Our corporate offices are located in approximately 98,360 total square feet of leased space in Stamford, Connecticut. Our other locations occupy a total of approximately 118,653 square feet, all of which are leased. The Americas division operates out of offices in New York, Stamford, Mexico City, Miami, Santiago and Toronto, the EuroAsia division operates out of offices in Paris, Singapore, Stockholm and Tokyo, the London Market division operates out of offices in London and Bristol, and the U.S. Insurance division operates out of offices in New York, Stamford, Chicago and Napa.
Assumes retroactive implementation of SFAS Nos. 141 and 142, which relate to goodwill and negative goodwill. These statements were adopted by us on January 1, 2002.
Odyssey Re Holdings Corp. is a holding company, incorporated in the state of Delaware, which owns all of the common stock of Odyssey America Reinsurance Corporation. Odyssey America directly or indirectly owns all of the common stock of: Clearwater Insurance Company; Clearwater Select Insurance Company; Odyssey UK Holdings Corporation; Newline Underwriting Management Ltd., which owns and manages a syndicate at
Our gross premiums written for the year ended December 31, 2004 were $2.7 billion, an increase of $98.3 million, or 3.8%, compared to gross premiums written for the year ended December 31, 2003 of $2.6 billion. Continued premium growth was evident in the EuroAsia, London Market and U.S. Insurance divisions while gross premiums written declined in the Americas division. We continue to opportunistically expand in certain classes of business and geographically. Our non-United States operations accounted for 45.9% of our premium volume for the year ended December 31, 2004 compared to 41.9% for the year ended December 31, 2003. For the years ended December 31, 2004 and 2003, our net premiums written were $2.4 billion and $2.2 billion, respectively, and our net income was $186.9 million and $249.2 million, respectively. As of December 31, 2004, we had total assets of $7.7 billion and total stockholders’ equity of $1.6 billion.
The property and casualty reinsurance and insurance industries use the combined ratio as a measure of underwriting profitability. The GAAP combined ratio is the sum of losses and loss adjustment expenses incurred as a percentage of net premiums earned plus underwriting expenses, which include acquisition costs and other underwriting expenses, as a percentage of net premiums earned. The combined ratio reflects only underwriting results, and does not include income from investments. Underwriting profitability is subject to significant fluctuations due to competition, catastrophic events, economic and social conditions, foreign currency fluctuations and other factors. Our combined ratio, which includes the losses from four hurricanes as discussed below, was 98.0% for the year ended December 31, 2004, an increase of 1.2 percentage points from the 96.8% combined ratio for the year ended December 31, 2003. This continued underwriting profitability is a direct result of our underwriting actions, including improvements in pricing as well as terms and conditions, global diversification and our opportunistic expansion into better performing lines of business.
We operate our business through four divisions, the Americas, EuroAsia, London Market, and U.S. Insurance.
The Americas division is our largest division and writes casualty, surety and property treaty reinsurance, and facultative casualty reinsurance in the United States and Canada, and primarily treaty and facultative property reinsurance in Central and South America. The Americas division is comprised of three units, the United States, Canada, and Latin America, with two offices in New York City, and offices located in Stamford, Mexico City, Miami, Santiago and Toronto.
The EuroAsia division operates out of four offices, with principal offices in Paris and Singapore. The EuroAsia business consists of international reinsurance business that is geographically dispersed, mainly throughout the European Union, followed by Japan, Eastern Europe, the Pacific Rim, and the Middle East. The EuroAsia division has been successful in taking advantage of the rate increases throughout its international scope of operations and in creating new market opportunities by leveraging its long-term ceding company and broker relationships.
The London Market division is comprised of our Lloyd’s of London business, in which we participate through our 100% ownership of Newline, which in turn owns and manages Syndicate 1218, and our London branch office. Our Lloyd’s membership provides strong brand recognition, extensive broker and direct distribution channels and worldwide licensing, including the ability to write primary business on an excess and surplus lines basis in the United States. The London Market division in general, and Newline in particular, has experienced a resurgence of opportunities from domestic and international business. The London Market division writes insurance and reinsurance business worldwide, principally through brokers.
The U.S. Insurance division is comprised of Hudson, Hudson Specialty and Clearwater. The U.S. Insurance division writes specialty program insurance business, physicians medical malpractice and hospital professional liability business. The U.S. Insurance division operates out of Napa, Chicago and New York.
We derive our revenues from two principal sources: premiums from insurance placed and reinsurance assumed, net of premiums ceded (net premiums written); and income from investments. Net premiums written are earned (net premiums earned) as they are credited to revenue over the terms of the underlying contracts or certificates in force. The relationship between net premiums written and net premiums earned will, therefore, vary depending generally on the volume and inception dates of the business assumed and ceded and the mix of such business between proportional and excess of loss reinsurance.
Estimates of reserves for unpaid losses and loss adjustment expenses are contingent on many events occurring in the future. The eventual outcome of these events may be different from the assumptions underlying our reserve estimates. In the event the business environment and loss trends diverge from selected trends, we may have to adjust our reserves accordingly. Management believes that the recorded estimate represents the best estimate of unpaid losses and loss adjustment expenses based on the information available as of December 31, 2004. The estimate is reviewed on a quarterly basis and the ultimate liability may be more or less than the amounts provided, for which any adjustments will be reflected in the periods in which they become known.
The Americas division accounted for $2.7 billion of our gross reserves for unpaid losses and loss adjustment expenses, comprised of case reserves of $1.6 billion and IBNR of $1.1 billion as of December 31, 2004. The Americas division ceded reserves for losses and loss adjustment expenses of $752.3 million, of which $229.9 million is IBNR as of December 31, 2004. The Americas division net reserves for unpaid losses and loss adjustment expenses as of December 31, 2004 were $2.0 billion of which $1.1 billion was case reserves and $849.9 million was IBNR.
Acquisition costs consist principally of commissions and brokerage expenses incurred on business written under reinsurance contracts or certificates and insurance policies. These costs are deferred and amortized over the period in which the related premiums are earned. Commission adjustments with ceding companies are accrued based on the underwriting profitability of the business produced. Deferred acquisition costs are limited to their estimated realizable value, which considers anticipated losses and loss adjustment expenses and estimated remaining costs of servicing the contracts or certificates, all based on our historical experience. The methods of making such estimates and establishing the deferred costs are continually reviewed by the Company, and any adjustments are made in the accounting period in which the adjustment arose. We believe the estimate of these deferred acquisition costs is a “critical accounting estimate,” because changes in these estimates can materially affect net income.
On an overall basis, for the year ended December 31, 2004, total reinsurance gross premiums written of $2.0 billion remained relatively unchanged compared to the year ended December 31, 2003. Insurance gross premiums written for the year ended December 31, 2004 were $702.1 million, compared to $634.9 million for the year ended December 31, 2003, a 10.6% increase.
The Americas division accounted for $1.3 billion, or 47.2%, of our gross premiums written for the year ended December 31, 2004, a decrease of $158.2 million, or 11.1%, compared to $1.4 billion, or 54.7%, of our gross premiums written for the year ended December 31, 2003. Gross premiums written by the United States unit for the year ended December 31, 2004 were $1.0 billion, a decrease of $143.6 million, or 12.1%, compared to $1.2 billion for the year ended December 31, 2003. Decreases in the casualty treaty business of $109.0 million are related to a number of factors, primarily ceding companies increasing their net retentions, non-renewal of certain business which did not meet our underwriting standards, and market competition. Gross premiums written by the Latin America unit for the year ended December 31, 2004 were $171.3 million, an increase of $21.6 million, or 14.4%, compared to $149.7 million for the year ended December 31, 2003. This increase is attributable to an increase in new property business written through our Latin American offices. The Canadian unit had gross premiums written of $46.0 million for the year ended December 31, 2004, a decrease of $33.6 million, or 42.2%, compared to $79.6 million for the year ended December 31, 2003. The decrease is primarily due to the cancellation of certain affiliated Canadian company business during 2004.
The decrease in the Americas division gross premiums written for the year ended December 31, 2004, compared to 2003, is comprised of decreases in treaty property of $62.1 million (16.7%) and treaty casualty of $125.2 million (15.2%). These decreases are offset by increases in other treaty business of $12.6 million (15.6%) and facultative reinsurance of $16.5 million (11.4%).
For the year ended December 31, 2004, the EuroAsia division had gross premiums written of $553.7 million, or 20.7%, of our gross premiums written, an increase of $145.6 million, or 35.7%, compared to $408.1 million, or 15.7%, of our gross premiums written for the year ended December 31, 2003. The increase is due to new business and increased participations on existing client business, combined with continued strong renewal rates across most lines of business. Growth has been most notable in the property, motor and credit classes of business. Our EuroAsia division continues to access an increased level of profitable opportunities resulting from recent years’ catastrophe losses, competitor withdrawals and asset impairments, particularly in
The London Market division generated $447.7 million, or 16.7%, of our gross premiums written for the year ended December 31, 2004, an increase of $9.8 million, or 2.2%, compared to $437.9 million, or 16.8%, of our gross premiums written for the year ended December 31, 2003. Gross premiums written by the London branch for the year ended December 31, 2004 were $182.5 million, an increase of $28.1 million, or 18.2%, compared to $154.4 million for the year ended December 31, 2003. A portion of this increase is related to $11.4 million of reinstatement premiums due to hurricane activity. Our Lloyd’s syndicate, which mainly writes professional liability insurance business, had gross premiums written of $265.2 million for the year ended December 31, 2004, a decrease of $18.3 million, or 6.5%, compared to $283.5 million for the year ended December 31, 2003.
The increase in the London branch gross premiums written for the year ended December 31, 2004, compared to 2003, is comprised of increases in treaty property business of $10.5 million (16.8%), treaty casualty business of $12.1 million (35.3%) and treaty marine and aerospace business of $5.5 million (9.6%). The Lloyd’s syndicate business is principally comprised of liability insurance business.
The U.S. Insurance division accounted for $412.1 million, or 15.4%, of our gross premiums written for the year ended December 31, 2004, an increase of $78.3 million, compared to $333.8 million, or 12.8%, of our gross premiums written for the year ended December 31, 2003. The Program unit had gross premiums written of $274.4 million for the year ended December 31, 2004, an increase of $51.2 million, or 22.9%, compared to $223.2 million for the year ended December 31, 2003. New professional liability and personal automobile programs contributed to the increase in gross premiums written. Our Healthcare unit, which writes physicians medical malpractice insurance and hospital professional liability business, had $137.7 million of premiums written for the year ended December 31, 2004, an increase of $27.1 million, or 24.5%, compared to $110.6 million for the year ended December 31, 2003.
Net Premiums Written. Net premiums written for the year ended December 31, 2004 increased by $209.0 million, or 9.7%, to $2.4 billion from $2.2 billion for the year ended December 31, 2003. Net premiums written represents gross premiums written less ceded premiums written. The percentage increase in net premiums written is greater than the gross premiums written as a result of the reduction in ceded premiums written as discussed above.
growth in the current year. The London Market division increased by $87.0 million, or 26%, reflecting the prior period growth in premium volume, and the U.S. Insurance division increased by $102.7 million, or 107.4%, representing the growth in net premiums written in 2004.
Net Investment Income. Net investment income for the year ended December 31, 2004 increased by $30.6 million, or 22.8%, to $164.7 million from $134.1 million for the year ended December 31, 2003. This increase is mainly attributable to the reinvestment in 2004 of the significant cash balances maintained during 2003 into asset classes with investment yields substantially greater than the amount earned on the cash balances. As disclosed in note 4 of the consolidated financial statements, net investment income is comprised of gross investment income of $196.6 million less investment expenses of $31.9 million for the year ended December 31, 2004, compared to gross investment income of $170.2 million less investment expenses of $36.1 million for the year ended December 31, 2003. The increase in gross investment income is due to an increase on interest on fixed income securities of $31.9 million, dividends on equity securities of $14.6 million, interest on cash and short term investments of $3.6 million, offset by a decrease in other investments of $23.7 million. Investment expenses decreased by $4.2 million, primarily related to the decrease in the interest on funds held associated with the aggregate excess of loss cover. The direct investment yield was 4.2% and 4.9% for the years ended December 31, 2004 and 2003, respectively.
Losses and Loss Adjustment Expenses. Incurred losses and loss adjustment expenses increased 22.9% to $1,629.6 million for the year ended December 31, 2004 from $1,325.8 million for the year ended December 31, 2003. The increase in incurred losses and loss adjustment expenses was principally related to the 18.6% increase in net premiums earned, $93.5 million of property catastrophe losses related to the four hurricanes occurring in the third quarter of 2004, and an increase in losses and loss adjustment expenses principally related to casualty classes of business written for accident years prior to 2001 of $181.2 million for the year ended December 31, 2004, compared to $116.9 million for the year ended December 31, 2003. As a result of our reinsurance protection, there were no net adjustments related to asbestos and environmental loss reserves.
through 2003. For the year ended December 31, 2003, reserve adjustments of $87.0 million, principally related to casualty exposures, were recorded.
For the EuroAsia division, incurred losses and loss adjustment expenses increased 20.5% to $299.8 million for the year ended December 31, 2004 from $248.7 million for the year ended December 31, 2003. The increase in the dollar amount is due to the net premiums earned growth of 32.2%, as the loss ratios on the underlying business improved. In the EuroAsia division, net losses and loss adjustment expense reserve adjustments related to accident years 2003 and prior for the year ended December 31, 2004 were $6.6 million, principally related to bond exposures underwritten in 2002. For the year ended December 31, 2003, there were $11.0 million of reserve adjustments related to prior accident years.
For the London Market division, incurred losses and loss adjustment expenses increased 42.9% to $293.6 million for the year ended December 31, 2004 from $205.5 million for the year ended December 31, 2003 due to the increase in net premiums earned of 26.0% and the property catastrophe losses of $25.4 million related to the four hurricanes occurring in the third quarter of 2004. In the London Market division, net losses and loss adjustment expense reserve adjustments related to accident years 2003 and prior for the year ended December 31, 2004 decreased by $0.2 million. For the year ended December 31, 2003, there were $22.6 million of reserve adjustments principally related to casualty exposures in the Lloyd’s syndicate.
For the U.S. Insurance division, incurred losses and loss adjustment expenses increased 85.0% to $130.1 million for the year ended December 31, 2004 from $70.4 million for the year ended December 31, 2003. The increase in incurred losses and loss adjustment expenses was principally related to the increase in net premiums earned. In the U.S. Insurance division, net losses and loss adjustment expense reserve adjustments related to accident years 2003 and prior for the year ended December 31, 2004 decreased by $1.2 million. There were $1.4 million of reserve adjustments related to prior accident years in the U.S. Insurance division for the year ended December 31, 2003.
Acquisition Costs. Acquisition costs for the year ended December 31, 2004 were $528.4 million, compared to $476.0 million for the year ended December 31, 2003, with the increase due to premium growth. The resulting acquisition cost ratio, i.e., acquisition expenses expressed as a percentage of net premiums earned, was 22.7% for the year ended December 31, 2004, compared to 24.2% for the year ended December 31, 2003. The decrease in the acquisition expense ratio is attributable to the increase in premium volume in the EuroAsia, London Market, and U.S. Insurance divisions which has a lower overall acquisition ratio compared to the Americas, which had an overall decrease in net premium volume in 2004 compared to 2003.
Other Expenses, Net. Other expenses, net, for the year ended December 31, 2004, were $21.2 million, compared to $7.9 million for the year ended December 31, 2003. The other expense is primarily comprised of the operating expenses of our holding company and includes audit related fees; Sarbanes-Oxley compliance consulting fees; other corporate related legal and consulting fees; and compensation expense, including the amortization of restricted share grants. Other expenses, net, for the year ended December 31, 2004, also includes the minority interest elimination of an investment that is consolidated in our financial statements (see note 4 to our consolidated financial statements).
Federal and Foreign Income Tax Provision. Our federal and foreign income tax provision for the year ended December 31, 2004 decreased by $37.2 million to $91.9 million, compared to $129.1 million for the year ended December 31, 2003, as a result of the decrease in pre-tax income. Our effective tax rates were 33.0% and 34.1% for the years ended December 31, 2004 and 2003, respectively.
On an overall basis, for the year ended December 31, 2003, total reinsurance gross premiums written increased by $404.4 million, or 25.9%, to $2.0 billion from $1.6 billion for the year ended December 31, 2002. Included in this amount are increases in property treaty business of $161.6 million (31.0%) and casualty treaty business of $158.9 million (20.9%). Insurance gross premiums written for the year ended December 31, 2003 were $634.9 million, compared to $369.5 million for the year ended December 31, 2002, a 71.8% increase.
For the year ended December 31, 2003, the EuroAsia division had gross premiums written of $408.1 million, or 15.7%, of our gross premiums written, an increase of $149.4 million, or 57.8%, compared to $258.6 million, or 13.4%, of our gross premiums written for the year ended December 31, 2002. Opportunities in our EuroAsia division have increased due to catastrophe losses, competitor withdrawals and asset impairments, particularly in Europe. For the years ended December 31, 2003 and 2002, our Paris office had gross premiums written of $299.9 million and $186.7 million, respectively, an increase of $113.2 million, or 60.6%. For the years ended December 31, 2003 and 2002, our Singapore office had gross premiums written of $90.6 million and $68.8 million, respectively, an increase of $21.8 million, or 31.7%. For the year ended December 31, 2003, First Capital had $17.6 million of direct premiums written, as compared to $3.2 million of direct premiums written for the three months ended December 31, 2002. First Capital was acquired on September 10, 2002, thus there was only one quarter’s worth of results in 2002.
Ceded Premiums Written. Ceded premiums written for the year ended December 31, 2003 increased by $141.3 million, or 53.7%, to $404.6 million from $263.3 million for the year ended December 31, 2002. The increase in ceded premiums written is attributable to an increase in cessions to the whole account aggregate excess of loss covers associated with prior underwriting years in the amount of $49.3 million, the addition of the Healthcare unit in 2003, which accounted for $37.1 million of the increase, and the increase in cessions attributable to the Hudson business of $22.2 million. The remaining increase in ceded premiums written is attributable to the increase in the gross premiums written.
Net Premiums Written. Net premiums written for the year ended December 31, 2003 increased by $522.3 million, or 32.0%, to $2.2 billion from $1.6 million for the year ended December 31, 2002, consistent with the increase in gross premiums written. Net premiums written represents gross premiums written less ceded premiums written.
Net Investment Income. Net investment income for the year ended December 31, 2003 increased by $11.1 million, or 9.0%, to $134.1 million from $123.0 million for the year ended December 31, 2002. The net investment yield was 4.9% and 4.3% for the years ended December 31, 2003 and 2002, respectively. The increase in investment income before expenses results principally from an increase in cash and invested assets of over $1.0 billion, as well as an increase in income from our other invested assets category, which includes certain investment participations including limited investment partnerships.
compared to 68.9% for the year ended December 31, 2002. The improved losses and loss adjustment expense ratio reflects the general improvements in primary and reinsurance pricing.
Acquisition Costs. Acquisition costs for the year ended December 31, 2003 increased by $113.7 million, or 31.4%, to $476.0 million from $362.3 million for the year ended December 31, 2002, with the increase due to premium growth offset by a slight decrease in our acquisition cost ratio. The resulting acquisition cost ratio, i.e., acquisition expenses expressed as a percent of earned premium, was 24.2% for the year ended December 31, 2003 compared to 25.3% for the year ended December 31, 2002. The decrease in the acquisition expense ratio is attributable to the negotiation of lower commission and brokerage costs across the portfolio and mix of business, combined with the increased primary insurance underwritten during 2003, which has a lower acquisition cost ratio.
premiums, collections on losses recoverable and investment income, net of paid losses, acquisition costs and underwriting and investment expenses. Cash provided by operations was $603.2 million for the year ended December 31, 2004, compared to $564.1 million for the year ended December 31, 2003. Increased premium collections are directly attributable to the increase in premium volume realized since the latter part of calendar year 2001, which occurred as a result of substantially improved market conditions. Each of our business segments contributed to the improvement in our operating cash flow.
During the fourth quarter of 2003, we issued $225.0 million aggregate principal amount of senior notes due November 1, 2013. The issue was sold at a discount of $0.4 million, which is being amortized over the life of the notes. Interest accrues on the senior notes at a fixed rate of 7.65%, which is due semi-annually on May 1st and November 1st. The senior notes are redeemable at a premium, prior to maturity, at our discretion.
In December 2001, we issued $100.0 million aggregate principal amount of senior notes due November 30, 2006, pursuant to a private placement. Interest accrues on the senior notes at a fixed interest rate of 7.49%, which is due semi-annually on May 31st and November 30th. The senior notes are redeemable at a premium, prior to maturity, at our option. In November 2003 and June 2002, we prepaid $50.0 million and $10.0 million, respectively, aggregate principal amount of the senior notes. Immediately following the issuance of the senior notes, we entered into an interest rate swap agreement with Bank of America N.A. (“Bank of America”) that effectively converted the fixed 7.49% interest rate into a variable interest rate of London Interbank Offered Rate (“LIBOR”) plus 263 basis points. In May 2003, we sold the variable interest rate instrument for a gain of $6.4 million. The gain has been deferred and is being amortized over the remaining life of the senior notes. In conjunction with the prepayment of the senior notes, a portion of the deferred gain was immediately realized. As of December 31, 2004, the aggregate principal amount of the senior notes outstanding was $40.0 million and the remaining deferred gain is $1.5 million.
Through UK Holdings, Odyssey America became a limited liability participant in the Lloyd’s market in 1997. In order to continue underwriting at Lloyd’s, Odyssey America has established a clean irrevocable letter of
credit and a deposit trust account in favor of the Society and Council of Lloyd’s. As of December 31, 2004, Odyssey America had pledged U.S. treasuries in the amount of $164.7 million in support of a letter of credit and had placed $170.9 million in a deposit trust account in London. The letter of credit and deposit trust account effectively secure the future contingent obligations of UK Holdings should the Lloyd’s underwriting syndicate in which Odyssey America participates incur net losses. Odyssey America’s contingent liability to the Society and Council of Lloyd’s is limited to the aggregate amount of the letter of credit and the deposit trust account.
Financial strength ratings represent the opinions of the rating agencies of the financial strength of a company and its capacity to meet the obligations of insurance policies and reinsurance contracts. The rating agencies
consider many factors in determining the financial strength rating of an insurance or reinsurance company, including the relative level of statutory surplus necessary to support the business operations of the company.
The Emerging Issues Task Force (“EITF”) Issue 4-08 “The Effect of Contingently Convertible Instruments on Diluted Earnings Per Share,” which is effective for periods ending after December 15, 2004, requires that the dilutive effect of contingently convertible debt securities, with a market price threshold, should be included in diluted earnings per share. The terms of our convertible senior debentures (see note 17 of our consolidated financial statements) meet the criteria defined in EITF Issue 4-08, and accordingly, the effect of conversion of our senior debentures to common stock has been assumed when calculating our diluted earnings per share. The diluted earnings per share for the years ended December 31, 2003 and 2002 have been restated to conform to the requirements of EITF Issue 4-08. See note 8 of our consolidated financial statements included in this Form 10-K.
We are evaluating the two methods of adoption allowed by SFAS 123R: the modified-prospective transition method and the modified-retrospective transition method, and the related financial statement impact.
We have certain business arrangements with affiliated companies that have financial implications. A description of these arrangements is provided in note 12 of our consolidated financial statements included in this Form 10-K.
The term “market risk” refers to the risk of loss arising from adverse changes in market rates and prices.
The preceding table indicates an asymmetric market value response to equivalent basis point shifts, up and down, in interest rates. This partly reflects exposure to fixed income securities containing a put feature. In total these securities represent approximately 4% and 5% of the fair market value of the total fixed income portfolio as of December 31, 2004 and December 31, 2003, respectively. The asymmetric market value response reflects our ability to put these bonds back to the issuer for early maturity in a rising interest rate environment (thereby limiting market value loss) but to hold these bonds to their much longer full maturity dates in a falling interest rate environment (thereby maximizing the full benefit of higher market values in that environment).
We have exposure to credit risk, primarily as a holder of fixed income securities. We control this exposure by emphasizing investment grade credit quality in the fixed income securities we purchase.
As a component of the swap transactions, the Company continues to own Standard & Poor’s 500 and XLF index call options at a cost of $13.6 million, with a strike price of approximately 120% of the notional amount of the swap transactions. A call option gives the purchaser the right, but not the obligation, to purchase an underlying security at a specific price or prices at or for a certain time. The call options limit the maximum potential loss on the swap transactions to 20% ($90.4 million) of the notional amount of the swap transactions. The call options are recorded at fair value in other invested assets in the consolidated balance sheet, and changes in the fair value are recorded as a realized gain or loss in the consolidated statement of operations. As of December 31, 2004, the net change in the fair value of call options resulted in a net realized gain of $6.7 million.
currency in which these assets are denominated. As of December 31, 2004 and 2003, our total exposure to foreign denominated securities in U.S. dollar terms was approximately $1.1 billion and $816.4 million, respectively, or 21.6% and 18.9%, respectively, of our investment portfolio, including cash and cash equivalents. The primary foreign currency exposure was in Canadian dollar denominated securities, which represented 4.8% and 5.4% of our investment portfolio as of December 31, 2004 and 2003, respectively, and the British pound, which represented 7.8% and 5.4%, respectively, of our investment portfolio, including cash and cash equivalents. As of December 31, 2004, the potential impact of a 10% decline in each of the foreign exchange rates on the valuation of investment assets denominated in those respective foreign currencies would result in a total of $111.6 million decline in the fair value of the total investment portfolio.
We frequently review our investment portfolio for declines in value, and focus our attention on securities which have a market value of less than 80% of their amortized cost at the time of review. Generally, a change in the market or interest rate environment does not constitute an impairment of an investment but rather a temporary decline. Temporary declines in investments will be recorded as unrealized losses in accumulated other comprehensive income. If we determine that a decline is “other than temporary,” the carrying value of the investment will be written down to the fair value and a realized loss will be recorded in our consolidated statements of operations. Our assessments are based on current evaluations of the financial position and future projections of the entity that issued the investment security. Prior assessments can change, depending upon current pertinent information.
In determining possible impairment of debt securities held as investments, we review market and industry shifts, debt payment schedules that report how current and timely the issuer is with interest and principal payments, the issuer’s current financial position, the effect of foreign exchange rates and relevant analysis by rating agencies, investment advisors and analysts. In determining the possible impairment of equity securities, we review market and industry shifts, historical price to earnings ratios, recent financial statements, independent auditor’s reports on the issuer’s financial statements and any significant recommendations by investment advisors or rating agencies. Additional relevant information is also considered in determining the valuation of an investment.
The gross unrealized depreciation of $118.0 million resulted principally from the change in the value of U.S. and non-U.S. equities, the credit quality of fixed income securities and the current interest rate environment.
Based on the review discussed above, we determined that there were no securities that required an impairment to be recognized in our statement of operations for the year ended December 31, 2004, as we believe the decline in the investment value of certain securities to be temporary. We have the ability and intent to hold these securities until the fair market value recovers.
For further detail on our operating lease payments see note 12 of our consolidated financial statements included in this Form 10-K.
We have completed an integrated audit of Odyssey Re Holdings Corp.’s 2004 consolidated financial statements and of its internal control over financial reporting as of December 31, 2004 and audits of its 2003 and 2002 consolidated financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our opinions, based on our audits, are presented below.
As discussed in note 2 to the consolidated financial statements, effective January 1, 2002, the Company adopted Statement of Financial Accounting Standard 142, “Goodwill and Other Intangible Assets”.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting
Unrealized appreciation or depreciation of the Company’s fixed income and equity securities, net of applicable deferred income taxes, is included in accumulated other comprehensive income. Unrealized losses that are deemed other than temporary are charged to operations. Realized investment gains or losses are determined on the basis of average cost. Investment income, which is reported net of applicable investment expenses, is recorded as earned.
(e) A purchase price in excess of net assets (“goodwill”), arising from a business combination is recorded as an asset, and is not amortized. Intangible assets with a finite life are amortized over the estimated useful life of the asset. Intangible assets with an indefinite useful life are not amortized. Goodwill and intangible assets are tested for impairment on an annual basis or more frequently if events or changes in circumstances indicate that the carrying amount may not be recoverable. If the goodwill or intangible asset is impaired, it is written down to its realized value with a corresponding expense reflected in the consolidated statements of operations. Management has determined that the goodwill and intangible assets of $37.1 million and $30.7 million, reflected in other assets as of December 31, 2004 and 2003, respectively, is not impaired. Unamortized deferred credits related to net assets acquired in excess of purchase price (“negative goodwill”) arising from a business combination are recognized as an extraordinary gain in the statement of operations.
Effective January 1, 2002, the Company, in accordance with the provisions of SFAS 141, “Business Combinations” and SFAS 142, “Goodwill and Other Intangible Assets,” fully amortized its negative goodwill of $36.9 million related to the 1996 acquisition of Clearwater and reflected the amortization as a cumulative effect of a change in accounting principle in its statement of operations for the year ended December 31, 2002. There is no effect on the Company’s federal and foreign income taxes resulting from the amortization of negative goodwill.
The reserves for losses and loss adjustment expenses are estimates of amounts needed to pay reported and unreported claims and related loss adjustment expenses. The estimates are based on assumptions related to the ultimate cost to settle such claims. The Company’s reserves for losses and loss adjustment expenses are determined in accordance with sound actuarial practices and management believes that such reserves are adequate. The inherent uncertainties of estimating reserves are greater for reinsurers than for primary insurers, due to the diversity of development patterns among different types of reinsurance contracts and the necessary reliance on ceding companies for information regarding reported claims. As a result, there can be
Deferred federal income taxes are provided for temporary differences between the financial statement and tax bases of assets and liabilities. Such differences relate principally to deferred acquisition costs, unearned premiums, unpaid losses and loss adjustment expenses and investments.
(h) All derivative instruments are recognized as either assets or liabilities on the balance sheet and measured at their fair value. Gains or losses from changes in the derivative values are accounted for based on how the derivative is used and whether it qualifies for hedge accounting.
(i) The Company has identified its operating segments to reflect the manner in which management monitors and evaluates the Company’s financial performance. The Company’s operations are comprised of four segments: Americas, EuroAsia, London Market and U.S. Insurance.
(k) Basic earnings per share are calculated by dividing net income by the weighted average number of common shares outstanding, excluding those non-vested shares granted under the OdysseyRe Restricted Share Plan. Diluted earnings per share are calculated by dividing net income by the weighted average number of common shares outstanding, inclusive of: vested and non-vested shares, as determined using the treasury stock method, granted under the OdysseyRe Restricted Share Plan; stock options that would be assumed to be exercised on the balance sheet date; and the effect of the conversion of OdysseyRe’s convertible debt to equity securities (see note 8). Restricted shares, stock options or the effect of the conversion of the convertible debt would not be included in the calculation of diluted earnings per share, if the effect would be anti-dilutive.
the application of the fair value based method to compensation awards granted, modified, or settled on or after the date of adoption. Accordingly, net income for the years ended December 31, 2004 and 2003 reflects stock-based compensation expense related to stock options granted in 2003 and subsequently. For stock options granted during 2002, the Company accounted for stock-based compensation based on the intrinsic-value method prescribed in Accounting Principles Board Opinion (“APB”) 25, “Accounting for Stock Issued to Employees” and related interpretations, as permitted under SFAS 123. Had compensation cost been charged to earnings in accordance with the fair value based method as prescribed in SFAS 123 for all outstanding stock-based compensation awards (occurring both before and after adoption of the recognition provisions of SFAS 123), the Company’s net income and net income per share (on a pro forma basis) would have been as follows (in thousands, except per share amounts):
In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS 123R, “Share-Based Payment.” This Statement is a revision of SFAS 123, “Accounting for Stock-Based Compensation,” and supersedes APB 25 and its related implementation guidance. SFAS 123R focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. The statement requires entities to recognize stock compensation expense for awards of equity instruments to employees based on the grant-date fair value of those awards (with limited exceptions). SFAS 123R is effective for the first interim or annual reporting period that begins after June 15, 2005. In addition, SFAS 123R requires that excess tax benefits related to stock compensation expense to be reported as a financing cash inflow rather than as a reduction of taxes paid in cash flow from operations.
(n) Funds held under reinsurance treaties is an account used to record a liability, in accordance with the contractual terms, arising from the Company’s receipt of a deposit from a reinsurer or the withholding of a portion of the premiums due as a guarantee that a reinsurer will meet its loss and other obligations. Interest generally accrues on withheld funds in accordance with contract terms. Funds held by ceding insurers is an account used to record an asset resulting from the ceding company, in accordance with the contractual terms, withholding a portion of the premium due the Company as a guarantee that the Company will meet its loss and other obligations.
In December 2004, the FASB issued FASB Staff Position No. 109-2, “Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004” (FSP 109-2). The American Jobs Creation Act of 2004 (“AJCA”) introduces a special one-time dividends received deduction on the repatriation of certain foreign earnings to a U.S. taxpayer (repatriation provision), provided certain criteria are met. The primary criteria to be met is that the repatriated funds must be reinvested in the United States and the Company is evaluating whether that criteria can be met given the Company’s current U.S. and foreign capital structure. The FSP 109-2 provides accounting and disclosure guidance for the repatriation provision.
On November 15, 2004, the Company acquired Overseas Partners US Reinsurance Company (“Opus Re”), a reinsurance company domiciled in the state of Delaware. Opus Re’s name has been changed to Clearwater Select Insurance Company. The purchase price of $43.0 million, which was based on the fair value of the net assets of Opus Re at the date of acquisition, was comprised of $237.8 million of assets, principally investments and $194.8 million of liabilities, principally unpaid losses and loss adjustment expense reserves. On November 30, 2004, Clearwater Select was contributed to Clearwater.
interest in Fairfax Asia. Fairfax Asia is included in the consolidated financial statements in accordance with the equity method of accounting. On September 10, 2002, OdysseyRe purchased 56.0% of the issued and outstanding shares of First Capital and during the second quarter of 2003 increased its ownership in First Capital to 97.7%. First Capital’s balance sheet is included in the consolidated balance sheet as of December 31, 2003 and its statements of operations are included in the consolidated statements of operations from September 10, 2002 through September 30, 2004.
The composition of the fixed income securities, common stocks carried at fair value and short-term investments as of December 31, 2003, follows (in thousands):
The amortized cost and fair value of fixed income securities as of December 31, 2004, by contractual maturity, are shown below in thousands.
Actual maturities may differ from the contractual maturities shown in the table above due to the existence of call features or put features. In the case of securities containing call features, the actual maturity will be the same as the contractual maturity if the issuer elects not to exercise its call feature. Total securities subject to call
Based on the review discussed above, the Company determined that there were no securities that required an impairment to be recognized in its statement of operations for the year ended December 31, 2004, as the Company believes the decline in the investment value of certain securities to be temporary. The Company has the ability and intent to hold these securities until the fair market value recovers.
In the third quarter of 2004, the Company sold short Standard & Poor’s Insurance Rating Services (“Standard & Poor’s”) 500 depository receipts (“SPDRs”) and The Financial Select SPDR Fund (“XLF”) as an economic hedge against a decline in its equity portfolio. In order to reduce the margin maintenance requirements for these short positions, the Company replaced the short positions with total return swaps, which are included in other invested assets. The margin maintenance requirement related to the total return swaps was $99.2 million as of December 31, 2004.
The aggregate notional amount of the swap transactions is $451.8 million. The swap transactions terminate during the fourth quarter of 2006. As of December 31, 2004, the Company has provided $99.2 million of U.S. Treasury bills as collateral for the swap transactions. The swap transactions are recorded at fair value, based on the remainder of the notional amount less the fair value of the underlying securities. Changes in the fair value of the swap transactions are recorded as realized gains or losses in the consolidated statement of operations. As of December 31, 2004, the net change in the fair value of the swap transactions resulted in a net realized loss of $44.9 million.
In addition, as of December 31, 2004, the Company had sold short $49.8 million of borrowed securities, for which it recorded a liability of $56.1 million. The net realized loss was $13.3 million for the year ended December 31, 2004. As of December 31, 2004, the Company provided cash and fixed income securities of $84.7 million as collateral for the borrowed securities. The Company’s net investment income for the year ended December 31, 2004 reflects $2.7 million related to interest expense associated with the borrowed securities.
The Company has purchased credit default swaps, which are included in other invested assets, that provide a hedge against adverse movements in fair value of investments and other corporate assets resulting from systemic
financial risk emanating from severe credit problems developing in the consumer lending markets. Under a credit default swap, the Company agrees with other parties to pay at specified periods fixed premium amounts calculated by reference to an agreed notional principal amount in exchange for the credit default protection on a specified asset. Credit default swaps are recorded at fair value, with the related changes in fair value recognized as realized gain or loss. The net change in fair value of the credit default swaps resulted in a net realized loss of $4.5 million. The total cost of the credit default swaps was $11.5 million and $5.2 million and the fair value was $4.1 million and $2.2 million as of December 31, 2004 and 2003, respectively. The notional amount of the credit default swaps was $420.3 million and $190.3 million as of December 31, 2004 and 2003, respectively.
Counterparties to the derivative instruments expose the Company to credit related losses in the event of non-performance. The Company believes this risk is low given diversification amongst various highly rated counterparties. The credit risk exposure is represented by the fair value of the derivative instruments at the statement date.
Fixed income securities carried at $937.0 million as of December 31, 2004 were on deposit with various regulatory authorities to comply with insurance laws.
The Company has increased its ownership in the HWIC Asia Fund (“HWIC”) and as of December 31, 2004 owned 56.2% of HWIC. Accordingly, HWIC has been consolidated in the Company’s consolidated financial statements as of and for the year ended December 31, 2004. The minority interest ownership of HWIC of $184.8 million as of December 31, 2004 is included in other liabilities. The minority interest in HWIC’s net income of $4.8 million is included in other expense, net. HWIC was previously accounted for under the equity method and included in other invested assets for the years ended December 31, 2003 and 2002.
Common stocks at equity as of December 31, 2004, include the Company’s investments in TRG Holding Corporation (100.0% owned by Fairfax and its affiliates, including 13.0% owned by the Company), Advent Capital (Holdings) PLC (46.8% owned by Fairfax and its affiliates, including 15.0% owned by the Company), MFXchange Holdings Inc. (“MFX”) (100% owned by Fairfax and its subsidiaries, including 7.4% owned by the Company) and Hub International Limited (26.4% owned by Fairfax and its affiliates, including 13.6% owned by the Company). Zenith National Insurance Corporation (“Zenith”) (24.5% owned by Fairfax and its affiliates, including 6.0% owned by the Company) is included in common stocks and carried at fair value because Fairfax entered into agreements which eliminate any voting or other direct or indirect control by Fairfax and its affiliates over the operations of Zenith.
Clearwater is the beneficiary of a stop loss reinsurance agreement with nSpire Re Limited (“nSpire Re”), a wholly owned subsidiary of Fairfax (the “1995 Stop Loss Agreement”). Pursuant to the agreement, Clearwater ceded premium of $60.5 million in 1995 for an aggregate limit of $175.0 million in excess of its December 31, 1995 reserves for unpaid losses and allocated loss adjustment expenses and potentially uncollectible reinsurance recoverables. Ceded losses and loss adjustment expenses incurred for the years ended December 31, 2004, 2003 and 2002 of $17.5 million in each year related to the stop loss agreement are included in the accompanying statements of operations and note 6. Reinsurance recoverables on paid and unpaid losses related to this agreement of $157.5 million and $140.0 million as of December 31, 2004 and 2003, respectively, are reflected in the accompanying balance sheets and are secured by letters of credit or cash.
Odyssey America utilizes whole account stop loss retrocessional agreements on an excess of loss basis to manage its reinsurance exposures, including catastrophic occurrences and the potential accumulation of exposures. The whole account stop loss retrocessional agreements were purchased on an underwriting year basis for 1996 through 2004 and on an accident year basis for 1994 and 1995. Accident year agreements were also purchased to supplement the 1996 and 1997 underwriting year agreements. Each agreement provides for recoveries from the retrocessionaires, subject to a limit, in the event that the net subject business results in a
The whole account stop loss agreements provide that Odyssey America may withhold a significant portion of the premium payable to the retrocessionaires in a funds held account, which funds, under certain circumstances, may be set-off against the retrocessionaires’ loss and other obligations owed to Odyssey America. This retained premium is recorded as a liability on the Company’s balance sheet. Interest, calculated using a contractual fixed interest rate, on the funds held account is credited quarterly by the Company, which results in an increase in the funds held account balance and is recorded as an expense, reducing the Company’s investment income. Loss payments are deducted from the funds held account balance, which reduces the liability as such payments become due.
The income (loss) before income taxes reflected in the Company’s statements of operations related to the whole account stop loss retrocessional agreements for the years ended December 31, 2004, 2003 and 2002 are as follows (in thousands):
The reinsurance recoverable on paid and unpaid losses related to the whole account stop loss retrocessional agreements are $242.1 million and $289.4 million as of December 31, 2004 and 2003, respectively.
The Company’s subsidiaries have entered into various reinsurance arrangements with their affiliates. The approximate amounts included in or deducted from income, expense, assets and liabilities in the accompanying consolidated financial statements, with respect to reinsurance assumed and ceded, follow (in thousands):
Investment management agreements with Hamblin Watsa Investment Counsel Ltd. (“Hamblin Watsa”), a wholly owned subsidiary of Fairfax, and administrative agreements with Fairfax have been entered into by the Company and its subsidiaries with respect to their investment portfolios. Pursuant to the agreements, base, administrative and incentive fees, based upon total invested assets and realized gains, are paid to Hamblin Watsa and Fairfax. For the years ended December 31, 2004, 2003 and 2002, fees of $7.5 million, $13.3 million and $6.3 million, respectively, are included in the consolidated statements of operations. In addition, for the years ended December 31, 2004 and 2003, the Company paid $0.3 million and $1.0 million of intranet fees, respectively, to MFX, an affiliate. No payments were made to MFX for the year ended December 31, 2002. Included in other expense, net for the year ended December 31, 2004 is a charitable contribution expense of $2.4 million related to the Sixty Four Foundation, an affiliate. There were no charitable contributions to the Sixty Four Foundation for the years ended December 31, 2003 and 2002. In connection with the acquisition of Opus Re (now known as Clearwater Select Insurance Company), the Company incurred a $2.5 million expense which is included in other expense, net, to RiverStone Group LLC (“RiverStone”), an affiliate, for services RiverStone provided to the Company. The expense for RiverStone’s services can increase to a maximum of $5.0 million based upon the profitability of Clearwater Select. In connection with the sale of Old Lyme Insurance Company, Ltd. (“OLIC”) by an affiliate of the Company to Old Lyme Insurance Group, Ltd. (“OLIG”), an unrelated entity, Odyssey America provided a loan to OLIG in the amount of $9.0 million to finance this transaction. This loan has a term of five years, bears interest at a rate of prime plus 3% and is collateralized by the shares of OLIC’s common stock.
Included in the consolidated balance sheets are amounts receivable related to expense sharing arrangements with affiliates of $4.9 million and $1.1 million as of December 31, 2004 and 2003, respectively, and payable to
Management believes that the revenues and expenses related to the transactions with affiliated entities would not be materially different if such transactions were with unaffiliated entities.
The following table shows the components of the change in accumulated other comprehensive income (loss) for the years ending December 31, 2004, 2003 and 2002 (in thousands):
The components of comprehensive income (loss) for the years ending December 31, 2004, 2003 and 2002 are shown in the following table (in thousands):
Net income per common share for the years ended December 31, 2004, 2003 and 2002 has been computed in the following table based upon weighted average common shares outstanding and includes the effect of implementing EITF 4-08 on a retroactive basis (in thousands, except share amounts):
The Company maintains a qualified, non-contributory, defined benefit pension plan (“Plan”) covering substantially all employees who have reached age twenty-one and who have completed one year of service. Employer contributions to the Plan are in accordance with the minimum funding requirements of the Employee Retirement Income Security Act of 1974.
The investment policy for the defined benefit plan is to invest in highly rated, lower risk securities that preserve the investment asset value of the Plan while seeking to maximize the return on those invested assets. The Plan assets as of December 31, 2004 and 2003 are invested principally in highly rated fixed income securities. The long term rate of return assumption is based on the fixed income securities portfolio. The actual return on assets has historically been close to our assumptions of expected returns. During 2004, the Company contributed $13.7 million to the Plan. Based on the Company’s current expectations, the 2005 contribution should approximate $3.0 million.
The accumulated benefit obligation for the Excess Plans is $10.4 million and $8.9 million as of December 31, 2004 and 2003, respectively.
The Company established a trust fund, which invests in U.S. government securities, related to the Excess Plans. The trust fund, which is included in other invested assets, had assets of $6.2 million and $5.9 million as of December 31, 2004 and 2003, respectively, Plan benefits are paid by the Company as they are incurred by the participants, accordingly, there are no assets held directly by the Excess Plans.
The Company also maintains a defined contribution profit sharing plan for all eligible employees. Each year, the Board of Directors may authorize payment of an amount equal to a percentage of each participant’s basic annual earnings based on the experience of the Company for that year. These amounts are credited to the employee’s account maintained by a third party, which has contracted to provide benefits under the plan. No contributions were made in 2004, 2003 or 2002.
The Company provides certain health care and life insurance (“postretirement”) benefits for retired employees. Substantially all employees may become eligible for these benefits if they reach retirement age while working for the Company. The Company’s cost for providing postretirement benefits other than pensions is accounted for in accordance with SFAS 106 “Employers’ Accounting for Postretirement Benefits Other Than Pensions.” The following tables set forth the amounts recognized for the postretirement benefit plan, which has a
The accumulated benefit obligation for the postretirement benefit plan was $8.5 million and $8.3 million as of December 31, 2004 and 2003, respectively.
The annual assumed rate of increase in the per capita cost of covered benefits (i.e., health care cost trend rate) is assumed to be 11.5% in 2004 and decreasing to 5% in 2013 and remaining constant thereafter. The health care cost trend rate assumption has a significant effect on the amounts reported. For example, increasing the assumed health care cost trend rates by one percentage point in each year would increase the accumulated postretirement benefit obligation by $1.7 million and the service and interest cost components of net periodic postretirement benefit costs by $0.4 million for 2004. Decreasing the assumed health care cost trend rates by one percentage point in each year would decrease the accumulated postretirement benefit obligation, and the service and interest cost components of net periodic postretirement benefit cost for 2004 by $1.4 million and $0.3 million, respectively.
In April 2002, the Company’s stockholders approved the Odyssey Re Holdings Corp. 2002 Stock Incentive Plan (the “2002 Plan”). An aggregate of 1.5 million shares of the Company’s common stock may be granted under the 2002 Plan. The 2002 Plan provides for the grant of non-qualified stock options to officers, key employees and directors who are employed by, or provide services to, the Company or its subsidiaries. Pursuant to the 2002 Plan, 25% of the options granted become exercisable on each annual anniversary of the grant in each of the four years following the grant and expire 10 years from the date of grant, and shall be exercisable at the grant price. As of December 31, 2004 and 2003, a total of 793,250 stock options have been granted under the 2002 Plan at a weighted average price of $18.68 per share. No options were granted in 2004 pursuant to the 2002 Plan. As of December 31, 2004, there were 706,750 remaining stock options available to be granted.
A summary of the combined status of the 2002 Plan and changes during the years ended December 31, 2004 and 2003 is presented below:
During 2001, the Company adopted the Odyssey Re Holdings Corp. Stock Option Plan (the “Option Plan”), which provides for the grant of stock options to directors and key employees of the Company. Under the Option Plan, such options will generally vest and become exercisable in two equal installments on the fifth and tenth anniversary of the date of grant. As of December 31, 2004 and 2003, respectively, 97,685 and 52,654 options were issued with an exercise price of zero. For the year ended December 31, 2004, 48,472 options were granted, 741 options were exercised and 2,700 options were forfeited, pursuant to the Option Plan. The Company has reflected, in other expense, net, $0.5 million, $0.2 million and $0.4 million of expense for the years ended December 31, 2004, 2003 and 2002 respectively, which represents the vested portion of the stock options.
During 2001, the Company adopted the Odyssey Re Holdings Corp. Restricted Share Plan (the “Restricted Share Plan”), which provides for the grant of restricted shares to directors and key employees of the Company. Shares granted under the Restricted Share Plan generally vest in two equal installments on the fifth and tenth anniversary of the date of grant. As of December 31, 2004 and 2003, respectively, 506,866 and 439,474 shares of restricted stock were outstanding. During the year ended December 31, 2004, 184,005 restricted shares were granted, 72,272 restricted shares vested and 44,341 restricted shares were forfeited, pursuant to the Restricted Share Plan. At the time of grant, the market value of the shares awarded is recorded as unearned compensation and is presented as a separate component of stockholders’ equity. The unearned compensation is charged to operations over the vesting period. In respect to the above grants, the compensation expense incurred for each of the years ended December 31, 2004, 2003 and 2002 was $1.8 million, $1.1 million and $1.1 million, respectively, and is included in other expense, net.
The Company paid federal and foreign income taxes of $116.6 million and $142.2 million for the years ended December 31, 2004 and 2003, respectively. The Company recovered $4.3 million for the year ended December 31, 2002. The Company has a current tax recoverable of $4.5 million as of December 31, 2004 and a current tax payable of $0.7 million as of December 31, 2003.
The amounts above are reduced by an aggregate minimum rental recovery of $3.2 million resulting from the sublease of space to other companies.
Rental expense, before sublease income, under these operating leases was $9.9 million, $8.4 million and $7.8 million in 2004, 2003 and 2002, respectively. The Company recovered $0.4 million, $0.7 million and $1.9 million in 2004, 2003 and 2002, respectively, from subleases.
Odyssey America agreed, as of April 1, 2002, to guarantee the prompt payment of all of the insurance contract obligations (the “Subject Contracts”), whether incurred before or after the agreement, of Falcon Insurance Company (Hong Kong) Limited (“Falcon”), an affiliate, in the event Falcon becomes insolvent. Odyssey America’s potential exposure in connection with this agreement is estimated to be approximately $38.2 million, based on Falcon’s loss reserves at December 31, 2004. Falcon’s stockholders’ equity on a U.S. GAAP basis is estimated to be $30.0 million as of December 31, 2004. Additionally, Fairfax has agreed to indemnify Odyssey America for any obligation under this agreement. Falcon has agreed to pay Odyssey America one percent of all gross earned premium associated with the Subject Contracts on a quarterly basis. For each of the years ended December 31, 2004 and 2003, Falcon paid $0.6 million and $0.4 million, respectively, to Odyssey America related to this agreement. Odyssey America anticipates that Falcon will meet all of its obligations in the normal course of business and does not anticipate making any payments under this guarantee that would require Odyssey America to utilize the indemnification from Fairfax. In connection with the guarantee, Falcon has granted Odyssey America the option (the “Option”) to assume a ten percent quota share reinsurance participation for a period of up to three years of all of Falcon’s liabilities under the Subject Contracts entered into by Falcon on or after the date of the exercise of the Option by Odyssey America. If the Option is exercised, the one percent fee will be cancelled during the term of the quota share reinsurance agreement. As of December 31, 2004, this option has not been exercised by Odyssey America. The Option will terminate on December 31, 2005.
In January 2004, two retrocessionaires of Odyssey America under the common control of London Reinsurance Group Inc. (together, “London Life”) filed for arbitration under a series of aggregate stop loss agreements covering the years 1994 and 1996-2001 (the “Treaties”). London Life has alleged that Odyssey America has improperly administered the Treaties. The arbitration hearing is scheduled for November 2005. Odyssey America finds London Life’s claims to be without merit and is vigorously defending the arbitration. At this stage of the proceedings it is not possible to make a determination regarding the outcome of this matter; however, Odyssey America expects the arbitration panel to enforce the Treaties in its favor.
Odyssey America paid dividends to the Company of $55.0 million during 2004 and $18.0 million during 2002 and did not pay any dividends during 2003. The maximum amount of dividends which Odyssey America may pay to the Company in 2005, without prior approval, is $167.6 million.
The Company’s assumed financial guaranty reinsurance exposure to loss, in the event of nonperformance by the underlying insured and assuming underlying collateral proved to be of no value, was $55.7 million and $74.7 million as of December 31, 2004 and 2003, respectively. It is the responsibility of the ceding insurer to collect and maintain collateral under financial guaranty reinsurance. The Company ceased writing financial guaranty business in 1992.
Estimates of reserves for unpaid losses and loss adjustment expenses are contingent on many events that may occur in the future. The eventual outcome of these events may be different from the assumptions underlying the Company’s reserve estimates. In the event the business environment and loss trends diverge from selected trends, the Company may have to adjust its reserves accordingly. Management believes that the recorded estimate represents the best estimate of unpaid losses and loss adjustment expenses based on the information available at December 31, 2004. The estimate is reviewed on a quarterly basis and the ultimate liability may be more or less than the amounts provided, for which any adjustments will be reflected in the periods in which they become known.
The Company, through a review of its reinsurance contracts, has evaluated its exposure arising from four hurricanes which occurred in August and September 2004. A pre-tax loss of $97.5 million (losses and loss adjustment expenses of $93.5 million and net reinstatement premiums ceded of $4.0 million) and an after-tax loss
of $63.4 million have been included in the statements of operations for the year ended December 31, 2004. The Company’s estimates of the losses from these hurricanes are based on the most recent information available; however, as additional information becomes available, such estimates may be revised, potentially resulting in adverse effects to the Company. Considerable time may elapse before the adequacy of the Company’s estimates can be determined.
The Company uses tabular reserving for workers’ compensation indemnity reserves and discounts such reserves using an interest rate of 3.5%. Losses have been discounted using the Life Table for Total Population: United States, 1979 - 1981. Reserves reported at the discounted value were approximately $81.9 million and $78.0 million as of December 31, 2004 and 2003, respectively. The amount of case reserve discount was $52.6 million and $48.3 million as of December 31, 2004 and 2003, respectively. The amount of incurred but not reported reserve discount was $24.1 million and $18.4 million as of December 31, 2004 and 2003, respectively.
The Company has exposure to asbestos, environmental pollution and latent injury damage claims and exposures. Exposure arises from reinsurance contracts under which the Company has assumed liabilities, on an indemnity or assumption basis, from ceding companies primarily in connection with general liability insurance policies issued by such ceding companies. The Company’s estimate of its ultimate liability for such exposures includes case basis reserves and a provision for liabilities incurred but not reported. Case basis reserves are a combination of reserves reported to the Company by ceding companies and additional case reserves determined by the Company’s dedicated asbestos and environmental claims unit based on its claims audits of ceding companies. The provision for liabilities incurred but not reported is established based on various methods such as loss development, market share and frequency and severity.
Management believes, given these uncertainties, it is not feasible to establish a meaningful range of results involving these liabilities.
The Company’s reserves for asbestos and environmental related liabilities displayed below are from business written for accident years 1985 and prior. The Company has minimal exposure in the more recent accident years.
Favorable emergence for environmental claims for the year ended December 31, 2004 was offset by strengthening loss reserves for asbestos claims where there has been additional emergence. Net losses and loss adjustment expenses for asbestos claims increased $21.2 million for the year ended December 31, 2004.
During the fourth quarter of 2003, the Company issued $225.0 million aggregate principal amount of senior notes due November 1, 2013. The issue was sold at a discount of $0.4 million, which is being amortized over the life of the notes. Interest accrues on the senior notes at a fixed rate of 7.65%, which is due semi-annually on May 1st and November 1st. The senior notes are redeemable at a premium, prior to maturity, at the discretion of the Company.
In June 2002, the Company issued $110.0 million aggregate principal amount of 4.375% convertible senior debentures (“Convertible Debt”) due 2022. The Convertible Debt is redeemable at the Company’s option beginning on June 22, 2005. Each holder of Convertible Debt may, at its option, require the Company to repurchase all or a portion of its Convertible Debt on June 22, 2005, 2007, 2009, 2012 and 2017. Under certain circumstances specified in the indenture under which the Convertible Debt was issued, each Convertible Debt holder has the right to convert its Convertible Debt into 46.9925 shares of the Company’s common stock for every $1,000 principal amount of the Convertible Debt held by such holder; however, as of December 31, 2004 such circumstances had not occurred and therefore the Convertible Debt was not convertible as of such date. Upon conversion of the Convertible Debt, the Company may choose to deliver, in lieu of the Company’s common stock, cash or a combination of cash and common stock. It is the Company’s intent to settle any debt conversion in cash. During the fourth quarter of 2004, the Company retired $0.1 million of the Convertible Debt. The Convertible Debt is reflected on the Company’s balance sheet at a value of $109.9 million, the aggregate principal amount of Convertible Debt outstanding.
The financial results of these divisions for the years ended December 31, 2004, 2003 and 2002 are as follows (in thousands):