New York City, New York (Argo Group U.S and Argo Specialty)
In addition, the Company has entered into other leases in conjunction with its operations at various geographic locations throughout the world. The properties are leased on terms and for durations that are reflective of commercial standards in the communities where these properties are located. Argo Group believes the facilities it occupies are adequate for the purposes in which they are currently used and are well maintained.
For the year ended December 31, 2008, Argo Group reported net income of $62.9 million, or $2.05 per fully diluted share. In May 2008, the Company completed the acquisition of Heritage. Included in the Company’s consolidated results of operations for the year ended December 31, 2008, is seven months of activity specifically attributable to Heritage. Net income for the year ended December 31, 2007 was $143.8 million, or $5.58 per fully diluted share, including an extraordinary gain resulting from the Merger of PXRE and Argonaut Group of $66.3 million, or $2.57 per fully diluted share. Net income for the year ended December 31, 2006 was $106.0 million or $4.82 per fully diluted share. The following is a comparison of selected data from the Company’s operations:
The increase in consolidated gross written premiums and earned premiums for the year ended December 31, 2008 as compared to the same periods in 2007 and 2006 was primarily attributable to the operations of Argo Re and Heritage, coupled with premium growth in the public entity products written in the Commercial Specialty segment. Earned premiums resulting from Heritage were $183.4 million from the date of acquisition through December 31, 2008. Earned premiums resulting from Argo Re were $52.4 million for the year ended December 31, 2008 compared to $1.0 million for the year ended December 31, 2007. Argo Re began operations during the third quarter of 2007. Earned premiums for the public entity products written in the Commercial Specialty segment increased $36.7 million from $77.0 million for the year ended December 31, 2007 to $113.7 million for the same period in 2008. The increase in earned premiums for the public entity products was primarily attributable to the expansion into the New England area as a result of an acquisition. During the year ended December 31, 2008, competition across virtually all products the Company offers continued to increase with respect to pricing. For year ended December 31, 2008, pricing continued to decline moderately. Earned premiums for the year ended December 31, 2008 were reduced by $3.5 million for net reinstatement premiums related to property catastrophe reinsurance contracts as a result of hurricane activity in 2008.
Consolidated net investment income increased for the year ended December 31, 2008 as compared to the same periods in 2007 and 2006 due to higher invested asset balances resulting from positive cash flows from operations and due to invested assets acquired in the Merger and Heritage transaction. Total invested assets at December 31, 2008 were $3,779.6 million; net of $215.8 million of invested assets attributable to Heritage’s Trade Capital providers. Total invested assets as of December 31, 2007 were $3,582.8 million, including $750.3 million acquired as part of the Merger. Additionally, invested assets totaling $173.5 million were classified as “Assets held for sale” as of December 31, 2007. Total invested assets were $2,534.0 million as of December 31, 2006.
Consolidated gross realized gains were $22.1 million for the year ended December 31, 2008, as compared to $12.4 million and $23.0 million in 2007 and 2006, respectively. Included in gross realized gains for the year ended December 31, 2006 was $8.4 million from the sale of a strategic investment and a realized gain of $7.6 million from the sale of a real estate holding. Consolidated gross realized losses were $57.2 million, $6.5 million and $1.8 million for the years ended December 31, 2008, 2007 and 2006, respectively. Included in consolidated gross realized losses for the years ended December 31, 2008, 2007 and 2006 were write downs of approximately $51.3 million, $2.3 million and $1.2 million, respectively, from the recognition of other-than-temporary impairments on certain investment securities.
The favorable development as related to total net reserves for loss and loss adjustment expenses as of December 31, 2007 represents 3.3%. The reserve movement depicted above in commercial auto liability and auto physical damage represents movement between those specific lines business for a product the Company provides effectively as one form of coverage. Aside from the favorable development in the auto physical damage line of business, resulting from the shift of reserves between commercial auto liability and auto physical damage, the special property line had the largest percentage change with a decrease of 35.1% as compared with carried reserves for the special property line of business as of December 31, 2007. Special property is a short-tailed line of business. As such most claims are reported and subsequently settled within a relatively short period of time from the date of loss. Therefore, the Company was able to attach a high level of credibility to the actual loss emergence patterns and consequently revise its estimate as to ultimate losses for prior accident years. The revised estimate for the PXRE Legacy net loss reserves totals $17.5 million and is similar to special property, in that the tail is short and ultimate loss estimates are revised based on loss emergence. The general liability line of business had the greatest magnitude of favorable prior accident year loss development with $30.0 million of favorable emergence subsequent to December 31, 2007, driven in large part from the restatement of Excess and Surplus Lines reserves for the 2004 and 2005 accident years. However, the $30.0 million of favorable development over twelve months represented only 3.6% of the Company’s general liability reserve balance at the beginning of the year.
Consolidated losses and loss adjustment expenses for the year ended December 31, 2006 included $44.9 million of favorable development on prior accident years across all lines and segments. Partially offsetting this favorable development was higher than anticipated reserves for the 2006 accident year of $29.1 million due to higher than anticipated claims in the property, transportation and other liability occurrence lines.
In determining appropriate reserve levels as of December 31, 2008, the Company maintained the same general processes and disciplines that were used to set reserves at prior reporting dates. No changes in key assumptions were made to estimate the reserves since the last reporting date; however, the maturation of claims since the last analysis provided a basis to assign greater credibility to emerged loss development patterns. Consistent with prior reserve valuations, actuarial estimates were refined to assign alternate weights to the different loss forecasting methodologies in order to respond to any emerging trends in the paid and reported loss data. These modifications to the analysis varied depending on whether the line of business was short-tailed or long-tailed and also varied by accident year.
uncertainties, both internal and independent actuarial reviews relied, to a large extent on the paid and incurred Bornhuetter-Ferguson methodologies, which generally produce higher projections of ultimate losses than the other methods. Compared with other actuarial methodologies, the paid and incurred Bornhuetter-Ferguson methods assigned the smallest weight to actual reported loss experience, with the greatest weighting assigned to an expected or planned loss ratio. The expected or planned loss ratio has typically been determined using various assumptions pertaining to prospective loss frequency and loss severity. In setting reserves at December 31, 2008, the Company continued to rely most heavily on the paid and incurred Bornhuetter-Ferguson methods; however certain additional weighting was assigned to other actuarial methods to recognize the most current trends emerging in paid and reported loss data.
Another factor that was considered in setting loss reserves at December 31, 2008 was the impact of the Company’s reinsurance protection. The Company’s excess of loss reinsurance coverage has varied by product. For most general liability products, the net per occurrence retention increased from $250,000 to $500,000 on September 1, 2002 and then to $1,000,000 on October 1, 2006. When loss reserves were initially established, the Company expected a greater number of large claims in the $250,000 excess of $250,000 layer of coverage. In 2006 and again in 2007, after a review of reported large loss activity, the Company began to recognize that the increased retention in the $250,000 excess of $250,000 layer did not have as material an impact on net retained losses as had originally been contemplated. Furthermore, the decision to increase net retentions had a favorable effect on net loss ratios. In the fourth quarter of 2008, as part of the Company’s internal actuarial review of reserves, the Company continued to observe lower than expected large loss activity in the $250,000 excess of $250,000 layer of coverage and further reduced its loss estimates for the 2003 through 2005 accident years.
For the Run-off Lines segment, in determining appropriate reserve levels, the Company maintained the same general processes and disciplines that were used to set reserves at prior reporting dates. No changes in key assumptions were made to estimate the reserves since the last reporting date; however the maturation of claims for twelve additional months since the date of last report provided the actuaries with a basis to assign greater credibility to emerged loss development patterns.
Consolidated loss reserves were $2,996.6 million (including $183.3 million of reserves attributable to Heritage’s Trade Capital providers), $2,425.5 million (which excludes $135.7 million of loss reserves which are classified as “Liabilities held for sale”) and $2,029.2 million as of December 31, 2008, 2007 and 2006, respectively. Management has recorded its best estimate of loss reserves as of December 31, 2008 based on current known facts and circumstances. Due to the significant uncertainties inherent in the estimation of loss reserves, there can be no assurance that future loss development, favorable or unfavorable, will not occur.
Consolidated underwriting, acquisition and insurance expenses were $407.1 million, $328.1 million and $285.1 million for the years ended December 31, 2008, 2007 and 2006, respectively. Included in consolidated underwriting, acquisition and insurance expenses for the year ended December 31, 2008 was $63.0 million resulting from Heritage. Included in consolidated underwriting, acquisition and insurance expenses for the year ended December 31, 2007 was $10.2 million of additional compensation expense resulting from the acceleration of the vesting of certain share-based payment arrangements prior to the Merger. Additionally, included in consolidated underwriting, acquisition and insurance expenses was $18.8 million resulting from the operations of PXRE for the period from the closing date of the Merger through December 31, 2007.
With the acquisition of Heritage in May 2008, management determined that the results of the operations of Heritage defined a new reporting segment. Management determined that “International Specialty” most accurately described the activities of this segment. The results of operations of Argo Re and other reinsurance programs constituted a new reporting segment, “Reinsurance”. Management believes this segment structure better reflects the current operations and future business plan of the Company. Amounts applicable to current and prior periods for Argo Re and the international reinsurance programs have been reclassified to the Reinsurance segment.
In evaluating the operating performance of its segments, the Company focuses on core underwriting and investing results before consideration of realized gains or losses from the sales of investments. Management excludes realized investment gains and losses from segment results, as decisions regarding the sales of investments are made at the corporate level. Although this measure of profit (loss) does not replace net income (loss) computed in accordance with GAAP as a measure of profitability, management utilizes this measure of profit (loss) to focus its reporting segments on generating operating income, which excludes realized gains and losses on sales of investments.
Losses and loss adjustment expenses for the year ended December 31, 2008 resulted in a loss ratio of 60.2%, compared to 57.5% for each of same periods ended 2007 and 2006. Included in losses and loss adjustment expenses for the year ended December 31, 2008 was $12.7 million in losses resulting from the 2008 hurricane activity. Additionally, $16.7 million of increased losses for the 2008 accident year were recorded for other storm losses and fire losses. Included in losses and loss adjustment expense for the year ended December 31, 2008 was $39.6 million in favorable loss reserve development on prior accident years primarily driven by property lines for the 2006 and 2007 accident years and general liability lines written on both claims
Losses and loss adjustment expenses for the year ended December 31, 2007 included $38.5 million in favorable development on prior accident years. This favorable development consisted primarily of $24.3 million favorable development in the general liability and automobile lines, $5.3 million in the property lines and $6.0 million across all other lines. Favorable development was primarily the result of lower claim counts and lower severities for the 2004 through 2006 accident years. Partially offsetting the favorable development related to prior year loss reserves was $21.1 million in losses related to the 2007 accident year. Of the $21.1 million, $4.8 million was related to higher than expected property losses and the remainder was associated with casualty business resulting from increased severity, rate changes and an increased net retention due to changes in reinsurance coverages.
The increase in earned premiums for the year ended December 31, 2008 as compared to the same period in 2007 was primarily attributable to growth in gross written premiums in the public entity and programs division. Earned premiums for the public entity products increased $36.7 million, from $77.0 million for the year ended December 31, 2007 to $113.7 million for the same period in 2008. The increase in earned premiums was primarily attributable to the expansion of the public entity products into the New England area due to an acquisition. Additionally, earned premiums for the program business increased $15.8 million from $2.2 million for the year ended December 31, 2007 to $18.0 million for the same period in 2008, primarily related to a program which incepted in the fourth quarter of 2007. The Commercial Specialty segment has experienced pricing pressure for the year ended December 31, 2008 compared to the same periods in 2007 and 2006. Earned premiums for the year ended December 31, 2008 were reduced by $1.2 million due to reinstatement premiums related to the property catastrophe reinsurance contracts affected by Hurricanes Gustav and Ike. The increase in earned premiums for the year ended December 31, 2007 as compared to the same period of 2006 was primarily attributable to growth within the public entity and grocery products.
Losses and loss adjustment expenses for the year ended December 31, 2008 resulted in a loss ratio of 68.0%, compared to 60.3% and 60.6% for the same periods ended 2007 and 2006, respectively. The increase in the loss ratio for the year ended December 31, 2008 was primarily attributable to increased losses for the 2008 accident year. The increased losses for the year ended December 31, 2008 included $2.8 million in losses resulting from hurricane activity and $12.5 million in other property losses, primarily attributable to other storm activity and $12.3 million in casualty losses, workers compensation and commercial automobile lines. Additionally in 2008, the Commercial Specialty segment recognized $8.2 million of net favorable development primarily comprised of: (a) $5.0 million of favorable development in an assumed Directors and Officers program, (b) $4.0 million of favorable development in workers compensation lines, (c) $1.5 million of favorable development in property lines of business, (d) $3.8 million of favorable development in other liability lines of business and (e) $6.1 million of adverse development in commercial automobile products.
Loss reserves for the Commercial Specialty segment were $574.8 million, $481.7 million and $425.9 million as of December 31, 2008, 2007 and 2006, respectively.
The increase in net investment income for the year ended December 31, 2008 as compared to 2007 and 2006 was primarily attributable to higher invested assets resulting from cash flows. Invested assets were $726.2 million, $705.3 million and $549.8 million as of December 31, 2008, 2007 and 2006, respectively.
Fee income, which consists of commissions earned by the Company’s managing general underwriters for brokerage business placed outside the Company, was $5.9 million for the year ended December 31, 2008. Other expenses, which represent the expenses associated with the generation of fee income, was $5.3 million for the year ended December 31, 2008.
Losses and loss adjustment expenses for the year ended December 31, 2008 resulted in a loss ratio of 47.1%, compared to 54.4% and 64.3% for the same periods ended 2007 and 2006, respectively. Included in losses and loss adjustment expense for the year ended December 31, 2008 were $16.1 million in losses resulting from the Hurricanes Gustav and Ike, including $9.6 million attributable to Argo Re’s property catastrophe programs. The Reinsurance segment had favorable loss development of $2.7 million driven by favorable property loss reserve development on two reinsurance contracts. Absent the hurricane activity, the loss ratio for the year ended December 31, 2008 as compared to 2007 declined due to the inclusion of a full year of Argo Re results, which writes to a lower ultimate loss ratio than the assumed business. The decrease in the loss ratio for the year ended December 31, 2007 as compared to 2006 was primarily attributable to a new program entered into in 2007 which reported a 40.1% loss ratio for the year ended December 31, 2007. Loss reserves for the Reinsurance segment were $59.8 million and $17.3 million at December 31, 2008 and 2007, respectively.
The increase in net investment income for the year ended December 31, 2008 as compared to 2007 was primarily attributable to the inclusion of a full year of investment income for Argo Re. Invested assets as of December 31, 2008 for the Reinsurance segment were $195.5 million, compared to $304.0 million at December 31, 2007. The decrease in invested assets was due to the acquisition of Heritage in the second quarter of 2008.
Certain underwriting, acquisition and insurance expenses are incurred in British Pound Sterling. The expense ratio has benefitted from the strengthening of the U.S. Dollar against the British Pound Sterling.
Net investment income represents earnings on investments retained for the benefit of the Company. Total invested assets for the International Specialty segment as of December 31, 2008 were $502.1 million, excluding $215.8 million attributable to the trade capital providers.
Fee income represents fees and profit commission derived from the management of third party capital on its underwriting syndicates at Lloyds. Other expense represents those costs incurred by the non-risk bearing activities of this segment.
Earned premiums for the year ended December 31, 2008 were reduced due to $15.0 million in ceded premiums due to the expiration of a reinsurance contract in 2008, in addition to decreased reinstatement premiums on reinsurance programs previously written. Earned premiums for the year ended December 31, 2007 were primarily attributable to adjustments resulting from final audits and other adjustments on policies previously written. Earned premiums for the year ended December 31, 2006 was primarily attributable to the run-off of premiums written prior to a renewal rights sale.
Losses and loss adjustment expenses for the year ended December 31, 2007 included $23.1 million in net unfavorable development on prior accident years. The unfavorable development included $26.0 million for the Company’s asbestos and environmental exposure. Workers compensation claims recorded $7.0 million in unfavorable development, primarily due the settlement of one claim for $5.5 million, coupled with $2.0 million due to the reserve discount. Loss reserves for involuntary pools and unallocated loss adjustment expenses increased $0.8 million for prior accident years. Favorable development of $8.7 million was recognized on the general liability and automobile lines, primarily related to the 2000 through 2004 accident years. Favorable development on the general liability lines includes reserve take downs due to the Company closing its last open construction defect claim and the corresponding reversal of the construction defect bulk reserve.
For the year ended December 31, 2006, the Company strengthened loss reserves for the asbestos and environmental claims by $12.2 million. The Company also increased its unallocated loss adjustment expense reserves by $4.7 million to reserve for the cost to handle and run-off these claims. Partially offsetting these increases was a reduction to the medical malpractice reserves of $7.0 million. As of December 31, 2008, all potential medical malpractice claims have been closed or dismissed and the Company is beyond the statutes of limitations for filing new medical malpractice claims in all jurisdictions. Losses and loss adjustment expenses in the former risk management lines of $10.3 million for the year ended December 31, 2006 were offset by an equal amount of favorable development on prior accident year reserves. Favorable development consisted of $7.0 million in the workers compensation line due to continued improvement in the 2001 through 2005 accident years due to the impact of California Benefit Reform. The Company recognized $2.6 million in favorable development on involuntary pool losses, and other lines had $0.7 million of favorable development.
Net investment income decreased to $31.3 million for the year ended December 31, 2008, compared to $43.1 million and $33.7 million for the years ended December 31, 2007 and 2006, respectively. The decrease in 2008 as compared to 2007 was primarily attributable to a reduction in invested assets during 2008, primarily attributable to the sale of PXRE Reinsurance Company in the first quarter of 2008. The increase in 2007 as compared to 2006 was attributable to the inclusion of $13.1 million of investment income attributable to the former PXRE entities. Invested assets were $689.4 million as of December 31, 2008. Invested assets as of December 31, 2007 were $1,088.6 million, and included $466.5 million from the Merger with PXRE. Invested assets were $772.2 million as of December 31, 2006.
against businesses that were not directly involved in the manufacture or installation of materials containing asbestos. The Company believes that a significant portion of claims generated out of this population of claimants may result in incurred losses generally lower than the asbestos claims filed over the past decade and could be below the attachment level of Argonaut Insurance Company.
The following table represents the components of gross loss reserves for the Run-off Lines for each of the years in the three-year period ended December 31, 2008:
The following table represents gross payments on asbestos and environmental claims for each of the years in the three-year period ended December 31, 2008:
ultimate liability to the Company due to the potentially long waiting period between exposure and emergence of any bodily injury or property damage and the resulting potential for involvement of multiple policy periods for individual claims. Additionally, recent industry trends show an increasing number of claims being filed by individuals who claim asbestos exposure, but who have no apparent symptoms of asbestos-related disease. Due to these uncertainties, the current trends may not be indicative of future results. Although management has determined and recorded its best estimate of the reserves for losses and loss adjustment expenses for Run-off Lines, current judicial and legislative decisions continue to broaden liability, expand policy scopes and increase the severity of claims payments. As a result of these and other recent developments, the uncertainties inherent in estimating ultimate loss reserves are heightened, further complicating the already complex process of determining loss reserves. The industry as a whole is involved in extensive litigation over these coverages and liability issues, and must contend with the continuing uncertainty in its effort to quantify these exposures.
The Company’s principal cash flow sources are premiums and investment income. The primary cash outflows are claim payments, reinsurance costs and operating expenses. The nature of insurance is that cash collected for premiums written is invested, interest and dividends are earned thereon, and loss and settlement expenses are paid out over a period of years. This period of time varies by line of business and by the circumstances surrounding each claim. A substantial portion of the Company’s loss and loss expenses are paid out over more than one year. Additional cash outflow occurs through payments of underwriting and acquisition costs such as commissions, taxes, payroll and general overhead expenses. Management believes that cash receipts from premiums and investment income are sufficient to cover cash outflows in the foreseeable future. Should the need for additional cash arise, the Company has access to additional sources of liquidity.
Net cash used by investing activities totaled $115.0 million, $190.6 million and $300.7 million for the years ended December 31, 2008, 2007 and 2006, respectively. The change in 2008 as compared to 2007 was primarily due to the net proceeds from investment activity year over year and the cash proceeds received in 2008 from the sale of PXRE Reinsurance Company being in excess of the cash payments associated with the Company’s 2008 acquisitions (Heritage, Massamont and Insight). In 2007, cash was primarily used to acquire fixed maturity and equity securities, offset by cash received from sales, calls and maturities of fixed maturity securities and sales of equity securities. The Company received net cash of $10.4 million upon the closing of the Merger of PXRE and Argonaut Group in August 2007. The Company received $17.3 million in cash as a result of the sale of a strategic investment during the year ended December 31, 2006. As of December 31, 2008, 2007 and 2006, $513.6 million, $648.8 million and $233.1 million, respectively, of the investment portfolio were invested in short-term investments. The increase in 2008 and 2007 reflects the duration of liabilities from Argo Re.
In addition, the Company’s ability to receive dividends from its downstream subsidiaries is subject to the ability of each parent corporation within the corporate ownership structure to receive dividends from its respective subsidiary(ies), based upon the subsidiary’s domiciliary regulations. Argo Re is the primary direct subsidiary of Argo Group and is subject to Bermuda insurance laws. Argo Ireland is directly owned by Argo Re and is a mid-level holding company subject to Irish laws, and its primary subsidiary is Argo Group US. Argo Group US is a second tier mid-level holding company subject to Delaware laws. Argo Group US is the parent of all of the Company’s U.S. insurance subsidiaries.
On November 13, 2007, the Board of Directors authorized the repurchase of up to $150.0 million of the Company’s common shares. During 2008, the Company began repurchasing common shares. As of December 31, 2008, the Company had purchased 145,999 shares at an average price of $35.23 ($5.1 million). The Company may continue to acquire stock based on available liquidity and market conditions.
Throughout 2008, the Company had no preferred shares outstanding. Cash dividends paid to preferred shareholders totaled $0.1 million and $1.4 million for the years ended December 31, 2007 and 2006, respectively. In the first quarter of 2007, 500,000 preferred shares and in the second quarter of 2007, all remaining preferred shares were converted into the Company’s common stock. At December 31, 2006, preferred shares outstanding were 1.0 million.
In 2008 and 2006, the Company did not pay cash dividends to common shareholders. In 2007, cash dividends paid to common shareholders totaled $57.1 million. On June 6, 2007, the Board of Directors of Argonaut Group declared a special dividend of $1.65 per common share to its shareholders of record on June 26, 2007. The special dividend was paid to Argonaut Group’s shareholders on July 10, 2007.
The Company has access to various sources of liquidity including holding company investments and cash, capacity under its revolving credit facility and access to the debt and equity capital markets, if available. On March 6, 2006, Argonaut Group entered into a Credit Agreement (“the Credit Agreement”) with JPMorgan Chase Bank, N.A., as administrative agent, and the other lenders thereto that provided for an initial $75.0 million revolving credit facility. On February 27, 2009 the Company entered into a $100 million, 364 day revolving credit facility with JPMorgan Chase Bank, N.A., as administrative agent, and other lenders thereto (the “New Credit Facility”). The New Credit Facility replaced the Credit Agreement. The New Credit Facility allows for borrowings by the Company, Argo Group US, and certain companies in our International Specialty segment, the proceeds of which can be used for general corporate purposes, including working capital and permitted acquisitions. At December 31, 2008, the Company had borrowed $50.0 million under the Credit Agreement. The Company has borrowed $60.0 million under the New Credit Facility of which $50.0 million was used to re-pay and terminate the Credit Agreement. The Credit Agreement and the New Credit Facility each contain certain affirmative and negative covenants. The Company was in compliance with all covenants of the Credit Agreement as of December 31, 2008 and is currently in compliance with all covenants of the New Credit Facility. Included in the New Credit Facility is a provision which allows up to $10.0 million of the revolver to be used for letters of credit (“LOC”), subject to availability under the line. In 2009, the Company had drawn $60,000 LOCs against the New Credit Facility. Management believes that the Company has sufficient liquidity to meet its needs.
The Company has three additional LOC facilities that allow it to provide LOCs to its ceding companies if such LOC is required under the terms of the contract. All of the facilities require the Company to provide collateral in the form of fixed maturity securities or cash to the issuing bank as security for outstanding LOCs. The first is a $200.0 million committed facility under which the Company pays the issuing bank an annual standby commitment fee of 0.10% per annum. The Company is currently in discussions concerning the renewal of the second, a $110.0 million committed facility under which the Company pays the issuing bank an annual standby commitment fee of 0.15% per annum. The third is an uncommitted facility that allows for LOCs to be issued subject to satisfactory collateral being provided to the issuing bank by the Company. There is no commitment fee for the third facility. The Company must transfer eligible assets to collateral accounts prior to each respective bank issuing an LOC. Since eligible assets include fixed income investments, such securities need not be sold in order to qualify as eligible collateral. As of December 31, 2008, the Company has pledged assets with a fair value of $120.2 million to support outstanding letters of credit.
During 2005, Argonaut Group Statutory Trust X (“Trust X”), a wholly-owned subsidiary (non-consolidated) of Argonaut Group, now known as Argo Group US, sold 30,000 Floating Rate Capital Securities (the “2005 Capital Securities”) (liquidation amount $1,000 per Capital Security) in a private sale for $30.0 million. Trust X used the proceeds from this sale, together with the proceeds from its sale of 928 shares of Floating Rate Common Securities (liquidation amount $1,000 per Common Security) to Argo Group US, to purchase $30.9 million of a series of Floating Rate Junior Subordinated Debentures (the “2005 Debentures”) due 2035 from Argo Group US. The 2005 Debentures have the same payment terms as the 2005 Capital Securities. The 2005 Debentures are unsecured and are subordinated in right of payment to all of the Company’s existing and future senior indebtedness. The initial interest rate on the 2005 Debentures and the 2005 Capital Securities issued by Trust X is fixed at 7.75% for the first five years. After five years, the interest rate is equal to three-month LIBOR plus 3.40%, which rate is reset quarterly. After September 15, 2010, Argo Group US will have the right to redeem the 2005 Debentures, in whole or in part, but in all cases in a principal amount in integral multiples of $1,000, at a price equal to 100% of the principal amount of the 2005 Debentures, plus accrued and unpaid interest to the date of redemption.
During 2003, Argonaut Group, now known as Argo Group US, through a series of statutory trusts (non-consolidated), sold $27.0 million of Floating Rate Capital Securities (the “2003 Capital Securities”) (liquidation amount $1,000 per Capital Security) in a series of private sales. In conjunction with the sales of the 2003 Capital Securities, the trusts sold $0.8 million of Floating Rate Common Securities to Argo Group US. The trusts used the proceeds from these sales to purchase $27.8 million
During 2003, PXRE, now known as Argo Group, through a series of statutory trusts (non-consolidated), sold $62.5 million of Capital Securities (the “2003 Argo Capital Securities”) (liquidation amount $1,000 per Capital Security) in a series of private sales. In conjunction with the sales of the 2003 Argo Capital Securities, the trusts sold $1.9 million of Common Securities to Argo Group. The trusts used the proceeds from these sales to purchase $64.4 million of Junior Subordinated Debentures (the “2003 Argo Debentures”) from Argo Group. The interest rate on the 2003 Argo Debentures and the 2003 Argo Capital Securities issued by PXRE Capital Trust III is fixed at 9.75% payable quarterly. The interest rates on the 2003 Argo Debentures and the 2003 Argo Capital Securities issued by the other trusts are fixed at rates ranging from 7.35% to 7.70% for the first five years. After five years, the interest rates are equal to the three-month LIBOR plus a margin ranging from 3.85% to 4.10%, reset quarterly. At December 31, 2008, the interest rates on these floating rate securities ranged from 5.36% to 7.36%. The 2003 Argo Debentures are unsecured and are subordinate in right of payment to all of the Company’s future senior indebtedness. The 2003 Argo Debentures are due 30 years after issuance, but may be redeemed after the five-year anniversary at a price equal to 104.875% to 100% of the principal amount of the 2003 Argo Debentures, plus accrued and unpaid interest on the date of redemption. Argo Group has the option to defer interest payments on the capital trust pass-through securities and redeem them earlier than the due dates, subject to limits and penalties as set out in the relevant indentures.
The Company’s insurance subsidiaries require liquidity and adequate capital to meet ongoing obligations to policyholders and claimants, and to fund operating expenses. During the three years ended December 31, 2008, the Company’s liquidity generated from operations and investment income were sufficient to meet obligations. Adequate levels of liquidity and surplus are maintained to manage the risks inherent with any differences between the duration of its liabilities and invested assets. The Company believes it maintains sufficient liquidity to pay claims and expenses, as well as satisfy its commitments in the event of unforeseen events such as reinsurer insolvencies, inadequate premium rates, or reserve deficiencies.
The insurance subsidiaries must maintain certain levels of policyholders’ surplus to support premium writings. Guidelines of the National Association of Insurance Commissioners suggest that a property and casualty insurer’s ratio of annual statutory net premium written to policyholders’ surplus should not exceed 3-to-1. The ratio of combined annual statutory net premium written by the U.S. subsidiaries to their combined policyholders’ surplus was 1.3-to-1 as of December 31, 2008. Current levels of policyholders’ surplus are adequate to support current premium writings, based on this standard. The Company monitors premium and statutory surplus levels of the insurance subsidiaries to ensure that the subsidiaries maintain adequate premiums to surplus ratios. Failure of any insurance subsidiary to maintain adequate levels of policyholders’ surplus could negatively impact the ability to write additional premiums.
In addition, regulators utilize a risk based capital (“RBC”) test designed to measure the acceptable amount of surplus an insurer should maintain, based on specific inherent risks of each insurer. Insurers failing to meet this benchmark level may be subject to scrutiny by the insurer’s domiciliary insurance department and potentially result in rehabilitation or liquidation. At December 31, 2008, the total adjusted capital of each of the Company’s U.S. subsidiaries exceeded the minimum levels required under RBC. The Company continually monitors the RBC ratios and will implement strategies to maintain ratios above the regulatory minimums.
The Company controls its credit exposure related to financial instruments by limiting exposure to any one counterparty and mandating minimum credit ratings. The Company utilizes specific criteria to judge the credit quality of its investments and counterparties, and also reviews ratings published by various credit rating services, if available.
The report of the independent auditors, the consolidated financial statements of Argo Group International Holdings, Ltd. and subsidiaries and the supplementary financial statements called for by this Item 8 are included in this report beginning on page and are incorporated herein by reference.