We currently lease office space in Pembroke, Bermuda, where the Company, Montpelier Re and Blue Ocean are located. We also lease office space in London, U.K. where MUA, MCL, MMSL and MUSL are located; in Zug, Switzerland, where MEAG is located; in Boston, MA, Chicago, IL, Hartford, CT, Overland Park, KS, and Shelton, CT where MUI is located; in Scottsdale, AZ where MUSIC is located; and in Woburn, MA and Hanover, NH where MTR is located.
Selected consolidated statement of operations data, ending balance sheet data and share data for each of the five years ended December 31, 2008, follows:
(a) From December 2005 to June 2008, the period prior to Blue Ocean becoming a wholly-owned subsidiary, we fully consolidated Blue Ocean in our financial statements in accordance with FIN 46R.
(b) As of January 1, 2007, we adopted FAS 157 and FAS 159. As a result, in all periods subsequent to adoption substantially all of our investments are 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, our available for sale investments were carried at fair value with changes in fair value being reported as a separate component of shareholders’ equity, with changes therein reported as a component of other comprehensive income (loss).
(c) During 2008, we incurred substantial net realized and unrealized investment losses.
(d) During 2008, we incurred substantial catastrophe losses associated with hurricane Ike. During 2005, we incurred substantial catastrophe losses associated with hurricanes Katrina, Wilma and Rita.
(e) During 2008, Blue Ocean repaid $75.0 million in debt that it issued in 2006. In 2006, we issued $103.1 million of junior subordinated debt securities.
(f) During 2008, we repurchased 7,799,019 of our common shares for $125.7 million.
(h) During 2006, we privately sold 6,896,552 common shares for $100.0 million.
(j) See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in
The following is a discussion and analysis of our results of operations for the years ended December 31, 2008, 2007 and 2006 and our financial condition as of December 31, 2008 and 2007. This discussion and analysis should be read in conjunction with the audited consolidated financial statements and related notes thereto included within this filing.
We ended 2008 with a fully converted tangible book value per share of $15.88, a decrease of 9.2% for the year inclusive of dividends. The decrease in fully converted tangible book value per share experienced during 2008 was largely the result of catastrophe losses from hurricanes Gustav and Ike and realized and unrealized losses associated with our investment portfolio. Our comprehensive loss for 2008 was $150.9 million and our GAAP combined ratio was 91.0%.
We ended 2006 with a fully converted tangible book value per share of $15.46, an increase of 33.2% for the year inclusive of dividends. The increase was largely the result of favorable underwriting conditions resulting from attractive pricing and a low level of catastrophes experienced throughout the year, as well as strong investment results. Our comprehensive income for 2006 was $361.5 million and our GAAP combined ratio was 60.3%.
Our underwriting results for 2006 included no significant individual catastrophe losses and $23.8 million of prior year favorable loss development. Our investment results for 2006 included $4.0 million of net realized and unrealized investment gains which were comprised of $8.3 million in net losses from fixed maturities and $12.3 million in net gains from equity securities.
(2) Under the terms of the share issuance agreement, 7,920,000 common shares remain issued and outstanding. In view of the contractual undertakings of the forward counterparty in the share issuance agreement, which have the effect of substantially eliminating the economic dilution that would otherwise result from the issuance such shares, we do not consider these shares outstanding for the purposes of this computation. See Note 7.
The most significant price decline in 2007 was related to writings of collateralized property catastrophe retrocessional business which, from January 1, 2006 to June 30, 2007, was predominantly written by Blue Ocean Re. This was the first segment to show significant rate increases following the 2005 catastrophes and, likewise, its pricing deteriorated most rapidly. As a result, since the second half of 2007 and throughout 2008, Blue Ocean Re wrote no new business.
During 2008, pricing throughout the insurance and reinsurance markets continued to decline with direct and facultative property business being the class showing the single largest rate decline. We also observed strong incumbent market retention within existing positions on desirable programs, which means that our Montpelier Bermuda segment was able to maintain and/or expand positions with its long-term target client base. We also observed that aggregate demand was either static or decreasing in most catastrophe markets.
During 2009 to date, we observed positive pricing trends in the majority of our business lines, ending twenty-two consecutive months of price reductions. The premium-weighted renewal price index across the entire portfolio incepting in January was 107%. Within our Property Catastrophe Excess-of-loss line, our largest block of business to renew at that time, the renewal price index was 108% or 110% for our U.S. portfolio and 105% for our International treaty portfolio.
The formation of MUA represents the latest step in a series of strategic initiatives we began in mid 2006. We now have operations in four countries employing three different insurance licenses. As a result, we are optimistic in our outlook for 2009 as we expect to see increasingly attractive opportunities for all of our underwriting platforms.
As a predominantly short-tail property reinsurer, we have exposure to natural catastrophes around the world. We manage our exposure to catastrophes using a combination of CATM (our proprietary modeling tool), third-party vendor models, underwriting judgment, and our own reinsurance purchases.
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, 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:
In addition to monitoring exposed contract limits and single event accumulation potential, we attempt to measure enterprise-wide risk using a simulated annual aggregate operating result approach. This approach estimates comprehensive income over simulated annual return periods, including contributions from certain variables such as aggregate premiums, losses, expenses, and investment results. We view this approach as a supplement to our single event stress test as it allows for multiple losses from natural catastrophe and other sources and attempts to take into account certain risks from non-underwriting sources. Through our modeling we endeavor to take into account many risks that we face as an enterprise. By the very nature of the insurance and reinsurance business, and the limitations of models generally, our modeling does not cover every potential risk. Examples include emerging risks, changes in liability awards, pandemic illnesses, asteroid strikes, climate change, bioterrorism, scientific accidents, and various imaginable and unimaginable political and financial market catastrophes.
Underwriting results for Montpelier Bermuda, our largest operating segment, for the years ended December 31, 2008, 2007 and 2006 were as follows:
· Property Catastrophe premiums written during 2008 decreased by 9% over 2007, reflecting softening prices in the property catastrophe market as a whole experienced throughout most of 2008. 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. Additionally, approximately $30.0 million of Property Catastrophe premium that would have been written within this segment was written within our Montpelier Syndicate 5151 segment. These factors were partially offset by an increase in reinstatement premiums, which totaled $21.2 million and $8.4 million during 2008 and 2007, respectively. The reinstatement premiums recognized during the 2008 period related primarily to hurricane Ike. The reinstatement premiums recognized during 2007 related primarily to European windstorm Kyrill and U.K. floods.
· Property Specialty premiums written during 2008 decreased by 22% as compared to 2007. This decrease, which was largely concentrated within our direct and facultative lines within Property Specialty, was mainly due to the impact of significant rate reductions experienced during the periods as well as non-renewals due to inadequate terms and pricing.
· Other Specialty premiums written during 2008 decreased by 33% over 2007. This decrease was due mainly to: (i) the non-renewal of several contracts due to inadequate terms and pricing and (ii) loss-sensitive premium adjustments made during the year within some of Montpelier Bermuda’s retrospectively rated casualty contracts. Montpelier Bermuda reduced its estimate of casualty losses incurred on some of these contracts, and consequently reduced the associated premium written.
· Property Catastrophe premiums written during 2007 increased from a repositioning of the portfolio from proportional treaty (Property Specialty) business to excess-of-loss (Property Casualty) business.
· A further increase in Property Catastrophe resulted from writings within areas of broader geographic diversity than our historical book of business,
· An 11% decline in Other Specialty business written, mainly casualty, as rates were declining and terms and conditions had weakened.
All of Montpelier Bermuda’s reinsurance purchases to date have represented prospective cover; that is, ceded reinsurance purchased to protect it against the risk of future losses as opposed to covering losses that have already incurred but have not been paid. The majority of these contracts are excess-of-loss contracts covering one or more lines of business. To a lesser extent we have also purchased quota share reinsurance with respect to specific lines of business. Montpelier Bermuda also purchases industry loss warranty policies which provide coverage for certain losses provided they are triggered by events exceeding a specified industry loss size.
Net premiums earned during 2008, 2007 and 2006 were $459.7 million, $491.3 million and $510.1 million, respectively, representing a decrease of 6% and 4% during 2008 and 2007, respectively. Net premiums earned are a function of the amount and timing of net premiums written.
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, 2008.
During 2008, Montpelier Bermuda incurred significant 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.
Reinsurance recoveries of $35.4 million, $6.9 million and $31.2 million were netted against Montpelier Bermuda’s loss and LAE for the years ended 2008, 2007 and 2006, respectively.
· Net estimated ultimate Property Catastrophe losses for prior years decreased by $54.9 million due primarily to the reassessment of loss and LAE reserves relating to the 2007 loss events noted above, as well as with hurricanes that occurred in 2004 and 2005.
· Net estimated ultimate Property Specialty losses for prior years decreased by $26.6 million mainly as a result of a reduction in losses reported to us in connection with several large, facultative claims.
· Net estimated ultimate Other Specialty losses for prior years decreased by $23.3 million largely as a result of the reassessment of loss and LAE reserves in our casualty class of business, as well as in other classes.
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 within the following lines of our business:
· Net estimated ultimate Property Catastrophe losses for prior years decreased by $4.0 million due to the re-assessment of loss and LAE reserves relating to several small loss events within Montpelier Bermuda’s Property Catastrophe lines.
· Net estimated ultimate Other Specialty losses for prior years decreased by $5.8 million due to the re-assessment of loss and LAE reserves relating to several classes of business within Montpelier Bermuda’s Other Specialty line.
During the year ended December 31, 2006, Montpelier Bermuda experienced $23.8 million in favorable development on net loss and LAE reserves relating to prior year losses within the following lines of our business:
· Net estimated ultimate Property Catastrophe losses for prior years increased by $30.2 million due primarily to an increase in expected ultimate losses in Montpelier Bermuda’s retrocessional book of business relating to the 2005 hurricanes, mainly hurricane Wilma.
· Net estimated ultimate Property Specialty losses for prior years decreased by $30.6 million due primarily to a decrease in expected ultimate losses for property risk excess claims.
· Net estimated ultimate Qualifying Quota Share losses for prior years decreased by $3.5 million due to favorable commutations of such contracts.
The following table presents Montpelier Bermuda’s underwriting expenses for the years ended December 31, 2008, 2007 and 2006:
Acquisition costs (which include brokerage costs, commissions and excise taxes, when applicable) are generally driven by contract terms and are normally a set percentage of gross premiums written. Acquisition costs consist of the net of commission expenses incurred on assumed business and commission revenue earned on purchased reinsurance covers. Commission revenue on purchased reinsurance covers is earned over the same period over which the corresponding premiums are expensed.
Acquisition costs incurred by Montpelier Bermuda during 2008 were $72.8 million, essentially unchanged from those incurred in 2007. Acquisition costs incurred by Montpelier Bermuda during 2007 were $72.9 million, a decrease of 32% from those incurred in 2006. This decrease reflects a business shift towards excess-of-loss business from pro rata business during the period, which generally has lower acquisition costs per dollar of premium.
The following table summarizes Montpelier Bermuda’s general and administrative expenses during the years ended December 31, 2008, 2007 and 2006:
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 new operations gain significance and begin 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 increase from 2006 to 2007 is primarily the result of additional costs associated with upgrades to our information technology infrastructure and increased rent, operating and maintenance costs related to our new premises in Bermuda, which we moved into during the third quarter of 2006.
Underwriting results for Montpelier Syndicate 5151, which commenced operations on July 1, 2007, were as follows for the years ended December 31, 2008 and 2007:
All of Montpelier Syndicate 5151’s reinsurance purchases to date have represented prospective cover; that is, ceded reinsurance purchased to protect it against the risk of future losses as opposed to covering losses that it has already incurred but has not been paid.
The following tables present Montpelier Syndicate 5151’s unpaid loss and LAE reserves, by line of business, as of and for the years ended December 31, 2008 and 2007. During each of the periods presented, Montpelier Syndicate 5151’s gross reserves were equal to their net reserves.
We estimated Montpelier Syndicate 5151’s 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, 2008. Our best estimate for Montpelier Syndicate 5151’s ending loss and LAE reserves at December 31, 2008 and 2007 was $48.8 million and $4.2 million, respectively, which includes $0.6 million in foreign currency movements.
Montpelier Syndicate 5151’s fixed expenses are driven mainly by salaries and premises costs associated with its underwriting and Coverholder operations located in the U.S., U.K. and Switzerland and intercompany allocations of information technology and risk modeling expenses. These fixed expenses increased significantly during 2008 as Montpelier Syndicate 5151 continued to expand its U.S. and U.K. operations.
Fixed expenses incurred during 2008 and 2007 also included Lloyd’s fees of $7.6 million and $5.8 million, respectively, and management fees paid to Spectrum of $4.6 million and $3.8 million, respectively. These fees are largely tied to Montpelier Syndicate 5151’s underwriting capacity, which increased from £47 million in 2007 to £143 million in 2008. With the establishment of the MUA, Syndicate 5151 will begin to experience a reduction and eventual elimination of fees from Spectrum as the operations will soon be managed through internal resources.
Underwriting results for MUSIC, which we acquired on November 1, 2007, were as follows for the years ended December 31, 2008 and 2007:
n/m - not meaningful due to the start-up nature of these operations.
MUSIC wrote $5.6 million of Excess and Surplus Lines premium during 2008, of which $2.1 million was earned during the year. MUSIC’s loss and LAE expenses for 2008 of $1.8 million primarily represented IBNR. MUSIC wrote a de minimis amount of premium during the period from November 1, 2007 to December 31, 2007.
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. As a result, during 2007, Blue Ocean began returning capital to its shareholders and Blue Ocean Re ceased writing new business.
Blue Ocean did not incur any losses during the periods presented.
(1) Represents the elimination of an inter-segment reinsurance cover among Montpelier Bermuda and Montpelier Syndicate 5151.
The significant increase in fixed expenses during 2008, as compared to 2007, is primarily the result of: (i) an increase in salaries and benefits associated with the hiring of additional finance, risk management and legal personnel in support of its new insurance and reinsurance initiatives; (ii) the promotion of certain corporate officers in connection with the Company’s 2008 succession planning actions; and (iii) increased inter-segment allocations from the Company’s service companies; and (iv) upgrades made to the Company’s information and accounting systems during 2008. The increase in fixed expenses during 2007, as compared to 2006, is primarily the result of start-up costs associated with its new insurance and reinsurance initiatives. Other fixed expenses include director fees, corporate insurance, audit fees and fees associated with being a publicly traded company.
The following table summarizes our consolidated net investment income and total investment return for the years ended December 31, 2008, 2007 and 2006:
Our interest income decreased significantly in 2008 compared to 2007 as a result of having a smaller weighted average investment portfolio (including cash) coupled with a sharp decrease in short-term interest rates. In addition, during 2008 we discontinued our participation in a securities lending program (fees earned from our securities lending activities are a component of our investment income). Investment income increased in 2007 compared to 2006 due primarily to a shift in the portfolio away from U.S. government and U.S. government-sponsored enterprise securities to asset-backed and corporate securities of a longer average duration.
Investment expenses were higher during 2008, as compared to 2007, due mainly to an increase in the number of investment managers and consultants during the year. Investment expenses were higher during 2007, as compared to 2006, due mainly to a change in investment managers made during the year.
During 2008, we experienced $171.3 million in net unrealized investment losses which were comprised of $59.2 million in losses from fixed maturities, $97.6 million in losses from equity securities and $14.5 million in losses from other investments. During 2007, we experienced $13.9 million in net unrealized investment gains from fixed maturities, $13.1 million in net losses from equity securities and a loss of $0.9 million from other investments. During 2006, our fixed maturity portfolio experienced a $0.4 million unrealized loss, which was included in earnings.
The net unrealized losses experienced during 2008 within our fixed maturity portfolio, namely our mortgage and asset-backed securities, corporate bonds and government-sponsored enterprise securities, were largely the result of widening credit spreads between the yields on those securities versus that of U.S. treasuries. The net unrealized losses we experienced during 2008 within our equity portfolio were consistent with the declines of the overall U.S. equity market during the period.
During 2008, 2007 and 2006, we experienced net foreign exchange gains (losses) on cash and investments of $(3.4) million, $7.9 million and $7.5 million, respectively. The foreign exchange gains (losses) during the periods are due to the weakening (strengthening) of the U.S. dollar against the various foreign currencies in which we transact, principally the British pound.
Our net foreign exchange transaction gains (losses) on insurance 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 expense (income) from derivative instruments during the years ended December 31, 2008, 2007 and 2006:
In 2008, we purchased an option on hurricane seasonal futures (the “Hurricane Option”) for $1.0 million in order to provide protection against our eastern U.S. hurricane exposure during the period from June 1, 2008 to November 30, 2008. The maximum possible recovery to Montpelier under the Hurricane Option was $5.0 million. The Hurricane Option expired without value.
The fair value of the ILW Swap was zero at December 31, 2008.
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. The first $75.0 million tranche (“Class A”) covered earthquakes affecting Japan and/or the U.S. The remaining $15.0 million tranche (“Class B”), provided second event coverage for a U.S. hurricane or earthquake. 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 is accounted for as a derivative, rather than as a reinsurance transaction, and is carried at fair value.
From time to time we have entered into foreign currency exchange agreements (the “Foreign Exchange Contracts”) which constitute an obligation to purchase or sell a specified currency at a future date at a price set at the inception of the contract. These agreements do not eliminate fluctuations in the value of our assets and liabilities denominated in foreign currencies; rather, they allow us to establish a rate of exchange at a future point in time. Our open foreign currency agreements at December 31, 2008 were denominated in Swiss francs (CHF), euros (EUR), British pounds (GBP) and Japanese yen (JPY).
At December 31, 2008 and December 31, 2007, we were a party to outstanding foreign currency exchange agreements having a gross notional exposure of $33.0 million and $86.9 million, respectively. We recorded net expense (revenue) associated with our Foreign Exchange Contracts of $4.1 million, $(3.2) million and $(2.5) million during 2008, 2007 and 2006, respectively.
During 2008, we executed various exchange-traded investment options and futures (the “Investment Options and Futures”) as part of our investing strategy. As of December 31, 2008, we had closed all of our investment futures and held open long options with a fair value of $0.1 million.
In 2006, we entered into a catastrophe bond facility (the “CAT Bond Facility”) under which we are entitled to receive contract payments from a third-party in return for assuming mark-to-market risk on a portfolio of securitized catastrophe risks. The difference between the notional capital amounts of the catastrophe bonds and their market value is marked to market over the terms of the bonds; the difference is settled on a monthly basis.
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. As a result, the CAT Bonds are now held on the Company’s consolidated balance sheets as other investments.
We recorded net revenues associated with our CAT Bond Facility of $1.0 million, $5.3 million and $1.3 million during 2008, 2007 and 2006, respectively.
In 2007, we sold ILW protection (the “ILW Contract”) to a third-party for $3.7 million under which qualifying loss payments are 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 on August 13, 2008 without any required payment by us.
Our other revenue is comprised of interest on funds advanced to ceding companies to cover losses in accordance with contract terms, fees earned by MCA from the Pioneer Diversified High Income Trust (the “Pioneer Fund”) and, for 2006, ceding commissions and incentive fees relating to our investment in Rockridge Reinsurance Ltd. (“Rockridge”), a former affiliate. The following table summarizes our consolidated other revenue for the years ended December 31, 2008, 2007 and 2006:
During 2003, we issued $250.0 million of senior unsecured debt. The Senior Notes bear interest at a rate of 6.125% per annum, payable semi-annually in arrears on February 15 and August 15 of each year. The Senior Notes are scheduled to mature on August 15, 2013. The unamortized carrying value of the Senior Notes at December 31, 2008 and December 31, 2007, was $249.4 million and $249.3 million, respectively.
In the normal course of business, Montpelier Re and MCL provide letters of credit for the benefit of their clients. In addition, Blue Ocean Re establishes trust funds for the benefit of ceding companies. See “Liquidity and Capital Resources” contained in Item 7.
Our income tax provision (benefit) for the years ended December 31, 2008, 2007 and 2006 consisted of the following:
The Company is domiciled in Bermuda and has subsidiaries domiciled in several countries, including the U.S. The Company and its Bermuda-domiciled affiliates, including Montpelier Re and Blue Ocean Re, have received an assurance from the Bermuda Minister of Finance exempting them from all Bermuda-imposed income, withholding and capital gains taxes until March 2016. At the present time, no such taxes are levied in Bermuda.
The Company has no operations of its own and relies heavily on dividends and distributions from its subsidiaries to pay its operating expenses, interest on debt and dividends and to fund any share repurchase activities. There are restrictions on the payment of dividends to the Company from its regulated operating companies as described under “Regulation” herein. We currently have in place a regular dividend of $.075 per common share per quarter. Any future determination to pay dividends or distributions to our shareholders will be at the discretion of our Board of Directors and will be dependent upon many factors, including our results of operations, cash flows, financial position, capital requirements, general business opportunities, legal, tax, regulatory and contractual restrictions.
As of December 31, 2008, our sources of immediate liquidity consisted of: (i) $212.5 million of unrestricted cash; (ii) $328.3 million in cash equivalents and short-term investments which currently trade at a very narrow bid/ask spread and whose proceeds are available upon one days notice; (iii) $353.2 million of investment securities which currently trade at a narrow bid-ask spread and whose proceeds are available upon three days notice; and (iv) up to $89.1 million from our Forward Sale Agreement (as described below) which is available upon three to five 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.
During the years ended December 31, 2008, 2007 and 2006, we were able to meet all of our cash obligations. We anticipate that our current cash and cash equivalent balances, sales and maturities of investments and our projected future cash flows from operations should be sufficient to cover our cash obligations under most loss scenarios through the foreseeable future.
Our common shareholders’ equity at December 31, 2008 was $1,357.6 million, which is net of an accumulated retained deficit of $214.6 million. Our total capital decreased by $459.1 million during 2008 as we experienced a comprehensive loss of $150.9 million, we repurchased $125.7 million of our common shares, we declared $25.5 million in dividends to our common shareholders, we repaid the Blue Ocean Debt, we paid dividends and made capital distributions to Blue Ocean’s minority shareholders and we acquired all of Blue Ocean’s outstanding share capital from its minority shareholders.
In the normal course of business, Montpelier Re and MCL maintain letter of credit facilities and provide letters of credit to third-parties. These letter of credit facilities were secured by collateral accounts containing cash and investments totaling $724.5 million at December 31, 2008. The following table outlines these facilities as of December 31, 2008:
Montpelier Re amended its $500.0 million syndicated secured facility 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.
In June 2007, the Company, Montpelier Re and MCL entered into a secured £74.0 million standby letter of credit facility through December 31, 2012, which will be used specifically as Funds at Lloyd’s to support business to be underwritten by Syndicate 5151. In October 2008, this facility was increased to £110.0 million with a revised expiry date of December 31, 2013. This facility is subject to an annual commitment fee of 0.45% on drawn balances and 0.158% on undrawn balances.
The agreements governing these facilities contain covenants that limit Montpelier’s ability, among other things, to grant liens on its assets, sell assets, merge or consolidate, incur debt and enter into certain burdensome agreements. In addition, the syndicated secured facilities and the Lloyd’s standby facility each require the Company to maintain debt leverage of no greater than 30% and Montpelier Re to maintain an A.M. Best financial strength rating of no less than B++. If the Company or Montpelier Re were to fail to comply with these covenants or fail to meet these financial ratios, the lenders could revoke the facilities and exercise remedies against the collateral. As of December 31, 2008 and 2007, the Company and Montpelier Re were in compliance with all covenants.
In the event that our letter of credit facilities are cancelled, non-renewed or become prohibitively expensive, we believe that we could alternatively collateralize our existing and future reinsurance obligations through the use of trust agreements, funds withheld and/or Funds at Lloyd’s deposits.
The number of common shares to be sold in return for these proceeds is a function of the share price as well as the terms of the contract. If the share price on a given settlement date falls at or between the contractual floor and cap prices, the number of common shares sold to the forward counterparty will equal the number that would need to be sold on a public exchange in order to generate the same proceeds, resulting in no economic gain or loss to us. If the share price on a given settlement date is above the cap price, the number of common shares sold to the forward counterparty will be more than the number that would need to be sold on a public exchange in order to generate the same proceeds, resulting in an economic loss to us. If the share price on a given settlement date is below the floor price, the number of common shares sold to the forward counterparty will be less than the number that would need to be sold on a public exchange in order to generate the same proceeds, resulting in an economic gain to us.
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 a provider of short tail reinsurance and insurance for losses resulting 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, 2008, we had entered into several derivative transactions as described herein. The ILW Swap, the CAT Bond Protection, the Foreign Exchange Contracts, the Investment Options and Futures and the Forward Sale Agreements and the Share Issuance Agreement each constitute off-balance sheet arrangements.
Excluding the off-balance sheet derivative transactions outlined above, we are not party to any other off-balance sheet transaction, agreement or other contractual arrangement to which an entity unconsolidated with us is a party that management believes is reasonably likely to have a current or future effect on our financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that we believe is material to our investors.
Our cash flows provided from operations totaled $71.5 million which resulted primarily from premiums received, net of acquisition costs, exceeding net paid losses of $317.9 million.
· we paid $30.5 million to Blue Ocean’s minority shareholders pursuant to the Blue Ocean Transaction,
· we had $192.4 million in net dispositions of securities lending collateral,
Our cash flows used for financing activities totaled $485.7 million, resulting from the following:
· we paid $28.4 million in dividends to our common shareholders and repurchased $129.8 million of our common shares,
· we acquired MUSIC for $9.8 million and acquired, as part of the acquisition, $3.1 million of cash and cash equivalents,
· we paid $3.9 million to the forward counterparty to amend the Forward Sale Agreement,
· we had a $122.3 million net reduction in securities lending payable.
· we made $38.5 million of net purchases of equity securities and other investments,
· we had a $0.1 million in net acquisition of securities lending collateral,
· we had a $35.5 million increase in our restricted cash,
· we issued the Junior Subordinated Debt and the Blue Ocean Debt and received cash proceeds of $173.3 million,
· we entered into a purchase agreement with WLR Recovery Fund, II, L.P. and WLR Recovery Fund III, L.P. for a private sale of 6,896,552 common shares and received net cash proceeds of $99.5 million,
Estimating loss reserves requires us to make assumptions regarding reporting and development patterns, frequency and severity trends, claims settlement practices, potential changes in the legal environment and other factors such as inflation and demand surge. These estimates and judgments are based on numerous factors, and may be revised as additional experience or other data becomes available and is reviewed, as new or improved methodologies are developed, or as current laws change.
Our IBNR reserves are determined using various actuarial methods as well as a combination of our own historical loss experience, historical insurance industry loss experience, estimates of pricing adequacy trends, and our professional judgment. In the case of our reinsurance business, we also take into account ceding company reports on IBNR reserves in making our estimates when such reports are provided. The process we use to estimate our IBNR reserves involves projecting our estimated ultimate loss and LAE reserves and then subtracting paid claims and case reserves as notified by the ceding company, to arrive at our IBNR reserve.
We do not typically experience significant claims processing backlogs, although such backlogs may occur following a major catastrophic event. At December 31, 2008 and 2007, we did not have a significant backlog in either our insurance or reinsurance claims processing.
We have determined that our best estimate for loss and LAE reserves net of reinsurance ceded (as discussed below), at December 31, 2008 and 2007, was $686.0 million and $708.2 million, respectively.
Generally, on pro rata contracts and certain excess-of-loss contracts in which a deposit or minimum premium is not specified in the contract, an estimate of written premium is recorded in the period in which the underlying insurance policies incept. The premium estimate is based on information provided by ceding companies at the inception of the contract. When the actual premium is reported by the ceding company, generally on a quarterly or six month lag, it may be significantly higher or lower than the estimate.
Excess-of-loss contracts often include contract terms that require an automatic reinstatement of coverage in the event of a loss. The associated reinstatement premium is generally calculated on the basis of (a) a fixed percentage (normally 100%) of the deposit or minimum premium and (b) the proportion of the original limit exhausted. In a year of large loss events, reinstatement premiums will be higher than in a year in which there are no such events. Reinstatement premiums are fully earned or expensed as applicable when a triggering loss event occurs and losses are recorded. We accrue reinstatement premiums on a basis consistent with our estimates of loss and LAE. Generally pro rata contracts do not contain provisions for the reinstatement of coverage.
Premiums from excess-of-loss contracts are earned ratably over the contract term, which is ordinarily twelve months. However, most pro-rata contracts are written on a risks attaching basis, which means that we assume a stated percent share of each policy that the ceding company writes. As a result, we earn these contracts over the risk period of the underlying insurance policies.
In the normal course of business, we purchase reinsurance from third-parties in order to manage our exposures. All of our reinsurance purchases to date have represented prospective cover, meaning that the coverage has been purchased to protect us against the risk of future losses as opposed to covering losses that have already occurred but have not yet paid. The majority of our reinsurance contracts are excess-of-loss contracts covering one or more lines of business. To a lesser extent, we have also purchased quota share reinsurance with respect to specific lines of our business. We also purchase industry loss warranty policies which provide us with coverage for certain losses we incur provided they are triggered by events exceeding a specified industry loss size. In addition, for certain pro-rata contracts that we enter into, the associated direct insurance contracts carry underlying reinsurance protection from third-party reinsurers, known as inuring reinsurance, which we net against our gross premiums written.
The recognition of reinsurance recoverable requires two key judgments. The first involves our estimation of the amount of gross IBNR to be ceded to reinsurers. Ceded IBNR is generally developed as part of our loss reserving process and consequently, its estimation is subject to similar risks and uncertainties as the estimation of gross IBNR. The second relates to the amount of the reinsurance recoverable balance that we will ultimately be unable to recover from reinsurers due to insolvency or other reasons. As of December 31, 2008 and 2007, we recorded $36.4 million and $16.8 million in reinsurance recoverable on paid losses, respectively, and $122.9 million and $152.5 million in reinsurance recoverable on unpaid losses, respectively. Based on a review of the financial condition of the reinsurers and other factors, we have determined that a reserve for uncollectible reinsurance recoverable on paid and unpaid loss and LAE was not considered necessary as of December 31, 2008 and 2007.
In addition to the ceded reinsurance described above, we have also entered into various derivative instruments, namely the ILW Swap and the CAT Bond Protection that provide similar coverage against the risk of losses. Amounts recoverable under these derivative instruments are determined solely on the basis of modeled or industry losses, rather than by actual losses incurred by us. For that reason, we account for these instruments as derivatives, rather than reinsurance transactions.
The LTIP is our primary long-term incentive plan and was approved by our shareholders in May 2007. Incentive awards currently outstanding under the LTIP consist of performance shares and RSUs.
With respect to the 2006-2008 performance period, 167,000 performance shares were originally granted to employees of which 153,000 remained outstanding at December 31, 2008. In accordance with our accounting policy, the expected ultimate harvest ratio for this performance share tranche was subsequently adjusted to a more current harvest estimate and the reference price of our common shares was reduced from $19.23 (the closing price on the date of grant) to $16.23 (the average of the last five trading days in 2008). The Company recognized performance share (income) expense for grants made under this performance share cycle of $(1.3) million during 2008 and $2.6 million during 2007.
With respect to the 2007-2009 performance period, 180,000 performance shares were originally granted to employees of which 172,000 remained outstanding at December 31, 2008. In accordance with our accounting policy, the expected ultimate harvest ratio for this performance share tranche was subsequently adjusted to a more current harvest estimate and the reference price of our common shares was reduced from $18.92 (the closing price on the date of grant) to $16.23 (the average of the last five trading days in 2008). The Company recognized performance share expense for grants made under this performance share cycle of $0.4 million during 2008 and $1.1 million during 2007.
The unamortized grant date fair value of the 965,583 Fixed RSUs outstanding as of December 31, 2008 was $5.0 million. The fair value of these Fixed RSUs was $16.6 million on the date of grant.