We encourage you to read the consolidated financial statements included in this Annual Report on Form 10-K because they contain our complete consolidated financial statements for the years ended December 31, 2009, 2008 and 2007. The results of operations for the year ended December 31, 2009 are not necessarily indicative of future results.
The Financial Accounting Standards Board (“FASB”) issued an accounting standard which requires that the dilutive effect of contingently convertible debt securities, with a market price threshold, should be included in diluted earnings per share. The terms of our formerly outstanding convertible senior debentures, which were issued in June 2002, (see Note 13 to our consolidated financial statements included in this Annual Report on Form 10-K) meet the criteria defined in this accounting standard, and accordingly, the effect of conversion of our convertible senior debentures to common shares has been assumed when calculating our diluted earnings per share for the years ended December 31, 2005 through 2007. The convertible senior debentures were converted into common shares in 2007, and none of the debentures remain issued and outstanding. See Notes 2(l) and 5 to our consolidated financial statements included in this Annual Report on Form 10-K.
Prior to our 100% ownership by Fairfax (see Note 1 to our consolidated financial statements included in this Annual Report on Form 10-K), we calculated earnings per share using the two-class method. We treated unvested share-based payment awards that had non-forfeitable rights to dividends or dividend equivalents as a separate class of securities in the calculation. Under our former restricted share plan, the grantees had non-forfeitable rights to dividends before the vesting date and, accordingly, the restricted shares were considered participating securities. As noted above, in the fourth quarter of 2009 Fairfax attained 100% ownership of OdysseyRe; accordingly we have not presented earnings per common share for the year ended December 31, 2009.
The London Market division is comprised of our Lloyd’s of London business, in which we participate through our 100% ownership of Newline Syndicate (1218), our London branch office, and NICL, our London-based insurance company. The London Market division writes insurance and reinsurance business worldwide, principally through brokers.
The U.S. Insurance division writes specialty insurance lines and classes of business, such as medical and other professional liability, non-standard personal and commercial automobile, specialty liability, property and package, and crop business.
The consolidated financial statements and related notes included in Item 8 of this Annual Report on Form 10-K have been prepared in accordance with GAAP and include the accounts of Odyssey Re Holdings Corp. and its subsidiaries.
Consistent with our significant accounting policies, for our reinsurance business we utilize estimates in establishing premiums written, the corresponding acquisition expenses, and unearned premium reserves. These estimates are required to reflect differences in the timing of the receipt of accounts from the ceding company and the actual due dates of the accounts at the close of each accounting period.
Gross premiums written estimates, acquisition costs, premiums receivable and unearned premium reserves are established on a contract level for significant accounts due but not reported by the ceding company at the end of each accounting period. The estimated ultimate premium for the contract, actual accounts reported by the ceding company, and our own experience on the contract are considered in establishing the estimate at the end of each accounting period. Subsequent adjustments based on actual results are recorded in the period in which they become known. The estimated premiums receivable balances are considered fully collectible. The estimates primarily represent the most current two underwriting years of account for which all corresponding reported accounts have been settled within contract terms. The estimates are considered “critical accounting estimates” because changes in these estimates can materially affect net income.
In any specific financial period, the original estimated premium for a specific contract may vary from actual premium reported through the life of the contract by up to 15% due to the reporting patterns of the ceding
companies and, in some cases, movements in foreign exchange rates over the period. However, historically, the final reported premium compared to the original estimated premium has deviated by insignificant amounts.
We review information received from ceding companies for reasonableness based on past experience with the particular ceding company or our general experience across the subject class of business. We also query information provided by ceding companies for reasonableness. Reinsurance contracts under which we assume business generally contain specific provisions that allow us to perform audits of the ceding company to ensure compliance with the terms and conditions of the contract, including accurate and timely reporting of information.
Our losses and LAE reserves, for both reported and unreported claims obligations, are maintained to cover the estimated ultimate liability for all of our reinsurance and insurance obligations. Losses and LAE reserves are categorized in one of three ways: (i) case reserves, which represent unpaid losses and LAE as reported by cedants and insureds to us, (ii) additional case reserves (“ACRs”), which are reserves we establish in excess of the case reserves reported by the cedant on individual claim events, and (iii) incurred but not reported reserves (“IBNR”), which are reserves for losses and LAE that have been incurred, but have not yet been reported to us, as well as additional amounts relating to losses already reported, that are in excess of case reserves and ACRs. Incurred but not reported reserves are estimates based on all information currently available to us and are reevaluated quarterly utilizing the most recent information supplied from our cedants and claims adjusters.
contract. Proportional, or quota share, reinsurance contracts are typically reported on a quarterly basis, providing premium and loss activity as estimated by the ceding company. Reporting for excess of loss, facultative and insurance contracts includes detailed individual claim information, including a description of the loss, confirmation of liability by the cedant or claims adjuster and the cedant’s or claims adjuster’s current estimate of the ultimate liability under the claim. Upon receipt of claim notices from cedants and insureds, we review the nature of the claim against the scope of coverage provided under the contract. Questions arise from time to time regarding the interpretation of the characteristics of a particular claim measured against the scope of contract terms and conditions. Reinsurance contracts under which we assume business generally contain specific dispute resolution provisions in the event that there is a coverage dispute with the ceding company. The resolution of any individual dispute may impact estimates of ultimate claims liabilities. Reported claims are in various stages of the settlement process. Each claim is settled individually based on its merits, and certain claims may take several years to ultimately settle, particularly where legal action is involved. Based on an assessment of the circumstances supporting the claim, we may choose to establish additional case reserves over the amount reported by the ceding company. Aggregate case reserves established in addition to reserves reported by ceding companies were $14.5 million and $19.6 million as of December 31, 2009 and 2008, respectively. Due to potential differences in ceding company reserving and reporting practices, we perform periodic audits of our ceding companies to ensure the underwriting and claims procedures of the cedant are consistent with representations made by the cedant during the underwriting process and meet the terms of the reinsurance contract. Our estimates of ultimate loss liabilities make appropriate adjustment for inconsistencies uncovered in this audit process. We also monitor our internal processes to ensure that information received from ceding companies is processed in a timely manner.
and severity loss activity underlying overall loss emergence trends is not practical. Generally, we rely on BF and loss ratio methods for estimating ultimate loss liabilities for more recent treaty years. These methodologies, at least in part, apply a loss ratio, determined from aggregated analyses of internally developed pricing trends across reserve cells, to premium earned on that business. Adjustments to premium estimates generate appropriate adjustments to ultimate loss estimates in the quarter in which they occur using the BF and loss ratio methods. To estimate losses for more mature treaty years, we generally rely on the incurred loss development methodology, which does not rely on premium estimates. In addition, we may use other methods to estimate liabilities for specific types of claims. For property catastrophe losses, we may utilize vendor catastrophe models to estimate ultimate loss soon after a loss occurs, where loss information is not yet reported to us from cedants. The provision for asbestos loss liabilities is established based on an annual review of internal and external trends in reported loss and claim payments. IBNR is determined by subtracting the total of paid loss and case reserves including ACRs from ultimate loss.
The ultimate settlement values of losses and LAE related to business written in prior periods for the years ended December 31, 2009 and 2008 were, in each year, 0.2% below our estimates of reserves for losses and LAE as previously established at December 31, 2008 and 2007. For the year ended December 31, 2007, the ultimate settlement value of losses and LAE related to business written in prior periods exceeded our estimates of reserves for losses and LAE as previously established at December 31, 2006 by 0.9%. Any future impact to income from changes in losses and LAE estimates may vary considerably from historical experience. Our estimates of ultimate losses and LAE are based upon the information we have available at any given point in time and upon our assumptions derived from that information. Every one percentage point difference in the ultimate settlement value of losses and LAE compared to our estimate of reserves for losses and LAE as of December 31, 2009 will impact pre-tax income by $46.7 million.
Historically, our actual results have varied considerably in certain instances from our estimates of losses and LAE because historical loss emergence trends have not been indicative of future emergence for certain segments of our business. In this period, we experienced loss emergence, resulting from a combination of claim frequency and severity of losses, greater than expectations that were established based on a review of prior years’ loss emergence trends, particularly for business written in the late 1990s and early 2000s. General liability and excess workers’ compensation classes of business during these years were adversely impacted by the highly
The following table provides detail on net adverse (favorable) loss and LAE development for prior years, by division, for each of the three years in the period ended December 31, 2009 (in millions):
The Americas division reported net increases in prior period loss estimates of $70.1 million, $66.6 million and $143.1 million for the years ended December 31, 2009, 2008 and 2007, respectively. The increase in prior period loss estimates for the years ended December 31, 2009 and 2008 were principally attributable to loss emergence greater than expectations in the period on asbestos. The increase in prior period loss estimates for the year ended December 31, 2007 was principally due to loss emergence greater than expectations in the period on U.S. casualty business, including asbestos, and included $21.2 million related to settlement of litigation during the period.
The EuroAsia division reported net decreases in prior period loss estimates of $22.8 million, $2.4 million and $6.9 million for the years ended December 31, 2009, 2008 and 2007, respectively. The decrease in prior period loss estimates for the year ended December 31, 2009 was principally attributable to loss emergence lower than expectations in the period on property business. The decrease in prior period loss estimates for the year ended December 31, 2008 was principally attributable to loss emergence lower than expectations in the period on credit business, partially offset by loss emergence greater than expectations in the period on miscellaneous property lines of business. The reduction in prior period loss estimates for the year ended December 31, 2007 was principally attributable to favorable loss emergence on credit and miscellaneous property lines of business, partially offset by increased loss estimates on motor and liability exposures in the period.
The U.S. Insurance division reported net decreases in prior period loss estimates of $35.3 million, $34.3 million and $38.7 million for the years ended December 31, 2009, 2008 and 2007, respectively. The reductions in prior period loss estimates for the years ended December 31, 2009, 2008 and 2007 were principally due to loss emergence lower than expectations on professional liability business in each period.
The following table summarizes, by type of reserve and division, the unpaid losses and LAE reserves as of December 31, 2009 and 2008. Case reserves represent unpaid claim reports provided by cedants and claims adjusters plus additional reserves determined by us. IBNR is the estimate of unreported loss liabilities established by us.
We believe that these uncertainties and factors make projections of these exposures, particularly asbestos, subject to less predictability relative to non-environmental and non-asbestos exposures. Current estimates, as of December 31, 2009, of our asbestos and environmental losses and LAE reserves, net of reinsurance, are $241.6 million and $23.9 million, respectively. See Note 10 to the consolidated financial statements for additional historical information on losses and LAE reserves for these exposures.
The following table provides the gross and net asbestos and environmental losses and LAE incurred for each of the three years in the period ended December 31, 2009 (in millions):
We may purchase reinsurance to increase our aggregate premium capacity, to reduce and spread the risk of loss on our insurance and reinsurance business and to limit our exposure to multiple claims arising from a single occurrence. We are subject to accumulation risk with respect to catastrophic events involving multiple contracts. To protect against this risk, we have purchased catastrophe excess of loss reinsurance protection. The retention, the level of capacity purchased, the geographical scope of the coverage and the costs vary from year to year. Specific reinsurance protections are also placed to protect our insurance business outside of the United States.
When we purchase reinsurance protection, we cede to reinsurers a portion of our risks and pay premiums based upon the risk and exposure of the policies subject to the reinsurance. Although the reinsurer is liable to us for the reinsurance ceded, we retain the ultimate liability in the event the reinsurer is unable to meet its obligations at some later date.
paid losses. We have also established a reserve for potentially uncollectible insurance and assumed reinsurance balances of $5.5 million and $3.0 million as of December 31, 2009 and 2008, respectively, which has been netted against premiums receivable.
In accordance with the terms of certain of our reinsurance agreements, we have recorded interest expense associated with our ceded reinsurance agreements of $3.7 million, $5.3 million and $8.0 million for the years ended December 31, 2009, 2008 and 2007, respectively.
We have categorized our financial instruments, based on the priority of the inputs to the valuation technique, into a three-level fair value hierarchy. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). To verify Level 3 pricing, we assess the reasonableness of the fair values by comparison to economic pricing models, by reference to movements in credit spreads, and by comparing the fair values to recent transaction prices for similar assets, where available.
A review of fair value hierarchy classifications is conducted on a quarterly basis. Changes in the observability of valuation inputs may result in a reclassification for certain financial assets or liabilities. Reclassifications impacting Level 3 of the fair value hierarchy are generally reported as transfers in or out of the Level 3 category as of the beginning of the period in which the reclassifications occur. We have determined, after carefully considering the impact of recent economic conditions and liquidity in the credit markets on our portfolio, that we should not re-classify any of our investments from Level 1 or Level 2 to Level 3. However, during the third quarter of 2009, we transferred our investment in Advent Capital (Holdings) PLC (“Advent”) from Level 2 to Level 3, following Advent’s delisting from the London Stock Exchange.
On a quarterly basis, we review our investment portfolio for declines in value, and specifically consider securities with fair values that have declined to less than 80% of their cost or amortized cost at the time of review. Declines in the fair value of investments that are determined to be temporary are recorded as unrealized depreciation, net of tax, in accumulated other comprehensive income. If we determine that a decline is “other-than-temporary,” the cost or amortized cost of the investment will be written down to the fair value and a realized loss will be recorded in our consolidated statements of operations.
In assessing the value of our debt and equity securities held as investments, and possible impairments of such securities, we review (i) the issuer’s current financial position and disclosures related thereto, (ii) general and specific market and industry developments, (iii) the timely payment by the issuer of its principal, interest and other obligations, (iv) the outlook and expected financial performance of the issuer, (v) current and historical valuation parameters for the issuer and similar companies, (vi) relevant forecasts, analyses and recommendations by research analysts, rating agencies and investment advisors, and (vii) other information we may consider relevant. Generally, a change in the market or interest rate environment would not, of itself, result in an
Gross Premiums Written. Gross premiums written for the year ended December 31, 2009 decreased by $99.5 million, or 4.3%, to $2,195.0 million, compared to $2,294.5 million for the year ended December 31, 2008, as reflected in the following table (in millions):
United States - The decrease in gross premiums written was primarily due to a decrease in facultative business of $14.9 million, to $57.1 million, for the year ended December 31, 2009, as compared to $72.0 million for the year ended December 31, 2008.
EuroAsia. Gross premiums written in the EuroAsia division for the year ended December 31, 2009 were $559.2 million, a decrease of $37.5 million, or 6.3%, compared to $596.7 million for the year ended December 31, 2008. These amounts represented 25.5% of our gross premiums written for the year ended December 31, 2009 and 26.0% in the corresponding period of 2008. The decrease in gross premiums written during 2009 compared to 2008 is principally comprised of $50.3 million attributable to the movement in foreign exchange rates, and $5.9 million due to a modification to our estimation method in June 2008, offset by reinstatement premiums of $16.2 million, primarily for Windstorm Klaus and Windstorm Wolfgang. The modification to the estimating process impacted gross and net premiums written but had no effect on earned premium. Excluding the effects of the foreign exchange rate movement and the modification to the estimating process, gross premiums written would have increased by $18.7 million.
London Market. Gross premiums written in the London Market division for the year ended December 31, 2009 were $342.9 million, a decrease of $38.8 million, or 10.2%, compared to $381.7 million for the year ended December 31, 2008. These amounts represented 15.6% of our gross premiums written for the year ended December 31, 2009 and 16.7% in 2008. Gross premiums written across each unit of the London Market division were as follows (in millions):
The decrease in gross premiums written by Newline was primarily attributable to timing of the placement of a number of medical professional liability contracts with a value of $20.0 million.
Gross premiums written related to property and package and specialty liability increased for the year ended December 31, 2009 compared to the year ended December 31, 2008 as a result of an increase in crop business and the reclassification of a program to the U.S. Insurance division from the Americas division, where it was previously managed and its results were previously recorded. The increases were offset by a reduction in gross premiums written resulting from a loss of an environmental program in professional liability and competitive market conditions affecting medical professional liability and automobile lines of business.
The decrease in net premiums written in the Americas division was consistent with the 3.9% decrease in gross premiums written.
EuroAsia. Net premiums written in the EuroAsia division for the year ended December 31, 2009 were $533.0 million, compared to $569.3 million for 2008, a decrease of 6.4%. These amounts represented 28.2% of our net premiums written for the year ended December 31, 2009 and 28.0% for the year ended December 31, 2008. The net retention ratio was 95.3% for the year ended December 31, 2009, compared to 95.4% for the year ended December 31, 2008.
London Market. Net premiums written in the London Market division for the year ended December 31, 2009 were $254.5 million, compared to $306.5 million for 2008, a decrease of 17.0%. These amounts represented 13.4% of our net premiums written for the year ended December 31, 2009 and 15.1% for the year ended December 31, 2008. The net retention ratio was 74.2% for the year ended December 31, 2009, compared to 80.3% for the year ended December 31, 2008.
The decrease in net premiums written consisted of a decrease in gross premiums written of $38.8 million, coupled with an increase in ceded premiums written of $13.2 million due to increased reinsurance purchases and higher reinsurance costs on casualty insurance business.
U.S. Insurance. Net premiums written in the U.S. Insurance division for the year ended December 31, 2009 were $375.1 million, compared to $394.3 million for the year ended December 31, 2008, a decrease of 4.9%. These amounts represented 19.8% of our net premiums written for the year ended December 31, 2009 and 19.4% for the year ended December 31, 2008. The net retention ratio was 68.6% for the year ended December 31, 2009, compared to 73.1% for the year ended December 31, 2008.
The decrease in net premiums written was due to a lower retention rate, primarily due to an increase in quota share reinsurance purchased for our medical professional liability business.
Losses and Loss Adjustment Expenses. Net losses and LAE incurred decreased $206.7 million, or 13.7%, to $1,302.0 million for the year ended December 31, 2009, from $1,508.7 million for the year ended December 31, 2008, as follows (in millions):
The loss and LAE ratio for the years ended December 31, 2009 and 2008 and the percentage point change for each of our divisions and in total are as follows:
The following tables reflect total losses and LAE as reported for each division and include the impact of catastrophe losses and prior period reserve development, expressed as a percentage of net premiums earned (“NPE”), for the years ended December 31, 2009 and 2008 (in millions):
EuroAsia Division - Losses and LAE decreased $4.5 million, or 1.1%, to $392.7 million for the year ended December 31, 2009, from $397.2 million for the year ended December 31, 2008. This resulted in a loss and LAE ratio of 72.4% for the year ended December 31, 2009, compared to 70.1% for the year ended December 31, 2008. This decrease in losses and LAE was principally due to a decrease in loss exposure associated with a decline in net premiums earned of $23.8 million, to $542.7 million for the year ended December 31, 2009, from $566.5 million for the year ended December 31, 2008. Losses and LAE for the year ended December 31, 2009 included current year property catastrophe losses of $108.5 million, with $53.5 million for Windstorm Klaus, $16.2 million for Windstorm Wolfgang, $10.1 million for Turkey floods, $8.4 million for the Central Europe flood, $7.9 million for the France hailstorm, and a decrease in prior period losses of $22.8 million, principally due to loss emergence lower than expectations in the period on property business. Losses and LAE for the year ended December 31, 2008 included current year property catastrophe losses of $81.3 million, with $45.9 million for the China winter storm, $19.1 million for Windstorm Emma, $5.1 million for the China earthquake, and a decrease in prior period losses of $2.4 million, principally attributable to loss emergence lower than expectations in the period on credit business, partially offset by loss emergence greater than expectations in the period on miscellaneous property lines of business.
London Market Division - Losses and LAE decreased $47.8 million, or 25.3%, to $140.8 million for the year ended December 31, 2009, from $188.6 million for the year ended December 31, 2008. This resulted in a
loss and LAE ratio of 56.0% for the year ended December 31, 2009, compared to 59.9% for the year ended December 31, 2008. This decrease in losses and LAE was principally due to a decrease in loss exposure associated with a decline in net premiums earned of $63.0 million, to $251.6 million for the year ended December 31, 2009, from $314.6 million for the year ended December 31, 2008. Losses and LAE for the year ended December 31, 2009 included current year property catastrophe losses of $1.0 million and a decrease in prior period losses of $23.3 million, principally attributable to loss emergence lower than expectations in the period on liability business. Losses and LAE for the year ended December 31, 2008 included current year property catastrophe losses of $26.5 million, with $23.1 million for Hurricane Ike, and reflected a decrease in prior period losses of $40.0 million, principally due to loss emergence lower than expectations in the period on professional liability and miscellaneous property lines of business.
Other Underwriting Expenses. Other underwriting expenses for the year ended December 31, 2009 were $185.7 million, compared to $175.0 million for the year ended December 31, 2008. The other underwriting expense ratio, expressed as a percentage of net premiums earned, was 9.6% for the year ended December 31, 2009, compared to 8.4% for the corresponding period in 2008. The increase in the other underwriting expense ratio was principally attributable to a decrease in net premiums earned of $149.0 million, combined with an increase in other underwriting expenses of $10.7 million, primarily relating to businesses acquired during the second half of 2008 by our U.S. Insurance division.
The following table reflects the acquisition and other underwriting expenses, expressed as a percentage of net premiums earned, for the years ended December 31, 2009 and 2008 for each of our divisions:
The GAAP combined ratio is the sum of losses and LAE as a percentage of net premiums earned, plus underwriting expenses, which include acquisition costs and other underwriting expenses, as a percentage of net premiums earned. The combined ratio reflects only underwriting results, and does not include investment results. Underwriting profitability is subject to significant fluctuations due to catastrophic events, competition, economic and social conditions, foreign currency fluctuations and other factors. Our combined ratio was 96.7% for the year ended December 31, 2009, compared to 101.2% for the year ended December 31, 2008. The following table reflects the combined ratio for the years ended December 31, 2009 and 2008 for each of our divisions:
Net Investment Income. Net investment income for the year ended December 31, 2009 increased by $62.7 million, or 24.6%, to $317.9 million, from $255.2 million for the year ended December 31, 2008. Net investment income was comprised of gross investment income of $346.4 million less investment expenses of $28.5 million for the year ended December 31, 2009, compared to gross investment income of $295.5 million less investment expenses of $40.3 million for the year ended December 31, 2008. The increase in net investment income for the year ended December 31, 2009 was primarily attributable to the following:
an increase of $27.7 million, or 81.2%, in net investment income from equity investments for the year ended December 31, 2009, compared to the year ended December 31, 2008. Net income of common stocks, at equity, increased by $7.0 million, along with an increase in dividends on common stocks of $20.7 million;
a decrease in investment expenses of $11.8 million for the year ended December 31, 2009, compared to 2008, which was primarily due to the expense related to total return swaps that were closed out during the fourth quarter of 2008; offset by:
a decrease in net investment income from short-term investments and cash of $44.1 million, or 83.3%, for the year ended December 31, 2009, compared to the year ended December 31, 2008.
Interest expense on funds held, which is included in investment expenses, of $3.7 million for the year ended December 31, 2009, represents a decrease of $1.6 million, or 30.2%, from $5.3 million for the year ended December 31, 2008. The decrease was primarily attributable to ceded paid losses reducing the funds held balance.
a decrease in net mark-to-market realized investment gains of $12.8 million on short positions, which were closed out during the second quarter of 2008; partially offset by:
an increase in foreign exchange realized investment gains on short-term investments, cash and cash equivalents of $153.9 million resulting from the weakening of the U.S. dollar compared to foreign currencies;
increased net realized investment gains on equity securities of $336.6 million, which include other-than-temporary write-downs of equity securities of $123.4 million during the year ended December 31, 2009, compared to $339.0 million in realized investment losses for the year ended December 31, 2008.
During the year ended December 31, 2009, net realized investment gains were reduced by other-than-temporary impairment losses in the amount of $127.0 million, relating to equity securities of $123.4 million, fixed income securities of $3.4 million and preferred stock of $0.2 million. During the year ended December 31, 2008, net realized investment gains were reduced by other-than-temporary impairment losses in the amount of $358.7 million, relating to fixed income securities of $18.9 million, equity securities of $339.0 million and preferred stock of $0.8 million. Other-than-temporary impairments reflect situations where the fair value was below the cost of the securities, and the ability of the security to recover its value could not be reasonably determined.
2009 and 2008, respectively. During the first quarter of 2009, Odyssey America purchased 704,737 shares of our Series B preferred stock, with a liquidation preference of $17.2 million, for $9.2 million. The purchase of the Series B preferred shares resulted in an increase in net income attributable to common shareholders of $8.0 million for the year ended December 31, 2009, compared to $1.5 million for the year ended December 31, 2008.
Gross Premiums Written. Gross premiums written for the year ended December 31, 2008 increased by $11.8 million, or 0.5%, to $2,294.5 million, compared to $2,282.7 million for the year ended December 31, 2007, as reflected in the following table (in millions):
Total reinsurance gross premiums written for the year ended December 31, 2008 were $1,502.2 million, compared to $1,545.9 million for 2007, a decrease of 2.8%. Total insurance gross premiums written for the year ended December 31, 2008, which include our U.S. Insurance division, our Lloyd’s syndicate and NICL, were $792.3 million, compared to $736.8 million for 2007, an increase of 7.5%. For the year ended December 31, 2008, total reinsurance gross premiums written represented 65.5% (67.7% in 2007) of our business, and insurance represented the remaining 34.5% (32.3% in 2007) of our business.
Latin America - The increase in gross premiums written is comprised of treaty pro rata business of $15.4 million and treaty excess business of $2.9 million, offset by a decrease in property facultative business of $1.6 million.
Canada - The decrease in gross premiums written was primarily due to the movement in the Canadian dollar exchange rate between 2008 and 2007.
EuroAsia. Gross premiums written in the EuroAsia division for the year ended December 31, 2008 were $596.7 million, an increase of $31.1 million, or 5.5%, compared to $565.6 million for the year ended December 31, 2007. These amounts represent 26.0% of our gross premiums written for the year ended December 31, 2008 and 24.8% in 2007. The increase in gross premiums written was comprised of: (i) $42.4 million attributable to the movement in foreign exchange rates during 2008 compared to 2007; and (ii) a modification to the estimating process during 2008, which contributed $6.2 million to the increase over 2007. The modification to the estimating process impacted gross and net premiums written, but had no effect on earned premiums. Excluding the effects of foreign exchange rate movements and the modification to the estimating process, gross premiums would have decreased $17.5 million.
Gross premiums written increased for the year ended December 31, 2008 compared to the year ended December 31, 2007 as a result of increases in crop business and offshore energy business, which are included in property and package, and new programs in the logging and transportation industries, which are included in
commercial automobile. This increase in gross premiums written was partially offset by a decrease in our personal automobile business due to market conditions, a decrease in our medical professional liability business due to certain client groups retaining more exposure by self-insuring their own programs, as well as more competitive market conditions in 2008 and a decrease in our professional liability business.
Americas. Net premiums written in the Americas division for the year ended December 31, 2008 were $760.7 million, compared to $817.8 million for the 2007 period, a decrease of $57.1 million, or 7.0%. These amounts represented 37.5% of our net premiums written for the year ended December 31, 2008 and 39.1% for the year ended December 31, 2007. The net retention ratio, which represents net premiums written as a percent of gross premiums written, was 98.0% for both of the years ended December 31, 2008 and 2007.
EuroAsia. Net premiums written in the EuroAsia division for the year ended December 31, 2008 were $569.3 million, compared to $542.1 million for 2007, an increase of 5.0%. These amounts represented 28.0% of our net premiums written for the year ended December 31, 2008 and 25.9% for the year ended December 31, 2007. The net retention ratio for the year ended December 31, 2008 was 95.4%, compared to 95.8% for the year ended December 31, 2007.
London Market. Net premiums written in the London Market division for the year ended December 31, 2008 were $306.5 million, compared to $305.6 million for the year ended December 31, 2007, an increase of 0.3%. These amounts represented 15.1% of our net premiums written for the year ended December 31, 2008 and 14.6% for the year ended December 31, 2007. The net retention ratio was 80.3% for the year ended December 31, 2008, compared to 87.3% for the year ended December 31, 2007.
U.S. Insurance. Net premiums written in the U.S. Insurance division for the year ended December 31, 2008 were $394.3 million, compared to $423.9 million for the year ended December 31, 2007, a decrease of 7.0%. These amounts represented 19.4% of our net premiums written for the year ended December 31, 2008 and 20.3% for the year ended December 31, 2007. The net retention ratio was 73.1% for the year ended December 31, 2008, compared to 79.6% for the year ended December 31, 2007.
Net Premiums Earned. Net premiums earned for the year ended December 31, 2008 decreased by $44.1 million, or 2.1%, to $2,076.4 million, from $2,120.5 million for the year ended December 31, 2007. Net premiums earned decreased in the Americas division by $61.8 million, or 7.3%, and in the U.S. Insurance division of $13.5 million, or 3.2%, offset by an increase in the EuroAsia division of $23.4 million, or 4.3% and in the London Market division by $7.8 million, or 2.5%.
Americas Division - Losses and LAE decreased $16.0 million, or 2.4%, to $645.5 million for the year ended December 31, 2008, from $661.5 million for the year ended December 31, 2007. This resulted in a loss and LAE ratio of 82.8% for the year ended December 31, 2008, compared to 78.6% for the year ended December 31, 2007. This decrease in losses and LAE was principally due to a decrease in prior period losses of $76.5 million, to $66.6 million for the year ended December 31, 2008, from $143.1 million for the year ended December 31, 2007, and a decrease in loss exposure associated with a decrease in net premiums earned of $61.8 million. These decreases were partially offset by an increase in current year catastrophe events of $97.3 million, to $129.3 million for the year ended December 31, 2008, from $32.0 million for the year ended December 31, 2007. Losses and LAE for the year ended December 31, 2008 included current year property catastrophe losses of $129.3 million, with $93.9 million for Hurricane Ike, $9.3 million for Hurricane Gustav, $8.2 million for Australia floods and an increase in prior period losses of $66.6 million, principally attributable to loss emergence greater than expectations in the period on asbestos. Losses and LAE for the year ended December 31, 2007 included current year property catastrophe losses of $32.0 million, with $10.0 million for the Mexico flood in Tabasco and an increase in prior period losses of $143.1 million, which included $11.7 million for increased loss estimates on prior period catastrophe events, principally attributable to Hurricanes Katrina and Wilma, $77.4 million for increased asbestos and environmental loss estimates, principally attributable to the annual review of these exposures, and $21.2 million related to settlement of litigation in the period, with the remainder principally due to loss emergence greater than expectations in the period on U.S. casualty business.
Losses and LAE for the year ended December 31, 2007 included current year property catastrophe losses of $53.4 million, with $26.8 million for Windstorm Kyrill, $12.3 million for Cyclone Gonu, $5.6 million for the Jakarta floods and a reduction in prior period losses of $6.9 million, principally attributable to favorable loss emergence on credit and miscellaneous property lines of business, partially offset by increased loss estimates on motor and liability exposures.
The GAAP combined ratio is the sum of losses and LAE as a percentage of net premiums earned, plus underwriting expenses, which include acquisition costs and other underwriting expenses, as a percentage of net premiums earned. The combined ratio reflects only underwriting results, and does not include investment results. Underwriting profitability is subject to significant fluctuations due to catastrophic events, competition, economic and social conditions, foreign currency fluctuations and other factors. Our combined ratio was 101.2% for the year ended December 31, 2008, compared to 95.5% for the year ended December 31, 2007. The following table reflects the combined ratio for the years ended December 31, 2008 and 2007 for each of our divisions:
investment income from fixed income securities was $197.1 million for the year ended December 31, 2008, a decrease of $8.8 million, or 4.3%, compared to the corresponding period in 2007. An increase in the average amortized cost of our fixed income securities for the year ended December 31, 2008, compared to the corresponding period in 2007, was offset by a decrease in the investment yield, resulting in a decrease in investment income;
a decrease in net investment income from short-term investments and cash of $26.9 million, or 33.7%, for the year ended December 31, 2008, compared to the corresponding period in 2007, which is representative of a decrease in short-term interest rates during the period; and
Our total effective annualized yield on average invested assets, net of expense but before the impact of interest expense from funds held balance, was 3.3% and 4.5% for the years ended December 31, 2008 and 2007, respectively.
Net Realized Investment Gains. Net realized investment gains of $692.3 million for the year ended December 31, 2008 increased by $153.2 million, from $539.1 million for the year ended December 31, 2007. The increase in net realized investment gains is principally due to the following:
an increase in net realized investment gains on derivatives of $668.0 million, primarily attributable to the net change in fair value of our credit default swaps and of our total return swaps on indexes, caused by widening credit spreads and declining equity indexes, respectively; and
lower net realized investment gains on equity securities of $435.1 million, which included other-than-temporary write-downs of equity securities of $339.0 million and $42.1 million for the years ended December 31, 2008 and 2007, respectively. The year ended December 31, 2007 included gains of $119.2 million related to the sale of shares of Hub;
lower net realized investment gains on other securities of $7.4 million; and
Other Expenses, Net. Other expenses, net, for the year ended December 31, 2008, were $60.4 million, compared to $14.0 million for the year ended December 31, 2007. Other expenses are primarily comprised of operating expenses at our holding company, including audit related fees, corporate-related legal fees, consulting fees, and compensation expense and foreign currency exchange gains and losses. The increase of $46.4 million for the year ended December 31, 2008 compared to 2007 is primarily comprised of $45.8 million related to foreign exchange related adjustments.
Preferred Dividends and Purchases. We recorded preferred dividends related to our Series A and Series B non-cumulative perpetual preferred shares of $7.4 million and $8.3 million in the years ended December 31, 2008 and 2007, respectively. During the year ended December 31, 2008, Odyssey America purchased 128,000 shares of our Series B preferred stock, with a liquidation preference of $3.1 million, for $1.6 million. The purchase of the Series B preferred shares resulted in an increase in net income attributable to common shareholders of $1.5 million for the year ended December 31, 2008.
Odyssey Re Holdings Corp. is a holding company that does not have any significant operations or assets other than its ownership of Odyssey America, and its principal sources of funds are cash dividends and other permitted payments from its operating subsidiaries, primarily Odyssey America. If our subsidiaries are unable to make payments to the holding company, or are able to pay only limited amounts, we may be unable to pay dividends on our preferred shares or make payments on our indebtedness. The payment of dividends by our operating subsidiaries is subject to restrictions set forth in the insurance laws and regulations of Connecticut, Delaware, New York and the United Kingdom. Holding company cash, cash equivalents and short-term investments totaled $33.0 million as of December 31, 2009, compared to $23.9 million as of December 31, 2008. During the years ended December 31, 2009 and 2008, the holding company received dividends from Odyssey America of $200.0 million and $410.0 million, respectively.
Although the obligations of our reinsurers to make payments to us are based on specific contract provisions, these amounts only become recoverable when we make a payment of the associated loss amount, which may be several years, or in some cases decades, after the actual loss occurred. Reinsurance recoverables on unpaid losses, which represent 92.3% of our total reinsurance recoverables as of December 31, 2009, will not be due for collection until some time in the future, and over this period of time, economic conditions and the operational performance of a particular reinsurer may negatively impact its ability to meet its future obligations to us. We manage our exposure by entering into reinsurance transactions with companies that have a strong capital position and a favorable long term financial profile.
Our total reinsurance recoverable on paid losses as of December 31, 2009, net of the reserve for uncollectible reinsurance, was $70.5 million. The top ten reinsurers measured on total reinsurance recoverables represented $45.1 million, or 64.0%, of the total paid loss recoverable, of which $2.7 million is collateralized and the remaining $42.4 million is with highly rated companies. The remaining $25.4 million recoverable on paid losses is with numerous companies, and no single company has a balance greater than $4.2 million net of the reserve on uncollectible reinsurance.
Approximately $40.8 million of our total reinsurance paid recoverable is current billings, and $29.7 million is over 120 days past due. The change in the economic conditions of any of our retrocessionaires may impact their ability to meet their obligations and negatively impact our liquidity.
Total investments and cash amounted to $8.7 billion as of December 31, 2009, an increase of $834.6 million compared to December 31, 2008. Our average invested assets were $8.3 billion for the year ended December 31, 2009, compared to $7.8 billion for the year ended December 31, 2008. We anticipate that our cash and cash equivalents will continue to be reinvested on a basis consistent with our long-term, value-oriented investment philosophy. Cash, cash equivalents and short-term investments, excluding cash and cash equivalents held as collateral, represented 15.1% and 25.1% of our total investments and cash, excluding cash and cash equivalents held as collateral, as of December 31, 2009 and 2008, respectively. Total fixed income securities were $4.9 billion as of December 31, 2009, compared to $3.9 billion as of December 31, 2008. As of December 31, 2009, 61.9% of our fixed income portfolio was rated “AAA”, with 10.5% of securities rated below investment grade. The duration of our investment portfolio, including short-term investments, cash and cash equivalents, was 8.5 years.
On November 28, 2006, we completed the private sale of $40.0 million aggregate principal amount of floating rate senior debentures, series C due December 15, 2021 (the “Series C Notes”). Interest on the Series C Notes accrues at a rate per annum equal to the three-month LIBOR, reset quarterly, plus 2.50%, and is payable quarterly in arrears on March 15, June 15, September 15 and December 15 of each year. We have the option to redeem the Series C Notes at par, plus accrued and unpaid interest, in whole or in part on any interest payment date on or after December 15, 2011. For the years ended December 31, 2009 and 2008, the average annual interest rate on the Series C Notes was 3.48% and 5.71%, respectively.
On July 13, 2007, we entered into a $200.0 million credit facility (the “Credit Agreement”) with Wachovia Bank National Association (“Wachovia”), KeyBank National Association and a syndicate of lenders. The original Credit Agreement provided for a five-year credit facility of $200.0 million, $100.0 million of which was available for direct, unsecured borrowings by us, and all of which was available for the issuance of secured letters of credit to support our insurance and reinsurance business. As of June 17, 2009, the Credit Agreement was amended to explicitly permit us to pledge collateral to secure our obligations under swap agreements, subject to certain financial limitations, in the event that such collateral is required by the counterparty or counterparties. As of February 24, 2010, the Credit Agreement was amended (i) to reduce the size of the facility to $100.0 million, removing the unsecured $100.0 million tranche, (ii) to remove the previous limitation on dividends and other “restricted payments” that we may pay to our shareholders during any fiscal year and (iii) to amend certain of the covenants and default provisions, the minimum ratings requirement, and the pricing of the credit facility.
The amended Credit Agreement contains an option that permits us to request an increase in the aggregate amount of the facility by an amount up to $50.0 million, to a maximum facility size of $150.0 million. Following such a request, each lender has the right, but not the obligation, to commit to all or a portion of the proposed increase. As of December 31, 2009, there was $54.9 million outstanding under the Credit Agreement, all of which was in support of secured letters of credit, which included $21.0 million in letters of credit that were cancelled effective January 15, 2010. (See Note 17 to the consolidated financial statements included in this Annual Report on Form 10-K.)
Our Board of Directors authorized a share repurchase program whereby we were authorized to repurchase shares of our common stock on the open market from time to time through December 31, 2009, up to an aggregate repurchase price of $600.0 million. Shares repurchased under the program were retired. From the inception of the program through October 21, 2009, we repurchased and retired 13,906,845 shares of our common stock at a total cost of $518.4 million.
We and our subsidiaries are assigned financial strength (insurance) and credit ratings from internationally recognized rating agencies, which include A.M. Best Company, Inc. (“A.M. Best”), Standard & Poor’s Ratings Services (“Standard & Poor’s”) and Moody’s Investors Service (“Moody’s”). Financial strength ratings represent the opinions of the rating agencies of the financial strength of a company and its capacity to meet the obligations of insurance and reinsurance contracts. The rating agencies consider many factors in determining the financial strength rating of an insurance or reinsurance company, including the relative level of statutory surplus necessary to support our business operations.
Our senior unsecured debt is currently rated “BBB-” by Standard & Poor’s, “Baa3” by Moody’s and “bbb” by A.M. Best. Our Series A and Series B preferred shares are currently rated “BB” by Standard & Poor’s, “Ba2” by Moody’s and “bb+” by A.M. Best.
risk, equity price risk and foreign currency risk. Market sensitive instruments discussed in this section principally relate to our fixed income securities and common stocks carried at fair value which are classified as available for sale. As of December 31, 2009, our total investments and cash of $8.7 billion include $4.9 billion of fixed income securities that are subject primarily to interest rate risk and credit risk.
The preceding table indicates an asymmetric fair value response to equivalent basis point shifts, up and down, in interest rates. This is partially caused by the impact of bonds in our portfolio that have put or call features, which reflect different dynamics in changing interest rate environments than bonds without these features. In an increasing interest rate environment, put features tend to limit losses in fair value by giving the holder the ability to put the bonds back to the issuer for early maturity. In a declining interest rate environment, call features tend to limit gains in fair value by giving the issuer the ability to call the bond, which limits the gain in fair value. As the mix of bonds with puts and calls in our portfolio changes, different asymmetric results in hypothetical fair values occur.
During 2008, we entered into Eurodollar futures contracts to manage our interest rate risk with respect to certain investments. During the first quarter of 2009, we closed the futures contracts. A futures contract is a variation of a forward contract, with some additional features, such as a clearinghouse guarantee against credit losses, a daily settlement of gains and losses, and trading on an organized electronic or floor trading facility. Futures contracts are entered either long or short. We had entered into the long side, which agrees to buy the underlying currency at the future date at the agreed-upon price. Futures contracts had net realized investment losses of $0.3 million for the year ended December 31, 2009.
Our credit risk exposure, based upon carrying value, as of December 31, 2009 and 2008 (without taking into account amounts pledged as collateral for our benefit of $220.2 million and $291.4 million as of December 31, 2009 and 2008, respectively) was comprised as follows (in millions):
Our risk management strategy with respect to investments in debt instruments is to invest primarily in securities of high credit quality issuers and to limit the amount of credit risk exposure with respect to any one issuer. While we review third party ratings, we carry out our own analysis and do not delegate the credit decision to rating agencies. We endeavor to limit credit exposure by imposing fixed income portfolio limits on individual corporate issuers and limits based on credit quality and may, from time to time, invest in credit default swaps, or other types of derivatives, to further mitigate credit risk exposure.
Our risk management objective is to mitigate the adverse change in the fair value of our financial assets that would likely result in the event of significant defaults or other adverse events in the U.S. credit markets. Beginning in 2003, we attempted to meet this objective by purchasing credit default protection (“credit default swaps”) referenced to various issuers in the banking, mortgage and insurance sectors of the financial services industry, which are representative of the systemic financial risk, versus hedging specific assets. We chose this approach because it was impossible to predict which of the hedged assets would be adversely affected and to what degree. As a result, we did not specifically align hedged items with hedging instruments.
The total cost of the credit default swaps was $20.6 million and $30.8 million as of December 31, 2009 and 2008, respectively, and the fair value was $10.0 million and $82.8 million, as of December 31, 2009 and 2008, respectively. The notional amount of the credit default swaps was $1.3 billion and $1.8 billion as of December 31, 2009 and 2008, respectively. The credit default swaps had net realized investment losses of $28.7 million and net realized investment gains of $350.7 million for the year ended December 31, 2009, and 2008, respectively. The fair values of credit default swaps are subject to significant volatility given potential differences in the perceived risk of default of the underlying issuers, movements in credit spreads and the length of time to the contracts’ maturities. The fair value of the credit default swaps may vary dramatically either up or down in short periods, and their ultimate value may therefore only be known upon their disposition. Credit default swap transactions generally settle in cash. As we fund all of our obligations relating to these contracts upon initiation of the transaction, there are no requirements in these contracts for us to provide collateral.
The fair values of credit default swap contracts are sensitive to individual issuer credit default swap yield curves and current market spreads. The timing and amount of changes in fair value of fixed income securities and underwriting balances are by their nature uncertain. As a result of these data limitations and market uncertainties, it is not possible to estimate the reasonably likely future impact of our economic hedging programs.
Our investment portfolio is managed with a long term, value-oriented investment philosophy emphasizing downside protection. We have policies to limit and monitor our individual issuer exposures and aggregate equity exposure. Aggregate exposure to single issuers and total equity positions are monitored at the subsidiary level and in aggregate at the consolidated level.
During much of 2008 and the immediately preceding years, we had been concerned with the valuation level of worldwide equity markets, uncertainty resulting from credit issues in the United States and global economic conditions. As protection against a decline in equity markets and as an “economic hedge” against a broad market downturn, we had held short positions effected by way of equity index-based exchange-traded securities including Standard & Poor’s depository receipts (“SPDRs”), the iShares Canadian S&P/TSX60 (XIU), U.S. listed common stocks, equity total return swaps and equity index total return swaps, referred to in the aggregate as our “equity hedges.” We had also purchased S&P 500 index call options to limit the potential loss on U.S. equity index total return swaps and SPDRs short positions, and to provide general protection against the short position in common stocks. In November 2008, following significant declines in global equity markets, we revised the financial objectives of our hedging program on the basis of our assessment that elevated risks in the global equity markets had moderated, and subsequently closed substantially all of our equity hedge positions.
During the remainder of the fourth quarter of 2008 and continuing into 2009, we increased our investments in equity securities as a result of the opportunities presented by significant declines in valuations. These additions to our portfolio, coupled with the significant appreciation in the value of the worldwide equity markets during 2009, resulted in a significant increase in the value of our equity holdings and, thus, to the exposure to increased loss potential should the equity markets again suffer a significant decline in value. We continue to manage our exposure to market price fluctuations primarily through policies designed to monitor and limit our individual issuer exposures and aggregate equity exposure. However, in late September 2009, we also initiated U.S. equity index total return swap contracts, which as of December 31, 2009 have a notional value of $818.4 million, to protect against potential future broad market downturns. The collateral requirement related to entering the total return swaps was $78.5 million as of December 31, 2009. These total return swap transactions terminate during the third quarter of 2010. The equity index total return swaps, in the aggregate, were in a gain position as of December 31, 2009, and are recorded in other invested assets. Changes in the fair values of equity index and common stock total return swaps are recorded as realized gains or losses in the consolidated statements of operations in the period in which they occur. As of December 31, 2009 and 2008, we had aggregate equity holdings with fair value of $2.2 billion (common stocks of $2.1 billion plus preferred stock of $0.1 billion) and $1.6 billion (common stocks), respectively.
Generally, a 10% decline in the global equity markets would result in a similar decrease in the value of our equity investment holdings, resulting in decreases in our pre-tax other comprehensive income, as the majority of our equity investment holdings are classified as available for sale. Conversely, a 10% increase in global equity markets would generally result in a similar increase in the value of our equity investment holdings, resulting in increases in our pre-tax other comprehensive income. As the equity hedges held by us as of December 31, 2009 were all entered into at the end of September 2009, and as there were no other equity hedges in our portfolio during 2009 prior to September, the effects of changes in the global equity markets for the year ended December 31, 2009 were not fully offset by the effects of any hedging activities. For the year ended December 31, 2008, however, during which our hedging activities were significant, the effect of changes in global equity markets on pre-tax other comprehensive income and pre-tax income was more than offset by the effect on pre-tax net income of the equity hedges, effected primarily through positions in derivatives, and securities sold but not yet purchased.
On a quarterly basis, we review our investment portfolio for declines in value and specifically consider securities with fair values that have declined to less than 80% of their cost or amortized cost at the time of review. Declines in the fair value of investments that are determined to be temporary are recorded as unrealized depreciation, net of tax, in accumulated other comprehensive income. If we determine that a decline is “other-than-temporary,” the cost or amortized cost of the investment will be written down to the fair value and a realized investment loss will be recorded in our consolidated statements of operations.
We believe the gross unrealized depreciation is temporary in nature and we have not recorded a realized investment loss related to these securities. Given the size of our investment portfolio and capital position, we believe it is likely that we will not be required to sell or liquidate these securities before the fair value recovers the gross unrealized depreciation.
For further detail on our long term debt principal and interest payments, see Note 13 to our consolidated financial statements included in this Annual Report on Form 10-K. For further detail on our operating lease payments, see Note 16 to our consolidated financial statements included in this Annual Report on Form 10-K. For further detail on our employee benefit plans, see Notes 19 and 20 to our consolidated statements in this Annual Report on Form 10-K.
III. Supplemental Insurance Information as of December 31, 2009 and 2008 and for the years ended December 31, 2009, 2008 and 2007
IV. Reinsurance for the years ended December 31, 2009, 2008 and 2007
In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Odyssey Re Holdings Corp. and its subsidiaries at December 31, 2009 and 2008, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2009 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedules listed in the accompanying index present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on these financial statements and on the Company’s internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
Odyssey Re Holdings Corp. (together with its subsidiaries, the “Company” or “OdysseyRe”) is an underwriter of reinsurance, providing a full range of property and casualty products on a worldwide basis, and an underwriter of specialty insurance, primarily in the United States and through the Lloyd’s of London marketplace. Odyssey Re Holdings Corp. was formed as a holding company and incorporated in Delaware in 2001 in conjunction with its initial public offering. Odyssey Re Holdings Corp. owns all of the common shares of Odyssey America Reinsurance Corporation (“Odyssey America”), its principal operating subsidiary, which is domiciled in the state of Connecticut. Odyssey America directly or indirectly owns all of the common shares of the following subsidiaries: Clearwater Insurance Company (“Clearwater”); Clearwater Select Insurance Company; Newline Holdings U.K. Limited, Newline Underwriting Management Limited, which manages Newline Syndicate (1218), a member of Lloyd’s of London, Newline Insurance Company Limited (“NICL”), Newline Corporate Name Limited (“NCNL”), which provides capital for and receives the distributed earnings from Newline Syndicate (1218) (collectively, “Newline”); Hudson Insurance Company (“Hudson”); Hudson Specialty Insurance Company (“Hudson Specialty”) and Napa River Insurance Services, Inc. As of December 31, 2009, Fairfax Financial Holdings Limited (“Fairfax”), a publicly traded financial services holding company based in Canada, owned 100.0% of OdysseyRe.
Pursuant to the Offer, which expired on October 21, 2009 at 12:00 midnight, New York City time, Fairfax acquired a total of approximately 14.3 million shares of common stock of OdysseyRe (the “Tendered Shares”). The Tendered Shares, combined with the shares previously owned by Fairfax and its subsidiaries, represented approximately 97.1% of the 58,451,922 shares of common stock of OdysseyRe outstanding. Following the purchase of the Tendered Shares, Fairfax caused a short-form merger pursuant to which Fairfax Investments USA Corp., a newly-formed, wholly-owned subsidiary of Fairfax, merged with and into OdysseyRe (the “Merger”).
The Merger was effected on October 28, 2009 pursuant to Section 253 of the General Corporation Law of the State of Delaware (the “DGCL”) by the execution and filing of a Certificate of Ownership and Merger with the Secretary of State of the State of Delaware. As a result of the Merger, all of the remaining shares of OdysseyRe’s common stock held by the remaining minority shareholders of OdysseyRe (the “Remaining Shares”) were cancelled and, subject to appraisal rights under Delaware law, converted into the right to receive $65.00 per share in cash, without interest, and subject to any applicable withholding of taxes. As a result of the Merger, Fairfax and its subsidiaries became the owner of 100% of the outstanding shares of the Company’s common stock. The Company subsequently withdrew its shares of common stock from listing on the New York Stock Exchange and terminated registration of these shares under the Securities Exchange Act of 1934. All common shares remaining in treasury following the Merger were cancelled.
(a) Basis of Presentation. The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The consolidated financial statements include the accounts of the Company and its subsidiaries. Intercompany
(b) Investments. The majority of the Company’s investments in fixed income securities and common stocks are categorized as “available for sale” and are recorded at their estimated fair value based on quoted market prices. Certain investments, including fixed income securities that contain embedded derivatives, are reflected in trading securities (see Note 3), while most investments in common stocks of affiliates are carried at the Company’s proportionate share of the equity of those affiliates. Short-term investments (some of which are classified as “available for sale”, and some of which are classified as “held as trading”), which have a maturity of one year or less from the date of purchase, are carried at fair value. The Company considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents. Investments in limited partnerships and investment funds have been reported in other invested assets. Other invested assets also include trust accounts relating to the Company’s benefit plans and derivative securities, all of which are carried at fair value. The Company routinely evaluates the carrying value of its investments in common stocks of affiliates and in partnerships and investment funds. In the case of limited partnerships and investment funds, the carrying value is generally established on the basis of the net valuation criteria as determined by the managers of the investments. Such valuations could differ significantly from the values that would have been available had markets existed for the securities. Investment transactions are recorded on their trade date, with balances pending settlement reflected in the consolidated balance sheet as a component of other assets or other liabilities.
(c) Premium Revenue Recognition. Reinsurance assumed premiums written and related costs are based upon reports received from ceding companies. Where reinsurance assumed premiums written have not been reported by the ceding company, they are estimated, at the individual contract level, based on historical patterns and experience from the ceding company and judgments of the Company. Subsequent adjustments to premiums written, based on actual results or revised estimates from the ceding company, are recorded in the period in which they become known. Reinsurance assumed premiums written related to proportional treaty business are established on a basis that is consistent with the coverage periods under the terms of the underlying insurance contracts. Reinsurance assumed premiums written related to excess of loss and facultative reinsurance business are recorded over the coverage term of the contracts, which is generally one year. Unearned premium reserves are established for the portion of reinsurance assumed premiums written to be recognized over the remaining contract period. Unearned premium reserves related to proportional treaty contracts are computed based on reports received from ceding companies, which show premiums written but not yet earned. Premium adjustments
The following table reflects the carrying amount of goodwill, intangible assets with an indefinite life and intangible assets with a finite life as of December 31, 2009 and 2008 (in thousands):
The reserve for unpaid losses and loss adjustment expenses is based on the Company’s evaluations of reported claims and individual case estimates received from ceding companies for reinsurance business or the estimates advised by the Company’s claims adjusters for insurance business. The Company utilizes generally accepted actuarial methodologies to determine reserves for losses and loss adjustment expenses on the basis of historical experience and other estimates. The reserves are reviewed continually during the year and changes in estimates in losses and loss adjustment expenses are reflected as an expense in the consolidated statements of operations in the period the adjustment is made. Reinsurance recoverables on unpaid losses and loss adjustment expenses are reported as assets. A reserve for uncollectible reinsurance recoverables is established based on an evaluation of each reinsurer or retrocessionaire and historical experience. The Company uses tabular reserving for workers’ compensation indemnity loss reserves, which are considered to be fixed and determinable, and discounts such reserves using an interest rate of 3.5%. Workers’ compensation indemnity loss reserves have been discounted using the Life Table for Total Population: United States, 2004.
with this accounting standard, these contracts are deemed as either transferring only significant timing risk or only significant underwriting risk or transferring neither significant timing nor underwriting risk.
(i) Derivatives. The Company utilizes derivative instruments to manage against potential adverse changes in the value of its assets and liabilities. Derivatives include credit default swaps, call options and warrants, total return swaps, interest rate swaps, forward currency contracts and other equity and credit derivatives. In addition, the Company holds options on certain securities within its fixed income portfolio, which allows the Company to extend the maturity date on fixed income securities or convert fixed income securities to equity securities. The Company categorizes these investments as trading securities, and changes in fair value are recorded as realized investment gains or losses in the consolidated statements of operations. All derivative instruments are recognized as either assets or liabilities on the consolidated balance sheet and are measured at their fair value. Gains or losses from changes in the derivative values are reported based on how the derivative is used and whether it qualifies for hedge accounting. As the Company’s derivative instruments do not qualify for hedge accounting, changes in fair value are included in realized investment gains and losses in the consolidated statements of operations. Margin balances required by counterparties in support of derivative positions are included in fixed income securities, available for sale.
(j) Operating Segments. The Company has four operating segments that reflect the manner in which management monitors and evaluates the Company’s financial performance. The Company’s four segments include: Americas, EuroAsia, London Market and U.S. Insurance (see Note 14).
date exchange rate and income statement accounts at the average exchange rate for the year. Translation gains or losses are recorded, net of deferred income taxes, as a component of accumulated other comprehensive income.
(m) Stock-Based Compensation Plans. Prior to the Merger, the Company accounted for its share-based payments to employees in accordance with Accounting Standards Codification (“ASC”) 718, “Share-Based Payment.” Following the acquisition, the Company established the Restricted Share and Equity Value Plan (the “Plan”). Under the terms of the Plan, each restricted equity value right (“REVRs”) will have a value (the “REVR Value”) equal to the total shareholders’ equity of the Company attributable to the common equity as of the last day of the most recently completed quarter of the Company for which Fairfax has publicly released its earnings report, or in the event that Fairfax does not intend to publicly release an earnings report, for which financial statements that report the Company’s book value are available, as adjusted for dividends, capital contributions or other extraordinary events (in each case, as determined by the Board of Directors of the Company or the Compensation Committee thereof, in its sole discretion), divided by 58,443,149 (which is the number of Company common shares outstanding as of September 30, 2009). Upon vesting of a REVR, a participant will receive a single sum cash payment equal to the REVR Value as of the applicable vesting date, less any applicable withholding of taxes. The Company accounts for the Plan as a liability plan in accordance with ASC 718.
(n) Payments. Payments of claims by the Company, as reinsurer, to a broker on behalf of a reinsured company are recorded on the Company’s books as a paid loss at the time the cash is disbursed. The payment is treated as a paid claim to the reinsured. Premiums due to the Company from the reinsured are recorded as receivables from the reinsured until the cash is received by the Company, either directly from the reinsured or from the broker.
(o) Funds Held Balances. Funds held under reinsurance contracts is an account used to record a liability, in accordance with the contractual terms, arising from the Company’s receipt of a deposit from a reinsurer or the withholding of a portion of the premiums due as a guarantee that a reinsurer will meet its loss and other obligations. Interest generally accrues on withheld funds in accordance with contract terms. Funds held by
(p) Fixed Assets. Fixed assets, with a net book value of $11.5 million and $10.7 million as of December 31, 2009 and 2008, respectively, are included in other assets. Property and equipment are recorded at cost. Depreciation and amortization are generally computed on a straight-line basis over the following estimated useful lives:
In December 2008, the FASB issued an accounting standard to require enhanced disclosures regarding the major categories of plan assets, concentrations of risk, inputs and valuation techniques used to measure the fair value of plan assets and the effect of using unobservable inputs (Level 3 classification under the fair value accounting standard). The disclosure requirements of this standard were adopted as of December 31, 2009 and are included in these consolidated financial statements.
In June 2009, the FASB issued an accounting standard to provide a timeline for the application of the codification project (“Codification”), which, effective July 1, 2009, eliminated the current four levels of hierarchy of authoritative accounting and reporting guidance and provides one source for authoritative accounting and reporting. The Codification does not change existing GAAP, as such affects the Company. The Codification was adopted by the Company in the third quarter of 2009.
In April 2009, the FASB issued an accounting standard to require additional interim period disclosures regarding the fair value of financial instruments. Entities are required to disclose how the amounts in the
In March 2008, the FASB issued an accounting standard that requires additional disclosures for derivative and hedging activities. On January 1, 2009, the Company adopted the disclosure provisions of this accounting standard.
In 2004, Hudson Specialty purchased 40% of Hooghuis Group LLC (“Hooghuis”), an underwriting agency specializing in U.S. directors’ and officers’ liability insurance. On June 9, 2008, Hudson Specialty purchased the remaining 60% of the outstanding shares of Hooghuis at a cost of $5.3 million. As a result of the acquisition, the Company acquired $9.9 million in assets (including $2.9 million in intangible assets, which is being amortized over the expected lives of such assets, and $1.0 million in goodwill) and $5.5 million in liabilities. As of December 31, 2009, the unamortized balance of the intangible assets was $1.8 million. On May 27, 2009, Hudson Specialty made a $3.4 million payment as final settlement for contingent consideration on its original 40% interest in Hooghuis, which has been reflected as additional goodwill.
On August 29, 2008, Hudson purchased certain assets and liabilities associated with the crop insurance business previously produced by CropUSA Insurance Agency, Inc. (“CropUSA”) for cash consideration of $8.0 million. Since 2006, CropUSA had acted as managing general underwriter for Hudson in the crop insurance sector. The acquisition resulted in an increase of $34.1 million in assets (including $7.7 million in goodwill and $5.5 million in intangible assets, which will be amortized over the expected lives of such assets) and $26.1 million in liabilities. As of December 31, 2009, the unamortized balance of the intangible assets was $3.8 million.
The Company accounts for a significant portion of its financial instruments at fair value as permitted or required by GAAP.
The Company has categorized its financial instruments, based on the priority of the inputs to the valuation technique, into a three-level fair value hierarchy. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). When the inputs used to measure fair value fall within different levels of the hierarchy, the level within which the fair value measurement is categorized is based on the lowest level input that is significant to the fair value measurement in its entirety. Gains and losses for assets and liabilities categorized within the Level 3 table below, therefore, may include changes in fair value that are attributable to both observable inputs (Levels 1 and 2) and unobservable inputs (Level 3). Financial assets and liabilities recorded in the consolidated balance sheets are categorized based on the inputs to the valuation techniques as follows:
Pricing models, the inputs for which are observable for substantially the full term of the asset or liability; and
Pricing models, the inputs for which are derived principally from, or corroborated by, observable market data through correlation or other means, for substantially the full term of the asset or liability.
The Company is responsible for determining the fair value of its investment portfolio by utilizing market
The Company’s Level 2 investments, the majority of which are in government, corporate and municipal fixed income securities, are priced using publicly traded over-the-counter prices and broker-dealer quotes. Observable inputs such as benchmark yields, reported trades, broker-dealer quotes, issuer spreads and bids are available for these investments. For determining the fair value of credit default swaps, which are classified as Level 2, the Company utilizes broker-dealer quotes that include observable credit spreads. Also included in Level 2 are inactively traded convertible corporate debentures that are valued using a pricing model that includes observable inputs such as credit spreads and discount rates in the calculation. During the year ended December 31, 2009, the Company transferred $47.8 million of Level 3 investments to Level 2 after determining that broker-dealer quotes were available to determine the fair value of the instruments.
The Company uses valuation techniques to establish the fair value of Level 3 investments. During the year ended December 31, 2009, the Company purchased $19.9 million of investments that are classified as Level 3. As of December 31, 2009, the Company held $47.5 million of investments that are classified as Level 3. These Level 3 investments are valued using a discounted cash flow model, including unobservable inputs that are supported by limited market-based activity. To verify Level 3 pricing, the Company assesses the reasonableness of the fair values by comparison to economic pricing models, by reference to movements in credit spreads and by comparing the fair values to recent transaction prices for similar assets, where available.
The following tables provide a summary of changes in the fair value of Level 3 financial assets for the years ended December 31, 2009 and 2008 (in thousands):
The fair value option (“FVO”) available under GAAP allows companies to irrevocably elect fair value as the initial and subsequent measurement attribute for certain financial assets and liabilities. Changes in the fair value of assets and liabilities for which the election is made will be recognized in net income as they occur. The FVO election is permitted on an instrument-by-instrument basis at initial recognition of an asset or liability or upon the occurrence of an event that gives rise to a new basis of accounting for that instrument.
On January 1, 2008, the Company elected the FVO for its investment in Advent. At the time, Advent was publicly traded on a foreign stock exchange and its traded price was determined to be a better indicator of its value than its carrying value under the equity method. During the third quarter of 2009, Fairfax and certain of its subsidiaries, including the Company, purchased additional shares of Advent, bringing Fairfax’s ownership in Advent to 97.0%. The remaining 3.0% of the outstanding shares of Advent were purchased by Fairfax during the fourth quarter of 2009, resulting in 100.0% ownership in Advent’s common stock, of which the Company holds 22.8%.
To determine the fair value of Advent, the Company evaluates observable price-to-book multiples of peer companies and applies such to Advent’s most recently available book value per share. As of December 31, 2009, Advent is recorded at fair value of $32.9 million in other invested assets, with related changes in fair value recognized as a realized investment gain or loss in the period in which they occur. The change in Advent’s fair value resulted in the recognition of a realized investment gain of $6.2 million for the year ended December 31,
2009 and a realized investment loss of $9.0 million for the year ended December 31, 2008. Advent’s value as of December 31, 2009, calculated in accordance with the equity method of accounting, would have been $38.6 million.
A summary of the Company’s investment portfolio as of December 31, 2008, excluding common stocks, at equity, other invested assets and fixed income securities held as trading securities, is as follows (in thousands):
The amortized cost and fair value of fixed income securities as of December 31, 2009, by contractual maturity, are shown below (in thousands).
The following table sets forth the components of net investment income for the years ended December 31, 2009, 2008 and 2007 (in thousands):
Included in net realized investment gains for the years ended December 31, 2009, 2008 and 2007 are $127.0 million, $358.7 million and $54.5 million, respectively, related to realized investment losses on the other-than-temporary impairment of investments, as follows (in thousands):
For those fixed income securities that were determined to be other-than-temporarily impaired, the Company determined that such impairments were related to credit, requiring the recognition of an impairment charge to income, and not related to other factors (e.g., interest rates and market conditions), which would have required charges to other comprehensive income.
The following table sets forth the changes in unrealized net appreciation (depreciation) of investments, and the related tax effect, reflected in accumulated other comprehensive income for the years ended December 31, 2009, 2008 and 2007 (in thousands):
As of December 31, 2009, the Company held one collateral loan which constituted a financial instrument without a quoted price, or a “non-traded investment.” This collateral loan was fully impaired during 2005. The Company periodically evaluates the carrying values of non-traded investments by reviewing the borrowers’ current financial position and the timeliness of their interest and principal payments.
The Company has utilized, credit default swaps, call options and warrants, total return swaps, interest rate options, forward currency contracts, futures contracts and short sales to manage against adverse changes in the values of assets and liabilities. These products are typically not linked to specific assets or liabilities on the consolidated balance sheets or a forecasted transaction and, therefore, do not qualify for hedge accounting. The following tables set forth the Company’s derivative positions, which are included in other invested assets or other liabilities in the consolidated balance sheets, as of December 31, 2009, and December 31, 2008, respectively (in thousands):
The Company holds credit default swaps, referenced to certain issuers in the banking and insurance sectors of the financial services industry worldwide, that serve as an economic hedge against declines in the fair value of investments and other corporate assets resulting from systemic financial and credit risk. Under a credit default swap, as the buyer, the Company agrees to pay to a specific counterparty, at specified periods, fixed premium amounts based on an agreed notional principal amount in exchange for protection against default by the issuers of specified referenced debt securities. The credit events, as defined by the respective credit default swap contracts, establishing the rights to recover amounts from the counterparties are comprised of ISDA-standard credit events, which are: bankruptcy, obligation acceleration, obligation default, failure to pay, repudiation/moratorium and restructuring. As of December 31, 2009 all credit default swap contracts held by the
Company have been purchased from and entered into with either Citibank, N.A., Deutsche Bank AG or Barclays Bank PLC as the counterparty, with positions on certain covered risks with more than one of these counterparties. The Company obtains market-derived fair values for its credit default swaps from third-party providers, principally broker-dealers. The Company assesses the reasonableness of the fair values obtained from these providers by comparison to models validated by qualified personnel, by reference to movements in credit spreads and by comparing the fair values to recent transaction prices for similar credit default swaps, where available.
times. Warrants, which are included in other invested assets, are recorded at fair value, with the related changes in fair value recognized as realized investment gains or losses in the consolidated statements of operations in the period in which they occur.
During 2008, the Company entered into Eurodollar futures contracts to manage its interest rate risk with respect to certain investments. During the first quarter of 2009, the Company closed the futures contracts. A futures contract is a variation of a forward contract, with some additional features, such as a clearinghouse guarantee against credit losses, a daily settlement of gains and losses, and trading on an organized electronic or floor trading facility. Futures contracts are entered either long or short. The Company had entered into the long position, which agrees to buy the underlying currency at the future date at the price agreed upon. As of December 31, 2008, futures contracts were recorded at fair value in other liabilities, with the related changes in fair value recognized as realized investment gains or losses in the consolidated statements of operations in the period in which they occur.
The Company holds options on certain securities within its fixed income portfolio, which allows the Company to extend the maturity date of fixed income securities or allows the Company to convert fixed income securities to equity securities. As a result of changes in accounting, on January 1, 2007, the Company no longer bifurcates these options from the host fixed income securities, and, beginning on January 1, 2007, changes in the fair value of the hybrid financial instruments are recorded as realized investment gains and losses in the Company’s consolidated statements of operations. Prior to these changes in accounting, changes in the fair value of the host instrument were recorded as unrealized investment gains and losses, a component of shareholders’ equity, while changes in the fair value of the embedded options were recorded as realized investment gains and losses. Upon adopting these changes in accounting, the Company recorded a cumulative adjustment of $16.5 million to reclassify unrealized investment gains, net of tax, including foreign currency effects, to retained earnings as of January 1, 2007. The following sets forth the components of the cumulative adjustment as of January 1, 2007 (in thousands):
The Company is required to maintain assets on deposit with various regulatory authorities to support its insurance and reinsurance operations. These requirements are generally promulgated in the statutes and regulations of the individual jurisdictions. The assets on deposit are available to settle insurance and reinsurance liabilities. The Company utilizes trust funds in certain transactions where the trust funds are set up for the benefit of the ceding companies and generally take the place of letter of credit requirements. As of December 31, 2009, restricted assets supporting these deposits and trust fund requirements totaled $1,074.0 million, as depicted in the following table (in thousands):
31, 2009 was principally attributable to a reduction in property catastrophe losses. The increase in losses and loss adjustment expenses for the year ended December 31, 2008 was primarily attributable to increased property catastrophe losses. For the years ended December 31, 2009, 2008 and 2007, current year catastrophe events were $131.1 million, $264.7 million and $105.9 million, respectively. For the year ended December 31, 2009, current year property catastrophe losses included $53.5 million related to Windstorm Klaus, $16.2 million related to Windstorm Wolfgang and $10.4 million related to the floods in Turkey. For the year ended December 31, 2008, current year property catastrophe losses included $143.8 million related to Hurricane Ike, $45.9 million related to the China winter storm, $19.1 million related to Windstorm Emma and $11.3 million related to Hurricane Gustav. For the year ended December 31, 2007, the total catastrophe losses included $38.5 million for Windstorm Kyrill, $12.3 million for Cyclone Gonu and $10.0 million for the Mexico flood in Tabasco.
Net losses and loss adjustment expenses incurred related to prior years decreased $11.3 million and $10.1 million for the years ended December 31, 2009 and 2008, respectively, and increased $40.5 million for the year ended December 31, 2007. The decrease in prior period losses and loss adjustment expenses for the year ended December 31, 2009 was attributable to reduced loss estimates due to loss emergence lower than expectations in the period on business written in the EuroAsia, London Market and U.S. Insurance divisions, partially offset by increased loss estimates due to loss emergence greater than expectations in the period in the Americas division. The decrease in prior period losses and loss adjustment expenses for the year ended December 31, 2008 was attributable to decreased loss estimates due to loss emergence lower than expectations in the period in the London Market and U.S. Insurance divisions, partially offset by increased loss estimates due to loss emergence greater than expectations in the period in the Americas division. The increase in prior period losses and loss adjustment expenses for the year ended December 31, 2007 was attributable to increased loss estimates due to loss emergence greater than expectations in the period in the Americas division and included $21.2 million related to settlement of litigation. This increase was partially offset by decreased loss estimates due to loss emergence lower than expectations in the period in the EuroAsia, London Market, and U.S. Insurance divisions.
The Company has exposure to losses from asbestos, environmental pollution and other latent injury damage claims. Net unpaid asbestos and environmental losses and loss adjustment expenses as of December 31, 2009
In addition, other issues have emerged regarding asbestos exposure that have further impacted the ability to estimate ultimate liabilities for this exposure. These issues include an increasingly aggressive plaintiffs’ bar, an increased involvement of defendants with peripheral exposure, the use of bankruptcy filings due to asbestos liabilities as an attempt to resolve these liabilities to the disadvantage of insurers, the concentration of litigation in venues favorable to plaintiffs, and the potential of asbestos litigation reform at the state or federal level.
The Company’s reserves for asbestos and environmental-related liabilities displayed below are from business written prior to 1986. The Company’s asbestos and environmental reserve development, gross and net of reinsurance, for the years ended December 31, 2009, 2008 and 2007, is set forth in the table below (in thousands):
Net losses and loss adjustment expenses for asbestos claims increased $40.0 million, $41.0 million and $63.0 million for the years ended December 31, 2009, 2008 and 2007, respectively. The increases in net losses and loss adjustment expenses incurred were primarily attributable to the annual reviews of claim activity and loss emergence trend information obtained in the calendar periods from ceding companies and other industry sources. Upon consideration of this new loss emergence information received in 2009, 2008 and 2007, the
In accordance with the terms of certain of its reinsurance agreements, the Company has recorded interest expense associated with its ceded reinsurance agreements of $3.7 million, $5.3 million and $8.0 million for the years ended December 31, 2009, 2008 and 2007, respectively.
Several individual reinsurers are part of the same corporate group. The following table shows the five largest aggregate amounts that are recoverable from all individual entities that form part of the same corporate group as of December 31, 2009 and the amount of collateral held from each group (in thousands):
The components of the Company’s debt obligations as of December 31, 2009 and 2008 were as follows (in thousands):
On February 22, 2006, the Company issued $100.0 million aggregate principal amount of floating rate senior debentures, pursuant to a private placement. The net proceeds from the offering, after fees and expenses, were $99.3 million. The debentures were sold in two tranches: $50.0 million of series A, due March 15, 2021 (the “Series A Notes”), and $50.0 million of series B, due March 15, 2016 (the “Series B Notes”). Interest on each series of debentures is due quarterly in arrears on March 15, June 15, September 15 and December 15 of each year. The interest rate on each series of debentures is equal to the three-month LIBOR, reset quarterly, plus 2.20%. The Series A Notes are callable by the Company on any interest payment date on or after March 15, 2011 at their par value, plus accrued and unpaid interest, and the Series B Notes are callable by the Company on any interest payment date on or after March 15, 2009 at their par value, plus accrued and unpaid interest. For the years ended December 31, 2009 and 2008, the average annual interest rate on each series of notes was 3.18% and 5.41%, respectively.
During the year ended December 31, 2007, the Company converted the remaining Convertible Notes into 1,103,099 shares of the Company’s common stock, resulting in a decrease to Convertible Notes, and a corresponding increase to shareholders’ equity, of $23.5 million.
During the first quarter of 2009 and the fourth quarter of 2008, Odyssey America purchased 704,737 and 128,000 shares, respectively, of the Company’s Series B preferred shares, with a liquidation preference of $17.2 million and $3.1 million, respectively, for $9.2 million and $1.7 million, respectively. As a result of the purchase of the Series B preferred shares, the Company recorded a gain of $8.0 million for the year ended December 31, 2009, and $1.4 million for the year ended December 31, 2008, which amounts were reflected in the Company’s retained earnings and included in net income available to common shareholders.
The financial results of these divisions for the years ended December 31, 2009, 2008 and 2007 are as follows (in thousands):
Domestic pre-tax income was $288.0 million, $642.4 million and $692.8 million for the years ended December 31, 2009, 2008 and 2007, respectively. Foreign pre-tax income was $204.9 million, $185.1 million and $220.4 million for the years ended December 31, 2009, 2008 and 2007, respectively.
The Company files income tax returns with various federal, state and foreign jurisdictions. The Company’s U.S. federal income tax return for 2007 and 2008 remain open for examination. The Internal Revenue Service completed their audit of the Company’s 2005 and 2006 tax returns in January 2010 and will commence their audit of the Company’s 2007 and 2008 tax returns in 2010. There have been no material adjustments proposed under the current audit cycle. Income tax returns filed with various state and foreign jurisdictions remain open to examination in accordance with individual statutes.
On February 8, 2007, the Company was added as a co-defendant in an amended and consolidated complaint in an existing action against the Company’s then-majority (now 100%) shareholder, Fairfax, and certain of Fairfax’s officers and directors, who include certain of the Company’s current and former directors. The amended and consolidated complaint has been filed in the United States District Court for the Southern District of New York by the lead plaintiffs, who seek to represent a class of all purchasers and acquirers of securities of Fairfax between May 21, 2003 and March 22, 2006, inclusive, and allege, among other things, that the defendants violated U.S. federal securities laws by making material misstatements or failing to disclose certain material information. The amended and consolidated complaint seeks, among other things, certification of the putative class, unspecified compensatory damages, unspecified injunctive relief, reasonable costs and attorneys’ fees and other relief. These claims are at a preliminary stage. Pursuant to the scheduling stipulations, the various defendants filed their respective motions to dismiss the amended and consolidated complaint, the lead plaintiffs filed their opposition thereto, and the defendants filed their replies to those oppositions; the motions to dismiss were argued before the Court in December 2007. The Court has not yet issued a ruling on these motions. In November 2009, the Court granted a motion by the lead plaintiffs to withdraw as lead plaintiffs, and allowed other prospective lead plaintiffs 60 days to file motions seeking appointment as replacement lead plaintiff. Two entities filed such motions and subsequently asked the Court to appoint them as co-lead plaintiffs. These motions remain pending. The Company intends to vigorously defend against the allegations. At this early stage of the proceedings, it is not possible to make any determination regarding the likely outcome of this matter.
As of July 14, 2000, Odyssey America agreed to guarantee the performance of all the insurance and reinsurance contract obligations, whether incurred before or after the agreement, of Compagnie Transcontinentale de Réassurance (“CTR”), a subsidiary of Fairfax, in the event CTR became insolvent and CTR was not otherwise indemnified under its guarantee agreement with a Fairfax affiliate. The guarantee, which was entered into while Odyssey America and CTR were each 100% owned by Fairfax, was provided by Odyssey America to facilitate the transfer of renewal rights to CTR’s business, together with certain CTR employees, to Odyssey America in 2000 in order to further expand the Company’s international reinsurance business. The guarantee was terminated effective December 31, 2001. There were no amounts received from CTR under the guarantee, and the Company did not provide any direct consideration for the renewal rights to the business of CTR. CTR was dissolved and its assets and liabilities were assumed by subsidiaries of Fairfax that have the responsibility for the run-off of its liabilities. Although CTR’s liabilities were assumed by Fairfax subsidiaries, the guarantee only pertains to those liabilities attaching to the policies written by CTR. Fairfax has agreed to indemnify Odyssey America for all its obligations incurred under its guarantee. The Company’s potential exposure in connection with this agreement stems from CTR’s remaining gross reserves, which are estimated to be $113.5 million as of December 31, 2009. The Company believes that the financial resources of the Fairfax subsidiaries that have assumed CTR’s liabilities provide adequate protection to satisfy the obligations that are
subject to this guarantee. The Company does not expect to make payments under this guarantee and does not consider its potential exposure under this guarantee to be material to its consolidated financial position.
Odyssey America agreed, as of April 1, 2002, to guarantee the payment of all of the insurance contract obligations (the “Subject Contracts”), whether incurred before or after the agreement, of Falcon Insurance Company (Hong Kong) Limited (“Falcon”), a subsidiary of Fairfax Asia Limited (“Fairfax Asia”), in the event Falcon becomes insolvent. Fairfax Asia is 100% owned by Fairfax, which includes a 26.2% economic interest owned by the Company. The guarantee by Odyssey America was made to assist Falcon in writing business through access to Odyssey America’s financial strength ratings and capital resources. Odyssey America is paid a fee for this guarantee of one percent of all gross premiums earned associated with the Subject Contracts on a quarterly basis. For the years ended December 31, 2009, 2008 and 2007, Falcon paid $0.3 million, $0.3 million and $0.5 million, respectively, to Odyssey America in connection with this guarantee. Odyssey America’s potential exposure in connection with this agreement is estimated to be $52.9 million, based on Falcon’s loss reserves at December 31, 2009. Falcon’s shareholders’ equity on a U.S. GAAP basis is estimated to be $58.4 million as of December 31, 2009. Fairfax has agreed to indemnify Odyssey America for any obligation under this guarantee. The Company believes that the financial resources of Falcon provide adequate protection to support its liabilities in the ordinary course of business. The Company anticipates that Falcon will meet all of its obligations in the normal course of business and does not expect to make any payments under this guarantee. The Company does not consider its potential exposure under this guarantee to be material to its consolidated financial position.
The Company and its subsidiaries are involved from time to time in ordinary litigation and arbitration proceedings as part of the Company’s business operations. In the Company’s opinion, the outcome of these suits, individually or collectively, is not likely to result in judgments that would be material to the financial condition or results of operations of the Company.
Rental expense, before sublease income under these operating leases, was $11.4 million, $11.3 million and $8.2 million for the years ended December 31, 2009, 2008 and 2007, respectively. The Company recovered pre-tax amounts of less than $0.1 million for the year ended December 31, 2009 and $0.1 million for each of the years ended December 31, 2008 and 2007, from subleases.
Odyssey America, the Company’s principal operating subsidiary, is subject to state regulatory restrictions that limit the maximum amount of dividends payable. In any 12-month period, Odyssey America may pay dividends equal to the greater of (i) 10% of statutory capital and surplus as of the prior year end or (ii) net income for such prior year, without prior approval of the Insurance Commissioner of the State of Connecticut (the “Connecticut Commissioner”). The maximum amount of dividends which Odyssey America may pay in 2010, without such prior approval is $351.3 million, based on Odyssey America’s separate company statutory financial statements. Connecticut law further provides that (i) Odyssey America must report to the Connecticut Commissioner, for informational purposes, all dividends and other distributions within five business days after the declaration thereof and at least ten days prior to payment and (ii) Odyssey America may not pay any dividend or distribution in excess of its earned surplus, defined as the insurer’s “unassigned funds surplus” reduced by 25% of unrealized appreciation in value or revaluation of assets or unrealized profits on investments, as reflected in its most recent statutory annual statement on file with the Connecticut Commissioner, without the Connecticut Commissioner’s approval. Odyssey America paid dividends to the Company of $200.0 million, $410.0 million and $155.0 million during the years ended December 31, 2009, 2008 and 2007, respectively.
indemnification agreements have been terminated. The indemnification agreements do not affect the accompanying consolidated financial statements, although Odyssey America’s, Clearwater’s and Hudson’s policyholders’ surpluses as of December 31, 2009 were negatively impacted by $14.4 million, $14.2 million and $0.2 million, respectively.
Written premiums assumed from Fairfax’s affiliates in 2009 represent 0.7% of OdysseyRe’s total gross premiums written for the year ended December 31, 2009. Ceded premiums written represent less than 0.1% of OdysseyRe’s total ceded premiums written for the year ended December 31, 2009. The largest amounts of related party assumed business in 2009 were received from Commonwealth Insurance Company and Lombard General Insurance Company of Canada.
The Company’s subsidiaries have entered into investment management agreements with Fairfax and its wholly-owned subsidiary, Hamblin Watsa Investment Counsel Ltd. These agreements provide for an annual base fee of 0.20% (20 basis points), calculated and paid quarterly based upon the subsidiary’s average invested assets for the preceding three months. The agreements also include incentive fees of 0.10% (10 basis points), which are payable if realized gains exceed 1% of the average investment portfolio in any given year, subject to cumulative realized gains on investments exceeding 1% of the average investment portfolio. Additional incentive fees are paid based upon the performance of the subsidiary’s equity portfolio equal to 10% of the return on equities (subject to an annual maximum) in excess of the Standard & Poor’s 500 index plus 200 basis points, provided that the equity portfolio has achieved such excess on a cumulative basis. If the performance of the equity portfolio does not equal or exceed this benchmark in a given year, the annual base fee, on the equity portion of the portfolio, is reduced to 0.18% (18 basis points). The aggregate annual investment management fee payable by each subsidiary, including incentive fees, is capped at 0.40% (40 basis points) of its investment portfolio, with
The OdysseyRe Foundation, a not-for-profit entity through which the Company provides funding to charitable organizations active in the communities in which the Company operates, was formed in February 2007. Prior to the formation of the OdysseyRe Foundation, the Company provided funding to charitable organizations through the Sixty-Four Foundation, a not-for-profit affiliate of Fairfax and the Company. Included in other expense, net for the years ended December 31, 2009, 2008 and 2007, are incurred charitable contributions of $5.0 million, $3.7 million and $2.5 million, respectively, related to these entities.
The following tables set forth the Plan’s unfunded status and accrued pension cost recognized in the Company’s consolidated financial statements as of December 31, 2009 and 2008 (in thousands):
As of December 31, 2009 and 2008, the fair value and percentage of fair value of the total Plan assets are as follows (in thousands):
The Plan seeks to maximize the economic value of its investments, by applying a long-term, value-oriented approach to optimize the total investment returns of the Plan’s invested assets. Assets are transferred and allocated among various investment vehicles, when appropriate. The long-term rate of return assumption is based on this flexibility to adjust to market conditions. The actual return on assets has historically been in line with the Company’s assumptions of expected returns. During 2009, the Company contributed $3.8 million to the Plan. The Company currently expects to make a contribution to the Plan in 2010 of $3.2 million.
The Company accounts for its Plan assets at fair value as required by GAAP. The Company has categorized its Plan assets, based on the priority of the inputs to the valuation technique, into a three-level fair value hierarchy. The Company uses the three-level hierarchy approach that is described in Note 6.
For determining the fair value of the Company’s Level 1 Plan assets, quoted market prices are used. The majority of these Plan assets are common stocks that are actively traded in a public market. The Plan’s money market account, for which the cost basis approximates fair value, is also classified as a Level 1 investment.
The Company’s Level 2 Plan assets, the majority of which are in government, corporate and municipal fixed income securities, are priced using publicly traded over-the-counter prices and broker-dealer quotes. Observable inputs such as benchmark yields, reported trades, broker-dealer quotes, issuer spreads and bids are available for these investments.
The following tables present the fair value hierarchy for those Plan assets measured at fair value on a recurring basis as of December 31, 2009 (in thousands):
The accumulated benefit obligation for the Plan is $49.6 million and $45.4 million as of the December 31, 2009 and 2008 measurement dates, respectively.
The Company recorded a one-time pension settlement expense of $1.6 million ($1.0 million after-tax) and a corresponding increase to other comprehensive income, during the second quarter of 2008 related to the settlement of retiree benefit obligations from the defined benefit pension plan. The settlement of the retiree benefit obligations resulted in the immediate recognition of a portion of a previously unrecognized actuarial loss. The settlement of retiree benefit obligations had no effect on total shareholders’ equity. Annuities have been purchased for those individuals whose retiree benefit obligations were settled under the defined benefit pension plan. Additionally, as a result of the settlement, the Company’s retiree benefit obligations and the fair value of the plan assets decreased by $7.7 million.
Net periodic benefit cost included in the Company’s consolidated statement of operations for the years ended December 31, 2009, 2008 and 2007 is comprised of the following components (in thousands):
The accumulated benefit obligation for the Excess Plans is $11.2 million and $11.7 million as of December 31, 2009 and 2008, respectively.
The Company estimates that it will record a $1.7 million expense related to the net periodic benefit cost during the year ended December 31, 2010.
Net periodic benefit cost included in the Company’s consolidated statements of operations for the years ended December 31, 2009, 2008 and 2007 is comprised of the following components (in thousands):
The annual assumed rate of increase in the per capita cost of covered benefits (i.e., health care cost trend rate) is assumed to be 8.75% in 2009, decreasing to 5.00% in 2015 and remaining constant thereafter. The health care cost trend rate assumption has a significant effect on the amounts reported. For example, increasing the assumed health care cost trend rates by one percentage point in each year would increase the accumulated postretirement benefit obligation by $4.1 million (16.9% of the benefit obligation as of December 31, 2009) and the service and interest cost components of net periodic postretirement benefit costs by $0.5 million for 2009. Decreasing the assumed health care cost trend rates by one percentage point in each year would decrease the accumulated postretirement benefit obligation and the service and interest cost components of net periodic postretirement benefit cost for 2009 by $3.4 million and $0.4 million, respectively.
The Company maintains a qualified deferred compensation plan pursuant to Section 401(k) of the Internal Revenue Code of 1986, as amended. Employees may contribute up to 50% of base salary on a pre-tax basis, subject to annual maximum contributions set by law ($16,500 in 2009). The Company contributes an amount equal to 100% of each employee’s pre-tax contribution up to certain limits. The maximum matching contribution is 4% of annual base salary, with certain government-mandated restrictions on contributions to highly compensated employees. The Company also maintains a non-qualified deferred compensation plan to allow for contributions in excess of qualified plan limitations. The Company’s contributions to these plans of $2.0 million in 2009, and $1.8 million in both 2008 and 2007, are included in other underwriting expenses in the consolidated statements of operations.
The Company had previously established three stock-based compensation plans (the “Stock-Based Compensation Plans”): the Odyssey Re Holdings Corp. 2002 Stock Incentive Plan (the “2002 Option Plan”), the Odyssey Re Holdings Corp. Stock Option Plan (the “2001 Option Plan”) and the Odyssey Re Holdings Corp. Restricted Share Plan (the “Restricted Share Plan”). The Stock-Based Compensation Plans generally provided officers, key employees and directors who were employed by or provided services to the Company, with stock options and/or restricted share awards. As a result of the Merger (see Note 1), the Stock-Based Compensation Plans were amended to allow for the conversion, substitution and issuance of restricted equity value rights (“REVRs”). Specifically, the Restricted Share Plan was amended and restated, as of October 28, 2009, as the “Odyssey Re Holdings Corp. Restricted Share and Equity Value Plan” (the “REVR Plan”).
In connection with the Merger, the common shares underlying each unvested option granted under the 2001 Option Plan and the 2002 Option Plan were converted into 1.2524 REVRs. Each REVR became exercisable, subject to the same terms and conditions, including the vesting schedule, as applicable to such option prior to the conversion.
Under the terms of the REVR Plan, each REVR has a value (the “REVR Value”) equal to the most recently reported common shareholders’ equity of the Company, as adjusted in accordance with the REVR Plan, divided by 58,443,149, which was the number of Company common shares outstanding as of September 30, 2009. Upon vesting of a REVR, a participant will receive a single sum cash payment equal to the REVR value as of the applicable vesting date, less any applicable withholding of taxes. The REVRs will be subject to the terms and conditions of the REVR Plan, including vesting and termination of employment provisions, and will not be paid until a participant satisfies the applicable vesting requirements.
The following table summarizes activity for the Restricted Cash Units and REVR Plan for the year ended December 31, 2009:
The Company has been provided with a geographic distribution of the debt service from all of its cedants. The following table summarizes the information which has been received by the Company from its cedants (in thousands):
A summary of selected quarterly financial information follows for each of the quarters in the years ended December 31, 2009 and 2008 (in thousands, except share amounts):
The condensed financial statements should be read in conjunction with the accompanying note and with the consolidated financial statements and notes thereto.