It is possible that TRH's actual results, financial condition and expected outcomes may differ, possibly materially, from those anticipated in these forward-looking statements. Important factors that could cause TRH's actual results to differ, possibly materially, from those discussed in the specific forward-looking statements may include, but are not limited to, uncertainties relating to economic conditions, financial and credit market conditions, cyclical industry conditions, credit quality, government, regulatory and accounting policies, volatile and unpredictable developments (including natural and man-made catastrophes), the legal environment, legal and regulatory proceedings, failures of pricing models to accurately assess risks, the reserving process, the competitive environment in which TRH operates, interest rate and foreign currency exchange rate fluctuations, the uncertainties inherent in international operations, risks associated with the ability to consummate the merger with Alleghany and the timing of the closing of the merger, the ability to successfully integrate our operations and employees, the ability to realize anticipated benefits and synergies of the transaction, the potential impact of the announcement of the transaction or consummation of the transaction on relationships, including with employees, credit rating agencies, customers and competitors the ability to retain key personnel, pricing and policy term trends, increased competition, the impact of acts of terrorism and acts of war, greater frequency or severity of unpredictable catastrophic events, negative rating agency action, the adequacy of loss reserves, changes in regulations or tax laws, changes in the availability, cost or quality of reinsurance or retrocessional coverage, adverse general economic conditions, and judicial, legislative, political and other government developments, as well as management's response to these factors.
These factors are further discussed throughout Management's Discussion and Analysis of Financial Condition and Results of Operations and in Part I, Item 1A. Risk Factors of this Form 10-K. TRH is not under any obligation to (and expressly disclaims any such obligation to) update or alter any forward-looking statement, whether written or oral, that may be made from time to time, whether as a result of new information, future events or otherwise, except as required by law.
The operations of the Company are conducted principally by its three major operating subsidiaries - Transatlantic Reinsurance Company® ("TRC"), Trans Re Zurich Reinsurance Company Ltd. ("TRZ") and Fair American Insurance and Reinsurance Company (formerly Putnam Reinsurance Company) ("Fair American") - and are managed based on its geographic segments. Through its operations on six continents, TRH offers reinsurance capacity on both a treaty and facultative basis - structuring programs for a full range of property and casualty products, with an emphasis on specialty lines, which may exhibit greater volatility of results over time than most other lines. Such capacity is offered through reinsurance brokers and, to a lesser extent, directly to domestic and foreign insurance and reinsurance entities.
TRH conducts its business and assesses performance through segments organized along geographic lines. The Domestic segment principally includes financial data from branches in the United States except Miami, as well as revenues and expenses of the Company (including interest expense on the Company's senior notes and merger-related costs (see Note 3 of Notes to Consolidated Financial Statements ("Note 3")). Prior to 2011, financial information for the Sydney branch was included in the London branch as part of the International-Europe segment. Sydney branch financial information for prior periods was not material. Starting in 2011, Sydney is more appropriately considered a segment for financial reporting purposes and is aggregated with other segments that are generally not material in International-Other. Segment information for periods prior to 2011 have been revised to conform to the current segment presentation. Data from the London and Paris branches and from TRZ are reported in the aggregate as International-Europe and considered as one segment due to operational and regional similarities. Data from the Miami (which serves Latin America and the Caribbean), Toronto, Hong Kong, Tokyo and Sydney branches are grouped as International-Other and represent the aggregation of segments that are generally not material.
In 2011, casualty lines comprised 70% of TRH's net premiums written, while property lines totaled 30%. Business written by international operations represented 51% of net premiums written in 2011. (See Operational Review for year to year comparisons of such measures.)
TRH's major sources of revenues are net premiums earned for reinsurance risks undertaken and income from investments. The great majority of TRH's investments are in available for sale fixed maturities. In general, premiums are received significantly in advance of related claims payments.
In 2011, TRH was involved in merger-related activities. See Note 3 for merger-related costs and Note 18 of Notes to Consolidated Financial Statements ("Note 18") for legal proceedings related to merger-related activities.
On November 20, 2011, the Company entered into an Agreement and Plan of Merger (the "Alleghany Merger Agreement") with Alleghany and Shoreline Merger Sub, Inc. (formerly, Shoreline Merger Sub, LLC), a wholly-owned subsidiary of Alleghany ("Shoreline"). The Alleghany Merger Agreement provides for the merger of the Company with and into Shoreline (the "Alleghany Merger"), with Shoreline continuing as the surviving company and a wholly-owned subsidiary of Alleghany. Upon completion of the Alleghany Merger, Shoreline's name will change to "Transatlantic Holdings, Inc." Pursuant to the terms and conditions of the Alleghany Merger Agreement, upon completion of the Alleghany Merger, stockholders of the Company will be entitled to receive, in exchange for each share of common stock they hold at the effective time of the Alleghany Merger, either stock or cash consideration with a value equal to the sum of (a) 0.145 multiplied by the average of the closing sales prices on the New York Stock Exchange for Alleghany common stock during the five trading days ending the day before the completion of the Alleghany Merger and (b) $14.22.
On February 6, 2012, the stockholders of the Company and the stockholders of Alleghany each approved the Alleghany Merger. The Alleghany Merger is expected to close in the first quarter of 2012, subject to regulatory approvals and customary closing conditions.
On June 12, 2011, Allied World and the Company agreed to a "merger of equals" business combination of the two companies pursuant to the terms of an Agreement and Plan of Merger, dated as of June 12, 2011 (the "Allied World Merger Agreement"), between Allied World, the Company and GO Sub, LLC, a wholly-owned subsidiary of Allied World ("GO Sub"). Pursuant to the terms of the Allied World Merger Agreement, GO Sub would have merged with and into the Company, with the Company surviving as a wholly-owned subsidiary of Allied World. Pursuant to the terms and conditions of the Allied World Merger Agreement, stockholders of the Company would have been entitled to receive 0.88 common shares of Allied World for each share of the Company's common stock (and cash in lieu of any fractional shares).
Secondary Public Offerings of the Company's Common Stock by American International Group, Inc. ("AIG") and its subsidiaries (collectively, the "AIG Group")
The following table summarizes TRH's revenues, (loss) income before income taxes and net (loss) income for the periods indicated:
2009. The increase in interest expense is due to the issuance of $350 million principal amount of TRH's 8.00% senior notes due in 2039 (the "2039 Notes") in November 2009. The decrease in net income between periods was mitigated by reduced tax expense in 2010 primarily related to the lower pre-tax income in 2010.
Trends in reinsurance rates at the beginning of 2009 were inconsistent, with rates increasing, staying level or deteriorating depending on the line of business or region. However, as 2009 progressed, improvements in general economic conditions, the strengthening of insurers' and reinsurers' balance sheets and the low level of catastrophe losses in 2009 put downward pressure on reinsurance rates. Insurers had greater capacity to retain risk and increased access to capital market alternatives to reinsurance compared to late 2008, while the strengthening of reinsurer balance sheets increased the amount of capacity available in the reinsurance market.
In the casualty lines, rates were uneven in 2009. Certain lines, like directors' and officers' liability ("D&O") of financial institutions showed rate increases, while others were flat or showed decreases. Results in many casualty lines benefited from favorable accident year loss severity and frequency trends in 2009. In the property lines, some catastrophe exposed regions, particularly peak zones, saw significant rate increases in the first half of 2009, which leveled off in the second half of 2009.
explosion, while rate increases leveled off in the aviation line. Primary rates for other casualty lines generally remained under pressure, although internationally they are showing some signs of improvement.
Overall market conditions were mixed in 2011, but with some positive signs in certain areas in which TRH is well positioned. 2011 was marked by major catastrophe events, with significant industry losses from earthquakes in Japan and New Zealand, flooding in Australia and Thailand and tornados in the U.S. Following the severity and frequency of catastrophe events over the last two years, rate improvements in property catastrophe exposed lines were evident in the loss-affected areas. However, areas not significantly impacted by catastrophe losses were more resistant to rate improvements. Overall U.S. property catastrophe business exhibited modestly higher risk-adjusted rates and stable terms and conditions. Additionally, changes to industry risk-exposure models in the U.S. increased upward rate pressure in certain regions and property lines, but significant industry capacity and a difficult economy limited improvements. In the catastrophe affected areas of the Pacific Rim, property catastrophe and other property rates improved in New Zealand, Australia and Japan. In the U.K. and continental Europe, traditional property and property catastrophe rates remained generally flat except in loss affected areas. In Latin America, property rates increased modestly but the market remained competitive.
In the January 1, 2012 renewal period, rates for casualty lines generally remained mixed, with terms and conditions largely remaining stable. In general casualty, U.S. general casualty, auto and umbrella rates generally remained flat or increased slightly, while rates in the U.K. and continental Europe generally faced downward pressure, although U.K. motor rates did see significant increases. Rates strengthened in marine programs and aviation programs saw some rate softening. In specialty casualty, D&O and E&O rates were generally flat while medical malpractice rates faced increased downward pressure as a result of favorable claims frequency levels in recent periods.
Property catastrophe rates increased during the January 1, 2012 renewal period, but were tempered by abundant capacity. Given the magnitude and frequency of catastrophe events in recent years, TRH expects rates for catastrophe exposed lines to continue to increase in 2012.
This discussion and analysis of financial condition and results of operations is based on TRH's consolidated financial statements which have been prepared in accordance with generally accepted accounting principles in the U.S. ("GAAP"). The preparation of these financial statements requires the
use of estimates and judgments that affect the reported amounts and related disclosures. TRH relies on historical experience and on various other assumptions that it believes to be reasonable, under the circumstances, to make judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ materially from these estimates.
Standard actuarial methodologies employed to estimate ultimate losses incorporate the inherent "lag" from the time claims are reported to the cedant to when the cedant reports the claims to the reinsurer. Certain actuarial methodologies may be more appropriate than others in instances where this "lag" may
•Loss trend factors are used to establish expected loss ratios ("ELRs") for subsequent accident years based on the projected loss ratios for prior accident years. Provisions for inflation and social inflation (e.g., awards by judges and juries which progressively increase in size at a rate exceeding that of general inflation) and trends in court interpretations of coverage are among the factors which must be considered.
During the loss settlement period, which can be many years in duration, additional facts regarding individual claims and trends generally become known. As these facts and trends emerge, it usually becomes necessary to refine and adjust the loss reserves upward or downward and even then the ultimate net liability may be materially different from the revised estimates. There is potential for significant variation in the development of loss reserves when actual costs differ from those costs implied by the use of the assumptions employed in the reserve setting process. This is particularly true for assumed reinsurance of long-tail casualty classes. Among the most critical assumptions are those made for ELRs and loss development factors.
The methodologies that TRH employs to assess the reasonableness of loss reserve estimates include the paid loss development, incurred loss development, paid Bornhuetter-Ferguson ("B-F") and incurred B-F methods. The actuarial methods that TRH employs to determine the appropriate loss reserves for short-tail lines of business are the same as those employed for longer-tail lines. However, the judgments that are made with regard to factors such as loss trends, ELRs and loss development factors for shorter-tail lines generally have much less of an effect on the determination of the loss reserve amount than when those same judgments are made regarding longer-tailed lines of business. In contrast to the longer-tailed lines of business, reported losses for the shorter-tailed classes, such as the property lines of business (e.g., fire and homeowners multiple peril) and certain marine and energy classes, generally reach the ultimate level of incurred losses in a relatively short period of time. Rather than having to rely on assumptions regarding ELRs and loss development factors for many accident years for a given line, these assumptions are generally only relevant for the most recent accident year or two. Therefore, these assumptions tend to be less critical and the reserves calculated pursuant to these assumptions are subject to less variability for the shorter-tailed lines of business.
•D&O and E&O: These classes are dominated by high layer excess-of-loss D&O business as well as E&O classes such as lawyers and accountants. Much of this business is domestic, although significant amounts are written by the London branch. This business is reviewed separately by operating branch and for pro rata versus excess-of-loss contracts and for treaty versus facultative. Additionally, homogeneous groupings of accountant, lawyer, and architect and engineer risks are reviewed separately. These classes are long-tailed in nature, often characterized by very high attachment points. Therefore, B-F methods are generally relied upon for the most recent years due to the lack of mature reported experience. The selections for older years will often be based on the weighted average of the loss development methods and B-F methods. The selection of ELRs for these classes is generally analogous to that of the Excess Casualty class described above but with added emphasis on actuarial pricing indications, as these accounts are often very large and are virtually all actuarially reviewed before the business is underwritten.
•Shorter-tailed lines: These would include the property lines of business (such as fire and homeowners multiple peril), A&H and certain marine and energy classes. These lines are written by several of TRH's worldwide offices and the reserves are reviewed separately for each operating branch. Where sufficiently credible experience exists, these lines are reviewed after segregating pro rata contracts from excess-of-loss contracts. For a reinsurer, these lines do not develop to ultimate loss as quickly as when written on a primary basis; however, they are significantly shorter-tailed than the casualty classes discussed earlier. For these classes, a combination of loss development methods and B-F methods are used. Generally, selections for all but the most recent few years are based on
loss development methods with the most recent years based on weightings of loss development and expected loss ratio indications.
While noting that there exists the potential for greater variations, TRH believes utilizing 5% and 10% changes to the assumptions made for both loss development factors and ELRs provide reasonable benchmarks for a sensitivity analysis of the loss reserve estimates at December 31, 2011. For example, changing the ELRs by 5 percentage points has an impact of about $190 million (either positively or negatively) on the loss reserve estimate. While less likely for many classes of business, TRH notes that changing the ELRs by 10 percentage points has an effect of about $385 million. As previously described, another key assumption is the selection of loss development patterns. The effect of increasing the tail on the selected loss development patterns by 5% is about $390 million. Similarly, a 10% deviation would impact the reserve estimate by about $765 million. Because a downward adjustment to the loss development patterns can result in implied negative future development on reported losses for certain years, this scenario is not believed to be as likely as that of an upward deviation of this amount.
scenario previously discussed. TRH also notes that the classes of business for which these assumptions are most critical are medical malpractice, D&O, E&O and excess casualty.
Net loss reserves include amounts for risks relating to environmental impairment and asbestos-related illnesses. The reserves carried for these claims, including the IBNR portion, are based upon known facts and current law. However, significant uncertainty exists in determining the amount of ultimate liability for environmental impairment and asbestos-related losses, particularly for those occurring in 1985 and prior. This uncertainty is due to inconsistent court resolutions and judicial interpretations with respect to underlying policy intent and coverage and uncertainties as to the allocation of responsibility for resultant damages, among other things.
As of December 31, 2011, of TRH's $13.2 billion of fixed maturities available for sale, equities available for sale and other invested assets measured at fair value on a recurring basis, approximately $13.1 billion was based on prices received from independent pricing services and approximately $0.1 billion was based on non-binding broker quotes or internal valuation sources. Management reviewed all fair values from external sources and did not make any material adjustments to the fair values.
See Note 4 for discussion of how TRH determines the fair value of its fixed maturities available for sale, equities available for sale and short-term investments.
Assets recorded at fair value in the consolidated balance sheet are classified in a hierarchy for disclosure purposes consisting of three levels based on the observability of inputs available in the market place used to measure fair value. (See Note 4 for additional information about fair value measurements.)
The valuation of Level 3 assets requires the greatest degree of judgment, as these measurements may be made under circumstances in which there is little, if any, market activity for the asset. At December 31, 2011, TRH classified $185.1 million of assets measured at fair value on a recurring basis as Level 3. This represented 1.4% of total assets measured at fair value on a recurring basis. Level 3 fair value measurements are based on valuation techniques that use at least one significant input that is unobservable. TRH's assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment.
•Residential mortgage-backed securities ("RMBS") and commercial mortgage-backed securities ("CMBS"): These assets initially are valued at the transaction price. Subsequently, they may be valued by comparison to transactions in instruments with similar collateral and risk profiles, remittances received and updated cumulative loss data on underlying obligations, discounted cash flow techniques and/or option adjusted spread analyses.
See Note 5(g) of Notes to Consolidated Financial Statements ("Note 5(g)") for the criteria TRH uses to evaluate if an investment is a candidate for OTTI.
Management must make certain judgments in the determination of premiums written and earned by TRH. For pro rata contracts, premiums written and earned are generally based on reports received from ceding companies. For excess-of-loss contracts, premiums are generally recorded as written based on contract terms and are earned ratably over the terms of the related coverages provided. Unearned premiums and prepaid reinsurance premiums represent the portion of gross premiums written and ceded premiums written, respectively, relating to the unexpired terms of such coverages. The relationship between net premiums written and net premiums earned will, therefore, vary depending generally on the volume and inception dates of the business assumed and ceded and the mix of such business between pro rata and excess-of-loss reinsurance.
Premiums written and earned, along with related costs, for which data have not been reported by the ceding companies, are estimated based on historical patterns and other relevant information. Such estimates of premiums earned are considered when establishing the IBNR portion of loss reserves. The differences between these estimates and the actual data subsequently reported, which may be material as a result of the diversity of cedants and reporting practices and the inherent difficulty in estimating premium inflows, among other factors, are recorded in the period when the actual data become available and may materially affect results of operations. In the Consolidated Statements of Operations, premiums written and earned and the change in unearned premiums are presented net of reinsurance ceded.
Domestic net premiums written in 2011 totaled $1.87 billion, a decrease of $76.2 million, or 3.9%, from 2010. Significant decreases in Domestic net premiums written in the other liability ($67.8 million) and mortgage guaranty ($14.9 million) lines were partially offset by a significant increase in the ocean marine ($13.2 million) line. The decrease in mortgage guaranty net premiums written includes a $19 million decrease resulting from the negotiated settlement of an arbitration proceeding. (See Note 18.)
International net premiums written in 2011 totaled $1.99 billion, an increase of $54.1 million, or 2.8%, from 2010. The most significant increases in net premiums written occurred in the London ($107.9 million), Hong Kong ($23.5 million) and Paris ($13.4 million) branches, partially offset by significant decreases in TRZ ($74.9 million) and the Miami ($17.3 million) branch. The most significant increases in International net premiums written were recorded in the auto liability ($85.6 million), ocean marine ($37.8 million), medical malpractice ($20.3 million) and credit ($15.9 million) lines along with relatively small increases spread across several lines, partially offset by significant decreases in the A&H ($62.6 million), other liability ($40.2 million) and fidelity ($25.6 million) lines. The increase in International net premiums written was partially due to an increase in net assumed reinstatement premiums related to catastrophe losses incurred and includes the impact of changes in foreign currency exchange rates. Changes in foreign currency exchange rates increased net premiums written in 2011 by $72.6 million compared to 2010. Excluding the impact of changes in foreign currency exchange rates, International net premiums written would have decreased 1.0% in 2011 compared to 2010.
International net premiums written in 2010 totaled $1.93 billion and remained level with 2009. Significant decreases in net premiums written occurred in the Miami ($36.5 million) and Paris ($35.7 million) branches, largely offset by significant increases in TRZ ($24.5 million) and the Hong Kong ($17.3 million), Sydney ($17.0 million) and Tokyo ($13.3 million) branches. Significant decreases in International net premiums written were recorded in the ocean marine ($26.9 million) and credit ($24.9 million) lines. These decreases were largely offset by significant increases in the A&H ($35.1 million) and auto liability ($22.2 million) lines. Changes in foreign currency exchange rates decreased 2010 International net premiums written by $4.6 million compared to 2009. Excluding the impact of changes in foreign currency exchange rates, International net premiums written would have increased 0.1% in 2010 compared to 2009.
The decreases in gross premiums written and ceded premiums written in 2011 compared to 2010 are largely due to a decrease in premiums assumed from a subsidiary of AIG that, by prearrangement with TRH, were then ceded in an equal amount to other subsidiaries of AIG. In the fourth quarter of 2011, TRH terminated such agreements with the subsidiaries of AIG. Upon termination, gross premiums written
were decreased by $86.4 million for the settlement of all remaining unearned premiums and ceded premiums written were decreased by an equal amount for the settlement of related prepaid reinsurance premiums, with no impact on net premiums written. The majority of the increase in premiums ceded in 2010 compared to 2009 is due to an increase in premiums assumed from a subsidiary of AIG that, by prearrangement with TRH, were then ceded in an equal amount to other subsidiaries of AIG.
Net investment income in 2011 totaled $457.6 million, a decrease of $16.0 million, or 3.4%, from 2010 due largely to a decrease in investment income from other invested assets, partially offset by increased investment income from equities. The decrease in investment income from other invested assets is due mainly to losses from an insurance-related alternative investment and a decrease in equity method income from TRH's 40% interest in Kuwait Re. The increase in net investment income from equities is due in part to the rebalancing of TRH's equity portfolio to place a greater emphasis on dividend generation. The decrease in net investment income was partially mitigated by changes in foreign currency exchange rates in 2011 which increased net investment income by approximately $4.0 million, or 0.8%, compared to 2010. Net investment income from other invested assets can display greater volatility than other classes of investments. Net investment income in 2010 totaled $473.5 million, an increase of $6.1 million, or 1.3%, compared to 2009 due largely to an increase in investment income from fixed maturities of $25.1 million, offset by decreases in investment income from equities of $3.8 million and other investment income of $12.1 million. Excluding the impact of foreign currency exchange rate changes, net investment income in 2010 would have increased by 1.5% compared to 2009. The increase in investment income from fixed maturities is due in part to the investment of net operating cash inflows in recent periods. (See Note 5(d) of Notes to Consolidated Financial Statements for a breakdown of the components of net investment income and the cash flow discussion under Financial Condition and Liquidity.)
For 2011, 2010 and 2009, the pre-tax effective yields on investments were 3.4%, 3.7% and 4.1%, respectively. The pre-tax effective yield on investments represents net investment income divided by the average balance sheet carrying value of investments and interest-bearing cash. The decrease in pre-tax yield on investments in 2011 compared to 2010 is due in part to a lower pre-tax yield on the fixed maturity portfolio and a decrease in investment income from other invested assets, partially offset by increased investment income from equities. The decrease in the pre-tax effective yield on investments for 2010 compared to 2009 is due primarily to a lower pre-tax effective yield on the fixed maturity portfolio.
Realized net capital gains (losses) totaled $88.6 million, $30.1 million and ($70.6) million in 2011, 2010 and 2009, respectively. The increase in realized net capital gains in 2011 compared to 2010 was due in large part to an increase in realized net capital gains on equities available for sale, resulting largely from the rebalancing of TRH's equities available for sale portfolio, and net foreign currency transaction gains in 2011 compared to net foreign currency transaction losses in 2010. The realized net capital gain in 2010 compared to the realized net capital loss in 2009 is due largely to a decrease in OTTI write-downs in 2010 compared to 2009. Realized net capital gains (losses) generally result from (a) investment dispositions, which reflect TRH's investment and tax planning strategies to optimize after-tax income; (b) OTTI of investments; and (c) foreign currency transaction gains (losses). (See Note 5(e) for a breakdown of realized net capital gains (losses).)
capital losses in 2010 included ($8.0) million of OTTI write-downs charged to earnings, largely related to issuer-specific credit losses on fixed maturities. OTTI decreased in 2010 compared to 2009 due in large part to improvements in the financial and credit markets. Realized net capital losses in 2009 included ($83.1) million of OTTI write-downs charged to earnings, due in large part to the depressed fair values of certain securities and issuer specific credit events in 2009.
Upon the ultimate disposition of securities for which write-downs have been recorded, a portion of the write-downs may be recoverable depending on market conditions at the time of disposition. (See Note 5(g) for the criteria used in the determination of such write-downs.)
OTTI write-downs by balance sheet category and type of impairment recorded for the years indicated are presented in the table below:
In 2011, 2010 and 2009, TRH repurchased portions of its 5.75% senior notes due in 2015 (the "2015 Notes" and together with the 2039 Notes, the "Senior Notes"). There were no repurchases of the 2039 Notes in 2011, 2010 and 2009. (See Note 8 of Notes to Consolidated Financial Statements ("Note 8") for the impact of the repurchases.)
The property and casualty insurance and reinsurance industries use the combined ratio as a measure of underwriting profitability. The combined ratio reflects only underwriting results and does not include income from investments. Generally, a combined ratio under 100% indicates an underwriting profit and a combined ratio exceeding 100% indicates an underwriting loss. Underwriting profitability is subject to significant fluctuations due to competition, natural and man-made catastrophic events, economic and social conditions, foreign currency exchange rate fluctuations, interest rates and other factors. TRH's combined ratio and its components are presented in accordance with the methodology commonly used by insurance industry analysts and TRH's peers. The combined ratio represents the sum of the loss ratio and the underwriting expense ratio. The loss ratio represents net losses and LAE incurred expressed as a percentage of net premiums earned. The underwriting expense ratio represents the sum of the commission ratio and the other underwriting expense ratio. The commission ratio represents the sum of net commissions and the decrease (increase) in deferred policy acquisition costs expressed as a percentage of net premiums earned. The other underwriting expense ratio represents other underwriting expenses expressed as a percentage of net premiums earned.
In addition, in 2011, TRH decreased its estimates of the ultimate amounts of net losses occurring in 2010 and prior years by $122.0 million. This net favorable development was comprised of net favorable development of $224.7 million for losses occurring in 2002 to 2010, partially offset by net adverse development of $102.7 million relating to losses occurring in 2001 and prior. The detail of the $122.0 million net favorable development by line of business relating to all prior years is presented in the table below:
(1)Amount of reestimation represents the (increase) decrease in net losses and LAE incurred in 2011 relating to losses occurring in 2010 and prior years. (2)The year-end 2010 net reestimated liability at year-end 2011 includes the impact of a negotiated settlement of an arbitration proceeding on amounts recorded as paid and unpaid losses in prior years. (See Note 18.)
TRH writes a significant amount of non-proportional assumed casualty reinsurance as well as proportional assumed reinsurance of excess liability business for such volatile classes as medical malpractice, D&O, E&O and general casualty. At the primary level, there are significant risk factors which contribute to the variability and unpredictability of the loss trend factor for this business such as jury awards, social inflation, medical inflation, tort reforms and court interpretations of coverage. In addition, as a reinsurer, TRH is also highly dependent upon the claims reserving and reporting practices of its cedants, which vary greatly by size, specialization and country of origin and whose practices can be subject to change without notice.
For 2011 compared to 2010, the changes in gross and ceded losses and LAE incurred each include amounts relating to business assumed from an AIG subsidiary which, by prearrangement with TRH, was then ceded in an equal amount to other AIG subsidiaries. In the fourth quarter of 2011, TRH terminated such agreements with the subsidiaries of AIG. Upon termination, gross losses and LAE incurred were decreased by $250.9 million for the settlement of all remaining gross loss reserves related to these agreements and ceded losses and LAE incurred were decreased by an equal amount for the settlement of all remaining reinsurance recoverables, with no net impact on net losses and LAE incurred. In addition, the change in gross and ceded losses and LAE incurred includes the changes in gross and ceded catastrophe losses as discussed in Note 11.
In addition, in 2010, TRH decreased its estimates of the ultimate amounts of net losses occurring in 2009 and prior years by $57.0 million. This net favorable development was comprised of net favorable development of $216.9 million for losses occurring in 2002 to 2009, partially offset by net adverse
development of $159.9 million relating to losses occurring in 2001 and prior. The detail of the $57.0 million net favorable development by line of business relating to all prior years is presented in the table below:
While there were no significant net catastrophe costs for events occurring during 2009, 2009 includes estimated net catastrophe costs incurred of ($5.6) million relating to events occurring in prior years. Net catastrophe costs in the aggregate (decreased) added (0.1)%, 0.0%, (0.4)% and (0.1)% to the 2009 combined ratios for consolidated, Domestic, International-Europe and International-Other, respectively.
(1)Amount of reestimation represents the (increase) decrease in net losses and LAE incurred in 2009 relating to losses occurring in 2008 and prior years. Significant net favorable development was recorded for losses occurring in the fire and allied lines, arising principally from losses occurring in 2007 to 2008, and the surety and credit line, arising principally from losses occurring in 2004 to 2008. The line of business with the most significant net adverse development recorded in 2009 was the other liability line, arising principally from losses occurring in 2001 and prior, partially offset by favorable development from losses occurring between 2004 and 2006. The other liability line includes certain specialty casualty classes, such as D&O and E&O, and general casualty classes. In addition, significant net adverse development was recorded in 2009 for losses occurring in the fidelity line, arising principally from losses occurring in 2007 to 2008, related to the global credit crisis. (See Note 11 for amounts included in net favorable development that relate to catastrophe losses.)
The favorable development in 2004 through 2008 results generally from favorable loss trends. The net adverse development arising from losses occurring in 2001 and prior generally relates to various excess casualty lines such as general liability and excess umbrella liability which were impacted by late reported high layer excess claims. In 2009, ceding companies and their reinsurers continued to experience increased loss costs relative to expectations as loss emergence patterns continue to lengthen as regards the soft market years of 1997 through 2001.
2012, among other things. Retention agreements with Alleghany will replace the 2011 Retention Plan related to the stock-based retention agreements with substantially similar values and vesting terms and will generally become effective after the completion of the Alleghany Merger. (See Note 19 of Notes to Consolidated Financial Statements ("Note 19").)
General corporate expenses, certain stock-based compensation costs and expenses relating to Professional Risk Management Services, Inc. ("PRMS") are the primary components of "other expenses, net" on the Consolidated Statement of Operations. PRMS, a wholly-owned subsidiary of the Company, is an insurance program manager specializing in professional liability insurance services. "Other expenses, net" for 2011 includes merger-related costs, including the $115.0 million of termination fees and expenses paid to Allied World related to the termination of the Allied World Merger Agreement. (See Note 3.)
(Loss) income before income taxes was ($214.7) million in 2011, $472.8 million in 2010 and $596.0 million in 2009. The loss before income taxes in 2011 compared to the income before income taxes in 2010 is primarily the result of an underwriting loss of ($529.9) million in 2011 compared to an underwriting profit of $69.3 million in 2010 and $138.4 million of merger-related costs, partially offset by an increase in realized net capital gains. The decrease in underwriting profit (loss) in 2011 was due largely to increased net catastrophe costs, partially offset by increased estimated net favorable development and the net benefit from the negotiated settlement of an arbitration proceeding. (See Notes 7, 11 and 18.) In the aggregate, net catastrophe costs, net favorable development and the negotiated settlement of an arbitration proceeding decreased 2011 underwriting profit (loss) by $594.6 million compared to 2010.
net capital losses in 2009. The decrease in underwriting profit is due principally to increased catastrophe costs, partially offset by increased favorable net loss reserve development. The net impact of increased catastrophe costs and increased favorable net loss reserve development was to decrease pre-tax underwriting profit in 2010 by $185.5 million compared to 2009.
The effective tax rates, which represent the sum of current and deferred income taxes (benefits) divided by (loss) income before income taxes, were 53.8% in 2011, 14.9% in 2010 and 19.9% in 2009. The difference in effective tax rates in 2011 compared to 2010 was due primarily to the significant catastrophe costs and merger-related costs in 2011. The decrease in effective tax rates in 2010 compared to 2009 was due in part to tax exempt income representing a larger percentage of pretax income in 2010 compared to 2009, largely as a result of significant net catastrophe costs in 2010, and a tax benefit of $8.4 million (net of interest on taxes) related to the resolution of certain prior year tax matters. (See Note 6 of Notes to Consolidated Financial Statements ("Note 6").)
TRH recognized income tax (benefits) expenses relating to catastrophe costs of ($298.1) million, ($70.9) million and $2.0 million in 2011, 2010 and 2009, respectively, and, in 2011, recognized income tax benefits of ($6.1) million associated with merger-related costs.
Reasons for the changes between years are as discussed earlier. (See Note 10 of Notes to Consolidated Financial Statements for the calculation of net (loss) income per common share.)
includes net catastrophe costs of $85.3 million, principally related to second quarter 2011 tornado activity in the U.S.; the February 2011 earthquake in New Zealand; the March 2011 Tohoku earthquake and resulting tsunami in Japan; Hurricane Irene which occurred in August 2011; and fourth quarter 2011 flooding in Thailand. Net catastrophe costs in 2010 were insignificant.
Assets increased by $86 million in 2011 due principally to increases of $110 million in investments and $55 million in premium balances receivable, partially offset by a $77 million decrease in reinsurance recoverable. The increase in investments is due largely to an increase of $161 million in fixed maturities, partially offset by a $57 million decrease in short-term investments.
Revenues increased slightly in 2010 due principally to realized net capital gains in 2010 compared to realized net capital losses in 2009, largely offset by a decrease in net premiums earned. The increase in realized net capital gains (losses) is due in part to a reduction in OTTI in 2010. The decrease in net premiums earned occurred principally in the medical malpractice, auto liability, A&H and property lines, partially offset by an increase in the other liability line.
Assets increased by $337 million in 2010 due principally to a $356 million increase in investments. The increase in investments is due largely to an increase of $753 million in fixed maturities available for sale, partially offset by a decrease of $456 million in short-term investments. The increase in fixed
Revenues increased in 2011 due to realized net capital gains in 2011 compared to realized net capital losses in 2010 and an increase in net investment income. The increase in realized net capital gains (losses) is due in large part to net foreign currency transaction gains in 2011 compared to net foreign currency transaction losses in 2010. The increase in net investment income is due largely to an increase in investment income on fixed maturities. Revenues increased in the London and Paris branches, partially offset by a decrease in TRZ.
Income before income taxes decreased due primarily to an underwriting loss in 2011 compared to an underwriting gain in 2010. The decrease in underwriting profit (loss) is due largely to an increase in net catastrophe costs.
Assets increased by $374 million in 2011 due principally to increases of $272 million in investments and $34 million in premiums balances receivable. The increase in investments is due principally to a $266 million increase in fixed maturities available for sale resulting largely from the investment of operating cash inflows and an increase in net unrealized appreciation.
Revenues decreased due primarily to a decrease in net premiums earned. Revenues decreased in the London and Paris branches, partially offset by an increase in TRZ. The decrease in net premiums earned occurred principally in the property, ocean marine, boiler and machinery and credit lines, partially offset by significant increases in the A&H and other liability lines. Income before income taxes in 2010 remained level with 2009 as a small increase in underwriting profit was largely offset by a small decrease in net investment income. The increase in underwriting profit reflects a lower combined ratio excluding catastrophe costs partially offset by an increase in catastrophe costs.
(c) International-Other (Miami (serving Latin America and the Caribbean), Toronto, Hong Kong, Tokyo and Sydney branches):
Revenues increased in 2011 due largely to an increase in net premiums earned. Revenues increased in all branches except the Toronto branch which remained level with 2010. The increase in net premiums earned occurred principally in the auto liability, property and A&H lines. The increase in net premiums earned was partially due to an increase of $19.9 million in net assumed reinstatement premiums related to catastrophe losses.
includes net catastrophe costs of $577.4 million, principally related to the March 2011 Tohoku earthquake and resulting tsunami in Japan; the February 2011 earthquake in New Zealand; fourth quarter 2011 flooding in Thailand; and the first quarter 2011 flooding in Australia and Cyclone Yasi. 2010 includes net catastrophe costs of $127.3 million, principally related to the February 2010 earthquake in Chile; the September 2010 earthquake in New Zealand; and third quarter 2010 hailstorms in Canada.
Assets decreased by $230 million in 2011 due principally to decreases of $214 million in reinsurance recoverable and $64 million in prepaid reinsurance premiums, partially offset by an $82 million increase in cash and cash equivalents. The decreases in reinsurance recoverable and prepaid reinsurance premiums are due in large part to the termination of agreements with certain subsidiaries of AIG that had provided for TRH to assume premiums from a subsidiary of AIG and, by prearrangement, cede all such premiums to other subsidiaries of AIG. Upon termination, reinsurance recoverable and prepaid reinsurance premiums were reduced for the settlement of all remaining balances.
In addition, net premiums written increased in 2010 with the most significant increases occurring in the property and A&H lines, partially offset by a significant decrease in the auto liability line. Net premiums written increased in the Hong Kong, Sydney, Tokyo and Toronto branches and decreased in the Miami branch. Changes in foreign currency exchange rates between the U.S. dollar and the currencies in which premiums are written increased net premiums written by $34.8 million in 2010 as compared to 2009. Excluding the impact of changes in foreign currency exchange rates, net premiums written would have decreased 3.1% in 2010 compared to 2009.
While the expected payout pattern of liabilities (see the contractual obligations table later in this section) is considered in the investment management process, it is not the only factor considered as TRH has historically funded its claims payments from current operating cash flows. As a result of such funding history, TRH did not maintain a credit facility as of December 31, 2011. TRH's primary investment goal is to optimize after-tax income through a high quality diversified taxable fixed maturity and tax-exempt municipal fixed maturity portfolio, while maintaining an adequate level of liquidity. (See discussion later in this section of the potential liquidity strain that could arise as a result of significant acceleration of paid losses beyond TRH's ability to fund such cash needs.)
TRH primarily sources credit ratings from S&P. If a security is not rated by S&P, TRH looks to Moody's Investors Service ("Moody's") for a credit rating. The following table summarizes the credit ratings of fixed maturities available for sale:
(1)Principally S&P ratings. (2)Includes Belgium, the Czech Republic, Denmark, Luxembourg, Norway, Poland, Sweden and Switzerland.
The increase in net unrealized gains on all fixed maturities as of December 31, 2011 compared to December 31, 2010 largely related to municipal bonds. The increase in net unrealized appreciation on all fixed maturities in 2011 reflects a generally lower interest rate environment. The decrease in net unrealized gains on equities available for sale as of December 31, 2011 compared to December 31, 2010 is due largely to increased equity market uncertainty related to concerns about U.S. and European governmental debt and fiscal-policy. This uncertainty was due in part to the assignment of negative outlooks and/or the downgrading of U.S. and certain European government debt by certain rating agencies. Increases in actual or perceived default risks by governments could disrupt financial markets both within and outside of the subject country and could adversely impact the fair value and liquidity of TRH's investment portfolio. (See Note 5 of Notes to Consolidated Financial Statements ("Note 5") for additional details about gross unrealized gains and losses on fixed maturities and equities.)
Net loss reserves include amounts for risks relating to environmental impairment and asbestos-related illnesses totaling $351 million and $212 million at December 31, 2011 and 2010, respectively, including $227 million and $71 million at the aforementioned dates, respectively, relating to such losses occurring in 1985 and prior. Reserves for losses occurring in 1985 and prior relate to standard general liability coverages, where the environmental or asbestos-related liabilities were neither clearly defined nor specifically excluded. Reserves for losses occurring after 1985 were underwritten specifically as environmental and asbestos-related coverages. The reserves carried for these claims, including the IBNR portion, are based upon known facts and current law. However, significant uncertainty exists in determining the amount of ultimate liability for environmental impairment and asbestos-related losses, particularly for those occurring in 1985 and prior. This uncertainty is due to inconsistent court resolutions and judicial interpretations with respect to underlying policy intent and coverage and uncertainties as to the allocation of responsibility for resultant damages, among other things.
Because the reserving process is inherently difficult and subjective, actual losses may materially differ from reserves and related reinsurance recoverables reflected in TRH's consolidated financial statements, and, accordingly, may have a material effect on future results of operations, financial condition and cash flows. And while there is also the possibility of changes in statutes, laws, regulations and other factors that could have a material effect on these liabilities and, accordingly, the financial statement elements cited immediately above, TRH believes that its loss reserves carried at December 31, 2011 are adequate.
See Critical Accounting Estimates for a discussion of the significant assumptions and factors considered in the reserve setting process.
In the ordinary course of business, TRH is involved in lawsuits, arbitrations and other formal and informal dispute resolution procedures, the outcomes of which will determine TRH's rights and obligations under reinsurance agreements and other more general contracts. In some disputes, TRH seeks to enforce its rights under an agreement or to collect funds due to TRH. In other matters, TRH is resisting attempts by others to enforce alleged rights. Such disputes are resolved through formal and informal means, including litigation, arbitration and mediation. (See Item 3. Legal Proceedings and Note 18.)
For 2010, TRH's net operating cash inflows were $1.06 billion, an increase of $109.5 million from 2009. The increase results, in large part, from net recoveries of income taxes in 2010 compared to net payments of income taxes in 2009 and increased cash received from underwriting activities, partially offset by an increase in interest paid on the Senior Notes. The total income taxes recovered in 2010 of $131.1 million consisted of a $109.0 million refund of federal income taxes related to amended tax returns for prior tax years and $22.1 million of refund claims related to capital loss carrybacks to certain other prior tax years. (See Note 6.)
Based on its history of consistently strong operating cash flows, the present composition of its investment portfolio (including present levels of cash, cash equivalents, short-term investments and other liquid investment classes) and consideration of its cash needs, TRH considers its liquidity to be adequate through the end of 2012 and thereafter for a period the length of which is difficult to predict, but which TRH believes will be at least one year.
TRH's stockholders' equity totaled $4.08 billion at December 31, 2011, a decrease of $201.5 million from year-end 2010. The net decrease consisted primarily of $261.5 million of repurchases of the Company's common stock, net loss of $99.2 million and cash dividends declared of $39.5 million, partially offset by other comprehensive income ("OCI") of $176.3 million.
The abovementioned OCI principally consisted of net unrealized appreciation of investments, net of income taxes, ("URA, net of tax") of $194.1 million, partially offset by net unrealized foreign currency translation loss from functional currencies, net of income taxes, ("UTA, net of tax") of $16.6 million. The URA, net of tax, is composed principally of an increase of $236.8 million in net unrealized appreciation of fixed maturities available for sale, partially offset by a decrease of $42.0 million in net unrealized appreciation of equities available for sale. The increase in net unrealized appreciation, net of tax, on fixed maturities available for sale reflects a generally lower interest rate environment. $48.2 million of the increase in net unrealized appreciation, net of tax, on fixed maturities available for sale relates to the reclassification of fixed maturities previously classified as fixed maturities held to maturity to fixed maturities available for sale. The decrease in net unrealized appreciation, net of tax, on equities available for sale was due largely to increased equity market uncertainty related to concerns about U.S. and European governmental debt and fiscal-policy. (See Note 5 for details of gross unrealized gains and losses by security type and for additional information about the reclassification of fixed maturities previously classified as held to maturity to available for sale.)
URA, net of tax, is subject to significant volatility resulting from changes in the fair value of fixed maturities available for sale, equities available for sale and other invested assets. Fair values may fluctuate
due to changes in general economic and political conditions, market interest rates, prospects of investee companies and other factors.
As of December 31, 2011, the amounts due and the estimated period between year-end 2011 and the dates of payment, under specified contractual obligations of TRH are as follows:
Natural disasters such as hurricanes, earthquakes and other catastrophes have the potential to adversely affect TRH's operating results by material amounts. Other risks, such as an outbreak of a pandemic disease, a major terrorist event, the bankruptcy of a major company, or a marine and/or aviation disaster, could also have a materially adverse effect on TRH's business and operating results to an extent that may be only partially offset by reinsurance.
Consolidated Statements of Operations For the Years Ended December 31, 2011, 2010 and
II-Condensed Financial Information of Registrant As of December 31, 2011 and 2010 and For the Years Ended December 31, 2011, 2010 and 2009
IV-Reinsurance For the Years Ended December 31, 2011, 2010 and 2009
Immediately prior to June 10, 2009, American International Group, Inc. ("AIG", and collectively with its subsidiaries, the "AIG Group") beneficially owned approximately 59% of the Company's outstanding shares. On June 10, 2009, AIG and American Home Assurance Company ("AHAC"), a wholly-owned subsidiary of AIG, consummated a secondary public offering (the "June 2009 Offering") of 29.9 million issued and outstanding shares of the common stock of the Company owned by AIG and AHAC. On March 15, 2010, AHAC consummated another secondary public offering (the "March 2010 Offering", and collectively with the June 2009 Offering, the "Secondary Offerings") of 8.5 million issued and outstanding shares of the Company's common stock owned by AHAC. The Company repurchased 2.0 million shares of its common stock from AHAC in the March 2010 Offering pursuant to a stock offering agreement for an aggregate purchase price of approximately $105 million. TRH did not receive any proceeds from the Secondary Offerings. Immediately following the March 2010 Offering, the AIG Group, including AHAC, beneficially owned 0.7 million shares of the Company's common stock (excluding shares held by certain mutual funds that are advised or managed by subsidiaries of AIG), representing approximately 1.1% of the Company's then outstanding shares. As a result of its reduced ownership percentage, the AIG Group was no longer considered a related party after March 15, 2010.
Subsequent events through the time of filing of this Form 10-K were evaluated for potential recognition or disclosure in the financial statements.
Certain reclassifications and format changes have been made to prior years' amounts to conform to the 2011 presentation.
The below error and related corrections had no impact on the current period and did not have a material effect on any prior period and thus, prior period financial statements have not been restated.
For all periods subsequent to December 31, 2009, the amortized cost of fixed maturities and cost of equities available for sale that are denominated in functional currencies were properly translated into the reporting currency using period-end foreign currency exchange rates. However, as the correction of the treatment discussed earlier occurred in 2010, both net unrealized depreciation of investments, net of tax, and net unrealized currency translation gain, net of tax, in the 2010 Statement of Comprehensive Income include $63.7 million related to this correction, with no net effect on OCI. In addition, this correction had no net impact on AOCI and stockholders' equity as of December 31, 2010 nor did it have any net impact on net income, comprehensive income or cash flows for 2010.
premium revenues, as they require management's most significant exercise of judgment on both a quantitative and qualitative basis in the preparation of TRH's consolidated financial statements and footnotes. The accounting estimates that result require the use of assumptions about certain matters that are highly uncertain at the time of estimation. To the extent actual experience differs from the assumptions used, TRH's results of operations and financial condition would be affected, possibly materially.
Other invested assets primarily include alternative investments in which TRH holds a 5% or greater interest or where TRH has more than a minor influence over operations of the investee and TRH's 40% interest in Kuwait Reinsurance Company (K.S.C.). Such investments are accounted for on the equity method. In applying the equity method of accounting, TRH consistently uses the most recently available financial information for each of these investments for the period ended one to three months prior to the end of TRH's reporting period. The financial statements of these investees are generally audited on an annual basis. The carrying value of such investments represents TRH's share of the net asset value of these entities. The changes in such net asset values for investments carried on the equity method, other than the portion related to TRH's share of the investees' changes in AOCI, are recorded in net investment income. The fair value option was elected for one other invested asset. This investment is carried at fair value and unrealized gains and losses on this investment are reported in earnings through net investment income.
Unrealized gains and losses from fixed maturities available for sale, equities available for sale and most other invested assets, are reported as a separate component of AOCI, net of deferred income taxes, in stockholders' equity. Investments in fixed maturities and equities are recorded on a trade date basis.
Deferred tax assets and liabilities are recorded for the effects of temporary differences between the tax basis of an asset or liability and its reported amount in the consolidated financial statements. TRH assesses its ability to realize deferred tax assets considering all available evidence including earnings history, the timing, character and amount of future earnings potential, the reversal of taxable temporary differences and the tax planning strategies available to legal entities when recognizing deferred tax assets. See Note 6 for further discussion of income taxes.
Realized capital gains and losses principally emanate from the following sources:
•Sales and redemptions of fixed maturities, equities and alternative investments •Reductions to the cost basis of fixed maturities, equity securities and other invested assets (except for where the fair value option has been elected) for OTTI which are recognized through earnings •Exchange gains and losses resulting from foreign currency transactions
Assets and liabilities denominated in foreign currencies are translated into U.S. dollars at period-end exchange rates. Income and expense accounts are translated at average exchange rates for the year. The resulting unrealized currency translation gain (loss) for functional currencies is recorded, net of tax, in AOCI, a component of stockholders' equity.
For all other impaired fixed maturities, this guidance requires entities to develop a best estimate of the present value of expected cash flows on a security by security basis. Entities must recognize OTTI equal to the difference between the present value of expected cash flows and the amortized cost basis of the security if the results of the cash flow analysis indicate the entity will not recover the full amount of its amortized cost basis in the investment. This amount is the credit component of the OTTI and is recorded in earnings as a realized capital loss. The difference between the total unrealized loss position on the security and the OTTI amount recognized in earnings is non-credit related and is recorded in OCI as "net unrealized holding losses of fixed maturities on which other-than-temporary impairments were taken".
(c) In June 2011 and December 2011, the FASB issued new accounting guidance on the presentation of comprehensive income (ASU 2011-05 and ASU 2011-12). This guidance specifies that a reporting entity has the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement or in two separate but consecutive statements.
3. Merger Agreement with Alleghany and Terminated Merger Agreement with Allied World Assurance Company Holdings, AG ("Allied World") (Continued)
On November 20, 2011, the Company entered into the Alleghany Merger Agreement with Alleghany and Shoreline. The Alleghany Merger Agreement provides for the merger of the Company with and into Shoreline, with Shoreline continuing as the surviving company and a wholly-owned subsidiary of Alleghany. Upon completion of the Alleghany Merger, Shoreline's name will change to "Transatlantic Holdings, Inc." Pursuant to the terms and conditions of the Alleghany Merger Agreement, upon completion of the Alleghany Merger, stockholders of the Company will be entitled to receive, in exchange for each share of common stock they hold at the effective time of the Alleghany Merger, either stock or cash consideration with a value equal to the sum of (a) 0.145 multiplied by the average of the closing sales prices on the New York Stock Exchange for Alleghany common stock during the five trading days ending the day before the completion of the Alleghany Merger and (b) $14.22.
The degree of judgment used in measuring the fair value of financial instruments generally correlates with the level of pricing observability. Financial instruments with quoted prices in active markets generally have more pricing observability and less judgment is used in measuring fair value. Conversely, financial
instruments traded in other-than-active markets or that do not have quoted prices have less observability and are measured at fair value using valuation models or other pricing techniques that require more judgment. An active market is one in which transactions for the asset being valued occurs with sufficient frequency and volume to provide pricing information on an ongoing basis. An other-than-active market is one in which there are few transactions, the prices are not current, price quotations vary substantially either over time or among market makers, or in which little information is released publicly for the asset being valued. Pricing observability is affected by a number of factors, including the type of financial instrument, whether the financial instrument is new to the market and not yet established, the characteristics specific to the transaction and general market conditions.
TRH employs specific control processes to determine the reasonableness of the fair values of TRH's financial assets. TRH's processes are designed to ensure that the values received or internally estimated are accurately recorded and that the data inputs and the valuation techniques utilized are appropriate, consistently applied, and that the assumptions are reasonable and consistent with the objective of determining fair value. TRH assesses the reasonableness of individual security values received from valuation service providers through various analytical techniques. In addition, TRH may validate the reasonableness of fair values by comparing information obtained from TRH's valuation service providers to other third party valuation sources for selected securities. TRH also validates prices obtained from brokers for selected securities through reviews by those who have relevant expertise and who are independent of those charged with executing investing transactions.
Fair values for fixed maturity securities based on observable market prices for identical or similar instruments implicitly include the incorporation of counterparty credit risk. Fair values for fixed maturity securities based on internal models would incorporate counterparty credit risk by using discount rates that take into consideration cash issuance spreads for similar instruments or other observable information.
(2)Short-Term Investments Short-term investments are carried at cost or amortized cost, which approximates fair value, and principally include money market instruments, treasury bills and commercial paper. These instruments are typically not traded in active markets; however, their fair values are based on market observable inputs.
Assets recorded at fair value in the consolidated balance sheet are measured and classified in a hierarchy for disclosure purposes consisting of three levels based on the observability of inputs available in the marketplace used to measure fair values as discussed below:
•Level 2: Fair value measurements based on inputs other than quoted prices included in Level 1 that are observable for the asset, either directly or indirectly. Level 2 inputs include quoted prices for similar assets in active markets and inputs other than quoted prices that are observable for the asset, such as interest rates and yield curves that are observable at commonly quoted intervals. Assets measured at fair value on a recurring basis and classified as Level 2 generally include most government and government agency securities; state, municipal and political subdivision obligations (collectively, "municipal bonds"); corporate bonds; residential mortgage-backed securities ("RMBS"); commercial mortgage-backed securities ("CMBS"); other asset-backed securities; and short-term investments.
The following table presents information about assets measured at fair value on a recurring basis at December 31, 2011 and 2010 and indicates the level of the fair value measurement based on the levels of the inputs used:
In 2011, there were no transfers in or out of Level 1, $71.9 million of transfers into Level 2 from Level 3 and $59.2 million of transfers out of Level 2 into Level 3. In 2010, there were no transfers in or out of Level 1, $64.2 million of transfers into Level 2 from Level 3 and $10.8 million of transfers out of Level 2 into Level 3. The transfers into Level 2 from Level 3 were due to an increase in observable inputs related to the valuation of such securities. The transfers out of Level 2 into Level 3 were due to a decrease in observable inputs related to the valuation of such securities.
At December 31, 2011 and 2010, Level 3 assets totaled $185.1 million and $230.0 million, respectively, representing 1.4% and 2.0%, respectively, of total assets measured at fair value on a recurring basis.
Both observable and unobservable inputs may be used to determine the fair values of positions classified in Level 3. As a result, the unrealized gains and losses on instruments held at December 31, 2011 and 2010 may include changes in fair value that were attributable to both observable inputs (e.g., changes in market interest rates) and unobservable inputs (e.g., changes in unobservable long-dated volatilities).
Net unrealized depreciation related to Level 3 investments approximated $33.2 million and $6.7 million at December 31, 2011 and 2010, respectively.
(1)There were $6.1 million of OTTI related to RMBS fixed maturities available for sale that was recorded in realized net capital losses in 2010 on instruments still held at December 31, 2010. (2)Primarily private equities.
Investments with fair values of $645 million and $574 million at December 31, 2011 and 2010, respectively, were deposited with governmental authorities as required by law. The substantial majority of these deposits are fixed maturities and equities available for sale.
(1)Investments in fixed maturities are shown at amortized cost. (2)Represents the non-credit portion of OTTI, not adjusted for subsequent changes in unrealized gains or losses, taken on securities still held as of period-end.
See Note 5(h) for information about the reclassification in 2011 of fixed maturities previously classified as held-to-maturity to available for sale.
(1)Asset-backed and U.S. Government agency fixed maturities by their nature do not generally have single maturity dates.
In 2011 and 2010, the gross realized losses from sales and redemptions of equities available for sale were due in part to the rebalancing of TRH's equity portfolio. In 2009, securities in the equities available for sale portfolio were sold for a number of reasons, including the repositioning of TRH's equity portfolio with respect to the changes in the investment and credit markets during 2009 and the desire over time to take advantage of tax-basis capital loss carry-backs to prior years that had capital gains.
In general, gross realized losses on sales of fixed maturities available for sale in 2011, 2010 and 2009 were generally the result of (a) TRH's desire to manage the duration, credit and concentration risk of the investment portfolio as part of its overall view of prudent management of an available for sale fixed maturity investment portfolio; and (b) the disposition of certain securities that, based on TRH's judgment, were unlikely to provide on a relative basis as attractive a return as alternative securities entailing comparable risks. In addition, gross realized losses on sales of fixed maturities available for sale in 2009 were also partially the result of repositioning of the investment portfolio in light of the transition to a new investment manager in the third quarter of 2009.
As discussed in Note 5(g), the OTTI amounts on certain fixed maturities are separated into credit loss and non-credit loss components. The credit loss impairments are recognized in earnings as realized capital losses, while the non-credit loss impairments are recorded in OCI. The following table sets forth the amount of credit loss impairments on fixed maturities held by TRH as of December 31, 2011, 2010 and 2009, for which a portion of the OTTI amount was recorded in OCI.
At December 31, 2011, the carrying value of TRH's fixed maturity and equity securities aggregated $13.09 billion with aggregate pre-tax gross unrealized losses of $116 million. Additional information about these securities is as follows:
•Approximately 5.6% of the fixed maturity securities had issuer credit ratings which were below investment grade or not rated.
At December 31, 2011, TRH held 155 and 486 individual fixed maturity and equity investments, respectively, that were in an unrealized loss position, of which 96 individual fixed maturity investments were in a continuous unrealized loss position for 12 months or more.
As of December 31, 2011 and 2010, no single issuer accounted for more than 9% and 11%, respectively, of the aggregate gross unrealized losses.
OTTI on all investments other than fixed maturities are recognized through earnings as a realized capital loss. At each balance sheet date, TRH recognizes an OTTI on a fixed maturity in an unrealized loss position if (a) TRH intends to sell the security; (b) it is more likely than not TRH will be required to sell the security prior to an anticipated recovery in fair value in order to meet a liquidity, regulatory or other business need; or (c) TRH determines it will not recover the entire amortized cost basis of the security.
If TRH intends to sell an impaired fixed maturity security, or if it is more likely than not it will have to be sold, the total amount of the unrealized loss position is recognized in earnings as a realized capital loss. On a quarterly basis, TRH develops for fixed maturities, a best estimate of the present value of expected cash flows on a security by security basis. If the results of the cash flow analysis indicate TRH will not recover the full amount of its amortized cost basis in the investment, TRH recognizes OTTI equal to the difference between the present value of expected cash flows and the amortized cost basis of the security. This amount is the credit component of the OTTI and is recorded in earnings as a realized capital loss. The difference between the total unrealized loss position on the security and the OTTI amount recognized in earnings is non-credit related and is recorded in OCI as "net unrealized holding losses of fixed maturities on which other-than-temporary impairments were taken."
TRH evaluated the significant categories of fixed maturity investments in an unrealized loss position for OTTI. For municipal bonds, TRH takes into account the taxing power of the issuer, source of revenue, credit risk and credit enhancements and pre-refunding. For asset-backed securities, TRH discounted its best estimate of future cash flows at an effective rate equal to the original effective yield of the security or, in the case of floating rate securities, at the current coupon. Those models included TRH's assumptions about prepayment speeds, default and delinquency rates, and underlying collateral (if any), as well as credit ratings, credit enhancements and other observable market data. For corporate fixed maturities, TRH reviewed business prospects, credit ratings and available information from asset managers and rating agencies for individual securities.
rules of the Internal Revenue Code, and included, as appropriate, in the consolidated federal income tax return.
The U.S. federal income tax rate was 35% for 2011, 2010 and 2009. Actual tax (benefits) expenses on (loss) income before income taxes differs from the expected amount computed by applying the U.S. federal income tax rate because of the following:
The domestic deferred tax expense for 2009 is net of $56.7 million resulting from minimum tax credit carryforwards. The domestic current tax benefit for 2008 included the tax benefit on $100.3 million of tax capital loss carrybacks to prior years. The actual capital loss included in the 2008 U.S. consolidated tax return was $114.0 million. The 2009 tax expense includes an adjustment to align the amounts reflected in the 2008 tax expense with the amounts in the 2008 income tax return.
The components of the net deferred income tax asset at December 31, 2011 and 2010 were as follows:
No valuation allowance has been recorded as TRH has concluded that it is more likely than not that TRH will fully realize the deferred tax assets. The most significant deferred tax assets arise from the discounting of loss reserves, minimum tax credit carryforwards, realized and unrealized losses on investments and unearned premiums. TRH's strong history of operating earnings supports its conclusion that it has the ability to realize the full benefits associated with all deferred tax assets, particularly the assets associated with the discounting of loss reserves and minimum tax credits, which may be carried forward indefinitely. In addition to TRH's strong history of operating earnings, TRH also has a strong history of generating capital gains to offset capital losses.
At December 31, 2011 and 2010, TRH has current income tax receivables of $73.2 million and $17.5 million, respectively, which are included on the Consolidated Balance Sheets in other assets.
Income taxes (paid) recovered, net, in 2011, 2010 and 2009 consisted of:
The following table lists the tax years that remain subject to examination by major tax jurisdiction as of December 31, 2011:
2011 includes net catastrophe losses incurred of $882.6 million, principally relating to the March 2011 Tohoku earthquake and resulting tsunami in Japan; the February 2011 earthquake in New Zealand; fourth quarter 2011 flooding in Thailand; first quarter 2011 flooding in Australia and Cyclone Yasi; and second quarter 2011 tornado activity in the United States. In addition, in 2011, TRH decreased its estimates of the ultimate amounts of net losses occurring in 2010 and prior years by $122.0 million. This development was comprised of net favorable development of $224.7 million for losses occurring in 2002 to 2010, partially offset by net adverse development of $102.7 million relating to losses occurring in 2001 and prior.
as a reinsurer, TRH is also highly dependent upon the claims reserving and reporting practices of its cedants, which vary greatly by size, specialization and country of origin and whose practices can be subject to change without notice.
The favorable development in 2005 through 2009 resulted generally from favorable loss trends. The net adverse development arising from losses occurring in 2001 and prior, generally related to various excess casualty lines such as general liability and excess umbrella liability which were impacted by late reported excess claims.
The favorable development in 2004 through 2008 results generally from favorable loss trends. The net adverse development arising from losses occurring in 2001 and prior, generally relates to various excess casualty lines such as general liability and excess umbrella liability which were impacted by late reported high layer excess claims. Ceding companies and their reinsurers continue to experience increased loss costs relative to expectations as loss emergence patterns continue to lengthen as regards the soft market years of 1997 through 2001.
In December 2005, the Company completed a public offering of $750 million aggregate principal amount of its 5.75% senior notes due on December 14, 2015 (the "2015 Notes"). In November 2009, the Company completed a public offering of $350 million aggregate principal amount of its 8.00% senior notes due on November 30, 2039 (the "2039 Notes" and together with the 2015 Notes, the "Senior Notes").
In 2011, 2010 and 2009, TRH repurchased portions of the 2015 Notes. No repurchases of the 2039 Notes occurred in 2011, 2010 or 2009. The impact of the repurchases of the 2015 Notes in 2011, 2010 and 2009 are detailed below:
Common stock activity for each of the three years in the period ended December 31, 2011 was as follows:
Net catastrophe costs represent TRH's best estimates of the aggregate ultimate costs to be incurred relating to significant catastrophe events based upon information available at the time the estimate was made. These catastrophe cost estimates reflect significant judgment relating to many factors, including the ultimate resolution of certain legal and other issues. Such estimates are often heavily reliant on industry loss predictions, preliminary data from cedants, output from catastrophe modeling software and market share analysis. Due to the preliminary nature of information used to prepare certain of these estimates, among other factors, the ultimate costs that TRH will incur related to these events may differ materially
In 2008, the Board adopted, and the stockholders approved, the Transatlantic Holdings, Inc. 2008 Non-Employee Directors' Stock Plan (the "Non-Employee Directors' Plan"). The Non-Employee Directors' Plan provides that equity-based or equity-related awards can be granted to non-employee directors as determined by the Compensation Committee of the Board (the "Compensation Committee"). The maximum number of shares available for grant under the Non-Employee Directors' Plan is 100,000. As of December 31, 2011, there were 44,933 shares of common stock available for issuance in connection with future grants of awards under the Non-Employee Directors' Plan.
authorities on vested restricted stock units. TRH has not paid out any cash to settle share-based payment awards in 2011, 2010 or 2009. Cash savings resulting from excess tax benefits were insignificant in 2011 and totaled $0.3 million and $0.2 million in 2010 and 2009, respectively.
Historically, TRH has settled stock-based compensation exercises through the issuance of new shares.
No options were granted in 2011, 2010 or 2009. In earlier years, options to purchase the Company's common stock ("TRH shares") were granted to certain key employees and non-employee directors at prices not less than the New York Stock Exchange ("NYSE") closing price on the date of grant under the 2000 Plan. In general, 25% of the options become exercisable on the anniversary date of the grant in each of the four years following the grant and expire 10 years from the date of grant.
A summary of the status of options granted as of December 31, 2011 and the changes since January 1, 2011 is presented below:
Service RSUs and Performance RSUs have been granted under the 2009 Plan, the Non-Employee Directors' Plan and the 2003 Plan to officers, employees and directors of TRH. A summary of the status of
The Company reserves the right to make payments for the Service RSUs and Performance RSUs in TRH shares or the cash equivalent of the fair value of such shares on the date of vesting.
The number of Service RSUs granted and vested in 2011, 2010 and 2009 were as follows:
As of December 31, 2011, there was $8.4 million of total unrecognized compensation costs relating to Service RSUs granted but not yet vested. These costs are expected to be recognized over a weighted average period of 1.4 years.
Under the Partners Plan and Senior Partners Plan, the Compensation Committee awarded to senior executives Performance RSUs with a three-year performance period ("Three-Year Performance RSUs") that pay out in TRH shares if performance goals for a specified period are satisfied. Three-Year Performance RSUs were granted under the Partners Plan in 2011 and under the Senior Partners Plan in years prior to 2011. Each Three-Year Performance RSU converts into one TRH share. Three-Year Performance RSUs operate on the basis of successive overlapping three year performance periods, with a new period beginning each year. Recipients earn Performance RSUs based on BVPS Growth during the performance period. Based on the percentage of the BVPS Growth target achieved over the performance period, recipients can earn from 25% to 150% of the awarded number of Performance RSUs for Three-Year Performance RSUs granted under the Partners Plan and 25% to 200% of the awarded number of Performance RSUs for Three-Year Performance RSUs granted under the Senior Partners Plan. No Performance RSUs will be earned if BVPS Growth is less than 25% of target for the Partners Plan or 50% of target for the Senior Partners Plan.
A summary of unvested Three-Year Performance RSUs grants as of December 31, 2011 follows:
(1)Amount undeterminable as of December 31, 2011 as the performance period has not yet ended.
As of December 31, 2011, there was $11.2 million of total unrecognized compensation costs relating to Performance RSUs granted but not yet vested. Compensation expense for Performance RSUs is recognized on a straight-line basis. These costs are expected to be recognized over a weighted average period of 1.6 years.
Through March 15, 2010, AIG was considered a related party of TRH. (See Note 1.) After March 15, 2010, the AIG Group ceased to be a related party of TRH. TRH had service and expense agreements and certain other agreements with the AIG Group which provide for the reimbursement to the AIG Group of certain administrative and operating expenses which include, but are not limited to, investment advisory, investment recordkeeping, cash management services, office space and human resource related activities. Most of these service and expense agreements have ceased on various dates in 2009. Under the guidance of TRH's Finance and Investment Committee of the Board and senior management, the AIG Group acted as financial advisors and managers of TRH's investment portfolio through June 30, 2009. Effective July 1, 2009, TRH employed a third party not affiliated with AIG to provide these services. In 2009, $8.9 million of operating and investment expenses relate to services provided by the AIG Group under these agreements. There were no material operating or investment expenses related to services provided by the AIG Group in 2011 or 2010.
TRC and Fair American each prepare statutory financial statements in accordance with accounting practices prescribed or permitted by New York-their state of domicile. Prescribed statutory accounting practices are discussed in a variety of publications of the National Association of Insurance Commissioners ("NAIC"), as well as in state laws, regulations and general administrative rules. Permitted statutory accounting practices encompass all accounting practices not so prescribed. As required by the State of New York, TRC and Fair American use the Codification of Statutory Accounting Principles as primary guidance on statutory accounting. All material statutory accounting practices of TRC and Fair American are prescribed in the authoritative literature described above.
(1)Premiums written and earned that were ceded to related parties represent amounts from contracts with the AIG Group with effective dates of March 15, 2010 or earlier. (2)See Note 11 of Notes to Consolidated Financial Statements for gross and ceded catastrophe losses.
In the fourth quarter of 2011, TRH terminated such agreements with the subsidiaries of AIG. The 2011 amounts above include the following impacts of the termination, (a) gross premiums written were decreased by $86.4 million for the settlement of all remaining unearned premiums and ceded premiums written were decreased by $86.4 million for the settlement of related prepaid reinsurance premiums, with no impact on net premiums written; and (b) gross losses and LAE incurred were decreased by $250.9 million for the settlement of all remaining gross loss reserves related to these agreements and reinsured losses and LAE ceded was decreased by $250.9 million for the settlement of all remaining reinsurance recoverables, with no net impact on net losses and LAE incurred. There was no impact on gross, ceded or net premiums earned from the termination of these agreements.
Under its reinsurance security policy, TRH seeks to cede business to reinsurers generally rated "A-" or better. TRH considers reinsurers that are not rated or do not fall within the above rating categories and may grant exceptions to TRH's general policy on a case-by-case basis. At December 31, 2011,
approximately 94% of total reinsurance recoverable on paid and unpaid losses and LAE balances were due from reinsurers rated "A-" or better and 6% were due from reinsurers which were rated below "A-" or were not rated.
With respect to reinsurance recoverable on paid and unpaid losses and LAE, TRH is the beneficiary of substantial amounts of funds held, trust agreements and letters of credit collateralizing reinsurance recoverables with respect to certain reinsurers. At December 31, 2011 and 2010, such funds held, trust agreements and letters of credit secured $95.2 million and $352.1 million, respectively, of TRH's reinsurance recoverable on paid and unpaid losses. No uncollateralized amounts recoverable from a single retrocessionnaire are considered material to the financial position of TRH.
Prior to 2011, financial information for the Sydney branch was included in the London branch as part of the International-Europe segment. Sydney branch financial information for prior periods was not material. In 2011, Sydney is more appropriately considered a segment for financial reporting purposes and is aggregated with other segments that are generally not material in International-Other. Segment information for periods prior to 2011 has been revised to conform to the current segment presentation. Financial data from the London and Paris branches and from TRZ are reported in the aggregate as International-Europe and considered as one segment due to operational and regional similarities. Data from the Miami (which serves Latin America and the Caribbean), Toronto, Hong Kong, Tokyo and Sydney branches are grouped as International-Other and represent the aggregation of segments that are generally not material. In each segment, property and casualty reinsurance is provided to insurers and reinsurers on a treaty and facultative basis, through brokers or directly to ceding companies.
(2)Underwriting expenses represent the sum of net commissions, (increase) decrease in deferred policy acquisition costs and other underwriting expenses. (3)Underwriting profit (loss) represents net premiums earned less net losses and LAE and underwriting expenses. (4)See Note 11 of Notes to Consolidated Financial Statements for net catastrophe costs by segment. (5)Includes merger-related costs. (See Note 3 of Notes to Consolidated Financial Statements.) (6)The Miami, Tokyo and Sydney branch segment data are each considered significant for at least one of the periods presented. Certain key Miami, Tokyo and Sydney data elements which are included in International-Other are as follows:
In the ordinary course of business, TRH is involved in lawsuits, arbitrations and other formal and informal dispute resolution procedures, the outcomes of which will determine TRH's rights and obligations under reinsurance agreements and other more general contracts. In some disputes, TRH seeks to enforce its rights under an agreement or to collect funds due to TRH. In other matters, TRH is resisting attempts by others to enforce alleged rights. Such disputes are resolved through formal and informal means, including litigation, arbitration and mediation.
(1)Stockholder Legal Proceedings Related to the Allied World Merger Agreement and the Alleghany Merger Agreement
On June 29, 2011, defendants moved to dismiss or stay the three New York actions in favor of the virtually identical proceedings pending in the Delaware Court of Chancery. On July 25, 2011, the
plaintiffs in the three New York actions moved to consolidate those actions into a single action. On October 18, 2011, the parties stipulated that each of these actions would be discontinued without prejudice. The Court entered the parties' stipulation the following day.
On October 10, 2011, the Delaware plaintiffs filed a second consolidated amended complaint alleging that the Board breached a fiduciary duty (and that Allied World and GO Sub aided and abetted such breach) by, among other things, adopting and refusing to rescind a shareholder rights plan, approving certain payments to Allied World in conjunction with the Termination Agreement and approving a share repurchase program. The second amended complaint also asserted derivative claims for breach of fiduciary duty against the Board, Allied World and GO Sub, a claim for unjust enrichment against Allied World and GO Sub, and a derivative claim for declaratory relief that the Termination Agreement is null and void. The lawsuit sought the return of any payments from the Company to Allied World pursuant to the Termination Agreement, among other relief. On October 24, 2011, defendants moved to dismiss the second consolidated amended complaint.
In connection with the Alleghany Merger Agreement, two additional putative stockholder class action lawsuits were filed against the Company and the members of the Board challenging the merger contemplated by the Alleghany Merger Agreement. These lawsuits asserted that the members of the Board breached a fiduciary duty in connection with the approval of the Alleghany Merger and that the Company, Alleghany and Shoreline aided and abetted the alleged breaches of fiduciary duty. On January 4, 2012, the Company and the Board filed a motion to dismiss or stay one of the lawsuits.
On July 28, 2011, the Company filed a lawsuit in the United States District Court for the District of Delaware against Validus alleging that Validus violated Sections 14(a) and (e) of the Securities Exchange Act of 1934 ("Securities Exchange Act") and Section 11 of the Securities Act of 1933 by making materially false and/or misleading statements in its proxy and tender offer materials filed with the Securities and Exchange Commission. The lawsuit seeks, among other relief, an order: (a) compelling Validus to correct the material false and/or misleading statements it has made in connection with both its proxy and tender offer materials; and (b) prohibiting Validus from acquiring
or attempting to acquire shares of the Company until its misstatements have been corrected. On August 10, 2011, Validus filed a motion to dismiss the Company's lawsuit. On September 12, 2011, the Company filed an amended complaint against Validus and two Validus executives alleging that Validus and the executives violated Section 14(a) of the Securities Exchange Act by making materially false and/or misleading statements in its proxy and tender offer materials filed with the Securities and Exchange Commission and seeking a declaration that the Company's Schedule 14(D)-9 filed with the Securities and Exchange Commission complies with Section 14(d)(1) of the Securities Exchange Act. Pursuant to a stipulation filed with the court on October 3, 2011, the parties agreed, among other things, that Validus' motion to dismiss would be withdrawn as moot and that the Company could file an amended complaint after October 31, 2011.
On September 15, 2011, TRC entered into a negotiated settlement and commutation with United Guaranty Residential Insurance Company, United Guaranty Mortgage Indemnity Company, United Guaranty Credit Insurance Company and United Guaranty Residential Insurance Company of North Carolina (collectively, "UGC") with respect to arbitration proceedings involving certain contracts related to subprime mortgages and credit default insurance pursuant to which UGC purchased reinsurance from TRC. The negotiated settlement reduced 2011 net premiums written and net premiums earned by $19 million, net losses and loss adjustment expenses incurred in respect of losses occurring in prior years by $61 million and net commissions by $3 million, resulting in a pre-tax net benefit to (loss) income before income taxes of $45 million.
In the normal course of business, TRH has letters of credit outstanding as of December 31, 2011 totaling $44.9 million. These letters of credit are provided to secure certain loss reserves and other balances due to ceding companies. Where TRH provides a letter of credit, it is generally contractually obligated to continue to provide a letter of credit to the ceding company in the future to secure certain reserves and other balances.
Rent expense approximated $12.7 million, $12.5 million and $12.9 million in 2011, 2010 and 2009, respectively.
In June 2011, TRH offered retention agreements to key officers and employees (the "2011 Retention Plan"). Approximately $29 million of compensation offered consisted of stock-based compensation, which will vest equally on September 30, 2012 and December 31, 2013, subject to the recipients' continued employment with TRH on those dates, among other things. As of December 31, 2011, no stock-based compensation has yet been granted and therefore no expense has been recorded related to these agreements. The remainder of the program provides for cash awards aggregating $11 million payable on December 31, 2012, subject to the recipients' continued employment with TRH through December 31, 2012, among other things. Retention agreements with Alleghany will replace the 2011 Retention Plan related to the stock-based retention agreements with substantially similar vesting terms and will generally become effective after the completion of the Alleghany Merger.
In October 2008, TRH adopted a retention program (the "2008 Retention Plan") covering a significant number of its employees, including its senior-most management. Salary expenses incurred related to the 2008 Retention Plan totaled nil in 2011 and 2010 and approximately $20 million in 2009.