The Company leases office space in Bermuda where the Company’s principal executive offices are located. Additionally, the Company leases office space in various locations, including Beijing, Dublin, Greenwich (Connecticut), Hong Kong, Mexico City, Paris, Santiago, Seoul, Singapore, Tokyo, Toronto and Zurich.
The Company is a leading global reinsurer with a broadly diversified portfolio of risks. The Company writes all lines of business in virtually all markets worldwide, and differentiates itself through its approach to risk, its strategy to manage risk, and its financial strength. Through its broad product and geographic diversification, its excellent execution capabilities and its local presence in most major markets, the Company is able to respond quickly to market needs, and capitalize on business opportunities virtually anywhere in the world.
Reinsurance is by its nature a risk assumption business. The Company’s business is to assume its clients’ risks, thereby removing the volatility associated with these risks from the clients’ financial statements, and then manage those risks and the risk-related volatility. The Company’s ability to succeed in the risk assumption business is dependent on its ability to accurately analyze and quantify risk, to understand volatility and how risks aggregate or correlate, and to establish the appropriate capital requirements and absolute limits for the risks assumed.
The reinsurance markets have historically been highly cyclical in nature. The cycle is driven by competition, the amount of capital and capacity in the industry, loss events and investment returns. The Company’s long-term strategy to generate shareholder value focuses on broad product and geographic diversification of risks, assuming a moderately greater degree of risk than the market average, actively managing its capital across its portfolio and over the duration of the cycle, adding value through underwriting and transactional excellence and achieving superior returns on invested assets in the context of a disciplined risk framework.
The January 1, 2008 renewals saw a continuation of trends characteristic of a market in transition. The market was more competitive than at January 1, 2007, yet still rational. There were pricing declines in most major markets and most lines of business. There was a continuation of the trend toward increasing risk retention by cedants, and restructuring proportional coverages to non-proportional treaties, which led to the continued reduction in the amount of premiums in the reinsurance marketplace. Nevertheless, the Company wrote a
considerable amount of new business during the January 1, 2008 renewals and believes it has maintained priced profitability on business renewed above its long-term priced return on deployed capital target of 13% over a cycle. Despite challenging market conditions, the Company has not changed its strategy or approach and continues to be opportunistic in writing business in its core reinsurance activities, as well as exploring opportunities in the capital markets. The Company intends to continue to maintain balance and diversification in its overall portfolio.
Within the Company’s Life segment, the reinsurance market is differentiated between mortality and longevity products, with mortality being the larger market and longevity being smaller, but growing. For the mortality markets in which the Company writes business, the Company observed stable pricing for continental Europe and Latin America. In contrast, there are much more competitive conditions in the U.K. and Ireland, and while these two markets remain attractive, appropriate risk selection and pricing is important. The Company does not write life business in the U.S. market.
continues into 2008. The collapse of the U.S. sub-prime mortgage market affected a large number of collateralized debt obligations (CDOs) that contained sub-prime securities and developed into a liquidity and credit crisis. The potential impact of the turmoil in the credit markets has been substantially mitigated by the Company’s high quality asset portfolio described above and the Company did not have direct exposure to sub-prime mortgages in its investment portfolio at December 31, 2007. Even in this environment, the Company’s total return on the capital markets risks was positive during 2007, though below the risk-free rate of return. The Company believes that even though there will be years where capital markets risks return less than the risk-free rate of return, or potentially even results in a negative return, the rewards for assuming these risks in a disciplined and measured way will produce a positive excess return to the Company over time. Additionally, since capital markets risks are not fully correlated with the Company’s reinsurance risks, this element of our strategy increases the overall diversification of the Company’s risk portfolio.
ROE: Management uses operating return on beginning shareholders’ equity (ROE) as a measure of profitability that focuses on the return to common shareholders. It is calculated using net operating earnings (loss) available to common shareholders (net income or loss excluding net after-tax realized gains or losses on investments, net after-tax interest in earnings or losses of equity investments and preferred share dividends) divided by beginning common shareholders’ equity. Management has set a minimum 13% ROE target over the reinsurance cycle, which Management believes provides an attractive return to shareholders for the risk assumed. Each business unit and support department throughout the Company is focused on seeking to ensure that the Company meets the 13% return objective. This means that most economic decisions, including capital allocation and underwriting pricing decisions, incorporate an ROE impact analysis. For the purpose of that analysis, an appropriate amount of capital (equity) is allocated to each transaction for determining the transaction’s priced return on deployed capital. Subject to an adequate return for the risk level as well as other factors, such as the contribution of each risk to the overall risk level and risk diversification, capital is allocated to the transactions generating the highest priced return on deployed capital. Management’s challenge consists of (i) allocating an appropriate amount of capital to each transaction based on the incremental risk created by the transaction, (ii) properly estimating the Company’s overall risk level and the impact of each transaction on the overall risk level, and (iii) assessing the diversification benefit, if any, of each transaction. The risk for the Company lies in mis-estimating any one of these factors, which are critical in calculating a meaningful priced return on deployed capital, and entering into transactions that do not contribute to the Company’s 13% ROE objective.
Combined Ratio: The combined ratio is used industry-wide as a measure of underwriting profitability for Non-life business. The combined ratio is the sum of the technical ratio (losses and loss expenses and acquisition costs divided by net premiums earned) and the other operating expense ratio (other operating expenses divided by net premiums earned). A combined ratio under 100% indicates underwriting profitability, as the total losses and loss expenses, acquisition costs and other operating expenses are less than the premiums earned on that
business. While an important metric of success, the combined ratio does not reflect all components of profitability, as it does not recognize the impact of interest income earned on premiums between the time premiums are received and the time loss payments are ultimately made to clients. Since 2001, the Company has had five years of underwriting profitability reflected in combined ratios of less than 100% for its Non-life segment. In 2005, when the industry recorded its worst year in history in terms of catastrophe losses, with Hurricane Katrina being the largest insured event ever, the Company recorded a net underwriting loss and Non-life combined ratio of 116.3% as a result of the significant catastrophic loss events that year. The key challenges in managing the combined ratio metric consist of (i) focusing on underwriting profitable business even in the weaker part of the reinsurance cycle, as opposed to growing the book of business at the cost of profitability, (ii) diversifying the portfolio to achieve a good balance of business, with the expectation that underwriting losses in certain lines or markets may potentially be offset by underwriting profits in other lines or markets, and (iii) maintaining control over expenses.
A key challenge for Management is to maintain an appropriate level of capital. Management’s first priority is to hold sufficient capital to meet all of the Company’s obligations to cedants, meet regulatory requirements and support its position as one of the stronger reinsurers in the industry. Holding an excessive amount of capital, however, will reduce the Company’s ROE. Consequently, Management closely monitors its capital needs and
capital level throughout the cycle, and actively takes steps to increase or decrease the Company’s capital in order to achieve the proper balance of financial strength and shareholder returns. Capital management is achieved by either deploying capital to fund attractive business opportunities, or in times of excess capital, returning capital to shareholders by way of share repurchases and dividends.
The Company’s risk management framework encompasses all the meaningful risks faced by the Company: the strategic risks, including those that it shares with the rest of the reinsurance industry, assumed risks (the reinsurance and capital market risks that it is paid to assume) and the operational risks that are a part of running any business. Management identifies and categorizes risks in terms of their source, their impact on the Company and the preferred strategies for dealing with them. It takes an integrated approach, because it is impossible to manage any of these risks in isolation. There are interrelationships and dependencies between the various categories of risk. Each must be viewed in the context of the whole if their potential impact on the organization is to be fully understood and effectively managed.
There are three areas of risk that the Company has currently identified as having the greatest potential for shock losses. These are catastrophe, reserving for casualty and other long-tail lines, and equity investment risk. The Company manages the risk of shock losses by setting limits on its tolerance for specific risks and on the amount of capital that it is willing to expose to such risks. The Company establishes limits to manage the absolute maximum foreseeable loss from any one event and considers the possibility that several shock losses could occur at one time, for example a major catastrophe event accompanied by a collapse in the equity markets. Management believes that the limits that it has placed on shock losses will allow the Company to continue writing business in such an event.
Other risks such as interest rate risk and credit risk have the ability to impact results substantially and may result in volatility in results from quarter to quarter, but Management believes that by themselves, they are unlikely to represent a material downside threat to the Company’s long-term economic value. See Quantitative and Qualitative Disclosures about Market Risk in
The liability for unpaid losses and loss expenses for Non-life operations includes amounts determined from loss reports on individual treaties (case reserves), additional case reserves when the Company’s loss estimate is higher than reported by the cedants (ACRs) and amounts for losses incurred but not yet reported to the Company (IBNR). Such reserves are estimated by Management based upon reports received from ceding companies, supplemented by the Company’s own actuarial estimates of reserves for which ceding company reports have not been received, and based on the Company’s own historical experience. To the extent that the Company’s own historical experience is inadequate for estimating reserves, such estimates may be determined based upon industry experience and Management’s judgment. The estimates are continually reviewed and the ultimate liability may be in excess of, or less than, the amounts provided. Any adjustments are reflected in the periods in which they are determined, which may affect the Company’s operating results in future periods.
The liabilities for policy benefits for ordinary life and accident and health policies have been established based upon information reported by ceding companies, supplemented by the Company’s actuarial estimates of mortality, critical illness, persistency and future investment income, with appropriate provision to reflect uncertainty. Future policy benefit reserves for annuity and universal life contracts are carried at their accumulated values. Reserves for policy claims and benefits include both mortality and critical illness claims in the process of settlement, and claims that have been incurred but not yet reported. Interest rate assumptions used to estimate liabilities for policy benefits for life and annuity contracts at December 31, 2007 and 2006 ranged from 1.0% to 4.9%.
Acquisition costs, primarily brokerage fees, commissions and excise taxes, which vary directly with, and are primarily related to, the acquisition of reinsurance contracts, are capitalized and charged to expense as the related premium is earned. Anticipated losses and loss expenses, other costs and investment income related to these premiums are considered in determining the recoverability of deferred acquisition costs. Acquisition costs related
to individual life and annuity contracts are deferred and amortized over the premium-paying periods in proportion to anticipated premium income, allowing for lapses, terminations and anticipated investment income. Acquisition costs related to universal life and single premium annuity contracts for which there is no significant mortality or critical illness risk are deferred and amortized over the lives of the contracts as a percentage of the estimated gross profits expected to be realized on the contracts.
The Company writes certain business on a funds held basis. Under such contractual arrangements, the cedant retains the premiums that would have otherwise been paid to the Company and the Company earns interest on these funds. With the exception of those arrangements discussed below, the Company generally earns investment income on the funds held balances based upon a predetermined interest rate, either fixed contractually at the inception of the contract or based upon a recognized index (e.g., LIBOR). Interest rates ranged from 1.0% to 6.0% at December 31, 2007 and from 1.0% to 6.8% at December 31, 2006.
In certain circumstances, the Company may receive an investment return based upon either the result of a pool of assets held by the cedant, generally used to collateralize the funds held balance, or the investment return earned by the cedant on its entire investment portfolio. This is most common in the Company’s life reinsurance business. In these arrangements, gross investment returns are typically reflected in net investment income with a corresponding increase or decrease (net of a spread) being recorded as life policy benefits in the Company’s Consolidated Statements of Operations. In these arrangements, the Company is exposed, to a limited extent, to the underlying credit risk of the pool of assets inasmuch as the underlying life policies may have guaranteed minimum returns. In such cases, an embedded derivative exists under Statement of Financial Accounting Standards (SFAS) No. 133 Derivatives Implementation Group (DIG) Issue No. B36 “Embedded Derivatives: Modified Coinsurance Arrangements and Debt Instruments That Incorporate Credit Risk Exposures That Are Unrelated or Only Partially Related to the Creditworthiness of the Obligor under Those Instruments”. The fair value of these derivatives is recorded by the Company as an increase or decrease to the funds held balance, which is substantially offset by a comparable but opposite adjustment to deferred acquisition costs.
In the normal course of its operations, the Company enters into certain contracts that do not meet the risk transfer provisions of SFAS No. 113 “Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts”. These contracts are accounted for using the deposit accounting method in accordance with Statement of Position 98-7 “Deposit Accounting: Accounting for Insurance and Reinsurance Contracts That Do Not Transfer Risk”. For those contracts, the Company originally records deposit liabilities for an amount equivalent to the consideration received. The consideration to be retained by the Company, irrespective of the experience of the contracts, is earned over the expected settlement period of the contracts, with any unearned portion recorded as a component of deposit liabilities. Actuarial studies are used to estimate the final liabilities under these contracts and the appropriate accretion rates to increase or decrease the liabilities over the term of the contracts. The change for the period is recorded in other income or loss in the Consolidated Statements of Operations.
Other invested assets consist primarily of investments in non-publicly traded companies (including ChannelRe Holdings-see Note 20), private placement equity investments, private placement bond investments, derivative financial instruments and other specialty asset classes. Entities in which the Company has an ownership of more than 20% and less than 50% of the voting shares, and limited partnerships in which the Company has more than a minor interest, are accounted for using the equity method. Other investments are recorded based on valuation techniques depending on the nature of the individual assets. The valuation techniques used by the Company’s investment managers are generally commensurate with standard valuation techniques for each asset class.
Net investment income includes interest and dividend income, amortization of premiums and discounts on fixed maturities and short-term investments and investment income on funds held, and is net of investment expenses, dividend expenses relating to equity short sales and withholding taxes. Investment income is recognized when earned. Realized gains and losses on the disposal of investments are determined on a first-in, first-out basis.
In recording foreign currency transactions, revenue and expense items are converted into the functional currency at the weighted average rates of exchange for the period. Assets and liabilities originating in currencies other than the functional currency are translated into the functional currency at the rates of exchange in effect at the balance sheet dates. The resulting foreign exchange gains or losses are included in net foreign exchange gains and losses in the Consolidated Statements of Operations. The Company records realized and unrealized foreign exchange gains and losses on hedged items in net realized investment gains and losses in the Consolidated Statements of Operations (see Note 2(k)).
The Company formally documents all relationships between designated hedging instruments and hedged items, as well as its risk management objective and strategy for undertaking various hedge transactions. In this documentation, the Company specifically identifies the asset, liability, firm commitment or forecasted transaction that has been designated as a hedged item and states how the hedging instrument is expected to hedge the risks related to the hedged item. The Company formally measures effectiveness of its designated hedging relationships, both at the hedge inception and on an ongoing basis. The Company assesses the effectiveness of its designated hedges using the period-to-period dollar offset method on an individual currency basis. If the ratio obtained with this method is within the range of 80% to 125%, the Company considers the hedge effective under SFAS 133. The time value component of the designated fair value hedges is excluded from the assessment of hedge effectiveness.
The Company will discontinue hedge accounting prospectively if it is determined that the derivative is no longer effective in offsetting changes in the fair value of a hedged item. To the extent that the Company in the future chooses to discontinue hedge accounting related to its fair value hedge of currency risk related to its available for sale fixed income securities (liability funds) because, based on Management’s assessment, the derivative no longer qualifies as an effective fair value hedge, the derivative will continue to be carried in the Consolidated Balance Sheets at its fair value, with changes in its fair value recognized in current period net income, and changes in the fair value of the underlying available for sale fixed income securities due to currency movements will be recorded as a component of accumulated other comprehensive income.
written covered call options for the purpose of replicating investment positions, managing market exposure and duration risks, or enhancing investment performance. These instruments are recorded at fair value as assets and liabilities in the Consolidated Balance Sheets and changes in fair value are included in net realized investment gains and losses in the Consolidated Statements of Operations, except for the changes in fair values of non-designated foreign exchange forward contracts that are included in net foreign exchange gains and losses in the Consolidated Statements of Operations. The fair values of those derivatives are based on quoted market prices, or internal valuation models where quoted market prices are not available. Margin balances required by counterparties, which are equal to a percentage of the total value of open futures contracts, are included in cash and cash equivalents.
Common shares repurchased by the Company and not cancelled are classified as treasury shares, and are recorded at cost. This results in a reduction of shareholders’ equity in the Consolidated Balance Sheets.
Effective January 1, 2006, the Company adopted the provisions of SFAS No. 123 (revised 2004), “Share-Based Payment” (SFAS 123(R)), using the modified prospective method. Under SFAS 123(R), the fair value of
Effective December 31, 2006, the Company adopted SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans-an amendment of FASB Statements No. 87, 88, 106 and 132(R)” (SFAS 158). This statement requires an entity to, among other things: (a) recognize an asset or a liability in the Consolidated Balance Sheets for the funded status of defined benefit plans that are overfunded or underfunded, respectively, measured as the difference between the fair value of plan assets and the pension obligation; (b) recognize changes in the funded status of defined benefit plans in the year in which the changes occur as a component of accumulated other comprehensive income, net of tax; and (c) measure defined benefit plan assets and obligations as of the date of the employer’s balance sheet date.
FIN 46(R) requires a variable interest entity (VIE) to be consolidated by a company if that company is subject to a majority of the risk of loss from the VIE’s activities or is entitled to receive a majority of the entity’s residual returns or both. A VIE is a corporation, partnership, trust or any other legal structure used for business purposes that either (a) does not have equity investors with voting rights or (b) has equity investors that do not provide sufficient financial resources for the entity to support its activities. The Company has determined that PartnerRe Finance II, which issued the capital efficient notes (CENts), PartnerRe Capital Trust I (the Trust), which issued the Company’s trust preferred securities and PartnerRe Finance I, which owns the Trust, do not meet the consolidation requirements of FIN 46(R). As a result, the Company has not consolidated the Trust and PartnerRe Finance I or II and has reflected the debt related to the capital efficient notes issued by the Company to PartnerRe Finance II as liabilities in the Consolidated Balance Sheets (see Note 12). The interest on the debt related to the trust preferred securities and CENts is reported as interest expense in the Consolidated Statements of Operations.
Segments and sub-segments represent markets that are reasonably homogeneous in terms of geography, client types, buying patterns, underlying risk patterns and approach to risk management. These segments and sub-segments were determined in accordance with SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information”.
SFAS 157 will be effective for fiscal years beginning after November 15, 2007. The Company will adopt SFAS 157 as of January 1, 2008. The adoption of SFAS 157 is not expected to have a material impact on the Company’s consolidated shareholders’ equity or net income.
In February 2007, the FASB issued Statement No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities-Including an amendment of FASB Statement No. 115” (SFAS 159). SFAS 159 allows entities to choose, at specified election dates, to measure eligible financial assets and financial liabilities at fair value that are not otherwise required to be measured at fair value. If a company elects the fair value option for an eligible item, changes in that item’s fair value in subsequent reporting periods must be recognized in current earnings. SFAS 159 also establishes presentation and disclosure requirements designed to draw comparisons between entities that elect different measurement attributes for similar assets and liabilities.
SFAS 160 will be effective for fiscal years beginning after December 15, 2008, and the Company will adopt SFAS 160 as of January 1, 2009. SFAS 160 may not be applied retroactively and early adoption is prohibited. The Company is currently evaluating the impact of the adoption of SFAS 160 on its consolidated shareholders’ equity and net income.
(1) Cost is amortized cost for fixed maturities and short-term investments and original cost for equities, net of other-than-temporary impairments.
The following tables present the continuous periods during which the Company has held investment positions classified as available for sale that were carried at an unrealized loss at December 31, 2007 and 2006 (in millions of U.S. dollars):
As of December 31, 2007, the Company held approximately 500 investment positions that carried total gross unrealized losses of $80.4 million, including $22.5 million on securities that carried unrealized losses for more than 12 continuous months.
As of December 31, 2007 and 2006, the Company had no significant unrealized losses caused by other factors or circumstances, including an issuer’s specific corporate risk or due to industry or geographic risk, for which an other-than-temporary impairment charge has not been taken.
The distribution of available for sale fixed maturities and short-term investments at December 31, 2007, by contractual maturity, is shown below (in thousands of U.S. dollars). Actual maturities may differ from contractual maturities because certain borrowers have the right to call or prepay certain obligations with or without call or prepayment penalties.
The components of the net realized investment (losses) gains on available for sale securities for the years ended December 31, 2007, 2006 and 2005 were as follows (in thousands of U.S. dollars):
The components of net investment income for the years ended December 31, 2007, 2006 and 2005 were as follows (in thousands of U.S. dollars):
At December 31, 2007 and 2006, net unrealized investment gains on fixed maturity trading securities were $1.4 million and $4.9 million, respectively. At December 31, 2007 and 2006, equity trading securities had a net unrealized investment loss of $9.7 million and a net unrealized investment gain of $16.6 million, respectively.
At December 31, 2007 and 2006, approximately $27.5 million and $46.8 million, respectively, of cash and cash equivalents and approximately $1,410.6 million and $1,206.1 million, respectively, of available for sale securities were deposited, pledged or held in escrow accounts to support long-term debt, or in favor of ceding companies and other counterparties or government authorities to comply with reinsurance contract provisions and insurance laws.
Included in other invested assets are private placement bond investments with maturities of more than one year through ten years, with a cost, which approximates fair value, of $20 million and $15 million at December 31, 2007 and 2006, respectively.
The following table summarizes the net prior year (favorable) adverse development of loss reserves for the Company’s Non-life operations for the years ended December 31, 2007, 2006 and 2005 (in millions of U.S. dollars):
For the Global (Non-U.S.) P&C sub-segment, the Company reported net favorable loss development for prior accident years in 2007, 2006 and 2005. Losses reported by cedants in 2007 regarding prior accident years were lower than expected in all lines of business, which led the Company to decrease its expected ultimate loss ratios and loss estimates. The Company observed an improvement in loss experience in the property and casualty lines, and deterioration in the motor line, in 2006 and 2005. Losses reported by cedants during each of these years regarding prior accident years included no significant losses or reductions but a series of attritional losses or reductions.
For the Global (Non-U.S.) Specialty sub-segment, losses reported by cedants during 2007, 2006 and 2005 for prior accident years were lower than the Company expected in most lines of business. This led the Company to decrease its expected ultimate loss ratios and loss estimates for prior year losses in each of these years. Losses reported by cedants during each of these years regarding prior accident years included no significant losses or reductions but a series of attritional losses or reductions.
For the Catastrophe sub-segment, the Company reported net favorable loss development for prior accident years in 2007 and 2005, and net adverse loss development in 2006. During 2007 and 2005, the net favorable loss development was primarily due to favorable loss emergence, as losses reported by cedants for prior accident years were lower than the Company expected and, except for the 2005 hurricanes, included no individually significant losses or reductions but a series of attritional losses or reductions. During 2006, the net adverse loss development on prior accident years of $24 million included net adverse loss development of $36 million related
The Company’s net reserve for unpaid losses and loss expenses at December 31, 2007 and 2006 included $87.7 million and $95.2 million, respectively, that represents estimates of its net ultimate liability for asbestos and environmental claims. The gross liability for such claims at December 31, 2007 and 2006 was $97.8 million and $104.9 million, respectively, of which $89.1 million and $98.3 million, respectively, relate to U.S. casualty exposures arising from business written by PartnerRe SA and PartnerRe U.S. Ultimate loss estimates for such claims cannot be estimated using traditional reserving techniques and there are significant uncertainties in estimating the amount of the Company’s potential losses for these claims. In view of the changes in the legal and tort environment that affect the development of such claims, the uncertainties inherent in estimating asbestos and environmental claims are not likely to be resolved in the near future. There can be no assurance that the reserves established by the Company will not be adversely affected by development of other latent exposures, and further, there can be no assurance that the reserves established by the Company will be adequate. The Company does, however, actively evaluate potential exposure to asbestos and environmental claims and establishes additional reserves as appropriate. The Company believes that it has made a reasonable provision for these exposures and is unaware of any specific issues that would materially affect its loss and loss expense estimates.
The Life segment reported net adverse development for prior accident years during the year ended December 31, 2007 of $2 million, compared to net favorable development for prior accident years of $12 million for the year ended December 31, 2006. There was no loss reserve development for prior accident years for the year ended December 31, 2005.
The net adverse development and the net favorable development reported in 2007 and 2006 was primarily related to the receipt of additional reported loss information from cedants and changes in assumptions related to certain proportional guaranteed minimum death benefit treaties.
The Company uses retrocessional agreements to reduce its exposure to risk of loss on reinsurance assumed. These agreements provide for recovery of a portion of losses and loss expenses from retrocessionaires. The Company remains liable to its cedants to the extent that the retrocessionaires do not meet their obligations under
Net premiums written, net premiums earned and losses and loss expenses and life policy benefits are reported net of reinsurance in the Company’s Consolidated Statements of Operations. Assumed, ceded and net amounts for the years ended December 31, 2007, 2006 and 2005 were as follows (in thousands of U.S. dollars):
The Company has subsidiaries and branches that operate in various other jurisdictions around the world that are subject to tax in the jurisdictions in which they operate. The significant jurisdictions in which the Company’s subsidiaries and branches are subject to tax are France, Switzerland and the United States.
The Company establishes tax liabilities relating to uncertain tax positions as defined in FIN 48. The effect of the adoption of FIN 48 on the Company’s Consolidated Statement of Shareholders’ Equity was a reduction in opening retained earnings on January 1, 2007 of $8.7 million.
The total unrecognized tax benefits of $24.8 million at December 31, 2007 were recorded in net current tax liabilities ($1.4 million), net deferred tax liabilities ($16.1 million) and net FIN 48 unrecognized tax benefit ($7.3 million). The Company recognizes interest and penalties as income tax expense in its Consolidated Statements of Operations.
The total amount of unrecognized tax benefits for which it is reasonably possible that it will change within twelve months is $1.4 million, of which, $1.1 million relates to the expected expiration of the statute of limitations and $0.3 million relates to the amount the Company expects to pay.
Deferred tax assets and liabilities reflect the tax impact of temporary differences between the carrying amounts of assets and liabilities for financial reporting and income tax purposes. Significant components of the net deferred tax assets and liabilities as of December 31, 2007 and 2006 were as follows (in thousands of U.S. dollars):
As of December 31, 2007, the Company had net deferred tax assets of $49.3 million relating to operating loss carryforwards primarily in France. French tax law allows tax losses to be carried forward for an unlimited period.
In the normal course of its underwriting activities, the Company and certain subsidiaries entered into reinsurance contracts (assumed and ceded) with Atradius N.V. The activity included in the Consolidated Statement of Operations related to Atradius N.V. for the years ended December 31, 2007, 2006 and 2005 was as follows (in thousands of U.S. dollars):
In the normal course of its operations, the Company subleases office space to Novelis, and leased office space from Atis Real, on market terms. Pursuant to the agreements, rent (income) expense for the years ended December 31, 2007, 2006 and 2005, aggregated $(0.1) million, $(0.7) million, $4.9 million (through June 2005), respectively.
Contributions are made by the Company, and in some locations, these contributions are supplemented by the local plan participants. Contributions are based on a percentage of the participant’s base salary depending upon competitive local market practice. Vesting provisions meet legal compliance standards and market trends; the
The Company incurred expenses for these defined contribution arrangements of $10.3 million, $10.0 million and $12.3 million for the years ended December 31, 2007, 2006 and 2005, respectively.
The components of net periodic benefit cost for the years ended December 31, 2007 and 2006 consisted of (in thousands of U.S. dollars):
Total unfunded pension obligation recognized in accumulated other comprehensive income at December 31, 2007 and 2006 was $2.9 million (net of $0.8 million of taxes) and $7.0 million (net of $2.0 million of taxes), respectively.
The expected long-term rate of return on plan assets is based on the expected asset allocation and assumptions concerning long-term interest rates, inflation rates and risk premiums for equities above the risk-free rates of return. These assumptions take into consideration historical long-term rates of return for the relevant asset categories.
Prior to June 1999, the Company had defined benefit plans in place covering substantially all of its employees. All active employees previously enrolled in defined benefit plans have been transferred to defined contribution plans or the Zurich Plan. Benefit accruals under the former defined benefit plans were either frozen, except for certain disabled participants, or rolled into defined contribution plans or the Zurich Plan. At December 31, 2007, the frozen defined benefit plan had plan assets of $7.5 million with a pension obligation of $6.4 million, resulting in the defined benefit plan being overfunded by $1.1 million. At December 31, 2006, the frozen defined benefit plan had plan assets of $7.6 million with a pension obligation of $6.4 million, resulting in the defined benefit plan being overfunded by $1.2 million. In addition to the amounts recognized with respect to the Zurich Plan, the Company has also recognized $0.4 million in accumulated other comprehensive income as a result of initially applying FAS 158 to the frozen defined benefit plans in 2006.
In May 2005, the shareholders approved the PartnerRe Ltd. 2005 Employee Equity Plan (the EEP) and replaced the existing employee plan, the Employee Incentive Plan (the EIP). The EEP permits the grant of stock options, restricted shares (RS), restricted share units (RSU), share appreciation rights (SAR) or other share-based awards to employees of the Company. The EEP is administered by the Compensation Committee of the Board (the Committee).
Currently, the plan permits the grant of up to 2.3 million shares, of which a total of 750,000 shares can be issued as either RS or RSU. If an award under the EEP is cancelled or forfeited without the delivery of the full number of shares underlying such award, only the net number of shares actually delivered to the participant will be counted against the EEP’s authorized shares. If an outstanding award under the Company’s predecessor equity plans is cancelled or forfeited without the delivery of the number of shares underlying such award, such undelivered shares will also be available for issuance under the EEP in addition to all other shares authorized for issuance. The number of shares that may be added back to the plan from net share settlement of SAR and options is capped at 400,000 shares over the life of the plan. Under the EEP, the exercise price of the award will not be less than the fair market value of the award at the time of grant. The fair market value is defined in the EEP as the average of the highest and lowest sale prices reported on the date prior to the date of grant. Awards issued under the EEP generally vest over 3 years of continuous service, either ratably or with a cliff-vest provision, are expensed ratably over the vesting period and have a ten-year contractual term. Shares available for grant under the EIP at the time of replacement were transferred and became available for grant under the EEP, including an additional 1.0 million common shares approved by shareholders for issuance under the EEP.
Certain awards to certain senior executives will, if the Committee intends such award to qualify as “qualified performance based compensation” under Section 162(m) of the Internal Revenue Code (IRC), become earned and payable only if pre-established targets relating to one or more of the following performance measures are achieved: (i) earnings per share, (ii) financial year return on common equity, (iii) underwriting year return on equity, (iv) return on net assets, (v) organizational objectives, and (vi) premium growth. The individual maximum number of shares underlying any such share-denominated award granted in any year will be 800,000 shares, and the individual maximum amount earned with respect to any such non-share denominated award granted in any year will be $5,000,000.
Under the EIP, the Company granted, subject to certain restrictions, stock options, RS, RSU, SAR, performance units (PU) and performance shares (PS) to employees of the Company. Pursuant to the terms of the EIP, awards were granted to eligible employees at any time, in any amount, as determined by the Committee. The RS and RSU were subject to terms, conditions, restrictions and restricted periods fixed by the Committee that were generally linked to prescribed performance goals. The PU and PS awards were subject to performance goals that were fixed by the Committee. A total of 5 million common shares were authorized for issuance under the EIP.
The Non-Employee Directors’ Stock Plan (Directors’ Stock Plan), which is shareholder-approved, permits the grant of up to 0.5 million stock options, RS, RSU, alternative awards and other share-based awards. Under the Directors’ Stock Plan, the exercise price of the stock options will be equivalent to the fair market value of the stock options at the time of grant, as defined in the Directors’ Stock Plan. Awards issued under the Directors’ Stock Plan generally vest at the time of grant with a minimum delivery date restriction of five years, are expensed immediately and have a ten year contractual term. At December 31, 2007, 0.2 million shares remained available for issuance under this plan.
The Employee Share Purchase Plan (the ESPP), which is shareholder-approved, has one offering period per year with two purchase periods of six months. All employees are eligible to participate in the ESPP and can contribute between 1% and 10% of their base salary toward the purchase of the Company’s shares up to the limit set by the IRC. Employees who enroll in the ESPP may purchase the Company’s shares at a 15% discount of the fair market value. Participants in the ESPP are eligible to receive dividends on their shares as of the purchase date. A total of 0.3 million common shares may be issued under the ESPP.
For the years ended December 31, 2007, 2006 and 2005, the Company’s share-based compensation expense was $24.9 million, $23.0 million and $15.1 million, respectively with a tax benefit of $1.0 million, $2.2 million and $nil, respectively. The adoption of SFAS 123(R) resulted in additional compensation expense in 2006 of $2.0 million, or approximately $0.03 per basic and diluted share.
In 2007, 2006 and 2005 707,444, 285,382 and 609,799 stock options with a total grant-date value of $10.0 million, $4.1 million and $8.1 million were exercised, respectively. The aggregate intrinsic value of stock options exercised for the years ended December 31, 2007, 2006 and 2005 was $18.9 million, $5.6 million and $12.2 million, respectively. The Company received $35.1 million, $14.1 million and $27.0 million from stock option exercises for the years ended December 31, 2007, 2006 and 2005, respectively.
In 2007, the Company’s U.S. subsidiaries deducted $5.2 million from their taxable income upon exercises of stock options. The corresponding tax benefit realized on options exercised was $1.8 million. Shareholders’ equity at December 31, 2007 reflects a tax benefit of $1.8 million related to compensation expense deductions for stock options exercised by employees of the Company’s U.S. subsidiaries.
The activity related to the Company’s stock options for the years ended December 31, 2007, 2006 and 2005 was as follows:
Prior to the adoption of SFAS 123(R), the Company used historical experience to determine the expected life of stock options; expected volatility equivalent to the historical volatility of the Company’s common shares since inception of the Company; a risk-free interest rate based on the market yield of U.S. treasury securities with maturities equivalent to the expected life of the Company’s options; and a dividend yield reflecting the inception-to-date average dividend yield of the Company.
The activity related to the Company’s RSU for the years ended December 31, 2007 and 2006 was as follows:
Of the 681,428 RSU outstanding at December 31, 2007, 105,275 RSU are subject to a five year delivery date restriction from the grant date and were not released for conversion into shares.
During 2007 and 2006, the Company issued 360,228 and 174,770 SAR with a weighted average grant date fair value of $13.88 and $14.37, respectively.
The Company values SAR issued with a Black-Scholes valuation model and used the following assumptions for the years ended December 31, 2007 and 2006:
For the year ended December 31, 2005, the basic and diluted net loss per common share on an as reported basis was $1.56 per share. On a pro forma basis applying the fair value provisions of SFAS 123, the basic and diluted net loss per common share would have been $1.61 per share.
The reinsurance subsidiaries are required to file annual statements with insurance regulatory authorities prepared on an accounting basis prescribed or permitted by such authorities (statutory basis), maintain minimum levels of solvency and liquidity and comply with risk-based capital requirements and licensing rules. As of December 31, 2007, the reinsurance subsidiaries’ solvency, liquidity and risk-based capital amounts were in excess of the minimum levels required. The typical adjustments to insurance statutory basis amounts to convert to U.S. GAAP include elimination of certain statutory reserves, deferral of certain acquisition costs, recognition of deferred income taxes, valuation of bonds at market and presentation of ceded reinsurance balances gross of assumed balances.
At December 31, 2007 and 2006, the Company’s Swiss operations are a branch of Partner Reinsurance. Foreign insurance entities that are effecting or carrying on exclusively reinsurance business in Switzerland are exempt from Swiss insurance and reinsurance supervision, provided such entities are not acting for that purpose through a Swiss subsidiary.
On November 7, 2006, PartnerRe Finance II Inc. (PartnerRe Finance II), an indirect wholly-owned subsidiary of the Company, issued $250 million aggregate principal amount of 6.440% Fixed-to-Floating Rate Junior Subordinated CENts. The CENts will mature on December 1, 2066 and may be redeemed at the option of the issuer, in whole or in part, after December 1, 2016 or earlier upon occurrence of specific rating agency or tax events. Interest on the CENts is payable semi-annually commencing on June 1, 2007 to December 1, 2016 at an annual fixed rate of 6.440% and will be payable quarterly thereafter until maturity at an annual rate of 3-month LIBOR plus a margin equal to 2.325%. For the year ended December 31, 2007, the Company incurred interest expense of $16.5 million and paid interest of $17.7 million.
PartnerRe Finance II may elect to defer one or more interest payments for up to ten years, although interest will continue to accrue and compound at the rate of interest applicable to the CENts. The CENts will be ranked as junior subordinated unsecured obligations of PartnerRe Finance II. The Company has fully and unconditionally guaranteed on a subordinated basis all obligations of PartnerRe Finance II under the CENts. The Company’s obligations under this guarantee are unsecured and will rank junior in priority of payments to the Company’s current long-term debt (see Note 6). The Company used a portion of the net proceeds from the CENts to effect the redemption of all of the $200 million liquidation amount of the 7.90% trust preferred securities issued in 2001 by PartnerRe Capital Trust I and the remaining net proceeds were used for general corporate purposes.
Finance I Inc. (PartnerRe Finance I), a Delaware corporation formed solely for the purpose of issuing Junior Subordinated Debt securities to the Trust. PartnerRe Finance I is an indirect, wholly owned subsidiary of the Company.
In November and May 2007, the Company’s Board of Directors increased the shares authorized for repurchase by the Company to 5 million shares. At December 31, 2007, the Company had approximately 4.5 million common shares remaining under its current share repurchase authorization.
During 2007, the Company repurchased in the open market 3.6 million of its common shares pursuant to the share repurchase program at a total cost of $275.0 million, representing an average cost of $76.06, of which 3.1 million common shares, or $241.3 million, are currently held in treasury and are available for reissuance.
During 2005, the Company repurchased in the open market 1.2 million of its common shares pursuant to the share repurchase program at a total cost of $75.5 million, representing an average cost of $60.74. The repurchased shares were cancelled and are no longer outstanding.
In May 2003, the Company issued 11.6 million of 6.75% Series C cumulative redeemable preferred shares (Series C preferred shares) for a total consideration of $280.9 million after underwriting discounts and
commissions totaling $9.1 million. The Series C preferred shares cannot be redeemed before May 8, 2008. Beginning May 8, 2008, the Company may redeem the Series C preferred shares at $25.00 per share plus accrued and unpaid dividends without interest. Dividends on the Series C preferred shares are cumulative from the date of issuance and are payable quarterly in arrears. In the event of liquidation of the Company, the holders of outstanding preferred shares would have preference over the common shareholders and would receive a distribution of $25.00 per share, or an aggregate value of $290 million, plus accrued and unpaid dividends.
The reconciliation of basic and diluted net income (loss) per share for the years ended December 31, 2007, 2006 and 2005 is as follows (in thousands of U.S. dollars or shares, except per share amounts):
In October 2005, the Company entered into a forward sale agreement under which it will sell approximately 6.7 million of its common shares to an affiliate of Citigroup Global Markets Inc., which affiliate is referred to as the forward counterparty. Under the forward sale agreement, the Company will deliver common shares to the forward counterparty on one or more settlement dates chosen by the Company prior to October 2008. The purchase price the Company will receive from the forward counterparty will vary depending upon the market price of its common shares over a 40 trading day period surrounding the maturity of the forward sale agreement in October 2008, subject to a maximum price per share of $79.71 and a minimum price per share of $59.49 as of December 31, 2007. If the Company elects to settle all or a portion of the forward sale agreement prior to its maturity, the Company will deliver common shares to the forward counterparty and will initially receive the present value of the minimum price per share, and the remaining payment, if any, due to the Company will be made at maturity of the agreement based on the excess of the market price of the Company’s common shares over the minimum price per share at maturity of the contract. Settlement of the forward sale agreement may be accelerated by the forward counterparty upon the occurrence of certain events, and the maximum and minimum purchase prices will be reduced or increased quarterly depending on the amount of the Company’s dividends.
The Company’s investment portfolio is managed following prudent standards of diversification and a prudent investment philosophy. The Company is not exposed to any significant credit concentration risk on its investments, except for debt securities issued by the U.S. and other AAA-rated sovereign governments. The Company keeps cash and cash equivalents in several banks and may keep up to $500 million, excluding custodial accounts, at any point in time in any one bank.
The Company’s investment strategy allows for the use of derivative securities, subject to strict limitations. Derivative instruments may be used to replicate investment positions, to manage currency and market exposures and duration risk, or to enhance investment performance that would be allowed under the Company’s investment policy if implemented in other ways. The Company is exposed to credit risk in the event of non-performance by the counterparties to the Company’s foreign exchange forward contracts and other derivative contracts. However, because the counterparties to these contracts are high-credit-quality international banks, the Company does not anticipate non-performance. These contracts are generally of short duration and settle on a net basis. The difference between the contract amounts and the related market value is the Company’s maximum credit exposure.
The Company has exposure to credit risk as it relates to its business written through brokers, if any of the Company’s brokers is unable to fulfill their contractual obligations with respect to payments to the Company. In addition, in some jurisdictions, if the broker fails to make payments to the insured under the Company’s policy, the Company might remain liable to the insured for the deficiency.
The Company is also subject to the credit risk of its cedants in the event of insolvency or the cedant’s failure to honor the value of funds held balances for any other reason. However, the Company’s credit risk is mitigated, to a large extent, by the fact that the Company generally has the contractual ability to offset any shortfall in the payment of the premiums receivable or funds held balances with amounts owed by the Company to the cedant for losses payable and other amounts contractually due.
The Company leases office space under operating leases expiring in various years through 2019. The leases are renewable at the option of the lessee under certain circumstances. The following is a schedule of future minimum rental payments, exclusive of escalation clauses, on non-cancelable leases as of December 31, 2007 (in thousands of U.S. dollars):
Rent expense for the years ended December 31, 2007, 2006 and 2005, was $25.9 million, $25.3 million and $24.9 million, respectively.
The Company has also entered into non-cancelable operating subleases expiring in various years through 2010. The minimum rental income to be received by the Company in the future is $3.5 million. The leases are renewable at the option of the lessee under certain circumstances.
Under the terms of the Company’s forward sale agreement (see Note 14), the Company will pay approximately $9.8 million, including interest, in contract fees in 2008. Contract fees and interest paid was $10.8 million, $10.8 million and $nil for the years ended December 31, 2007, 2006 and 2005, respectively.
The Company has entered into service agreements and lease contracts that provide for business and information technology support and computer equipment. Future payments under these contracts amount to $37.0 million through 2013.
As of December 31, 2007, the Company was not a party to any litigation or arbitration that it believes could have a material adverse effect on the financial condition or business of the Company.
(1) In accordance with SFAS 107, the Company’s investments accounted for under the equity method were excluded for the purpose of the fair value disclosure. The negative fair value of other invested assets reflects mark to market adjustments on derivative financial instruments.
As part of the Company’s investment strategy, the Company utilizes, to a limited extent, equity short sales, which represent the sales of securities not owned at the time of the sale. The fair values for equity short sales are based on quoted market prices with the changes in fair value reported in net realized gains and losses in the Consolidated Statements of Operations. The fair value of equities sold but not yet purchased was $nil and $70 million, respectively, at December 31, 2007 and 2006 (see Note 3(h)).
Included in the total credit facilities available to the Company at December 31, 2007 is a $700 million five-year syndicated, unsecured credit facility. This unsecured credit facility has the following terms: (i) a maturity date of September 30, 2010, (ii) a $300 million accordion feature, which enables the Company to potentially increase its available credit from $700 million to $1 billion, and (iii) a minimum consolidated tangible net worth requirement as defined below. This facility is predominantly used for the issuance of letters of credit, although the Company does have access to a $350 million revolving line of credit under this facility. At December 31, 2007 and 2006, there were no borrowings under this revolving line of credit.
iii. a minimum consolidated tangible net worth of $2,100 million, for periods ended prior to June 30, 2006, and $2,100 million plus 50% of cumulative net income (if positive) since July 1, 2005 through the most recent June 30 or December 31, for periods subsequent to June 30, 2006. For the purposes of this covenant, consolidated tangible net worth includes the CENts and excludes goodwill. Minimum tangible net worth required at December 31, 2007 was $2,672 million.
The Company’s breach of any of the covenants would result in an event of default, upon which the Company may be required to repay any outstanding borrowings and replace or cash collateralize letters of credit issued under these facilities. At December 31, 2007 and 2006, the Company was not in breach of any of the covenants under its facilities. Its total debt to total capitalization ratio was 11.9% and 18.8%, respectively, and its consolidated tangible net worth was $4,142.1 million and $3,356.3 million, at December 31, 2007 and 2006, respectively.
As a result of recent organizational changes, during the fourth quarter of 2007, the Company redefined its financial reporting segments. Segment data for the years ended December 31, 2006 and 2005 has been recast to conform to the current year presentation.
The U.S. sub-segment includes property, casualty, motor, multiline, structured risk, agriculture, surety and other risks generally originating in the United States and written by PartnerRe U.S. The Global (Non-U.S.) P&C sub-segment includes property, casualty, motor and structured risk business generally originating outside of the United States, written by Partner Reinsurance and PartnerRe SA. The Global (Non-U.S.) Specialty sub-segment is comprised of business that is generally considered to be specialized due to the sophisticated technical underwriting required to analyze risks, and is global in nature. This sub-segment consists of several lines of business for which the Company believes it has developed specialized knowledge and underwriting capabilities. These lines of business include agriculture, aviation/space, credit/surety, engineering, energy, marine, specialty property, specialty casualty and other lines. The Catastrophe sub-segment includes catastrophe business written by Partner Reinsurance. The Life segment includes life, health and annuity lines of business. Corporate and Other is comprised of the Company’s capital markets and investment related activities, including principal finance transactions, insurance-linked securities (previously referred to as weather-related products) and strategic investments, including the Company’s equity investment in ChannelRe Holdings, and its corporate activities, including other operating expenses.
Management measures results for the Non-life segment on the basis of the loss ratio, acquisition ratio, technical ratio, other operating expense ratio and combined ratio (defined below). Management measures results for the Non-life sub-segments on the basis of the loss ratio, acquisition ratio and technical ratio (defined below). Management measures results for the Life segment on the basis of the allocated underwriting result, which includes revenues from net premiums earned, other income or loss and allocated net investment income for Life, and expenses from life policy benefits, acquisition costs and other operating expenses.
The following tables provide a summary of the segment revenues and results for the years ended December 31, 2007, 2006 and 2005 (in millions of U.S. dollars, except ratios):
(A) The Company reports the results of ChannelRe Holdings on a one-quarter lag. The 2007 period includes the Company’s share of ChannelRe Holdings’ net loss and a charge which represents the write-down of its total investment in ChannelRe Holdings due to unrealized mark-to-market losses on Channel Reinsurance Ltd’s credit derivative portfolio, which it expects to incur during the three-month period ended December 31, 2007 (see Note 20), for a total of $92.8 million.
(3) Acquisition ratio is obtained by dividing acquisition costs by net premiums earned.
(4) Technical ratio is defined as the sum of the loss ratio and the acquisition ratio.
(B) The 2006 period includes the Company’s share of ChannelRe Holdings’ net income in the amount of $11.7 million for the period of October 2005 to September 2006, as the Company reports the results of ChannelRe Holdings on a one-quarter lag.
(C) The 2005 period includes the Company’s share of ChannelRe Holdings’ net income in the amount of $9.4 million for the period of October 2004 to September 2005, as the Company reports the results of ChannelRe Holdings on a one-quarter lag.
The Company had two brokers that individually accounted for 10% or more of its gross premiums written during the years ended December 31, 2007, 2006 and 2005. The brokers accounted for 19%, 20% and 17% and 17%, 18% and 16%, respectively, of gross premiums written for the years ended December 31, 2007, 2006 and 2005.
ChannelRe Holdings is a non-publicly traded financial guaranty reinsurer based in Bermuda, which assumed a portfolio of in-force business from MBIA, and which participates in new MBIA reinsurance treaties and provides facultative reinsurance support to MBIA. The Company’s investment represents 20% of the common shares of Channel Reinsurance Ltd. (“Channel Reinsurance”), which is a subsidiary and the primary asset of ChannelRe Holdings. The investment in ChannelRe Holdings is accounted for using the equity method. The Company’s share of ChannelRe Holdings’ net income and other comprehensive income is reported in the Company’s net income and accumulated other comprehensive income, respectively, on a one-quarter lag. The Company calculates its share of ChannelRe Holdings’ net income and other comprehensive income on the basis of the Company’s ownership percentage of ChannelRe Holdings’ common shares currently outstanding.
We have audited the accompanying consolidated balance sheets of PartnerRe Ltd. and subsidiaries (the “Company”) as of December 31, 2007 and 2006, and the related consolidated statements of operations and comprehensive income, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2007. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of PartnerRe Ltd. and subsidiaries as of December 31, 2007 and 2006, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2007, in conformity with accounting principles generally accepted in the United States of America.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of December 31, 2007, based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 29, 2008 expressed an unqualified opinion on the Company’s internal control over financial reporting.