The weighted average ordinary shares outstanding shown for the years ended December 31, 2007, 2006, 2005 and 2004 reflect the conversion of Class A, B, C and D shares to ordinary shares on January 31, 2007, as part of the recapitalization completed in connection with the Merger, as if the conversion occurred on January 1, 2007, 2006, 2005 and 2004. As a result, both the book value per share and the earnings per share calculations for 2004, 2005 and 2006, previously reported, have been amended to reflect this change.
tax, regulatory or legal restrictions or limitations applicable to us or the insurance and reinsurance business generally;
changes in tax laws or regulations applicable to us or our subsidiaries, or the risk that we or one of our non-U.S. subsidiaries become subject to significant, or significantly increased, income taxes in the United States or elsewhere; and
Since our formation, we, through our subsidiaries, have completed several acquisitions of insurance and reinsurance companies and are now administering those businesses in run-off. In 2006, we completed 3 acquisitions of companies having combined total net assets of $222.9 million. In 2007, we completed 5 acquisitions of companies having combined total net assets of $625.3 million. In 2008, we completed 6 acquisitions of companies having combined total net assets of $1.02 billion. In addition we completed the following during 2008: 1) on June 13, 2008 we completed the acquisition of 44.4% of the outstanding capital stock of Stonewall Acquisition Corporation, the parent of two Rhode Island-domiciled insurers, Stonewall and Seaton; and 2) on October 27, 2008 we acquired the 49.9% of the shares of Hillcot Re Ltd. that we did not previously own. We derive our net earnings from the ownership and management of these companies primarily by settling insurance and reinsurance claims below the recorded loss reserves and from returns on the portfolio of investments retained to pay future claims. In addition, we provide management and consultancy services, claims inspection services and reinsurance collection services to our affiliates and third-party clients for both fixed and success-based fees.
In the primary (or direct) insurance business, the insurer assumes risk of loss from persons or organizations that are directly subject to the given risks. Such risks may relate to property, casualty, life, accident, health, financial or other perils that may arise from an insurable event. In the reinsurance business, the reinsurer agrees to indemnify an insurance or reinsurance company, referred to as the ceding company, against all or a portion of the insurance risks arising under the policies the ceding company has written or reinsured. When an insurer or reinsurer stops writing new insurance business, either entirely or with respect to a particular line of business, the insurer, reinsurer, or the line of discontinued business is in run-off.
covering those risks. These factors can distract management, drive up the cost of capital and surplus for the insurer or reinsurer, and negatively impact the insurer’s or reinsurer’s credit rating, which makes the disposal of the unwanted company or portfolio an attractive option. Alternatively, the insurer may wish to maintain the business on its balance sheet, yet not divert significant management attention to the run-off of the portfolio. The insurer or reinsurer, in either case, is likely to engage a third party, such as us, that specializes in run-off management to purchase the company or portfolio of the company, or to manage the company or portfolio in run-off.
In the sale of a run-off company, a purchaser, such as us, typically pays a discount to the book value of the company based on the risks assumed and the relative value to the seller of no longer having to manage the company in run-off. Such a transaction can be beneficial to the seller because it receives an up-front payment for the company, eliminates the need for its management to devote any attention to the disposed company and removes the risk that the established reserves related to the run-off business may prove to be inadequate. The seller is also able to redeploy its management and financial resources to its core businesses.
For a further discussion of our segments, see Note 19 to our consolidated financial statements for the year ended December 31, 2008 included in Item 8 of this annual report.
Our net investment income is principally derived from interest earned primarily on cash and investments offset by investment management fees paid. Our investment portfolio currently consists of the following: (1) bond portfolios that are classified as both available-for-sale and held-to-maturity and carried at fair value and amortized cost, respectively; (2) cash and cash equivalents; (3) other investments that are accounted for on the equity basis; and (4) fixed and short-term investments that are classified as trading and are carried at fair value.
Our current investment strategy seeks to preserve principal and maintain liquidity while trying to maximize investment return through a high-quality, diversified portfolio. The volatility of claims and the effect they have on the amount of cash and investment balances, as well as the level of interest rates and other market factors, affect the return we are able to generate on our investment portfolio. Investments held as available-for-sale, excluding short-term investments with an original maturity of three months or less, primarily relate to the restructuring of newly acquired investment portfolios whereby those acquired securities with either a maturity date beyond the anticipated expiration of the run-off or with credit quality concerns are designated available-for-sale. Trading securities relate to one of our reinsurance entities which has retrocessional arrangements providing for full reinsurance of all risks assumed. The investment portfolio supporting such liabilities is required by the retrocessionaire to be a trading portfolio whereby any related gains or losses are credited or debited to the retrocessionaire. When we make a new acquisition we will often restructure the acquired investment portfolio, which may generate one-time realized gains or losses.
reserves for losses incurred but not reported, or IBNR reserves, which are reserves established by us for claims that are not yet reported but can reasonably be expected to have occurred based on industry information, management’s experience and actuarial evaluation, less the portion that can be recovered from reinsurers; and
Policy buy-backs provide an opportunity for us to settle individual policies and losses usually at a discount to carried advised loss reserves. As part of our routine claims settlement operations, claims will settle at either below or above the carried advised loss reserve. The impact of policy buy-backs and the routine settlement of claims updates historical loss development information to which actuarial methodologies are applied, often resulting in revised estimates of ultimate liabilities. Our actuarial methodologies include industry benchmarking which, under certain methodologies (discussed further under “- Critical Accounting Policies” below), compares the trend of our loss development to that of the industry. To the extent that the trend of our loss development compared to the industry changes in any period, it is likely to have an impact on the estimate of ultimate liabilities. Additionally, consolidated net reductions, or potential increases, in loss and loss adjustment expense liabilities include reductions, or potential increases, in the provisions for future losses and loss adjustment expenses related to the current period’s run-off activity. Net reductions in net loss and loss adjustment expense liabilities are reported as negative expenses by us in our reinsurance segment. The unallocated loss adjustment expenses paid by the reinsurance segment comprise management fees paid to the consulting segment and are eliminated on consolidation. The consulting segment costs in providing run-off services are classified as salaries and general and administrative expenses. For more information on how the reserves are calculated, see “- Critical Accounting Policies - Loss and Loss Adjustment Expenses” below.
As our reinsurance subsidiaries are in run-off, our premium income is insignificant, consisting primarily of adjustment premiums triggered by loss payments.
On September 15, 2006, our board of directors and shareholders adopted the Enstar Group Limited 2006 Equity Incentive Plan, or the Equity Incentive Plan, and the Enstar Group Limited 2006-2010 Annual Incentive Compensation Plan, or the Annual Incentive Plan, which are administered by the Compensation Committee of our board of directors.
The Annual Incentive Plan provides for the annual grant of bonus compensation to our officers and employees, including our senior executive officers. Bonus awards for each calendar year from 2006 through 2008 were determined, and for each calendar year from 2009 through 2010 will be determined, based on our consolidated net after-tax profits. The Compensation Committee determines the amount of bonus awards in any calendar year, based on a percentage of our consolidated net after-tax profits. The percentage is 15% unless the Compensation Committee exercises its discretion to change the percentage no later than 30 days after our year-end. For the years ended December 31, 2008, 2007 and 2006 the percentage was left unchanged by the Compensation Committee. The Compensation Committee determines, in its sole discretion, the amount of bonus awards payable to each participant.
Our reporting currency is U.S. dollars. Our functional currency is U.S. dollars for all of our subsidiaries with the exception of Gordian and EPIC, whose functional currencies are Australian dollars and British pounds, respectively. Through our subsidiaries whose functional currency is the U.S. dollar, we hold a variety of foreign (non-U.S.) currency assets and liabilities, the principal exposures being Euros and British pounds. At each balance sheet date, recorded balances that are denominated in a currency other than U.S. dollars are adjusted to reflect the current exchange rate. Revenue and expense items are translated into U.S. dollars at average rates of exchange for the period. The resulting exchange gains or losses are included in our net income.
During 2008, we completed the following acquisitions having a minority interest: 1) Guildhall, a U.K.-based insurance and reinsurance company in run-off; 2) Gordian, AMP Limited’s Australian-based closed reinsurance and insurance operations; 3) EPIC, a Bermuda-based reinsurance company; 4) Goshawk, which owns Rosemont Reinsurance Limited, a Bermuda-based reinsurer in run-off; and 5) Unionamerica, a U.K.-based insurance and reinsurance company in run-off. We have a 70% economic interest in all of the above listed acquired subsidiaries with the exception of Goshawk in which we have a 75% economic interest. The results of the operations of the acquired subsidiaries are included in our consolidated statements of earnings with the remaining minority interests percent share of the economic interest of the respective subsidiaries reflected as a minority interest.
Negative goodwill represents the excess of the fair value of businesses acquired by us over the cost of such businesses. In accordance with the Statements of Financial Standards issued by FASB No. 141 “Business Combinations,” or FAS 141, this amount is recognized upon the acquisition of the businesses as an extraordinary gain. The fair values of the reinsurance assets and liabilities acquired are derived from probability-weighted ranges of the associated projected cash flows, based on actuarially prepared information and our management’s run-off strategy. Any amendment to the fair values resulting from changes in such information or strategy will be recognized when they occur. For more information on how the goodwill is determined, see “- Critical Accounting Policies - Goodwill” below.
The following table provides a breakdown of loss and loss adjustment expense reserves (net of reinsurance balances recoverable) by type of exposure as of December 31, 2008 and 2007:
Our “All other” exposure category consists of a mix of general casualty (approximately 45% of “All other” net reserves), professional liability (approximately 15% of “All other” net reserves), workers compensation/personal accident (approximately 10% of “All other” net reserves) and other miscellaneous exposures, which are generally long-tailed in nature.
As of December 31, 2008, the IBNR reserves (net of reinsurance balances receivable) accounted for $1,207.4 million, or 50.2%, of our total net loss reserves. The reserve for IBNR (net of reinsurance balance receivable) accounted for $570.7 million, or 49.1%, of our total net loss reserves at December 31, 2007.
Our loss reserves are related largely to casualty exposures including latent exposures relating primarily to A&E. In establishing the reserves for unpaid claims, management considers facts currently known and the current state of the law and coverage litigation. Liabilities are recognized for known claims (including the cost of related litigation) when sufficient information has been developed to indicate the involvement of a specific insurance policy, and management can reasonably estimate its liability. In addition, reserves are established to cover loss development related to both known and unasserted claims.
Asbestos reform efforts have been underway at both the federal and state level to address the cost and scope of asbestos claims to the American economy. While congressional efforts to create a federal trust fund that would
Furthermore, because of the reinsurance nature of the claims we manage, we focus on the activities at the (re)insured level rather than at the individual claims level. The counterparties with whom we typically interact are generally insurers or large industrial concerns and not individual claimants. Claims do not follow any consistent pattern. They arise from many insureds or locations and in a broad range of circumstances. An insured may present one large claim or hundreds or thousands of small claims. Plaintiffs’ counsel frequently aggregate thousands of claims within one lawsuit. The deductibles to which claims are subject vary from policy to policy and year to year. Often claims data is only available to reinsurers, such as us, on an aggregated basis. Accordingly, we have not found claim count information or average reserve amounts to be reliable indicators of exposure for our reserve estimation process or for management of our liabilities. We have found data accumulation and claims management more effective and meaningful at the (re)insured level rather than at the underlying claim level. As a result, we have designed our reserving methodologies to be independent of claim count information. As the level of exposures to a (re)insured can vary substantially, we focus on the aggregate exposures and pursue commutations and policy buy-backs with the larger (re)insureds.
We employ approximately 31 full time equivalent employees, including a U.S. attorney, actuaries, and experienced claims-handlers to directly administer our A&E liabilities. We have established a provision for future expenses of $49.2 million, which reflects the total anticipated costs to administer these claims to expiration.
Future viability of the practice of resolving asbestos liability for defendant companies through bankruptcy.
Enactment of tort reforms establishing stricter medical criteria for asbestos awards.
Potential future reforms and amendments to CERCLA, particularly as the resources of Superfund- the funding vehicle, established as part of CERCLA, to provide financing for cleanup of polluted sites where no PRP can be identified - become exhausted.
In addition to the specific considerations for each method described below, many general factors are considered in the application of the methods and the interpretation of results for each portfolio of exposures. These factors include the mix of product types (e.g., primary insurance versus reinsurance of primary versus reinsurance of reinsurance), the average attachment point of coverages (e.g., first-dollar primary versus umbrella over primary versus high-excess), payment and reporting lags related to our international domicile subsidiaries, payment and reporting pattern acceleration due to large “wholesale” settlements (e.g., policy buy-backs and commutations) pursued by us, lists of individual risks remaining and general trends within the legal and tort environments.
contains either direct insurance or assumed reinsurance reserves and groups relatively similar types of risks and exposures (e.g., asbestos, environmental, casualty and property) and lines of business written (e.g., marine, aviation and non-marine). Based on the exposure characteristics and the nature of available data for each individual reserving category, a number of methodologies are applied. Recorded reserves for each category are selected from the indications produced by the various methodologies after consideration of exposure characteristics, data limitations, and strengths and weaknesses of each method applied. This approach to estimating IBNR has been consistently adopted in the annual loss reserve studies for each period presented.
The five methodologies described above are applied for each of the 26 asbestos reserving categories and each of the 19 environmental reserving categories. As is common in actuarial practice, no one methodology is exclusively or consistently relied upon when selecting a recorded reserve. Consistent reliance on a single methodology to select a recorded reserve would be inappropriate in light of the dynamic nature of both the A&E liabilities in general, and our actual exposure portfolios in particular.
The following key assumptions were used to estimate A&E reserves at December 31, 2008:
The assumptions above as to Ultimate Industry Asbestos and Environmental losses have not changed from the immediately preceding period. For our company as a whole, the average selected lag for asbestos has increased slightly from 2.8 years to 2.9 years and the average selected lag for environmental has remained unchanged at 2.6 years. The changes to the asbestos selected lag arose largely as a result of the acquisition of new portfolios of A&E exposures.
The following tables provide a summary of the impact of changes in industry ultimate losses, from the selected $65 billion for asbestos and $35 billion for environmental, and changes in the time-lag, from the selected averages of 2.9 years for asbestos and 2.6 years for environmental, for us behind industry development that it is assumed relates to our insurance and reinsurance companies. Please note that the table below demonstrates sensitivity to
changes to key assumptions using methodologies selected for determining loss and allocated loss adjustment expenses, or ALAE, at December 31, 2008 and differs from the table on page 67, which demonstrates the range of outcomes produced by the various methodologies.
These methods assume that cohorts, or groups, of losses from similar exposures will increase over time in a predictable manner. Historical paid and incurred loss development experience is examined for earlier accident years to make inferences about how later accident years’ losses will develop. Where company-specific loss information is
Once the data has been analyzed as described above, an in-depth review is performed on classes of exposure with significant loss development. Discussions are held with appropriate personnel, including individual company managers, claims handlers and attorneys, to better understand the causes. If it were determined that development differs significantly from expectations, reserves would be adjusted.
On January 1, 2008, we adopted FAS 157, “Fair Value Measurements,” or FAS 157, which defines fair value as the price that would be received to sell an asset or paid to transfer a liability (i.e. the “exit price”) in an orderly transaction between market participants at the measurement date. See Note 2 of our consolidated financial statements for a further discussion of this new standard.
The following is a summary of valuation techniques or models we use to measure fair value by asset and liability classes, which have not changed significantly since December 31, 2007.
The pricing service uses market quotations for securities (e.g., public common and preferred securities) that have quoted prices in active markets. When quoted market prices are unavailable, the pricing service prepares estimates of fair value measurements for these securities using its proprietary pricing applications which include available relevant market information, benchmark curves, benchmarking of like securities, sector groupings, and matrix pricing.
As of December 31, 2008 there were no material differences between the prices obtained from the pricing services and the fair value estimates developed by us.
Further, on a quarterly basis, we evaluate whether the fair value of a fixed maturity security is other-than-temporarily impaired when its fair value is below amortized cost. To make this assessment we consider several factors including (i) the time period during which there has been a decline below cost, (ii) the extent of the decline below cost, (iii) our intent and ability to hold the security, (iv) the potential for the security to recover in value, (v) an analysis of the financial condition of the issuer, and (vi) an analysis of the collateral structure and credit support of the security, if applicable. If we conclude a security is other-than-temporarily impaired, we write down the amortized cost of the security to fair value, with a charge to net realized investment gains (losses) in the consolidated
Our equity securities are managed by an external advisor. Through this third party, we use nationally recognized pricing services, including pricing vendors, index providers and broker-dealers to estimate fair value measurements for all of our equity securities. These pricing services include FT Interactive Data and others.
For our investments in limited partnerships, limited liability companies and equity funds, we measure fair value by obtaining the most recently published net asset value as advised by the external fund manager or third-party administrator. The financial statements of each fund generally are audited annually, using fair value measurement for the underlying investments. For all public companies within the funds we have valued the investments based on the latest share price. The value of Affirmative Investment LLC (in which we own a non-voting 7% membership interest) is based on the market value of the shares of Affirmative Insurance Holdings, Inc.
For the year ended December 31, 2008, we incurred a $84.1 million loss in fair value on our other investments. Any unrealized losses or gains on our other investments are included as part of our net investment income.
The following table sets forth our selected consolidated statements of earnings data for each of the periods indicated.
(i) increased reduction in loss and loss adjustment expense liabilities of $217.6 million primarily as a result of favorable loss development and larger commutations of assumed liabilities; and
(iv) movement in foreign exchange from a gain of $7.9 million for the year ended December 31, 2007 to a loss of $15.0 million for the year ended 2008 - a total reduction of $22.9 million - which arose as a result of holding surplus net foreign currency assets, primarily British pounds, at a time when the U.S. dollar was appreciating against the majority of currencies;
(vii) an increase in minority interests’ share of net earnings of $44.1 million as a result of higher earnings in those subsidiaries with minority shareholders; and
Net realized (losses) gains for the year ended December 31, 2008 and 2007 were $(1.7) million and $0.2 million, respectively. The increase in net realized losses arose primarily as a result of mark-to-market adjustments in our equity portfolio held as trading. Based on our current investment strategy, we do not expect net realized gains and losses to be significant in the foreseeable future.
The following table shows the components of the movement in net reduction in loss and loss adjustment expense liabilities for the years ended December 31, 2008 and 2007.
(ii) A reduction in estimates of net ultimate losses of $139.7 million in our remaining insurance and reinsurance entities comprised net favorable incurred loss development of $24.1 million and reductions in IBNR
The reduction in aggregate provisions for bad debt of $36.1 million (excluding $3.1 million relating to one of our entities that benefited from substantial stop loss reinsurance protection discussed above) resulted from the collection, primarily during the three months ended December 31, 2008, of certain reinsurance receivables against which bad debt provisions had been provided in earlier periods, together with revised estimations of bad debt provisions based on additional information obtained during the three months ended December 31, 2008.
Salaries and benefits, which include expenses relating to our incentive bonus and employee share plans, were $56.3 million and $47.0 million for the years ended December 31, 2008 and 2007, respectively. The increase of $12.3 million relating to the reinsurance segment, for the year ended December 31, 2008, was primarily attributable to an increase of $3.6 million in the accrual related to our incentive bonus plan as well as $8.5 million of additional salary costs of staff directly employed by reinsurance companies that were newly acquired in 2008. In total, we have 292 staff members as of December 31, 2008 as compared to 221 as of December 31, 2007.
General and administrative expenses attributable to the reinsurance segment increased by $26.5 million during the year ended December 31, 2008 as compared to the year ended December 31, 2007. The increased costs for the year primarily related to additional general and administrative expenses of $28.1 million incurred in relation to companies that we acquired during 2008 partially offset by reductions in general and administrative expenses of $1.6 million for companies that were acquired prior to 2008 relating primarily to reduced third-party management fees and computer related costs.
For the year ended December 31, 2008, these losses arose primarily as a result of cumulative translation adjustments of $42.8 million, net of minority interest of $18.4 million, relating to Gordian. We have concluded that
under FAS No. 52, “Foreign Currency Translation” (“FAS 52”), the functional currency of Gordian is Australian dollars. As a result, upon conversion of the net Australian dollar assets of Gordian to U.S. dollars, we recorded $42.8 million, net of minority interest of $18.4 million, of U.S. dollar cumulative translation adjustment losses through accumulated other comprehensive income. This loss was due primarily to the decrease in the Australian to U.S. dollar foreign exchange rate from AU$1 = 0.9185 at the acquisition date, March 5, 2008, to AU$1 = 0.7026 at December 31, 2008.
We recorded a minority interest in earnings of $50.8 million and $6.7 million for the years ended December 31, 2008 and 2007, respectively. The total for the year ended December 31, 2008 relates to the minority economic interest held by third parties in the earnings of: 1) Gordian, Guildhall, Shelbourne, Goshawk, Royston and EPIC - all 2008 acquisitions; and 2) Hillcot. For the same period in 2007, the minority interest related was in respect of Hillcot and Shelbourne only.
We earned consulting fees of approximately $31.9 million and $33.9 million for the years ended December 31, 2007 and 2006, respectively. The decrease in consulting fees was due primarily to the acquisition of B.H. Acquisition Ltd., or B.H. Acquisition, which now forms part of the reinsurance segment and whose fee income is now eliminated. In 2006, we had recorded $1.3 million of fee income in respect of B.H. Acquisition.
Net investment income for the year ended December 31, 2007 increased by $16.0 million to $64.1 million, compared to $48.1 million for the year ended December 31, 2006. The increase was primarily attributable to our increase in average cash and investment balances from $1,093.2 million to $1,401.2 million for the years ended December 31, 2006 and 2007, respectively, as a result of cash and investment portfolios of reinsurance companies acquired in the year.
The average return on the cash and investments for the year ended December 31, 2007 was 4.57%, as compared to the average return of 4.40% for the year ended December 31, 2006. The increase in yield was primarily the result of increasing U.S. interest rates - the average U.S. federal funds rate has increased from 4.96% in 2006 to 5.05% in 2007. The average Standard & Poor’s credit rating of our fixed income investments at December 31, 2007 was AAA.
The reduction in estimates of net ultimate losses of $30.7 million comprised net adverse incurred loss development of $1.0 million offset by reductions in estimates of IBNR reserves of $31.7 million. An increase in estimates of ultimate losses of $2.1 million relating to one of our insurance entities was offset by reductions in estimates of net ultimate losses of $32.8 million in our remaining insurance and reinsurance entities.
whereby the ultimate adverse loss development of $23.4 million was largely offset by a recoverable from a single AA rated reinsurer such that a net ultimate loss of $2.1 million was retained by us.
(ii) Net favorable incurred loss development of $29.0 million, comprising net paid loss recoveries, relating to another one of our reinsurance companies, offset by increases in net IBNR loss reserves of $29.0 million, resulting in no ultimate gain or loss. This reinsurance company has retrocessional arrangements providing for full reinsurance of all risks assumed.
(iii) Net favorable incurred loss development of $6.6 million in our remaining insurance and reinsurance entities together with reductions in IBNR reserves of $26.3 million. The net favorable incurred loss development in our remaining insurance and reinsurance entities of $6.6 million, whereby net advised case and LAE reserves of $2.6 million were settled for net paid loss recoveries of $4.0 million, arose from the settlement of non-commuted losses in the year below carried reserves and approximately 57 commutations of assumed and ceded exposures at less than case and LAE reserves. We adopt a disciplined approach to the review and settlement of non-commuted claims through claims adjusting and the inspection of underlying policyholder records such that settlements of assumed exposures may often be achieved below the level of the originally advised loss and settlements of ceded receivables may often be achieved at levels above carried balances. The net reduction in the estimate of IBNR loss and loss adjustment expense liabilities relating to our remaining insurance and reinsurance companies amounted to $26.3 million and results from the application of our reserving methodologies to (i) the reduced historical incurred loss development information relating to remaining exposures after the 57 commutations, and (ii) reduced case and LAE reserves in the aggregate. Of the 57 commutations completed during 2007 for our remaining reinsurance and insurance companies, 5 were among their top 10 cedant and/or reinsurance exposures. The remaining 52 were of a smaller size, consistent with our approach of targeting significant numbers of cedant and reinsurer relationships, as well as targeting significant individual cedant and reinsurer relationships.
recovery by us of current and prior years value added taxes; and 3) increased rent costs of $1.4 million as a result of one of our U.K. subsidiaries moving to new offices.
General and administrative expenses attributable to the reinsurance segment increased by $3.4 million during the year ended December 31, 2007, as compared to the year ended December 31, 2006. The increased costs for the period related primarily to the following: 1) additional general and administrative expenses of $2.5 million incurred in relation to companies that we acquired in 2007; and 2) a write-off of a receivable of $0.9 million in respect of value added tax recoveries.
For 2007, this amount related to the interest on new loans from a London-based bank to partially assist with the financing of the acquisitions of Inter-Ocean and Marlon Insurance Company Limited and Marlon Management Services Limited, or together referred to herein as Marlon, along with interest charges from prior years loans that were made to partially assist with the financing of the acquisitions of Brampton Insurance Company Limited, or Brampton, and Cavell Holdings Limited (UK), or Cavell.
The foreign exchange gain for the year ended December 31, 2007 arose primarily as a result of: 1) the holding of surplus British pounds; and 2) the holding by Cavell of surplus net Canadian and Australian dollars, as required by local regulatory obligations, at a time when these currencies have been appreciating against the U.S. dollar. The gain for the year ended December 31, 2006 arose primarily as a result of having surplus British pounds as a result of our acquisitions of Brampton, Cavell, and Unione Italiana (U.K.) Reinsurance Company, or Unione, at a time when the British pound had strengthened against the U.S. dollar.
We recorded an income tax recovery of $7.4 million and $0.3 million for the years ended December 31, 2007 and 2006, respectively.
We recorded a minority interest in earnings of $6.7 million for the year ended December 31, 2007 reflecting the 49.9% minority economic interest held by a third party in the earnings from Hillcot, Brampton and Shelbourne, and $13.2 million for the year ended December 31, 2006 reflecting the 49.9% minority economic interest held by a third party in the earnings from Hillcot and Brampton.
The decrease in minority interest was primarily a result of reduced foreign exchange gains in Brampton and a decrease in net reduction in loss and loss adjustment expense liabilities for Hillcot Re Limited and Brampton.
Our future cash flows depend upon the availability of dividends or other statutorily permissible payments from our subsidiaries. The ability to pay dividends and make other distributions is limited by the applicable laws and regulations of the jurisdictions in which our insurance and reinsurance subsidiaries operate, including Bermuda, the United Kingdom, United States, Australia and Europe, which subject these subsidiaries to significant regulatory restrictions. These laws and regulations require, among other things, certain of our insurance and reinsurance subsidiaries to maintain minimum solvency requirements and limit the amount of dividends and other payments that these subsidiaries can pay to us, which in turn may limit our ability to pay dividends and make other payments. As of December 31, 2008 and 2007, our insurance and reinsurance subsidiaries’ solvency and liquidity were in excess of the minimum levels required. Retained earnings of our insurance and reinsurance subsidiaries are not currently restricted as minimum capital solvency margins are covered by share capital and additional paid-in-capital.
At December 31, 2008, total cash and investments were $3.49 billion, compared to $1.80 billion at December 31, 2007. The increase of $1.69 billion was due primarily to cash and investments of $2.40 billion acquired upon the acquisition of subsidiaries offset by: 1) net paid losses relating to settled claims of $174.0 million; 2) purchase costs of acquisitions, net of external financing, of $371.6 million; and 3) foreign exchange losses on cash and investments of $155.5 million.
Net cash provided by our operating activities for the year ended December 31, 2008 was $157.2 million compared to $73.7 million for the year ended December 31, 2007. This increase in cash flows was attributable to net assets assumed on retro-active reinsurance contracts and purchases of trading security investments held by us, partially offset by higher general and administrative and interest expenses, for the year ended December 31, 2008 as compared to the year ended December 31, 2007.
Net cash provided by our operating activities for the year ended December 31, 2007 was $73.7 million compared to $4.2 million for the year ended December 31, 2006. This increase in cash flows was attributable mainly to reinsurance collections and the sales of trading securities, offset by higher general and administrative expenses and interest expense incurred for the year ended December 31, 2007 as compared to the same period in 2006.
Investing cash flows consist primarily of cash acquired net of acquisitions along with net proceeds on the sale and purchase of investments. Net cash provided by investing activities was $245.1 million during the year ended December 31, 2008 compared to $475.1 million during the year ended December 31, 2007. The decrease in the cash flows was due to the increase in restricted cash and available-for-sale securities acquired in relation to the acquisitions during the year ended December 31, 2008, the decrease in cash from the sale and maturities of investments and the increase in purchases of available-for-sale investments during the year ended December 31, 2008 as compared to the year ended December 31, 2007.
Net cash provided by (used in) financing activities was $624.6 million during the year ended December 31, 2008 compared to $(4.5) million during the year ended December 31, 2007. The increase in cash provided by financing activities was primarily attributable to the increase in net proceeds from loan financing; the increase in contributions to surplus of subsidiaries by minority interests in relation to the acquisitions; and proceeds from the issuance of ordinary shares during the year ended December 31, 2008 as compared to the year ended December 31, 2007.
At December 31, 2008, the maturity distribution of our fixed income investment portfolio was as follows:
In February 2008, our wholly-owned subsidiary, Cumberland Holdings Limited, or Cumberland, entered into a term facility agreement jointly with a London-based bank and a German bank, or the Cumberland Facility. On March 4, 2008, we drew down AU$215.0 million (approximately $197.5 million) from the Facility A commitment, or Cumberland Facility A, and AU$86.0 million (approximately $79.0 million) from the Facility B commitment, or Cumberland Facility B, to partially fund the Gordian acquisition.
The interest rate on Cumberland Facility A is LIBOR plus 2.00%. Cumberland Facility A is repayable in five years and is secured by a first charge over Cumberland’s shares in Gordian. Cumberland Facility A contains various financial and business covenants, including limitations on liens on the stock of restricted subsidiaries, restrictions as
In February 2008, our wholly-owned subsidiary, Rombalds Limited, or Rombalds, entered into a term facility agreement, or the Rombalds Facility, with a London-based bank. On February 28, 2008, we drew down approximately $32.0 million from the Rombalds Facility to partially fund the acquisition of Guildhall. The interest rate on the Rombalds Facility was LIBOR plus 2.00%. On September 22, 2008, we fully repaid the outstanding principal and accrued interest on the Rombalds Facility totaling $32.0 million.
On June 20, 2008, in connection with the proposed acquisition by EAL of Goshawk through the Offer, EAL entered into a Term Facilities Agreement, or the Goshawk Facilities Agreement, with a London-based bank. The Goshawk Facilities Agreement provided for a term loan facility of up to $60.0 million to partially finance the acquisition of Goshawk and refinance certain debt obligations of one of Goshawk’s subsidiaries, or the Existing Debt.
On August 12, 2008, we and EAL entered into an amendment and restatement agreement under which the Goshawk Facilities Agreement was amended, or the First Amendment and Restatement Agreement. Under the First Amendment and Restatement Agreement, EAL was entitled to draw $47.5 million to fund the acquisition of Goshawk, or Goshawk Facility A, and we were entitled to draw $12.5 million to refinance the Existing Debt, or Goshawk Facility B. On August 14, 2008, we drew down $12.5 million from Goshawk Facility B to partially fund the refinancing of Existing Debt of $16.3 million; and on October 3, 2008, EAL drew down $36.1 million from Goshawk Facility A.
The interest rate on the Goshawk facilities is LIBOR plus 2.25%. The facilities are repayable within three years and Goshawk Facility A is secured by a first charge over EAL’s shares in Goshawk and certain of its material subsidiaries. The First Amendment and Restatement Agreement contains various financial and business covenants, including limitations on liens on the stock of certain subsidiaries, restrictions as to the disposition of the stock of those subsidiaries and limitations on mergers and consolidations. As of December 31, 2008, all of the financial covenants relating to Goshawk Facility A and Goshawk Facility B were met.
On October 6, 2008, we fully repaid the outstanding principal and accrued interest on the loan used to partially finance the acquisition of EPIC totaling $33.1 million.
Facilities Agreement), the lenders may declare that all amounts outstanding under the Unionamerica Facilities Agreement are immediately due and payable, declare that all borrowed amounts be paid upon demand, or proceed against the security. Amounts outstanding under the Unionamerica Facilities Agreement are also subject to acceleration by the lenders in the event of a change of control of Royston, successful application by Royston or certain of its affiliates (other than us) for listing on a stock exchange, or total amounts outstanding under the facilities decreasing below $10.0 million.
On September 10, 2008, we made a commitment to invest an aggregate of $100.0 million in J.C. Flowers Fund III L.P., or Fund III. Our commitment may be drawn down by Fund III over approximately the next six years. As of December 31, 2008, $0.1 million of the commitment had been drawn down. Fund III is a private investment
We have made a capital commitment of up to $10.0 million in the GSC European Mezzanine Fund II, LP, or GSC. GSC invests in mezzanine securities of middle and large market companies throughout Western Europe. As of December 31, 2008, the capital contributed to GSC was $5.9 million, with the remaining commitment being $4.1 million. The $10.0 million represents 8.5% of the total commitments made to GSC.
At December 31, 2008, we had not entered into any off-balance sheet arrangements, as defined by Item 303(a)(4) of Regulation S-K.
For the Years Ended December 31, 2008 and 2007 and 2006
Foreign currencies - At each balance sheet date, recorded balances that are denominated in a currency other than the functional currency of the Company are adjusted to reflect the current exchange rate. Revenue and expense items are translated into U.S. dollars at average rates of exchange for the years. The resulting exchange gains or losses are included in net earnings.
Acquisitions - Goodwill represents the excess of the purchase price over the fair value of the net assets received related to the acquisition of Enstar Limited (formerly “Castlewood Limited”) by Enstar in 2001. FAS No. 142, “Goodwill and Other Intangible Assets” requires that the Company perform an initial valuation of its goodwill assets and to update this analysis on an annual basis. If, as a result of the assessment, the Company determines the value of its goodwill asset is impaired, goodwill is written down in the period in which the determination is made. An annual impairment valuation has concluded that there is no impairment to the value of the Company’s goodwill asset. Negative goodwill arises where the fair value of net assets acquired exceeds the purchase price of those acquired assets and, in accordance with FAS No. 141, “Business Combinations,” has been recognized as an extraordinary gain.
New Accounting Pronouncements - The Company adopted FAS 157, “Fair Value Measurements” (“FAS 157”), effective January 1, 2008. Under this standard, fair value is defined as the price that would be received from the sale of an asset or paid to transfer a liability (i.e., the “exit price”) in an orderly transaction between market participants at the measurement date. In determining fair value, we use various valuation approaches, including market and income approaches. FAS 157 establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. The hierarchy is broken down into three levels based on the reliability of inputs as follows:
Level 1- Valuations based on quoted prices in active markets for identical assets or liabilities that we have the ability to access. Valuation adjustments and block discounts are not applied to Level 1 instruments. Since valuations are based on quoted prices that are readily and regularly available in an active market, valuation of these products does not entail a significant degree of judgment.
Level 2- Valuations based on quoted prices in markets that are not active or for which significant inputs are observable (e.g., interest rates, yield curves, prepayment speeds, default rates, loss severities, etc.) or can be corroborated by observable market data.
Assets and liabilities utilizing Level 2 inputs include: exchange-listed equity securities that are not actively traded; U.S. government and agency securities; non-U.S. government obligations; corporate and municipal bonds; mortgage-backed securities (“MBS”) and asset-backed securities (“ABS”).
The availability of observable inputs can vary from financial instrument to financial instrument and is affected by a wide variety of factors, including, for example, the type of financial instrument, whether the financial instrument is new and not yet established in the marketplace, and other characteristics particular to the transaction. To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires significantly more judgment. Accordingly, the degree of judgment exercised by management in determining fair value is greatest for instruments categorized in Level 3. We use prices and inputs that are current as of the measurement date, including during periods of market dislocation. In periods of market dislocation, the observability of prices and inputs may be reduced for many instruments. This condition could cause an instrument to be reclassified between levels.
In October 2008, the FASB issued FSP 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset is Not Active” (“FSP FAS 157-3”), which clarifies the application of FAS 157 in a market that is not active. The key considerations highlighted in FSP FAS 157-3 include the use of an entity’s own assumptions about future cash flows and appropriate risk-adjusted discount rates, appropriate risk adjustments for non-performance and liquidity risks, and the reliance that an entity should place on quotes that do not reflect the result of market transactions. FSP FAS 157-3 was effective upon issuance.
and liabilities acquired are derived from probability weighted ranges of the associated projected cash flows, based on actuarially prepared information and management’s run-off strategy. Any amendment to the fair values resulting from changes in such information or strategy will be recognized when they occur.
The negative goodwill of $31.0 million (net of minority interest) relating to the acquisitions completed in the year arose as a result of the following: (1) income earned by Brampton between the date of the balance sheet on which the agreed purchase price was based, December 31, 2004 and the date the acquisition closed, March 30, 2006; and (2) the strategic desire of the vendor of Cavell and Unione to achieve an exit from such operations and therefore to dispose of the companies at a discount to fair value.
Other assets acquired consisted of a building to be disposed of by sale and deferred tax assets.
The purchase price and fair value of the assets acquired for EGI and BH acquisitions were as follows:
On February 23, 2007, the Company, through a wholly-owned subsidiary, completed the acquisition of Inter-Ocean Holdings Ltd. (“Inter-Ocean”) for total consideration of approximately $57.5 million. Inter-Ocean owns two reinsurance companies, one based in Bermuda and the other based in Ireland.
On June 12, 2007, the Company completed the acquisition of Tate & Lyle Reinsurance Ltd. (“Tate & Lyle”) for total consideration of approximately $5.9 million. Tate & Lyle is a Bermuda-based reinsurance company in run-off.
The purchase price and fair value of the assets acquired in the Marlon acquisition were as follows:
The following summarizes the estimated fair values of the assets acquired and the liabilities assumed at the date of the acquisition:
On February 29, 2008, the Company completed the acquisition of Guildhall Insurance Company Limited (“Guildhall”), a reinsurance company based in the U.K., for total consideration of £33.4 million (approximately $65.9 million). The purchase price was financed by the drawdown of approximately £16.5 million (approximately $32.5 million) from a facility loan agreement with a London-based bank; approximately £5.0 million (approximately $10.0 million) from the Flowers Fund, by way of non-voting equity participation; and the balance of approximately £11.9 million (approximately $23.5 million) from available cash on hand.
The purchase price and fair value of the assets acquired in the Gordian acquisition were as follows:
On June 13, 2008, the Company’s indirect subsidiary, Virginia Holdings Ltd., completed the acquisition of 44.4% of the outstanding capital stock of Stonewall Acquisition Corporation (“Stonewall”) from Dukes Place Holdings, L.P., a portfolio company of GSC European Mezzanine Fund II, L.P. Stonewall Acquisition Corporation is the parent of two Rhode Island-domiciled insurers, Stonewall Insurance Company and Seaton Insurance Company, both of which are in run-off. The purchase price of $20.4 million was funded from available cash on hand.
Bermuda-based reinsurer that wrote primarily property and marine business, which was placed into run-off in October 2005. The Offer valued Goshawk at approximately £45.7 million in the aggregate.
The total purchase price, including acquisition costs, of approximately $82.0 million was financed by a drawdown of $36.1 million from a credit facility provided by a London-based bank, a contribution of $11.7 million of the acquisition price from the Flowers Fund, by way of non-voting equity participation, and the remainder from available cash on hand. The interest rate on the credit facility is LIBOR plus 2.25% and the facility is repayable within three years and is secured by a first charge over the Company’s shares in Goshawk.
In connection with the acquisition, Goshawk’s bank loan of $16.3 million was refinanced by the drawdown of $12.2 million (net of fees) from a credit facility provided by a London-based bank and $4.1 million from the Flowers Fund.
The purchase price of the Company’s 89.44% share of Goshawk and the fair value of the assets acquired were as follows:
On December 30, 2008, the Company completed the purchase of all of the outstanding capital stock of Unionamerica Holdings Limited (“Unionamerica”) for total consideration of approximately $343.4 million. Unionamerica is comprised of the discontinued operations of St. Paul Fire and Marine Insurance Company’s
The purchase price and fair value of the assets acquired in the Unionamerica acquisition were as follows:
Notes to the Twelve Months Ended December 31, 2008 Pro Forma Condensed Combined Income Statements:
Notes to the Twelve Months Ended December 31, 2007 Pro Forma Condensed Combined Income Statements:
On October 27, 2008, Kenmare Holdings Ltd., a wholly-owned subsidiary of the Company, completed the purchase of the entire share capital of Hillcot Re Ltd. (“Hillcot Re”) for consideration of $54.4 million. The Company owns 50.1% of the outstanding share capital of Hillcot with Shinsei Bank, Ltd. (“Shinsei”) owning the remaining 49.9%. Upon completion of the transaction, Hillcot paid a distribution to Shinsei of approximately $27.1 million representing its 49.9% share of the consideration received by Hillcot. J. Christopher Flowers, a member of the Company’s board of directors and one of its largest shareholders, is a director and the largest shareholder of Shinsei. The purchase price of $54.4 million was funded from approximately 50% available cash on hand and the remaining balance from intercompany advances.
The amortized cost and estimated fair value of investments in debt securities and other short-term investments classified as available for sale are as follows:
The gross unrealized losses on available for sale debt securities were split as follows:
As at December 31, 2008 and 2007 the number of securities classified as available-for-sale in an unrealized loss position was 30 and 1, respectively, with a fair value of $21.7 million and $0.2 million, respectively. As at December 31, 2008 one of these securities with a fair value of $0.2 million had been in an unrealized loss position for 12 months or longer. As at December 31, 2007, no securities classified as available-for-sale had been in an unrealized loss position for 12 months or longer.
and 45, respectively, with a fair value of $32.4 million and $102.5 million, respectively. As of December 31, 2008, none of these securities were considered to be other than temporarily impaired. The Company has the intent and ability to hold these securities until their maturities. The unrealized losses from these securities were not a result of credit, collateral or structural issues.
The estimated fair value of investments in debt securities, short-term investments classified as trading securities and equities as of December 31 was as follows:
In accordance with FAS 157, we have categorized our investments held as of December 31, 2008 among levels as follows:
The following table presents a reconciliation of the beginning and ending balances for all investments measured at fair value on a recurring basis using Level 3 inputs during the quarter ended December 31, 2008:
The amount of total losses for the quarter ended December 31, 2008 included in earnings attributable to the fair value of changes in assets still held at the reporting date was $37.8 million. Of this amount, $0.5 million was included in net realized gains/(losses) and $37.3 million in net investment income.
The following table presents a reconciliation of the beginning and ending balances for all investments measured at fair value on a recurring basis using Level 3 inputs during the year ended December 31, 2008:
During the year ended December 31, 2008 the Company acquired 44.4% of the outstanding capital stock of Stonewall. Stonewall is the parent of two Rhode Island-domiciled insurers, Stonewall Insurance Company and Seaton Insurance Company, both of which are in run-off. The investment is carried on the equity basis whereby the investment is initially recorded at cost and adjusted to reflect the Company’s share of after-tax earnings or losses and unrealized investment gains and losses and reduced by dividends. During the year ended December 31, 2008 the Company recorded a loss of $0.2 million representing the Company’s share of after-tax losses.
On January 1, 2007 the Company held 45% of the ordinary shares of BH. On January 31, 2007, the Company acquired the 55% of the shares of BH it did not previously own. The Company has consolidated the results of operations of BH from the acquisition date.
In establishing the liability for losses and loss adjustment expenses related to asbestos and environmental claims, management considers facts currently known and the current state of the law and coverage litigation. Liabilities are recognized for known claims (including the cost of related litigation) when sufficient information has been developed to indicate the involvement of a specific insurance policy, and management can reasonably estimate its liability. In addition, liabilities have been established to cover additional exposures on both known and unasserted claims. Estimates of the liabilities are reviewed and updated continually. Developed case law and adequate claim history do not exist for such claims, especially because significant uncertainty exists about the outcome of coverage litigation and whether past claim experience will be representative of future claim experience.
There can be no assurance that the reserves established by the Company will be adequate or will not be adversely affected by the development of other latent exposures. The Company’s liability for unpaid losses and loss adjustment expenses as of December 31, 2008 and 2007 included $846.4 million and $420.0 million, respectively, that represented an estimate of its net ultimate liability for asbestos and environmental claims. The gross liability for such claims as at December 31, 2008 and 2007 was $944.0 million and $677.6 million, respectively.
The reduction in estimates of ultimate losses in 2008, 2007 and 2006 arose from commutations and policy buy-backs, the settlement of losses in the year below carried reserves, lower than expected incurred adverse loss development and the resulting reductions in actuarial estimates of losses incurred but not reported. Based on a review during 2008 of reinsurance balances receivables and as a result of the collection of certain reinsurance receivables, against which bad debt provisions had been provided in earlier periods, the Company reduced its aggregate provisions for bad debt in 2008.
The Company incurred interest expense on its loan facilities of $23.4 million and $4.9 million for the years ended December 31, 2008 and 2007, respectively.
The interest rate on Cumberland Facility A is LIBOR plus 2.00%. Cumberland Facility A is repayable in five years and is secured by a first charge over Cumberland’s shares in Gordian. Cumberland Facility A contains various financial and business covenants, restrictions on intragroup advances or loans, including limitations on liens on the stock of restricted subsidiaries, restrictions as to the disposition of the stock of restricted subsidiaries and limitations on mergers and consolidations involving Cumberland. As of December 31, 2008, all of the financial covenants relating to Cumberland Facility A were met.
In October 2008, Cumberland repaid AU$86.2 million (approximately $60.6 million) of Cumberland Facility A. On October 3, 2008, the Company received permission from the Australian regulators to release AU$25.8 million (approximately $18.1 million), which will also be used to pay down Cumberland Facility A.
The interest rate on the Goshawk facilities is LIBOR plus 2.25%. The facilities are repayable within three years and Goshawk Facility A is secured by a first charge over EAL’s shares in Goshawk and certain of its material subsidiaries. The First Amendment and Restatement Agreement contains various financial and business covenants, including limitations on liens on the stock of certain subsidiaries, restrictions on intragroup advances or loans, restrictions as to the disposition of the stock of those subsidiaries and limitations on mergers and consolidations. As of December 31, 2008, all of the financial covenants relating to Goshawk Facility A and Goshawk Facility B were met.
On December 30, 2008, in connection with the Unionamerica acquisition, Royston borrowed the full amount of the $184.6 million available under a term facilities agreement (the “Unionamerica Facilities Agreement”), with National Australia Bank Limited (“NABL”). Of that amount, Royston borrowed $152.6 million under Facility A and $32.0 million under Facility B. The Company has provided a guarantee of all of the obligations of Royston under the Unionamerica Facilities Agreement, however, if NABL’s participation in the facilities is reduced to or below 50% of overall commitments, then the Company will be released from all obligations as guarantor. Royston incurred $6.9 million in fees in connection with this financing.
The loans are secured by a lien covering all of the assets of Royston. The interest rate on the Facility A portion is LIBOR plus 3.50% and the interest rate on the Facility B portion is LIBOR plus 4.00%. The current blended rate on the full amount to be borrowed is LIBOR plus 3.59%. During the existence of a payment default, the interest rates will be increased by 1.00%. During the existence of any event of default (as specified in the Unionamerica Facilities Agreement), the lenders may declare that all amounts outstanding under the Unionamerica Facilities Agreement are immediately due and payable, declare that all borrowed amounts be paid upon demand, or proceed against the security. Amounts outstanding under the Unionamerica Facilities Agreement are also subject to acceleration by the lenders in the event of a change of control of Royston, successful application by Royston or certain of its affiliates (other than us) for listing on a stock exchange, or total amounts outstanding under the facilities decreasing below $10.0 million.
The Facility A portion is repayable within three years from October 3, 2008, the date of the Unionamerica Facilities Agreement. The Facility B portion is repayable within four years from the date of the Unionamerica Facilities Agreement. The Flowers Fund has a 30% non-voting equity interest in Royston Holdings Ltd., the direct parent company of Royston.
As at December 31, 2008 and 2007, the authorized share capital was 156,000,000 ordinary shares, par value $1.00 per share. The following table is a summary of changes in ordinary shares issued and outstanding:
Accumulated other comprehensive income as of December 31, 2008 and 2007 is comprised of cumulative translation adjustments and unrealized holding gains on investments arising during the year.
The Company provides pension benefits to eligible employees through various plans sponsored by the Company. All pension plans are structured as defined contribution plans. Pension expense for the years ended December 31, 2008, 2007 and 2006 was $2.6 million, $2.1 million and $1.5 million, respectively.
Compensation costs of $0.6 million, $2.4 million and $22.4 million relating to the issuance of share-awards to employees of the Company in 2004 and 2005 have been recognized in the Company’s statement of earnings for years ended December 31, 2008, 2007 and 2006, respectively. Included in the amount for the year ended December 31, 2006 is $15.6 million relating to the modification of the Company’s employee share plan from a book value plan to a fair value plan.
As of December 31, 2008, the total unrecognized compensation costs related to the non-vested share awards was $nil.
The accrued liability relating to the 2006-2010 Annual Incentive Plan for the years ended December 31, 2008 and 2007 was $14.4 million and $11.6 million, respectively.
On February 26, 2008, the Company’s board of directors approved the Amended and Restated Enstar Group Limited Employee Share Purchase Plan (“the Plan”), and subsequently, on June 11, 2008, the Company’s shareholders approved the Plan at the Annual General Meeting.
Compensation costs of less than $0.1 million relating to the shares issued have been recognized in the Company’s statement of earnings for the year ended December 31, 2008. As at December 31, 2008, 2,695 shares have been issued to employees under the Plan.
EGI, prior to the Merger, had in place a Deferred Compensation and Stock Plan for Non-Employee Directors which permitted non-employee directors to receive all or a portion of their retainer and meeting fees in common stock and to defer all or a portion of their retainer and meeting fees in stock units. Upon completion of the Merger, each stock unit was converted from a right to receive a share of EGI common stock into a right to receive an Enstar Group Limited ordinary share. No additional amounts will be deferred under the plan.
For the years ended December 31, 2008 and 2007, 4,631 and 1,147 restricted share units, respectively, were credited to the accounts of Non-Employee Directors under the EGL Deferred Compensation Plan.
The weighted average ordinary shares outstanding shown for the years ended December 31, 2007 and 2006 reflect the conversion of Class A, B, C and D shares to ordinary shares on January 31, 2007, as part of the recapitalization completed in connection with the Merger, as if the conversion occurred on January 1, 2007 and 2006. For the year ended December 31, 2007, the ordinary shares issued to acquire EGI are reflected in the calculation of the weighted average ordinary shares outstanding from January 31, 2007, the date of issue.
The Company has, as of December 31, 2008, 2007 and 2006, investments in entities affiliated with Messers. Flowers and Oros with a total value of $54.5 million, $71.6 million, and $40.6 million, respectively, and outstanding commitments to entities managed by Messers. Flowers and Oros, for the same periods, of $104.0 million, $76.3 million, and $68.1 million, respectively. The Company’s outstanding commitments may be drawn down over approximately the next six years.
In April 2005, Enstar (US) Inc. entered into a lease agreement for use of office space with one of its directors running through to 2008. For the twelve months ended December 31, 2008, 2007 and 2006, Enstar (US) Inc. incurred rent expense of $0.1 million, $0.2 million, and $0.1 million, respectively.
The Company, in common with the insurance and reinsurance industry in general, is subject to litigation and arbitration in the normal course of its business operations. While the outcome of the litigation cannot be predicted with certainty, the Company is disputing and will continue to dispute all allegations that management believes are without merit. As of December 31, 2008, the Company was not a party to any material litigation or arbitration outside its normal course of business operations.
The Company has operating subsidiaries and branch operations in the United Kingdom, Australia, United States and Europe and is subject to the relevant taxes in those jurisdictions. The weighted average expected tax provision for the foreign operations has been calculated using pre-tax accounting income in each jurisdiction multiplied by that jurisdictions applicable statutory tax rate.
As of December 31, 2008, U.S. subsidiaries had deductible losses for tax purposes of approximately $25.1 million. Under U.S. tax law these tax losses can be carried forward and could be available to offset future taxable income of the companies that experienced the losses.
The actual income tax rate for the years ended December 31, 2008, 2007 and 2006, differed from the amount computed by applying the effective rate of 0% under the Bermuda law to earnings before income taxes as a result of the following:
As a result of the Company’s merger with EGI on January 31, 2007, the Company assumed approximately $15.3 million of liabilities for unrecognized tax benefits related to various U.S., state and local income tax matters,
During the years ended December 31, 2008 and December 31, 2007, there were certain reductions to the unrecognized tax benefit due to the expiration of statutes of limitations of $3.5 million and $8.5 million, respectively, which are included in net earnings.
Within specific countries, the subsidiaries may be subject to audit by various tax authorities and may be subject to different statutes of limitations expiration dates. With limited exceptions, the Company’s major subsidiaries that operate in the United States, United Kingdom and Australia are no longer subject to audits for years before 2004, 2006, and 2002 respectively.
The Company leases office space under operating leases expiring in various years through 2015. The leases are renewable at the option of the lessee under certain circumstances. The following is a schedule of future minimum rental payments on non-cancelable leases as of December 31, 2008:
As at December 31, 2008, the Company has guaranteed the obligations of two of its subsidiaries in respect of letters of credit issued on their behalf by London-based banks in the aggregate amount of £19.5 million (approximately $28.5 million) in respect of capital commitments to Lloyds Syndicate 2008 and insurance contract requirements of one of the subsidiaries. The guarantees will be triggered should losses incurred by the subsidiaries exceed available cash on hand resulting in the letters of credit being drawn. As at December 31, 2008, the Company had not recorded any liabilities associated with the guarantees.
On September 10, 2008, the Company made a commitment to invest in aggregate $100.0 million in J.C. Flowers Fund III L.P. (“Fund III”). The Company’s commitment may be drawn down by Fund III over approximately the next six years. As of December 31, 2008, the capital contributed to the fund was $0.1 million with the
On January 16, 2009, the Company committed to invest approximately $8.7 million in JCF III Co-invest I L.P., in connection with its investment in certain of the operations, assets and liabilities of IndyMac Bank, F.S.B.
We have audited the consolidated financial statements of Enstar Group Limited and subsidiaries (the “Company”) as of December 31, 2008 and 2007, and for the years ended December 31, 2008, 2007 and 2006, and the Company’s internal control over financial reporting as of December 31, 2008, and have issued our reports thereon dated March 4, 2009; such consolidated financial statements and reports are included elsewhere in this annual report. Our audits also included the financial statement schedule of the Company listed in Item 15. This consolidated financial statement schedule is the responsibility of the Company’s management. Our responsibility is to express an opinion based on our audits. In our opinion, the consolidated financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.