For our U.K.-based reinsurance and insurance operations, on April 1, 2005, Aspen Re signed an agreement for underleases (following our entry in October 2004 into a heads of terms agreement) with B.L.C.T. (29038) Limited (the landlord), Tamagon Limited and Cleartest Limited in connection with leasing office space in London of approximately a total of 49,500 square feet covering three floors. The term of each lease for each floor commenced in November 2004 and runs for 15 years. Service charges of approximately £0.5 million per annum are payable from this date, and are subject to increase. We will begin paying the yearly basic rent of approximately £2.7 million per annum in November 2007. The basic annual rent for each of the leases will each be subject to 5-yearly upwards-only rent reviews. There are no contractual provisions in any of the leases allowing us to terminate any of the leases prior to expiration of the 15-year contractual terms. We also license office space within the Lloyd’s building on the basis of a renewable twelve-month lease.
In addition, we lease office space in Marlton, New Jersey and Rocky Hill, Connecticut as well as other states in the United States in connection with our U.S. operations. We also lease office space in Paris, France. We believe that our office space is sufficient for us to conduct our operations for the foreseeable future.
(3) The expense ratio is calculated by dividing policy acquisition expenses and general and administrative expenses by net premiums earned.
(7) Diluted book value per share is calculated based on total shareholders’ equity, excluding the aggregate value of the liquidation preferences of our preference shares (in respect of 2005 and 2006), at December 31, 2002, 2003, 2004, 2005 and 2006, divided by the number of dilutive equivalent shares outstanding of 58,876,360, 71,481,906, 71,271,170, 98,126,046 and 89,876,459 at December 31, 2002, 2003, 2004, 2005 and 2006, respectively. There were no dilutive options at December 31, 2002. At December 31, 2003, 2004, 2005 and 2006, there were 2,302,603, 1,956,071, 2,917,038 and 2,088,084 dilutive options, respectively. Potentially dilutive shares outstanding are calculated using the treasury method.
Capital management. Also during 2006 we began a new phase of capital management which is intended to optimize our capital structure. While total capital increased during the year, the proportion funded by our ordinary shareholders decreased from 81% to 75%. This was achieved by repurchasing shares using the proceeds of the issuance of a new class of preference shares.
Investment management. We have further developed our asset allocation strategy during the year by investing approximately 3% of total invested assets and cash in funds of hedge funds. The duration of our fixed income portfolio remains steady at approximately three years and our allocation to non-government securities has increased. As a result, we have increased the book yield of our fixed income portfolio from 4.08% at December 31, 2005 to 4.52% at December 31, 2006.
This is in strong contrast to our net loss of $177.8 million for 2005 which included losses from the 2005 hurricanes of $507 million net of reinsurance and taking into account additional premiums receivable and payable, tax and our estimate of the fair value of a potential recovery from our catastrophe risk contract.
The most significant change over the last two years has been the development of our specialty insurance and reinsurance segment from 7.9% of total gross written premiums in 2004 to 26.3% in 2006. This is the result of our planned diversification into marine, energy and aviation insurance business.
Reserve releases. The loss ratios take into account any changes in our assessments of reserves for unpaid claims and loss adjustment expenses arising from earlier years. In each of the years ended December 31, 2006, 2005 and 2004, we recorded a reduction in the level of reserves for prior years. The amounts of these reductions and their effect on the loss ratio in each year are shown in the following table:
Other revenues and expenses. Other revenues and expenses in 2006 included $9.5 million of foreign currency exchange gains (2005-$18.2 million loss) and $8.0 million of realized investment losses (2005-$4.4 million loss). In 2006 we recorded a $13.1 million loss in the fair value of our catastrophe risk transfer swap (2005-$19.4 million gain). Interest payable was $16.9 million in 2006 (2005-$16.2 million).
Dividends. Beginning in the first quarter of 2005, we increased our quarterly dividends from $0.03 to $0.15 per ordinary share, and we paid such dividends on our outstanding shares in each quarter of 2005, notwithstanding our losses from the 2005 hurricanes. This quarterly dividend has been maintained at $0.15 per ordinary share throughout 2006.
Dividends paid on our preference shares in 2006 were $15.6 million and the full amount payable annually from 2007 (assuming no changes in the number or terms of shares outstanding) will be $27.7 million.
Shareholders’ equity and financial leverage. Total shareholders’ equity increased from $2,039.8 million at the end of 2005 to $2,389.3 million as of December 31, 2006. The most significant movements were:
• dividend payments to ordinary and preference shareholders totaling $71.8 million in 2006;
• an increase in unrealized gains in foreign currency translation accounted for as Other Comprehensive Income of $16.3 million;
• an increase in net unrealized losses on investments of $8.0 million;
• the repurchase of 5,899,770 of shares from two of our founder shareholders for a total consideration of $156.3 million; and
Our Preference Shares are classified in our balance sheet as equity but may receive a different treatment in some cases under the capital adequacy assessments made by certain rating agencies. Such securities are often referred to as ‘hybrids’ as they have certain attributes of both debt and equity. We also monitor the ratio of the total of debt and hybrids to total capital and this stands at 25.3% as of December 31, 2006 (2005-19.4%; 2004-14.4%).
As of December 31, 2006, we had in issue $377.7 million and £44.7 million in letters of credit to cedents, of which $171.2 million and £50.2 million were collateralized. Our reinsurance receivables decreased by 61% from $1,192.7 million at December 31, 2005 to $468.3 million at December 31, 2006, mainly as a result of amounts received from our reinsurers in respect of 2004 and 2005 hurricane claims.
Property Reinsurance Pricing at January 1 for U.S. peak zone property catastrophe reinsurance remained very attractive at near-record highs. Many accounts registered significant price increases over the previous year, although not quite reaching the levels achieved in July 2006. European renewals, however, recorded rates that were flat or declining.
Property and Casualty Insurance Our insurance segment does not typically experience a great deal of renewal business during January with the first major insurance renewal date expected at the end of March. U.K. commercial property and commercial liability insurance rates remain challenging and we expect this trend to continue in 2007.
The legislation enacted by the State of Florida in January 2007 which increased the reinsurance capacity of the state’s reinsurance facility provides a significant additional supply of capital to a part of the worldwide property catastrophe business, where previously buying demand greatly exceeded capital supply. As a result of this legislation we expect prices in Florida to decrease. In addition, property reinsurance rates worldwide may also decrease due to the redirection of the capital that entered the industry to take advantage of perceived attractive rates in Florida, as this capital may now target other exposures. For additional information on the Florida legislation, see ‘‘Risk Factors- Recent events may result in political, regulatory and industry initiatives which could adversely affect our business.’’
Non-proportional treaties. A large number of the reinsurance contracts we write are written on a non-proportional or excess of loss treaty basis. As the ultimate level of business written by each cedent can only be estimated at the time the reinsurance is placed, the reinsurance contracts generally stipulate a minimum and deposit premium payable under the contract with an adjustable premium determined by variables such as: the number of contracts covered by the reinsurance, the total premium received by the cedent and the nature of the exposures assumed. Minimum and deposit premiums generally cover the majority of premiums due under such treaty reinsurance contracts and the adjustable portion of the premium is usually a small portion of the total premium receivable. For excess of loss contracts, the minimum and deposit premium, as defined in the contract, is generally considered to be the best estimate of the contract’s written premium at inception. Accordingly, this is the amount we generally record as written premium in the period the underlying risks incept. During the life of a contract, notifications from cedents and brokers may affect the estimate of ultimate premium and result in either increases or reductions in reported revenue. Changes in estimated adjustable premiums do not generally have a significant impact on short term liquidity as the payment of adjustment premiums generally occurs after the expiration of a contract.
Many non-proportional treaties also include provision for the payment to us by the cedent of reinstatement premiums based on loss experience under such contracts. Reinstatement premiums are the premiums charged for the restoration of the reinsurance limit of an excess of loss contract to its full amount after payment by the reinsurer of losses as a result of an occurrence. These premiums relate to the future coverage obtained during the remainder of the initial policy term and are included in revenue in the same period as the corresponding losses.
Proportional treaties (‘‘treaty pro-rata’’). Estimates of premiums assumed under treaty pro-rata reinsurance contracts are recorded in the period in which the underlying risks are expected to incept and are based on information provided by brokers and ceding companies and estimates of the underlying economic conditions at the time the risk is underwritten. We estimate premium receivable initially and update our estimates regularly throughout the contract term based on treaty statements received from the ceding company.
The reported gross written premiums for treaty pro rata business includes estimates of premiums due to the Company but not yet reported by the cedent because of time delays between contracts being written by our cedents and the submission of treaty statements to the Company. This additional premium is normally described as pipeline premium. Treaty statements disclose information on the underlying contracts of insurance written by our cedents and are generally submitted on a monthly or quarterly basis, from 30 to 90 days in arrears. In order to report all risks incepting prior to a period end, we estimate the premiums written between the last submitted treaty statement and the period end.
• differences between the pattern of inception dates assumed in our estimate and the actual pattern of inception dates.
Premiums receivable. Premiums receivable are recorded as amounts due less any required provision for doubtful accounts. A significant portion of amounts included as premiums receivable, which represent estimated premiums written, net of commissions, is not currently due based on the terms of the underlying contracts. In determining whether or not any bad debt provision is necessary, we consider the financial security of the policyholder, past payment history and any collateral held. We have not made a provision for doubtful accounts in relation to assumed premium estimates as adjustable premiums are considered to be inseparable from minimum and deposit premiums. In addition, based on the above process, management believes that the premium estimates included in premiums receivable will be collectible and, therefore, we have not maintained a bad debt provision for doubtful accounts on the premiums at December 31, 2006.
more of our reinsurance counterparties to meet their financial obligations to the Company. The Company considers that under SFAS 133 this contract is a financial guarantee insurance contract that does not qualify for exemption from treatment for accounting purposes as a derivative. This is because it provides for the final settlement, expected to take place two years after expiry of cover, to include an amount attributable to outstanding and IBNR claims which may not at that point of time be due and payable to the Company.
The higher degree of uncertainty associated with reserves for reinsurance business is associated with the assumptions used in deriving IBNR claims. Where they are based on an analysis of past loss experience, then the principal assumption is that past patterns of development will be repeated on current business. The process of extrapolation is by necessity one involving subjective judgment because the actuary has to take into account the impact of the changing business mix as well as changes in legislative conditions, changes in judicial interpretation of legal liability policy coverages and inflation. These factors are incorporated in the recommended reserve range from which management selects its best point estimate.
The actuarial ranges are not intended to include the minimum or maximum amount that the claims may ultimately settle at, but are designed to provide management with ranges from which it is reasonable to select a single best estimate for inclusion in our financial statements taking into account the impact that all the factors affecting the reserves may have.
Actuarial range of net reserves. In determining the range of net reserves, we estimate recoveries due under our proportional and excess of loss reinsurance programs. For proportional reinsurance we apply the appropriate cession percentages to estimate how much of the gross reserves will be collectable. For excess of loss recoveries, if the upper and lower estimates of gross losses are contained within our reinsurance program then there will be minimal movement in the net losses but if gross losses are below the attachment point of the excess of loss program then movements in gross losses are replicated as movements in the net loss. Reinsurance recoveries in respect of estimated IBNR claims are assumed to be consistent with the historical pattern of such recoveries, adjusted to reflect changes in the nature and extent of our reinsurance program over time. An assessment is also made of the collectability of reinsurance recoveries taking into account market data on the financial strength of each of the reinsurance companies.
The net actuarial range for reserves for losses and loss expenses assuming that net reserves move in proportion to gross would be between $2,019 million and $2,468 million. The actual net reserves established as at December 31, 2006 were $2,351.7 million.
Lines of business where claims are typically reported relatively quickly after the claim event tend to display lower levels of volatility between initial estimates and final outcomes. Reinsurance claims are subject to a longer time lag both in their reporting and in their time to final settlement. The time lag is a factor which is included in the projections to ultimate claims within the actuarial analyses and helps to explain why in general a higher proportion of the initial reinsurance reserves are represented by IBNR than for insurance reserves for business in the same class. Delays in receiving information from cedents are an expected part of normal business operations and are included within the statistical estimate of IBNR to the extent that current levels of backlog are consistent with historical data. Currently, there are no processing backlogs which would materially affect our financial statements.
These factors are incorporated in the recommended reserve range from which management selects its best point estimate. As at December 31, 2006, a 5% change in the gross reserves for IBNR losses would equate to a change of approximately $68.7 million in loss reserves which would represent 14.6% of net income before income tax for the twelve months ended December 31, 2006. As at December 31, 2005, a 5% change in the gross reserve for IBNR losses would have equated to a change of approximately $78.8 million in loss reserves which would represent 49.1% of net income before income tax for the twelve months ended December 31, 2005.
The underlying changes in accident year loss ratios (which exclude the impact of the 2004 catastrophes and KRW losses in all years) by segment for the twelve months ended December 31, 2006, 2005 and 2004 are shown in the following table:
(1) Total includes 3.9% of increased KRW reserves ($66.0 million) although this is partially offset elsewhere in the income statement by additional net earned premiums of $14.1 million.
Expenses. We monitor the ratio of expenses to gross earned premium (the ‘‘gross expense ratio’’) as a measure of the cost effectiveness of our business acquisition, operating and administrative processes. The table below presents the contribution of the policy acquisition expenses and operating and administrative expenses to the gross expense ratios and the total net expense ratios for the twelve months ended December 31, 2006, 2005 and 2004. We also show the effect of reinsurance which impacts the reported net expense ratio by expressing the expenses as a proportion of net earned premiums.
Changes in the acquisition and operating expense ratios to gross earned premiums, and the impact of reinsurance on net earned premiums by segment for each of the twelve months ended December 31, 2006, 2005 and 2004 are shown in the following tables:
Net investment income. Net investment income consists primarily of interest on fixed income securities and is stated after deduction of expenses relating to the management of our investments. The total for 2006 includes $6.9 million from funds of hedge funds in which we made our first investment of $150 million on April 1, 2006. Net investment income increased by 68.5% in 2006 compared to 2005 and by 77.6% in 2005 compared to 2004. The increases have been driven by rising interest rates, fixed income sector allocation changes and asset allocation changes translating into higher book yields and by increases in our total cash and investment balances by 16.7% in 2006 and 46.9% in 2005. The increase in cash and investment balances in 2005 includes approximately $790 million after expenses in respect of the issuance of new ordinary shares and Perpetual PIERS (2004-$249 million in respect of issuance of our senior notes).
During 2006, our fixed income portfolio book yield increased from 4.08% as of December 31, 2005 to 4.52% as of December 31, 2006. In 2006, we continued to review our fixed income portfolio duration, as interest rates rose. However, the shape of the yield curve caused us to hold off extending duration beyond three years. As a result our fixed income portfolio duration remained steady at approximately three years for 2006.
Income before tax in 2004 was $263.2 million, which included underwriting income of $204.2 million and net investment income of $68.3 million.
Income tax expense. Income tax expense increased to $92.3 million in 2006 from $17.4 million in 2005 and $68.1 million in 2004. The tax charge in each year relates to our U.K. operations which remained profitable throughout the period. Our tax rate in 2006 was 19.6% compared to 25.9% in 2004, the most recent previous year in which we reported a profit. Our effective tax rate has decreased since 2004 due to a greater proportion of the Company’s profit being derived from our Bermudian operations.
Net income/(loss). In 2006, we had net income of $378.1 million, equivalent to diluted earnings per ordinary share of $3.75 based on the weighted average number of shares in issue during the period. In 2005 our net loss of $177.8 million loss was equivalent to a loss per ordinary share of $2.40. This compares to a net income of $195.1 million in 2004, equivalent to $2.74 diluted earnings per ordinary share. Preference share dividends are deducted from net income for the purpose of calculating earnings per ordinary share.
Our business segments are based on how we monitor the performance of our underwriting operations. Management measures segment results on the basis of the combined ratio, which is obtained by dividing the sum of the losses and loss expenses, acquisition expenses and operating and administrative expenses which cannot be attributed directly to any one segment by net premiums earned. As a relatively new company, our historical combined ratio may not be indicative of future underwriting performance. We do not manage our assets by segment; accordingly, investment income and total assets are not allocated to the individual segments. Operating and administrative expenses are allocated to segments based on each segment’s proportional share of gross premiums written.
As a result of the 2005 hurricanes, our loss ratio in this segment for the 2005 year was 140.9% as net premiums earned in the year were substantially less than the losses incurred. Losses and loss adjustment expenses for 2005 are stated after deduction of $605.0 million in reinsurance recoveries received or receivable (2004-$104.4 million). Any failure to collect these amounts as a result of the
inability of our reinsures to pay or as a result of disputes which are not resolved in our favor could result in charges in future years. See Part I, Item 1, ‘‘Business-Underwriting, Risk Management and Reinsurance.’’
Policy acquisition, operating and administrative expenses. Total expenses in 2006 increased by 13.8% to $176.1 million, equivalent to 26.6% of gross earned premiums. The increase from $154.7 million or 20.3% of gross premiums earned in 2005 reflected changes in business mix increasing average commissions. It also reflected the decision in 2006 to increase the proportion of administrative expenses allocated to the property reinsurance segment to better reflect the costs of actuarial and risk management support to this segment and in response to cost pressures in Bermuda caused by competition for skilled staff.
Total expenses in 2005 increased by 8.8% over 2004, mainly as a result of additional acquisition costs on the increased level of business written. Expenses as a percentage of gross premiums earned were 20.3% in 2005 and 22.6% in 2004. The decrease in the 2005 percentage of expenses to gross premiums earned compared to 2004 is attributable to two principal factors: (1) in 2005, gross premiums earned increased by $69.3 million due to reinstatement premiums, which typically do not incur commission charges; and (2) as other business lines developed, a greater amount of central administrative expenses was allocated to the other segments.
Our casualty reinsurance segment is written mainly on a treaty basis with a small proportion of facultative risks. The casualty treaty reinsurance is primarily written on an excess of loss basis and includes coverage for claims arising from automobile accidents, employers’ liability, professional indemnity and other third party liabilities. It is written in respect of cedents located mainly in the United States, the United Kingdom, Europe and Australia. The casualty facultative business covers United States umbrella, workers’ compensation and general liability business. For a more detailed description of this segment, see Part I, Item 1, ‘‘Business-Business Segments-Casualty Reinsurance.’’
Our specialty insurance lines include marine, liability, energy and aviation insurance written by Aspen Re. Our specialty reinsurance lines of business include aviation, marine and other tailored reinsurance. For a more detailed description of this segment, see Part I, Item 1, ‘‘Business-Business Segments-Specialty Insurance and Reinsurance.’’
The following table summarizes gross and net premiums written and earned, underwriting results and combined ratios for specialty insurance and specialty reinsurance for the twelve months ended December 31, 2006, 2005 and 2004:
Gross premiums written. Gross premiums written increased significantly in 2006 by 38.8% in the period. The table below shows our gross premiums written for each line of business for each of 2006, 2005 and 2004, and the percentage change in gross premiums written for each line:
The increase in gross written premiums in 2006 was due to the contribution from new aviation business and the significant price increases in energy offshore risks particularly in the Gulf of Mexico. Specialty insurance increased by $221.6 million in 2005 compared to 2004 because business in these lines was written for the first time in the fourth quarter of 2004 following the recruitment of new teams of specialist underwriters.
Losses and loss adjustment expenses increased by $103.0 million in 2005 compared to 2004. The increase in loss expenses was attributable to the growth of the specialty insurance lines in this segment as well as the losses shown in the table above.
The loss ratio for 2005 increased substantially compared to 2004, as a result of the 2005 hurricane losses and marine and aviation insurance business being reserved at a generally higher rate than our specialty reinsurance lines. However, 2005 also benefited from a release of $27.4 million from prior year reserves as discussed below under ‘‘-Reserves for Losses and Loss Adjustment Expenses-Prior Year Loss Reserves.’’
We write both commercial property and commercial liability insurance. Our commercial property line of business is primarily composed of U.K. commercial property insurance and U.S. excess and surplus lines property business written through Aspen Specialty. Our commercial liability line of business consists of employers’ and public liability insurance in the U.K. and casualty insurance in the U.S. written on a surplus lines basis. For a more detailed description of this segment, see Part I, Item 1, ‘‘Business-Business Segments-Property and Casualty Insurance.’’
The following table summarizes gross and net written premiums and earned, underwriting results and combined ratios for each of the lines of business within our insurance segment for the twelve months ended December 31, 2006, 2005 and 2004:
Property. The loss ratio for property insurance increased from 57.3% in 2005 to 85.9% in 2006. This was due in part to two factory fires in Europe ($14.4 million or 17.4% of net earned premiums), but the main cause was a disappointing result in our U.S. property surplus lines business which suffered from an unexpected frequency of large fire losses which cost $19.6 million, representing 23.7% of net earned premiums. Although 2005 was affected by $13.7 million of hurricane losses there were no other material property insurance claims in the year. The losses in 2004 included U.S hurricanes and a major U.K. factory fire.
Casualty. The loss ratio for casualty has held steady between 2006 and 2005 on lower volumes. The loss ratio for 2006 was improved by approximately 14.0% from prior year reserve releases (2005-7.0%; 2004-6.1%). Prior year reserve releases in the period were largely due to better than expected development of incurred claims, as further described below under ‘‘-Reserves for Losses and Loss Adjustment Expenses- Prior Year Loss Reserves.’’
Policy acquisition, operating and administrative expenses. Total expenses were $79.5 million for 2006, equivalent to 27.7% of net earned premiums. The reduction in the acquisition ratio was the result of profit commission being recognized by the U.K. liability account following the commutation of proportional reinsurance contracts with Montpelier Re covering the years 2003, 2004 and 2005. The increase in expense ratio was due to the premium growth in the U.S. property business which attracted a higher operating and administrative charge to the segment whereas reductions in U.K. business written have not resulted in reductions in administrative costs.
The reduction in the level of gross reserves between 2005 and 2006 is attributable to the payment during the year of hurricane losses recorded as outstandings and IBNR at December 31, 2005 and the absence in 2006 of any corresponding large major catastrophe loss.
The impact from the payment of 2005 hurricane losses is most significant in the property reinsurance segment where gross outstandings were reduced by $254.1 million. Gross IBNR for the property reinsurance segment has also reduced significantly in the year as losses which have been anticipated within IBNR crystallize and are formally reported as outstanding claims. Reserves for the casualty reinsurance segment have continued to increase reflecting the long-tail nature of the segment. Specialty insurance and reinsurance reserves have increased as the class expands and reserves have moved from IBNR to outstandings due to the formal reporting of hurricane losses in the marine energy and liability accounts. Property and casualty insurance reserves remain stable reflecting the maturity of the class. The movement between IBNR and outstanding reserves in the segment was due to the recognition of hurricane losses and the recording of large commercial property losses in the U.K. and U.S. property accounts.
Casualty Reinsurance. The lines contributing to the casualty reinsurance reserves release of $60.3 million, are $27.8 million attributed to international casualty and $28.6 million to U.S. casualty. Claims in these lines may take several years to emerge. Nonetheless, the experience to date compared with our starting loss ratios and expected patterns have been better than expected.
For the twelve months ended December 31, 2005. The analysis of the development by each segment is as follows:
Property and Casualty Insurance. The net reserves of the insurance segment as at December 31, 2004 were $ 326.2 million. Development in the shorter-tail property insurance lines has seen a lower claim development than had been expected and the liability insurance class has to date seen a lower level of incurred claims than projected giving rise to a release in net reserves of $26.2 million across these two classes.
For the twelve months ended December 31, 2004. The analysis of the favorable development by each segment is as follows:
Specialty Insurance and Reinsurance. The net reserves of the specialty segment as at December 31, 2003 were $94.0 million, largely derived through the Wellington quota share arrangements. Premium and claims information received from the cedent during the twelve months ended December 31, 2004 enabled the Company to refine its accident year assessment. Further information received concerning the development of reserves acquired on the acquisition of City Fire (now renamed Aspen Re) has also contributed to the overall release in reserves of $18.1 million.
Property and Casualty Insurance. The net reserves of the commercial property line of business as at December 31, 2003 were $40.5 million. Better than expected development in incurred claims during 2004 and the short-tail nature of this class of business has enabled us to refine our accident year assessment. This has given rise to a release in net reserves of $13.8 million. The net reserves of the commercial liability line of business as at December 31, 2003, were $126.8 million. During 2004, development of incurred claims has been slower than previously expected resulting in a reduction in the projected loss ratio suggested by the actuarial projection at December 31, 2004. This has resulted in a release in net reserves of $13.6 million in the period.
The following table shows our capital structure at December 31, 2006 compared to December 31, 2005.
Management monitors the ratio of debt to total capital, with total capital being defined as shareholders’ equity plus outstanding debt. At December 31, 2006, this ratio was 9.4%, (2005-10.9%, 2004-14.4%).
Our Preference Shares are classified in our balance sheet as equity but may receive a different treatment in some cases under the capital adequacy assessments made by certain rating agencies. Such securities are often referred to as ‘hybrids’ as they have certain attributes of both debt and equity. We also monitor the ratio of the total of debt and hybrids to total capital and this stands at 25.3% as of December 31, 2006 (2005-19.4% 2004-14.4%).
Shares, the Company entered into a Replacement Capital Covenant (the ‘‘Replacement Capital Covenant’’) with respect to the Perpetual Preference Shares initially for the benefit of persons that hold the Company’s senior notes, that the Company will not redeem or repurchase the Perpetual Preference Shares on or before November 15, 2046, unless, during the six months prior to the date of that redemption or repurchase, the Company receives a specified amount of proceeds from the sale of ordinary shares, Perpetual Preference Shares and certain other securities that have characteristics that are the same as, or more equity-like than, the applicable characteristics of the Perpetual Preference Shares at the time of that redemption or repurchase. The Replacement Capital Covenant provides a greater equity treatment of the Perpetual Preference Shares by Moody’s.
The two share repurchase transactions represented a total cumulative repurchase amount of approximately $200 million, being part of the $300 million share repurchase program authorized by the Company’s board of directors as announced on November 8, 2006. The cumulative share repurchase of approximately $200 million was funded materially with the proceeds of the sale of the Company’s Perpetual Preference Shares.
We manage these risks by making regular forecasts of the timing and amount of expected cash outflows and ensuring that we maintain sufficient balances in cash and short-term investments to meet these estimates. Notwithstanding this policy, if our cash flow forecast is incorrect, we could be forced to liquidate investments prior to maturity, potentially at a significant loss.
issue of letters of credit or maintain certain balances in trust funds for the benefit of policyholders. The following table shows the forms of collateral or other security provided to policyholders as at December 31, 2006 and 2005:
U.S. regulatory deposits. As at December 31, 2006 Aspen Specialty had a total of $6.8 million (2005-$7.4 million) on deposit with U.S. states in order to satisfy state regulations for writing business in those states.
Canadian trust fund. Aspen Re has established a Canadian trust fund with a Canadian bank to secure a Canadian insurance license. As at December 31, 2006 the balance held in trust was Can$117.7 million (2005-Can$55 million).
Consolidated cash flows for the twelve months ended December 31, 2004. Total net cash flow from operating activities in 2004 was approximately $961.3 million, an increase of $324.7 million from 2003. For the twelve months ended December 31, 2004, our cash flows from operations provided us
with sufficient liquidity to meet our operating requirements. We paid net claims of $164.6 million in 2004 and made net investments in the amount of $1,104.3 million in market securities during the period. We paid dividends of $8.3 million, and raised $249.3 million from our senior notes offering. At December 31, 2004, we had a cash balance of $284.9 million.
On April 1, 2005, Aspen Re signed an agreement for underleases for office space in London of approximately a total of 49,500 square feet covering three floors. The term of each lease for each floor commenced in November 2004 and runs for 15 years. Service charges of approximately £0.5 million per annum are payable from this date, and are subject to increase. We will begin paying the yearly basic rent of approximately £2.7 million per annum in November 2007. The basic annual rent for each of the leases will each be subject to 5-yearly upwards-only rent reviews. There are no contractual provisions in any of the leases allowing us to terminate any of the leases prior to expiration of the 15-year contractual terms.
For a discussion of derivative instruments we have entered into, please see note 7 to our audited financial statements for the twelve months ended December 31, 2006 included elsewhere in this report.