of losses relating to Hurricanes Gustav and Ike.
This favorable development was partially offset by net adverse development affecting several classes of business.
During 2009 and 2008, Montpelier Syndicate 5151’s acquisition costs included $1.0 million and $0.3 million of profit commissions, respectively, and premium deficiency charges (reversals) of $(0.7) million and $0.1 million, respectively. Absent these adjustments, Montpelier Syndicate 5151’s acquisition cost ratio increased slightly during 2009, due to a change in the mix of business compared to 2008. During 2007, acquisition costs included premium deficiency charges of $0.9 million, representing 21 points to that year’s acquisition costs ratio.
The following table summarizes Montpelier Syndicate 5151’s general and administrative expenses during the years ended December 31, 2009, 2008 and 2007:
Fixed expenses incurred during 2008 and 2007 included Lloyd’s fees of $7.6 million and $2.3 million, respectively, and management fees paid to Spectrum of $4.6 million and $2.5 million, respectively.
Underwriting results for MUSIC, which we acquired on November 1, 2007, were as follows for the years ended December 31, 2009, 2008 and 2007:
All premiums written to date by MUSIC relate to our Property and Specialty Individual Risk line of business. MUSIC has retained almost all of this gross premium, ceding $0.6 million during 2009 and zero in 2008. MUSIC wrote a de minimis amount of premium during 2007.
Underwriting results for Blue Ocean, which was liquidated and dissolved in 2009, for the years ended December 31, 2008 and 2007, were as follows.
Blue Ocean was formed in order to capitalize on the attractive market conditions that existed in the property casualty retrocessional market following Hurricanes Katrina, Rita and Wilma in 2005. While early pricing conditions for this segment were strong, increased competition and weaker demand experienced at the end of 2006 and throughout 2007 adversely impacted pricing.
During 2008 Blue Ocean Re was deregistered as a Bermuda insurer and we acquired all the outstanding share capital of Blue Ocean.
During 2009 Blue Ocean Re was amalgamated into Blue Ocean and Blue Ocean was liquidated and dissolved into the Company.
Our Corporate and Other results for the years ended December 31, 2009, 2008 and 2007 were as follows:
(1) Represents the elimination of an inter-segment reinsurance cover among Montpelier Bermuda, Montpelier Syndicate 5151 and MUSIC.
The following table summarizes the general and administrative expenses of Corporate and Other during the years ended December 31, 2009, 2008, and 2007:
The decrease in fixed expenses for 2009, as compared to 2008, is primarily attributable to: (i) a reduction in consulting services for information technology implementations; (ii) reduced legal expenses regarding corporate matters; (iii) lower audit fee allocations and (iv) reduced insurance allocations. The significant increase in corporate share-based and other incentive compensation recognized during 2009 versus 2008 is the result of an increase in accrued incentive compensation to above-target levels in response to stronger operating results achieved by the Company during 2009. Expenses incurred in 2008 reflected below-target incentive compensation costs, mainly as a result of the storm losses we incurred during the third quarter of that year.
Our investment income decreased in 2009, as compared to 2008 and 2007, mainly as a result of continued decreases in short-term interest rates and reductions in dividend income earned on a smaller portfolio of equity securities. In addition, we discontinued our securities lending program during the second quarter of 2008. Fees earned from our securities lending program during 2008 and 2007 were recorded as additional investment income.
During 2009, we experienced $104.2 million of net realized and unrealized gains from our fixed maturity investments, $74.6 million in net realized and unrealized gains from our equity investments and $3.0 million in net realized and unrealized gains from our other investments. The fixed maturity gains we experienced during 2009 were largely the result of tightening credit spreads between the yield on those securities versus that of U.S. treasuries. Our equity portfolio also experienced gains during 2009, benefitting from gains in the U.S. equity market as a whole.
During 2007, we experienced $19.9 million in net realized and unrealized investment gains from our fixed maturities, $7.5 million in net realized and unrealized gains from our equity investments and $0.9 million in net realized and unrealized losses from our other investments.
As of December 31, 2009, our fixed maturity portfolio contained certain securities with exposure to the subprime mortgage market and the Alternative-A mortgage market which had a fair value of $26.1 million, $19.9 million of which which were rated “AAA” (Extremely Strong) by Standard & Poor’s at that time. Our subprime and Alt-A securities had an amortized cost of $28.3 million as of December 31, 2009.
During 2009, 2008, and 2007, we experienced net foreign exchange gains (losses) on cash and investments of $0.8 million, $(3.3) million and $7.9 million, respectively. The foreign exchange gains (losses) experienced during these years are due to the weakening (strengthening) of the U.S. dollar against the various foreign currencies in which we transact, principally the British pound.
U.S. GAAP establishes a hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into the three broad levels. Level 3 assets are those whose valuations place significant reliance on “unobservable” inputs.
As of December 31, 2008, $191.3 million, or 9.3%, of our total invested assets measured at fair value were considered to be Level 3 assets. Our investments classified as Level 3 at December 31, 2008 primarily consisted of the following: (i) with respect to fixed maturity investments, certain corporate bonds, convertible debt and asset-backed securities, many of which are not publicly traded or are not actively traded; (ii) with respect to equity securities, warrants to acquire equity securities and certain non-U.S. securities; and (iii) with respect to other investments, our investment in Symetra.
Our net foreign exchange transaction gains (losses) on insurance and reinsurance balances primarily represent realized gains and losses resulting from premiums received and losses paid by Montpelier Bermuda in currencies other than the U.S. dollar. From time to time we have entered into foreign currency exchange agreements in order to mitigate the financial effects of foreign exchange rate fluctuations. See “Net Expense from Derivative Instruments” below.
The following table presents our net income (expense) from derivative instruments during the years ended December 31, 2009, 2008 and 2007:
In 2005, we purchased fully-collateralized coverage (the “CAT Bond Protection”) for losses sustained from qualifying hurricane and earthquake loss events from a third-party, Champlain, which financed this coverage through the issuance of $90.0 million in catastrophe bonds to investors under two separate bond tranches, each of which matured on January 7, 2009. Both tranches responded to parametric triggers, whereby payment amounts were determined on the basis of modeled losses incurred by a notional portfolio rather than by actual losses incurred by us. For that reason, this transaction was accounted for as a derivative, rather than as a reinsurance transaction, and was carried at fair value.
Through the date of maturity of the CAT Bond Protection, no industry loss event occurred which would have triggered a recovery by us.
At December 31, 2009 and December 31, 2008, we were a party to outstanding foreign currency exchange agreements having a gross notional exposure of $30.5 million and $33.0 million, respectively. We recorded net income (expense) associated with our Foreign Exchange Contracts of $(0.6) million, $(4.1) million and $3.2 million during 2009, 2008 and 2007, respectively.
During 2008, the CAT Bond Facility was terminated and we purchased the underlying CAT Bonds from the counterparty at their fair value of $71.6 million.
We recorded net revenues associated with our CAT Bond Facility of $1.0 million and $5.3 million during 2008 and 2007, respectively.
In 2007, we sold ILW protection (the “ILW Contract”) to a third-party for $3.7 million under which qualifying loss payments were triggered exclusively by reference to the level of losses incurred by the insurance industry as a whole rather than by losses incurred by the insured. The ILW Contract provided the insured with $15.0 million of second-event protection resulting from industry losses of a stated amount and expired in 2008 without payment.
We recorded revenues associated with the ILW Contract of $0.6 million and $3.1 million during 2008 and 2007, respectively.
The following table summarizes our consolidated interest and other financing expenses for the years ended December 31, 2009, 2008 and 2007:
Our interest and other financing expenses decreased slightly during 2009, as compared to 2008, due primarily to the repurchase of $21.0 million of our Senior Notes in March 2009, partially offset by higher letter of credit fees associated with our Lloyd’s Standby Facility. We increased the Lloyd’s Standby Facility from £110.0 million to $230.0 million in March 2009.
In January 2006 we, through Montpelier Capital Trust III, participated in a private placement of $103.1 million of floating rate capital securities (the “Trust Preferred Securities”). The Trust Preferred Securities mature on March 30, 2036, are redeemable at Montpelier Capital Trust III’s option at par beginning March 30, 2011, and require quarterly distributions of interest to the holders of the Trust Preferred Securities. The Trust Preferred Securities bear interest at 8.55% per annum through March 30, 2011, and thereafter at a floating rate of 3-month LIBOR plus 380 basis points, reset quarterly. Montpelier Capital Trust III simultaneously issued all of its share capital to us for a purchase price of $3.1 million which is carried in other investments.
Our consolidated income tax provision for the years ended December 31, 2009, 2008 and 2007 consisted of the following:
Our U.S. subsidiaries have not yet generated any U.S. Federal taxable income. Our U.S. subsidiaries incurred $0.1 million in state income taxes during each of 2009 and 2008.
Our U.K. and Swiss subsidiaries generated $4.8 million, $2.9 million and $(3.0) million of non-U.S. taxable income (loss) for the years ended December 31, 2009, 2008 and 2007, respectively. Our non-U.S. subsidiaries incurred $1.0 million, $1.0 million and $0.1 million in non-U.S. income taxes during the years ended December 31, 2009, 2008 and 2007, respectively.
In 2008 we acquired all the remaining outstanding common shares of Blue Ocean for $30.5 million in cash. This transaction resulted in an extraordinary gain of $1.0 million representing the excess of fair value of acquired net assets over our cost.
In 2008 and 2007 we had net income attributable to noncontrolling interests in Blue Ocean of $1.9 million and $31.9 million, respectively. As a result of the Blue Ocean Transaction, none of our net income for 2009 was attributable to noncontrolling interests.
As a provider of short-tail insurance and reinsurance, mainly from natural and man-made catastrophes, we could become liable for significant losses on short notice. As a result, we have structured our fixed maturity investment portfolio with high-quality securities with a short average duration in order to reduce our sensitivity to interest rate fluctuations and to provide adequate liquidity for the settlement of our expected liabilities. As of December 31, 2009, our fixed maturities had an average credit quality of “AA+” (Very Strong) by Standard & Poor’s and an average duration of 2.5 years. Nonetheless, if our calculations with respect to the timing of the payment of our liabilities are incorrect, or if we improperly structure our investments, we could be forced to liquidate investments prior to maturity, potentially at a significant loss.
As of December 31, 2009, our sources of immediate liquidity consisted of: (i) $194 million in unrestricted cash; (ii) $376 million in cash equivalents and other highly liquid investments which currently trade at a very narrow bid/ask spread and whose proceeds are available upon one days’ notice; and (iii) $733 million of investment securities which currently trade at a narrow bid-ask spread and whose proceeds are available upon three days’ notice. Further, we believe that we have significant sources of additional liquidity within our investment portfolio beyond these levels although the bid-ask spreads associated with such investment securities would be expected to be broader, perhaps significantly, from sales of those securities previously mentioned, particularly if a large individual investment holding were required to be liquidated in an expedient manner.
Our total capital increased by $349.9 million during 2009 as a result of our recording comprehensive income of $463.8 million, raising $32.0 million in equity capital through the termination of our second Forward Sale Agreement, recognizing $14.2 million of additional paid-in capital through the amortization and issuances of share based compensation, partially offset by declaring $26.5 million in dividends to our common shareholders, repurchasing $21.0 million of our Senior Notes and repurchasing $112.6 million of Common Shares.
We may need to raise additional capital in the future, through the issuance of debt, equity or hybrid securities, in order to, among other things, write new business, pay significant losses, respond to, or comply with, any changes in the capital requirements that rating agencies, regulatory authorities other parties use to evaluate us, acquire new businesses, invest in existing businesses or to refinance our outstanding debt.
The issuance of any new debt, equity or hybrid financial instruments might require terms and conditions that are less favorable to us and our shareholders than those contained within our current capital structure. More specifically, any new issuances of equity or hybrid securities could result in the issuance of securities with rights, preferences and privileges that are senior or otherwise superior to those of Common Shares and could prove to be dilutive to our existing Common Shares. Further, if we cannot obtain adequate capital on favorable terms or otherwise, our business, operating results and financial condition could be adversely affected.
Montpelier Re amended its Tranche B syndicated secured facility in August 2005. The amendment served to revise this facility from a $250.0 million three-year facility to a $225.0 million five-year facility with a revised expiry date of August 2010. This facility is subject to an annual commitment fee of 0.275% on drawn balances and 0.075% on undrawn balances.
Montpelier Re amended its syndicated secured facility (I) in June 2006. The amendment served to revise this facility from a one-year $1.0 billion facility, which expired in June 2007, to a five-year $500.0 million facility. This facility is subject to an annual commitment fee of 0.325% on drawn balances and 0.075% on undrawn balances.
Montpelier Re entered into its Bilateral facility in November 2005. This facility has no stated expiration date and is subject to an annual commitment fee of 0.20% on drawn balances only.
In June 2007 the Company, Montpelier Re and MCL entered into the Lloyd’s Standby Facility to support business written by Syndicate 5151. The Lloyd’s Standby Facility provided Montpelier with a secured £74.0 million standby letter of credit facility through December 31, 2012.
In October 2008 the Lloyd’s Standby Facility was amended and restated to provide Montpelier with a secured £110.0 million standby letter of credit facility through December 31, 2013. In March 2009 the Lloyd’s Standby Facility was further amended, so that it now provides Montpelier with a secured $230.0 million standby letter of credit facility through December 31, 2013. The current facility is subject to an annual commitment fee of 0.60% on drawn balances and 0.21% on undrawn balances.
Our loss and LAE reserves do not have contractual maturity dates. However, based on historical payment patterns, the preceding table includes an estimate of when we expect our loss reserves will be paid.
As of December 31, 2009, we had unfunded commitments to invest $23.5 million into three separate private investment funds. For purposes of this presentation, it is assumed that all of our unfunded commitments are called during 2010.
Our Foreign Exchange Contracts and Investment Options and Futures each constitute off-balance sheet arrangements.
Our cash flows used for investing activities totaled $175.6 million, resulting from the following:
Our cash flows used for financing activities totaled $121.9 million, resulting from the following:
· we spent $26.2 million on dividends to our common shareholders.
We also experienced a $5.6 million increase in cash and cash equivalents due to foreign exchange rate fluctuations.
Our cash flows provided from investing activities totaled $249.7 million, resulting from the following:
· we spent $1.8 million in net settlements of investment-related derivative contracts,
Our cash flows used for financing activities totaled $516.2 million which resulted from the following:
· we received $451.3 million from net sales and maturities fixed maturities,
· we spent $59.4 million on net purchases of equity securities and other investments,
· we had $122.3 million in net dispositions of securities lending collateral, and
Our cash flows used for financing activities totaled $462.4 million, resulting from the following:
· we spent $29.9 million on dividends to our common shareholders,
We also experienced a $1.8 million increase in cash and cash equivalents due to foreign exchange rate fluctuations.
The following discussion provides detailed information regarding our use of estimates and assumptions as it relates to such items.
In general, loss and LAE relating to short-tail property risks are reported and settled more promptly than those relating to long-tail risks, including the majority of casualty risks. However, the timeliness of loss reporting can be affected by such factors as the nature of the event causing the loss, the location of the loss, whether the losses are from policies in force with primary insurers or with reinsurers and where we fall within the cedant’s overall reinsurance program.
Our loss and LAE reserves include a component for both outstanding case reserves for claims that have been reported and for IBNR claims that have not been reported. Our case reserve estimates are initially set on the basis of loss reports received from third parties. IBNR consists of a provision for additional development in excess of the case reserves reported by ceding companies, as well as a provision for claims which have occurred but which have not yet been reported to us by ceding companies.
Estimating loss reserves for our modest book of longer-tail casualty reinsurance business, which can be either on an excess-of-loss or proportional basis, involves further uncertainties. In addition to the uncertainties inherent in the reserving process described above, casualty business can be subject to longer reporting lags than property business, and claims often take many years to settle. During this period, additional factors and trends will be revealed and as they become apparent we will adjust our reserves. There is also the potential for the emergence of new types of losses within our casualty book. Any factors that extend the time until claims are settled add uncertainty to the reserving process. At December 31, 2009 and 2008, we recorded gross loss and LAE reserves related to our casualty business of $188.8 million and $182.5 million, respectively.
We do not typically experience significant claims processing backlogs, although such backlogs may occur following a major catastrophic event. At December 31, 2009 and 2008, we did not have a significant backlog in either our insurance or reinsurance claims processing.
We believe that our reserves for loss and LAE are sufficient to cover losses that fall within the terms of our policies and agreements with our insured and reinsured customers on the basis of the methodologies used to estimate those reserves. However, there can be no assurance that our actual losses will not exceed our total reserves. Any adjustments for reserves are reflected in our loss and LAE during the period in which they are determined.
With the exception of periods immediately following a natural catastrophe and or other large loss event, the portion of loss reserves represented by IBNR tends to be lower for large loss events than it does for other business we write. During 2009, a year with a low level of large losses and sizable payments of existing reserves, our case reserves associated with such events decreased relative to total reserves.
We have determined that our best estimates for gross loss and LAE reserves at December 31, 2009 and 2008 were $680.8 million and $808.9 million, respectively. Of these estimates, at December 31, 2009 and 2008, $67.0 million and $51.6 million related to our insurance business, respectively, and $613.8 million and $757.3 million related to our reinsurance business, respectively.
Favorable development of prior period net losses experienced as a percentage of our opening net loss reserves across all underwriting years were 11.0%, 14.7% and 4.1% for the years ended December 31, 2009, 2008 and 2007, respectively. Based on this experience and the current makeup of our loss reserves, we believe it is reasonably likely our net unpaid loss and LAE reserves could increase or decrease by up to 10% from current amounts. As of December 31, 2009, we estimate that a 10% change in our net unpaid loss and LAE reserves would result in an increase or decrease of our net income and shareholders’ equity by approximately $61.1 million. The net income and shareholders’ equity impact of the change in net reserves may be partially offset by adjustments to items such as reinstatement premiums, profit commission expense, incentive compensation and income taxes.
Our assumed treaty reinsurance premium is written on an excess-of-loss or on a pro rata basis. Reinsurance contracts are generally written prior to the time the underlying direct policies are written by cedants and accordingly they must estimate such premiums when purchasing reinsurance coverage. For the majority of excess-of-loss contracts, including insurance contracts, a deposit or minimum premium is defined in the contract wording. The deposit or minimum premium is based on the ceding companies’ estimated premiums, and this estimate is recorded as written premium in the period the underlying risks incept. In the majority of cases, this premium is adjustable at the end of the contract period to reflect the changes in underlying risks in force during the contract period. Subsequent adjustments, based on reports by the ceding companies of actual premium, are recorded in the period they are determined, which is normally within six months to one year subsequent to the expiration of the policy. To date these adjustments have not been significant.
In the normal course of business, we purchase reinsurance from third parties in order to manage our exposures. The amount of ceded reinsurance that we buy varies from year to year depending on our risk appetite, as well as the availability and cost of the reinsurance coverage. Reinsurance premiums ceded are accounted for on a basis consistent with those used in accounting for the underlying premiums assumed, and are reported as a reduction of net premiums written. Certain of our assumed pro-rata contracts incorporate reinsurance protection provided by third-party reinsurers that inures to our benefit. These reinsurance premiums are reported as a reduction to our gross premiums written.
The cost of reinsurance purchased varies based on a number of factors. The initial premium associated with excess-of-loss reinsurance is generally based on the underlying premiums we assume. As these reinsurance contracts are typically purchased prior to the time the assumed risks are written, ceded premium recorded in the period of inception reflects an estimate of the amount that we will ultimately pay. In the majority of cases, the premium initially recorded is subsequently adjusted to reflect premium actually assumed by us during the contract period. These adjustments are recorded in the period that they are determined, and to date they have not been significant. In addition, losses which pierce excess-of-loss reinsurance cover may generate reinstatement premium ceded, depending on the terms of the contract. This reinstatement premium ceded is recognized as written and expensed at the time the reinsurance recovery is estimated and recorded.
We are currently involved in a dispute over two reinsurance contracts with MPCL. See Item 3, “Legal Proceedings.”
From 2002 to 2007, performance shares were a significant element of the Company’s LTIP awards. At target payout, each performance share represents the fair value of a common share. At the end of a performance period, which is generally the three-year period following the date of grant, the value of each performance share is adjusted to represent a harvest of between zero and 200% of target depending on the achievement of specific performance criteria relating to our operating and financial performance over the period. At the discretion of the CN Committee, any final payment in respect of such performance shares may take the form of cash, Common Shares or a combination of both.
With respect to the 2007-2009 performance cycle, 180,000 performance shares were originally granted to employees of which 172,000 remained outstanding at December 31, 2009. In accordance with our accounting policy, the expected ultimate harvest ratio for this performance share tranche was subsequently adjusted from 100% to 98% and the reference price of Common Shares was reduced from $18.92 (the closing price on the date of grant) to $17.74 (the average of the last five trading days in 2009). The Company recognized performance share expense for grants made under this cycle of $1.5 million during 2009, $0.4 million during 2008 and $1.1 million during 2007.
Throughout 2006 and 2007, RSU awards consisted solely of: (i) grants made to induce individuals to join us; (ii) grants made to retain certain key employees; (iii) grants made to reward employees exhibiting outstanding individual performance; and (iv) grants made to non-management members of the Board of Directors of the Company and MUAL as part of their total remuneration. In each of these cases, the number of RSUs granted to the recipient were fixed and determinable on the grant date (“Fixed RSUs”).
During 2008 we began using a new form of RSU award, in addition to Fixed RSUs, as the principal component of our ongoing long-term incentive compensation for employees (“Variable RSUs”) instead of performance share awards. Variable RSU awards are contingent awards in which the actual number of RSUs to be awarded is dependent on our performance during the initial year of the award cycle (the “Initial RSU Period”) meaning that the number of RSUs expected to be awarded for that cycle may fluctuate during the period. The actual number of Variable RSUs to be converted to Fixed RSUs is based on a targeted return on equity (“ROE”) assuming a standardized investment return. ROE is computed by dividing the sum of our actual underwriting result and standard investment result by our actual average shareholders’ equity for the period.
At grant date the Company assumes a 3% to 9% forfeiture rate, depending on the term of the award. Actual forfeitures are periodically compared to assumed forfeitures and adjustments are made as deemed necessary.
The financial statements and supplementary data have been filed as a part of this Annual Report on Form 10-K as indicated in the Index to Consolidated Financial Statements and Financial Statement Schedules appearing on page 86 of this report.