The Company leases office space in Hamilton (Bermuda) where the Company’s principal executive offices are located. Additionally, the Company leases office space in various locations, including Beijing, Dublin, Greenwich (Connecticut), Hong Kong, Mexico City, Miami, Montreal, New York, Paris, Santiago, Sao Paulo, Seoul, Singapore, Tokyo, Toronto, Washington, D.C., Zug and Zurich.
Successful risk management is the foundation of the Company’s value proposition, with diversification of risks at the core of its risk management strategy. The Company’s ability to succeed in the risk assumption and management business is dependent on its ability to accurately analyze and quantify risk, to understand volatility and how risks aggregate or correlate, and to establish the appropriate capital requirements and limits for the risks assumed. All risks, whether they are reinsurance related risks or capital market risks, are managed by the Company within an integrated framework of policies and processes that ensure the intelligent and consistent evaluation and valuation of risk, and ultimately provide an appropriate return to shareholders. For further discussion of the Company’s risk management framework, see Risk Management in Item 1 of Part I of this report.
The following discussion provides an overview of the Company’s business and trends and commentary regarding the outlook for 2012 in each business.
A key challenge facing the Company is to successfully manage risk through all phases of the reinsurance cycle. The Company believes that its long-term strategy of closely monitoring the progression of each line of business, being selective in the business that it writes, and maintaining the diversification and balance of its portfolio, will optimize returns over the reinsurance cycle. Individual lines of business and markets have their own unique characteristics and are at different stages of the reinsurance pricing cycle at any given point in time. Management believes it has achieved appropriate portfolio diversification by product, geography, line and type of business, length of tail, and distribution channel, and that this diversification, in addition to the financial strength of the Company and its strong global franchise, will help to mitigate cyclical declines in underwriting profitability and to achieve a more stable return over the reinsurance cycle.
During the January 2012 renewals, the Company experienced a modest increase in expected premium volume despite fragmented market conditions with reductions in pricing and increased cedant retentions in certain lines of business, while pricing improvements were observed in other areas. Management believes it has improved the balance and diversification in its portfolio by continuing to reduce its catastrophe exposures at January 1, 2012.
The Company’s Life segment derives revenues primarily from renewal premiums from existing reinsurance treaties and new premiums from existing or new reinsurance treaties. The long-term profitability of the Life segment mainly depends on the volume and amount of death claims incurred and the ability to adequately price the risk the Company assumes. The life reinsurance policies are often in force for the remaining lifetime of the underlying individuals insured, with premiums earned typically over a period of 10 to 30 years. The volume of the business may be reduced each year by terminations of the underlying treaties related to lapses, voluntary surrenders, death of insureds and recaptures by ceding companies. While death claims are reasonably predictable over a period of many years, claims become less predictable over shorter periods and can fluctuate significantly from quarter to quarter or from year to year.
Within the Company’s Life segment, the reinsurance market is differentiated between mortality (including disability) and longevity products, with mortality being the larger market. For both the mortality and longevity markets, the Company observed attractive opportunities to grow the portfolio during 2011. Management believes the life business provides the Company with additional diversification benefits and balance to its portfolio as it is generally non-correlated to the Company’s Non-life business. The Company does not write new life business in the U.S. market.
Given the majority of the Company’s Life segment contracts are written on a continuous basis, the January 1 renewals impact a relatively limited portion of the portfolio, which is exclusive to the mortality line. The Company observed unchanged pricing conditions and terms for renewals, leading the Company to cancel or reduce certain treaty participations, which was largely offset by improved terms on certain other existing treaties and new business from both new and existing clients.
In addition to the Consolidated Balance Sheets and Consolidated Statements of Operations and Comprehensive (Loss) Income, Management uses certain key measures to evaluate its financial performance and the overall growth in value generated for the Company’s common shareholders. The four key measures that Management uses, together with definitions of their calculations, are as follows at December 31, 2011 and 2010 and for the years ended December 31, 2011, 2010 and 2009:
Effective January 1, 2011, Management redefined its operating earnings or loss available to common shareholders (operating earnings or loss) calculation to additionally exclude net foreign exchange gains or losses. Management believes that net foreign exchange gains or losses are not indicative of the performance of, and distort trends in, the Company’s business as they predominantly result from general economic and foreign
The Company’s Diluted Book Value per Share decreased by 10% to $84.82 at December 31, 2011 from $93.77 at December 31, 2010, primarily due to the comprehensive loss of $537 million. The comprehensive loss was driven by the net loss of $520 million resulting primarily from the significant level of 2011 catastrophic events and dividends declared on the Company’s common and preferred shares of $206 million. These decreases were partially offset by the accretive impact of share repurchases during 2011. Net loss for the year ended December 31, 2011 and the significant level of 2011 catastrophic losses are described in Overview and Review of Net (Loss) Income below.
Operating earnings or loss available to common shareholders (operating earnings or loss): Management uses operating earnings or loss to measure its financial performance as this measure focuses on the underlying fundamentals of the Company’s operations by excluding net realized and unrealized gains or losses on investments, interest in earnings or losses of equity investments and net foreign exchange gains or losses. Net realized and unrealized gains or losses on investments in any particular period are not indicative of the performance of, and distort trends in, the Company’s business as they predominantly result from general economic and financial market conditions, and the timing of realized gains or losses on investments is largely opportunistic. Interest in earnings or losses of equity investments are also not indicative of the performance of, or trends in, the Company’s business as the Company does not control the investee companies’ activities. Net foreign exchange gains or losses are not indicative of the performance of, and distort trends in, the Company’s business as they predominantly result from general economic and foreign exchange market conditions. Management believes that the use of operating earnings or loss enables investors and other users of the Company’s financial information to analyze its performance in a manner similar to how Management analyzes performance. Management also believes that this measure follows industry practice and, therefore, allows the users of financial information to compare the Company’s performance with its industry peer group, and that the equity analysts and certain rating agencies which follow the Company, and the insurance industry as a whole, generally exclude these items from their analyses for the same reasons.
Operating earnings decreased by $1,134 million, from $492 million in 2010 to a loss of $642 million in 2011 mainly due to a decrease in the Non-life underwriting result of $1,177 million, which was driven primarily
Operating ROE decreased from 7.4% in 2010 to a loss of 10.1% in 2011. The decrease in Operating ROE was primarily due to the decrease in operating earnings, which was driven by the large 2011 catastrophic events.
Operating ROE decreased from 22.3% in 2009 to 7.4% in 2010 primarily due to the decrease in operating earnings and a higher beginning diluted book value per share balance in 2010 compared to 2009, which also resulted in a reduction in the Company’s premium leverage. The higher beginning diluted book value per share balance in 2010 was due to the strong net income during 2009.
Since 2002, the Company has had eight years of underwriting profitability reflected in combined ratios of less than 100% for its Non-life segment, with the only exceptions being 2005 and 2011. In 2005, when the industry recorded its worst year in history in terms of catastrophe losses, with Hurricane Katrina being the largest insured event ever, the Company recorded a net underwriting loss and Non-life combined ratio of 116.3%. In
The increase in the Non-life combined ratio of 30.4 points to 125.4% in 2011 from 95.0% in 2010 was primarily due to an increase in catastrophic loss activity. The large 2011 catastrophic events contributed 45.2 points to the combined ratio in 2011. In comparison, the Non-life combined ratio included 13.9 points for the year ended December 31, 2010 related to the Chile Earthquake, 2010 New Zealand Earthquake, the explosion and subsequent sinking of the Deepwater Horizon Drilling Platform (Deepwater Horizon) and an aggregate contract covering losses in Australia and New Zealand (collectively, 2010 catastrophic and large loss events).
Because a significant amount of time can elapse between the assumption of risk, occurrence of a loss event, the reporting of the event to an insurance company (the primary company or the cedant), the subsequent reporting to the reinsurance company (the reinsurer) and the ultimate payment of the claim on the loss event by
The reserve methodologies employed by the Company are dependent on data that the Company collects. This data consists primarily of loss amounts and loss payments reported by the Company’s cedants, and premiums written and earned reported by cedants or estimated by the Company. The actuarial methods used by the Company to project loss reserves that it will pay in the future (future liabilities) do not generally include methodologies that are dependent on claim counts reported, claim counts settled or claim counts open as, due to the nature of the Company’s business, this information is not routinely provided by cedants for every treaty.
A brief description of the reserving methods commonly employed by the Company and a discussion of their particular advantages and disadvantages follows:
The main strengths of the method are that it is reactive to loss emergence (payments) and that it makes full use of historical experience on claim emergence (payments). For homogeneous low volatility lines, under stable economic conditions the method can often produce good estimates of ultimate liabilities and reserves. However, the method has weaknesses when the underlying assumption of stable patterns is not true. This may be the consequence of changes in the mix of business, changes in claim inflation trends, changes in claim reporting practices or the presence of large claims, among other things. Furthermore, the method tends to produce volatile estimates of ultimate liabilities in situations where there is volatility in reported (paid) patterns. In particular, when the expected percentage reported (paid) is low, small deviations between actual and expected claims can lead to very volatile estimates of ultimate liabilities and reserves. Consequently, this method is often unsuitable for projections at early development stages of an underwriting year. Finally, the method fails to incorporate any information regarding market conditions, pricing, etc., which could improve the estimate of liabilities and reserves. It therefore tends not to perform very well in situations where there are rapidly changing market conditions.
estimate of ultimate liabilities (usually determined by multiplying an a priori loss ratio with estimates of premium volume). The accuracy of the a priori loss ratio is a critical assumption in this method. Usually a priori loss ratios are initially determined on the basis of pricing information, but may also be adjusted to reflect other information that subsequently emerges about underlying loss experience.
Although the method tends to provide less volatile indications at early stages of development and reflects changes in the external environment, this method can be slow to react to emerging loss development (payment). In particular, to the extent that the a priori loss ratios prove to be inaccurate (and are not revised), the B-F methods will produce loss estimates that take longer to converge with the final settlement value of loss liabilities.
(iii) the a priori loss ratios used as inputs in the B-F methods; and
(viii) the Company can form a credible initial expectation of the ultimate loss ratio of recent underwriting years through a review of pricing information, supplemented by qualitative information on market events.
During 2011, 2010 and 2009, the Company reviewed its estimate for prior year losses for the Non-life segment and, in light of developing data, adjusted its ultimate loss ratios for prior accident years. The following table summarizes the net prior year favorable reserve development for each sub-segment of the Company’s Non-life segment for the years ended December 31, 2011, 2010 and 2009 (in millions of U.S. dollars):
The table below summarizes the net prior year favorable (adverse) reserve development for the year ended December 31, 2011 by reserving line for the Company’s Non-life segment (in millions of U.S. dollars):
The following paragraphs discuss how losses paid and reported during the year ended December 31, 2011 compared with the Company’s expectations, and how the Company modified its reserving parameter assumptions in line with the emerging development in each reserving line.
Aviation / Space: The overall losses reported during the year were significantly lower than the Company’s expectations. The Company reflected this experience by selecting lower loss ratios for underwriting years 2008 to 2010.
Engineering: Aggregate reported losses were modestly higher than expected losses for the year, which was driven by increases in premium exposure for various underwriting years. The Company did not materially change its reserving assumptions for this line.
Marine/Energy Offshore: Aggregate reported losses during the year were lower than expected. The Company reacted to the favorable experience by reducing loss ratios for the 2007- 2009 underwriting years.
Aggregate losses reported for the Global (Non-U.S.) motor non-proportional line were significantly lower than expectations in most countries resulting in the Company lowering its loss development tail factor assumptions in addition to reflecting the experience within their loss ratio picks.
Aggregate losses reported for the Global (Non-U.S.) motor proportional line were modestly lower than expected resulting in the Company lowering its loss development tail factor assumptions in addition to reflecting the experience within their loss ratio picks.
(1) Tail factors are defined as aggregate development factors after 10 years from the inception of an underwriting year.
The net loss reserves represent the Company’s best estimate of future losses and loss expense amounts based on the information available at December 31, 2011. Loss reserves rely upon estimates involving actuarial and statistical projections at a given time that reflect the Company’s expectations of the costs of the ultimate settlement and administration of claims. Estimates of ultimate liabilities are contingent on many future events and the eventual outcome of these events may be different from the assumptions underlying the reserve estimates. In the event that the business environment and social trends diverge from historical trends, the Company may have to adjust its loss reserves to amounts falling significantly outside its current estimate. These estimates are continually reviewed and the ultimate liability may be in excess of, or less than, the amounts provided, for which any adjustments will be reflected in the period in which the need for an adjustment is determined.
Of the Company’s $10,920 million of net Non-life loss reserves at December 31, 2011, net loss reserves for accident years 2005 and prior of $1,012 million are guaranteed by Colisée Re, pursuant to the Reserve Agreement. The Company is not subject to any loss reserve variability associated with the guaranteed reserves. See Business - Reserves in Item 1 of Part I of this report.
Loss estimates arising from earthquakes are inherently more uncertain than those from other catastrophic events. The Company’s actual losses from the 2010 and the February and June 2011 New Zealand Earthquakes may materially exceed the estimated losses as a result of, among other things, an increase in industry insured loss estimates, the expected lengthy claims development period, in particular for earthquake related losses, and the receipt of additional information from cedants, brokers and loss adjusters. In addition, the Company’s loss estimate related to the Japan Earthquake is inherently more uncertain than those from other catastrophic events
given the characteristics of the Company’s reinsurance portfolio in the region. Further, changes in loss assumptions for specific cedants may have a material impact on the Company’s loss estimate related to this event given a significant portion of the losses are concentrated with a few large cedants. The Company believes there remains a high degree of uncertainty related to its loss estimates related to the 2010 and the February and June 2011 New Zealand Earthquakes and the Japan Earthquake, and the ultimate losses arising from these events may be materially in excess of, or less than, the amounts provided for in the Consolidated Balance Sheet at December 31, 2011.
Based upon information currently available and the estimated range of potential ultimate liabilities, the Company believes that unpaid loss and loss expense reserves contemplate a reasonable provision for exposure related to the 2011 catastrophic events. In addition to the sum of the point estimates recorded for each of the 2011 catastrophic events, the Company has recorded additional gross reserves of $50 million (net reserves of $48 million after the impact of retrocession), specifically related to the 2011 catastrophic events within its Catastrophe sub-segment. The additional gross reserves recorded are in consideration of the number of events, the complexity of certain events and the continuing uncertainties in estimating the ultimate losses for these events in the aggregate, as discussed in the preceding paragraphs.
Included in the business that is considered to have a long reporting tail is the Company’s exposure to asbestos and environmental claims. The Company’s net reserves for unpaid losses and loss expenses at December 31, 2011 included $195 million that represents estimates of its net ultimate liability for asbestos and environmental claims. The gross liability for such claims at December 31, 2011 was $203 million, which primarily relates to Paris Re’s gross liability for asbestos and environmental claims for accident years 2005 and prior of $127 million, with any favorable or adverse development being subject to the Reserve Agreement. Of the remaining $76 million in gross reserves, the majority relates to casualty exposures in the United States arising from business written by PartnerRe SA and PartnerRe U.S.
The reserves for the annuity portfolio of reinsurance contracts within the longevity book are established in accordance with the provisions for long duration insurance contracts under U.S. GAAP. Many of these contracts subject the Company to risks arising from policyholder mortality over a period that extends beyond the periods in which premiums are collected. For long duration contracts, the Company establishes initial reserves based upon Management’s best estimate of policy benefits and includes a provision for adverse deviation. Management’s best estimate relies upon actuarial indications of future policy benefits. The provision for adverse deviation contemplates reasonable deviations from the best estimate assumptions for the key risk elements relevant to the product being evaluated, including mortality, critical illness, persistency, expenses, and discount rate among others, and are recorded in accordance with U.S. GAAP and applicable actuarial standards. The Company’s actuaries annually verify the current reserving assumptions in consideration of evolving experience and the actuarial indications for assumptions relating to future policy benefits, including mortality, critical illness, persistency, and future investment income, among others. Management makes no adjustments to recorded deferred acquisition costs or future policy benefits if the actuarial indications conclude that current recorded U.S. GAAP policy benefits are adequate. The Company establishes a premium deficiency reserve, or an increase to future policy benefits to the extent that deferred acquisition costs are insufficient to cover the premium deficiency reserve, if the actuarial indication of life policy benefits is greater than current recorded aggregate amounts for policy benefits, settlement costs, and deferred acquisition costs.
The reserves for the long-term traditional mortality and TCI reinsurance portfolio are established in accordance with the provisions for long duration insurance contracts under U.S. GAAP and follow the reserving methodology discussed under the Longevity section above.
The reserves for the guaranteed minimum death benefits (GMDB) reinsurance business are established in accordance with the provisions for universal life contracts under U.S. GAAP. Key actuarial assumptions for this business are mortality, lapses, interest rates, expected returns on cash and bonds and stock market performance. For the last parameter, a stochastic option pricing approach is used and the benefits used in calculating the liabilities are based on the average benefits payable over a range of scenarios. The assumptions of investment performance and volatility are consistent with expected future experience of the respective underlying funds available for policyholder investment options. Recorded reserves for GMDB reflect Management’s best estimate which relies upon the quarterly actuarial indications.
Total gross policy benefits for life and annuity contracts include provisions for adverse deviation of $108 million and $85 million at December 31, 2011 and 2010, respectively. The increase in the provisions for adverse deviation is a result of new business written in the longevity line.
The sensitivity of a 1% per annum improvement in mortality rates related to standard annuities in the longevity line has increased from $122 million in 2010 to $177 million in 2011 due to a significant mortality swap written in the longevity line in 2011.
The magnitude and impact of changes in premium estimates differs for proportional and non-proportional treaties. Although proportional treaties may be subject to larger changes in premium estimates compared to non-proportional treaties, as the Company generally receives cedant statements in arrears and must estimate all premiums for periods ranging from one month to more than one year (depending on the frequency of cedant statements), the pre-tax impact is mitigated by changes in the cedant’s related reported acquisition costs and losses. The impact of the change in estimate on premiums earned and pre-tax results varies depending on when the change becomes known during the risk period and the underlying profitability of the treaty. Non-proportional treaties generally include a fixed minimum premium and an adjustment premium. While the fixed minimum premiums require no estimation, adjustment premiums are estimated and could be subject to changes in estimates.
(1) The estimate assumes that the changes in net premiums written become known at the mid-point of the risk period and is made by applying the reported technical ratio, before the impact of the 2011 catastrophic events and prior year loss reserve development, for the year ended December 31, 2011.
(3) The estimate relates to all of the Company’s Non-life treaties (both proportional and non-proportional) and assumes that the changes become known at the mid-point of the risk period and also assumes there is no change in premium estimates.
The Company has estimated the future tax effects attributed to temporary differences and has a deferred tax asset at December 31, 2011 of $157 million, net of a valuation allowance of $29 million. The most significant components of the deferred tax asset relate to loss reserve discounting for tax purposes.
The Company has projected future taxable income in the tax jurisdictions in which the deferred tax assets arise. These projections are based on Management’s projections of premium and investment income, capital gains and losses, and technical and expense ratios. Based on these projections and an analysis of the ability to utilize loss and foreign tax credits carryforwards at the taxable entity level, Management evaluates the need for a valuation allowance. The valuation allowance of $29 million, recorded at December 31, 2011, related to a tax loss carryforward in Singapore.
The Company must determine the appropriate level in the hierarchy for each financial instrument that it measures at fair value. In determining fair value, the Company uses various valuation approaches, including market, income and cost approaches. See Note 3 to Consolidated Financial Statements in Item 8 of Part II of this report for more detail on the valuation techniques, methods and assumptions that were used by the Company to estimate the fair value of its fixed maturities and short-term investments, equities, other invested assets and its fixed maturities, short-term investments and other invested assets underlying the funds held - directly managed account. See Note 6 to Consolidated Financial Statements in Item 8 of Part II of this report for more discussion of the Company’s use of derivative financial instruments.
For the Company’s Level 3 fixed maturities, equities, other invested assets and investments underlying the funds held - directly managed account, a 10% decline in the fair value of these investments at December 31, 2011 would result in a $61 million pre-tax charge to net income or loss and a corresponding reduction in total assets.
In addition, included in the Company’s other invested assets are various investments which are accounted for using the cost method of accounting, equity method of accounting or investment company accounting, totaling $268 million at December 31, 2011. The Company does not measure its investments that are accounted for using any of these three methods at fair value. For investments that are accounted for using the cost method of accounting, equity method of accounting or investment company accounting, a 10% decline in the carrying value of these investments at December 31, 2011 would result in a $27 million pre-tax charge to net income or loss and a corresponding reduction in investments and total assets.
respectively. At December 31, 2011, the Company estimated that a 10% improvement in the mortality assumption used in the Company’s internal valuation models for its longevity swaps would result in a $4 million decrease in the fair value of its longevity swap portfolio. The Level 3 weather derivatives are exposed to various wind events, with maximum aggregate limits of $15 million, and any change in the assumptions used in the Company’s internal models would have an insignificant impact on the fair values at December 31, 2011.
In making an assessment of the value of its goodwill, the Company uses both market based and non-market based valuations. The fair value of the reporting units is determined based on the earnings multiple, present value of estimated cash flows and present value of future profits methods. Significant changes in the data underlying these assumptions could result in an assessment of impairment of the Company’s goodwill asset. In addition, if the current economic environment and/or the Company’s financial performance were to deteriorate significantly, this could lead to an impairment of goodwill, the write-off of which would be recorded against net income in the period such deterioration occurred.
The Company measures its performance in several ways. Among the performance measures accepted under U.S. GAAP is diluted net income or loss per share, a measure that focuses on the return provided to the Company’s common shareholders. Diluted net income or loss per share is obtained by dividing net income or loss available to common shareholders by the weighted average number of common shares and common share equivalents outstanding. Net income or loss available to common shareholders is defined as net income or loss less preferred dividends. See the discussion of the non-GAAP performance measures that the Company uses (operating earnings or loss and Operating ROE) and the reconciliation of those non-GAAP measures to the most comparable GAAP measures in Key Financial Measures below.
the losses related to large catastrophic and large loss events in the years ended December 31, 2011 and 2010, compared to no significant catastrophic losses in the year ended December 31, 2009;
the decrease in gross and net premiums written and net premiums earned in the Non-life segment. These decreases are primarily due to cancellations and non-renewals of business as a result of declines in pricing in certain competitive markets and the repositioning of the Company’s portfolio following the integration of Paris Re’s business, including a reduction in catastrophe exposures;
costs related to the integration of Paris Re. These costs include charges related to the Company’s voluntary termination plan (voluntary plan) available to certain eligible employees in France, announced in April 2010 as part of the Company’s integration of Paris Re.
As the Company’s reinsurance operations are exposed to low frequency and high severity risk events, some of which are seasonal, results for certain periods may include unusually low loss experience, while results for other periods may include significant catastrophic losses. For example, the Company’s results for 2009 included no significant catastrophic losses, while 2010 included losses from large catastrophic and large loss events, and 2011 included an unusually high frequency of high severity catastrophic events, in particular the Japan Earthquake and the February and June 2011 New Zealand Earthquakes.
In 2011, the Company incurred losses, net of retrocession, reinstatement premiums and profit commission adjustments, of $1,790 million related to the combined impact of the 2011 catastrophic events. The Company’s incurred net losses related to these events included $919 million related to the Japan Earthquake, $455 million related to the February and June 2011 New Zealand Earthquakes, $120 million related to the Thailand Floods, $107 million related to the U.S. tornadoes, $100 million related to aggregate contracts covering losses in New Zealand and Australia, $41 million related to the Australian Floods and an additional IBNR reserve of $48 million related to the 2011 catastrophic events, above the sum of the recorded point estimates, given the high frequency of, and uncertainty related to, these complex and volatile events (see Results by Segment below and Critical Accounting Policies-Reserves above for further details).
In comparison, the Company incurred large catastrophic and large losses of $559 million in 2010, net of retrocession, reinstatement premiums and profit commission adjustments, related to the combined impact of the Chile Earthquake, 2010 New Zealand Earthquake, Deepwater Horizon and an aggregate contract covering losses in Australia and New Zealand.
In 2011, U.S. and European risk-free interest rates decreased and credit spreads widened, while the U.S. dollar ending exchange rate at December 31, 2011 strengthened against most major currencies compared to December 31, 2010. Equity markets were relatively flat over the full year of 2011, despite volatility during the quarterly periods. As a result of these movements, the value of the Company’s investment portfolio and cash and cash equivalents at December 31, 2011 increased compared to December 31, 2010, positively affected by the impact of decreased risk-free interest rates, which were largely offset by the impact of widening credit spreads and foreign exchange rates.
In 2010, the Company recorded pre-tax charges of $41 million related to the costs of the voluntary plan within other operating expenses in its Corporate and Other segment. Participating employees will continue to receive salary and other employment benefits until they leave the Company. The continuing salary and other employment benefit costs related to employees participating in the voluntary plan will be expensed as the employee provides service and remains with the Company. Following their departure from the Company, the employees will continue to receive the pre-determined payments related to employment benefits, which were accrued for by the Company under the terms of the voluntary plan during the year ended December 31, 2010.
The decrease in net income, net income available to common shareholders and diluted net income per share for 2011 compared to 2010 resulted primarily from:
a decrease in the Non-life underwriting result of $1,177 million, which was driven by the 2011 catastrophic events, a modestly higher level of mid-sized loss activity and lower profitability driven by declines in pricing in certain lines of business. These decreases were partially offset by a modestly higher level of favorable prior year loss development in 2011 compared to 2010;
a decrease in pre-tax net realized and unrealized investment gains of $335 million; and
a decrease in net investment income of $44 million, primarily driven by lower reinvestment rates; partially offset by
a decrease in other corporate operating expenses of $67 million, primarily driven by the charges related to the Company’s voluntary termination plan in 2010;
The decrease in net income, net income available to common shareholders and diluted net income per share for 2010 compared to 2009 resulted primarily from:
a decrease in the Non-life underwriting result of $451 million, driven by large catastrophic losses related to the Chile Earthquake and 2010 New Zealand Earthquake, and losses related to Deepwater Horizon and an aggregate contract covering losses in Australia and New Zealand;
a decrease in income tax expense of $133 million, resulting primarily from a lower pre-tax income; and
an increase in net investment income of $77 million, driven by the inclusion of Paris Re’s net investment income for a full year in 2010 compared to the fourth quarter only in 2009.
The components of net (loss) income for the years ended December 31, 2011, 2010 and 2009 were as follows (in millions of U.S. dollars):
(2) Technical result and other income primarily relate to income on insurance-linked securities and principal finance transactions within the Corporate and Other segment. See the discussion in Corporate and Other - Technical Result and Other Income below for more details.
(3) Amortization of intangible assets relates to intangible assets acquired in the acquisition of Paris Re in 2009.
an increase in net favorable loss development on prior accident years of $52 million, from $478 million in 2010 to $530 million in 2011. The components of the net favorable loss development are described in more detail in the discussion of individual sub-segments in Results by Segment below; and
a decrease in other operating expenses of $34 million, primarily driven by lower personnel costs.
Net investment income decreased by $44 million, from $673 million in 2010 to $629 million in 2011. The decrease in net investment income of 6% is primarily attributable to a decrease in net investment income from fixed maturities and the fixed maturities underlying the funds held - directly managed account due to lower reinvestment rates. See Corporate and Other - Net Investment Income below for more details.
Income tax expense decreased by $60 million, from $129 million in 2010 to $69 million in 2011. The decrease in the income tax expense was primarily due to the Company’s taxable jurisdictions generating a lower pre-tax income in 2011 compared to 2010. See Corporate and Other - Income Taxes below for more details.
The underwriting result for the Non-life segment decreased by $451 million, from $655 million in 2009 to $204 million in 2010. The decrease was principally attributable to:
a decrease in net favorable loss development on prior years of $8 million, from $486 million in 2009 to $478 million in 2010. The components of the net favorable loss development are described in more detail in the discussion of individual sub-segments in Results by Segment below; partially offset by
Underwriting result for the Life segment decreased by $40 million, from a loss of $11 million in 2009 to a loss of $51 million in 2010. The decrease was primarily driven by net adverse prior year loss development in the longevity line in 2010 compared to net favorable prior year development in the mortality line in 2009. See Results by Segment below.
Net realized and unrealized investment gains decreased by $189 million, from $591 million in 2009 to $402 million in 2010. The net realized and unrealized investment gains of $402 million in 2010 were primarily due to decreases in U.S. and European risk-free interest rates and increases in equity markets. Net realized and unrealized investment gains of $402 million in 2010 consist of net realized investment gains on fixed maturities, short-term investments and equities of $218 million, the change in net unrealized investment gains on fixed maturities, short-term investments, equities and other invested assets of $212 million, net realized and unrealized investment gains on funds held - directly managed and net other realized and unrealized gains of $40 million, which were partially offset by net realized losses on other invested assets of $68 million.
Interest expense increased by $16 million, from $28 million in 2009 to $44 million in 2010 mainly due to interest related to the issuance of $500 million 5.500% Senior Notes in 2010.
Net foreign exchange losses increased by $20 million, from $1 million in 2009 to $21 million in 2010. The increase in net foreign exchange losses in 2010 resulted primarily from losses arising from the impact of the Company’s hedging program, partially offset by currency movements on unhedged equity securities. The Company hedges a significant portion of its currency risk exposure as discussed in Quantitative and Qualitative Disclosures about Market Risk in Item 3 of Part I of this report.
The Company monitors the performance of its operations in three segments, Non-life, Life and Corporate & Other. The Non-life segment is further divided into four sub-segments, North America, Global (Non-U.S.) Property and Casualty (Global (Non-U.S.) P&C), Global (Non-U.S.) Specialty and Catastrophe. Segments and sub-segments represent markets that are reasonably homogeneous in terms of geography, client types, buying patterns, underlying risk patterns and approach to risk management. See the description of the Company’s segments and sub-segments as well as a discussion of how the Company measures its segment results in Note 22 to Consolidated Financial Statements included in Item 8 of Part II of this report.
The North America sub-segment is comprised of lines of business that are considered to be either short, medium or long-tail. The short-tail lines consist primarily of agriculture, property and motor business and represented 48%, 47% and 54% of net premiums written in this sub-segment in 2011, 2010 and 2009, respectively. Casualty is considered to be long-tail and represented 40%, 42% and 37% of net premiums written in 2011, 2010 and 2009, respectively, while credit/surety and multiline are considered to have a medium-tail and accounted for the balance of net premiums written in this sub-segment. The casualty line typically tends to have a higher loss ratio and a lower technical result, due to the long-tail nature of the risks involved. Casualty treaties typically provide for investment income on premiums invested over a longer period as losses are typically paid later than for other lines. Investment income, however, is not considered in the calculation of technical result.
(1) Technical result is defined as net premiums earned less losses and loss expenses and acquisition costs.
The North America sub-segment represented 24%, 22% and 30% of total net premiums written in 2011, 2010 and 2009, respectively. The increase in the North America sub-segment’s net premiums written as a percentage of total net premiums written in 2011 compared to 2010 was mainly due to higher net premiums written in this sub-segment, primarily in the agriculture line of business, and decreases in net premiums written in the Company’s other Non-life sub-segments. The decrease in the North America sub-segment’s net premiums written as a percentage of total net premiums written in 2010 compared to 2009 was primarily due to lower net premiums written in the agriculture line of business, overall declining market conditions and the inclusion of the majority of Paris Re’s premiums in the Company’s other Non-life sub-segments.
Gross and net premiums written and net premiums earned increased by 7%, 8% and 9%, respectively, in 2011 compared to 2010. The increases in gross and net premiums written and net premiums earned were primarily attributable to the agriculture line of business and were mainly driven by increased demand, higher agricultural commodity prices and lower downward premium adjustments. The increase in gross and net premiums written and net premiums earned was partially offset by decreases in certain lines, primarily in the property line, driven by cancellations and lower renewals due to increased retentions and reductions in pricing, as
large catastrophic losses, primarily related to the U.S. tornadoes, of $56 million, or 4.9 points on the loss ratio;
The increase of $164 million in losses and loss expenses in 2011 compared to 2010 included:
an increase of approximately $137 million in losses and loss expenses resulting from the increase in the book of business and exposure and the related change in the mix of business towards the agriculture line of business, the impact of declining pricing and profitability of the business between periods and a higher level of mid-sized loss activity; and
an increase of $51 million in large catastrophic losses and large losses and loss expenses; partially offset by
losses and loss expenses related to Deepwater Horizon of $5 million, or 0.5 points on the loss ratio;
a lower level of loss estimates recorded in the casualty line of business reflecting abating economic and financial market conditions; and
The decrease of $151 million in losses and loss expenses in 2010 compared to 2009 included:
a decrease of $12 million in net favorable prior year loss development; and
The decrease of $55 million in the technical result and the corresponding increase in the technical ratio in 2011 compared to 2010 was primarily attributable to an increase of $45 million, net of profit commissions, in large catastrophic losses and large losses, the change in the mix of business towards the agriculture line, the impact of declining pricing and profitability of the business and a higher level of mid-sized loss activity. These decreases in the technical result were partially offset by an increase of $24 million in net favorable prior year loss development.
The increase of $2 million in the technical result and the corresponding decrease in technical ratio in 2010 compared to 2009 was primarily attributable to a lower level of loss estimates recorded in the casualty line of business and normal fluctuations in profitability between periods, partially offset by a decrease of $12 million in net favorable prior year loss development and an increase of $5 million related to Deepwater Horizon.
The Global (Non-U.S.) P&C sub-segment represented 15%, 19% and 17% of total net premiums written in 2011, 2010 and 2009, respectively. The decrease in the Global (Non-U.S.) P&C sub-segment’s net premiums written as a percentage of total net premiums written in 2011 compared to 2010 was primarily due to the effects of the Company’s decision to cancel or reduce business as a result of decreases in pricing and the repositioning of the Company’s portfolio, as described below. The increase in the Global (Non-U.S.) P&C sub-segment’s net premiums written as a percentage of total net premiums written in 2010 compared to 2009 was primarily due to the inclusion of Paris Re’s premiums for a full year compared to the fourth quarter only of 2009.
Gross and net premiums written and net premiums earned decreased by 25%, 24% and 17%, respectively, in 2011 compared to 2010. The decreases in gross and net premiums written and net premiums earned resulted from all lines of business and were mainly driven by the effects of the Company’s decision to cancel or reduce business due to lower pricing in competitive markets, the repositioning of the Company’s portfolio following the integration of Paris Re’s business, which included reducing catastrophe-exposed business in the property line, and higher retentions by cedants. These decreases were partially offset by foreign exchange fluctuations, which increased gross and net premiums written by 2% and net premiums earned by 4% due to the impact of the weaker U.S. dollar in 2011 compared to 2010. The decrease in net premiums earned was less pronounced than the decreases in gross and net premiums written due to the impact of continuing to earn the higher level of net premiums written in 2010 during the year ended December 31, 2011, given most business in this sub-segment is written on a proportional basis. Notwithstanding the increased competition and overall declines in pricing prevailing in certain lines of business and markets of this sub-segment, the Company was able to write business that met its portfolio objectives.
The losses and loss expenses and loss ratio reported in 2011 reflected:
net favorable loss development on prior accident years of $116 million, or 15.3 points on the loss ratio; and
an increase of $18 million in net favorable prior year loss development; and
The losses and loss expenses and loss ratio reported in 2010 reflected:
large catastrophic losses related to the Chile Earthquake and 2010 New Zealand Earthquake of $157 million, or 17.1 points on the loss ratio;
The net favorable loss development of $98 million included net favorable development for prior accident years in all lines of business, but was most pronounced in the property line. Loss information provided by cedants in 2010 for prior accident years was lower than the Company expected and included no individually significant losses or reductions but a series of attritional losses or reductions. Based on the Company’s assessment of this loss information, the Company decreased its expected ultimate loss ratios for all lines of business, which had the net effect of decreasing prior year loss estimates.
an increase of approximately $99 million in losses and loss expenses resulting from an increase in losses and loss expenses related to business written by Paris Re and an increase in the book of business and exposure, which was partially offset by normal fluctuations in profitability between periods and a lower level of mid-sized loss activity; and
a decrease of $54 million in net favorable prior year loss development.
Acquisition costs increased in 2010 compared to 2009 primarily as a result of higher net premiums earned. The increase in the acquisition ratio in 2010 compared to 2009 was primarily due to higher profit commission adjustments in the casualty line of business and new business with higher commission rates in the motor line of business, partially offset by the inclusion of Paris Re’s premiums which carry a lower acquisition ratio.
The Global (Non-U.S.) Specialty sub-segment represented 30%, 29% and 28% of total net premiums written in 2011, 2010 and 2009, respectively. The increase in the Global (Non-U.S.) Specialty sub-segment’s net premiums written as a percentage of total net premiums written in 2011 compared to 2010 was primarily due to the relatively modest decrease in this sub-segment’s net premiums written compared to decreases in net premiums written in the Global (Non-U.S.) P&C and Catastrophe sub-segments. The increase in the Global (Non-U.S.) Specialty sub-segment’s net premiums written as a percentage of total net premiums written in 2010 compared to 2009 was primarily due to the inclusion of Paris Re’s premiums for a full year in 2010 compared to the fourth quarter only of 2009.
Gross premiums written and net premiums earned decreased by 2% and net premiums written decreased by 3%, in 2011 compared to 2010. The decrease in gross and net premiums written and net premiums earned resulted from most lines of business and was primarily due to the effects of the Company’s decision to cancel or reduce business as a result of modestly reduced pricing in certain competitive lines of business and the repositioning of the Company’s portfolio following the integration of Paris Re’s business. These decreases were partially offset by an increase in upward premium adjustments reported by cedants in 2011 compared to 2010, which were primarily driven by the energy and engineering lines of business, increases in treaty participations in the credit/surety line of business, new business written in the specialty property line of business and the impact of the weaker U.S. dollar in 2011 compared to 2010. Foreign exchange fluctuations increased gross and net premiums written by 2% and net premiums earned by 4%. Notwithstanding the diverse conditions prevailing in various markets within this sub-segment, with terms in most markets soft and terms in loss affected lines strengthening, the Company was able to write business that met its portfolio objectives.
Gross and net premiums written and net premiums earned increased by 28%, 25% and 26% in 2010 compared to 2009, respectively. The increases in gross and net premiums written and net premiums earned resulted mainly from business written by Paris Re, which is included in this sub-segment’s results for a full year in 2010 compared to the fourth quarter only of 2009. The increases were also driven by the marine, specialty property, credit/surety and aviation lines of business, which benefited from new business written and increased treaty participations. These increases in gross and net premiums written and net premiums earned were partially offset by decreases in all other lines, predominantly in the engineering line of business, which was driven by a significant non-renewable treaty written in 2009.
net favorable loss development on prior accident years of $129 million, or 9.4 points on the loss ratio;
large catastrophic losses related to the Chile Earthquake of $54 million, or 3.9 points on the loss ratio;
losses and loss expenses related to Deepwater Horizon of $72 million, or 5.0 points on the loss ratio;
net favorable loss development on prior accident years of $171 million, or 12.2 points on the loss ratio;
increasing loss trends in the specialty casualty line of business; and
an increase in losses and loss expenses of approximately $190 million resulting from an increase in losses and loss expenses related to business written by Paris Re, a higher level of mid-sized loss activity, an increase in the book of business and exposure and increasing loss trends in the specialty casualty line of business, partially offset by lower loss estimates in the credit/surety line of business and normal fluctuations in profitability between periods; partially offset by
an increase of $63 million in net favorable prior year loss development.
Acquisition costs and the acquisition ratio increased in 2011 compared to 2010 primarily due to higher profit commission adjustments reported by cedants in the credit/surety line of business, and a shift in the mix of business towards the credit/surety line of business and towards proportional business, which generally carry relatively higher acquisition ratios. The increase in acquisition costs was partially offset by the impact of modestly lower net premiums earned in 2011 compared to 2010.
The decrease of $30 million in the technical result and the corresponding increase in the technical ratio in 2011 compared to 2010 was primarily attributable to a decrease of $42 million in net favorable prior year loss development, a higher level of mid-sized loss activity, higher acquisition costs, and modestly declining profitability in certain lines of business. These decreases in the technical result were partially offset by a decrease in large catastrophic losses and losses and loss expenses related to Deepwater Horizon of $59 million, net of retrocession and reinstatement premiums.
The Catastrophe sub-segment represented 13%, 14% and 10% of total net premiums written in 2011, 2010 and 2009, respectively. The decrease in the Catastrophe sub-segment’s net premiums written as a percentage of total net premiums written in 2011 compared to 2010 reflects a significant reduction in the portfolio and exposure, which is almost entirely offset by decreases in net premiums written in the Company’s other Non-life sub-segments. The increase in the Catastrophe sub-segment’s net premiums written as a percentage of total net premiums written in 2010 compared to 2009 was primarily due to the inclusion of Paris Re’s premiums written for a full year in 2010 compared to the fourth quarter only of 2009.
Gross and net premiums written and net premiums earned decreased by 16%, 13%, 15%, respectively, in 2011 compared to 2010. The decreases in gross and net premiums written and net premiums earned were primarily due to the Company’s decision to reduce certain catastrophe exposures and reposition its portfolio following the integration of Paris Re’s business, and were partially offset by new business written, reinstatement premiums related to the 2011 catastrophic events, increases in certain treaty participations and the impact of the weaker U.S. dollar in 2011 compared to 2010. Foreign exchange fluctuations increased gross and net premiums written by 2% and net premiums earned by 4%.
Gross and net premiums written and net premiums earned increased by 79%, 63% and 43%, respectively, in 2010 compared to 2009. The increases in gross and net premiums written and net premiums earned resulted mainly from the inclusion of catastrophe business written by Paris Re, which is included in this sub-segment’s results for a full year in 2010 compared to the fourth quarter only of 2009. The increase in gross and net
premiums written was also due to new business written as well as a timing difference related to the renewal of a significant treaty. The increase in net premiums earned was lower than the increases in gross and net premiums written primarily due to the earning of premiums in the fourth quarter of 2009 related to Paris Re’s business that was written prior to the date of acquisition.
large catastrophic losses related to the Japan Earthquake, the February and June 2011 New Zealand Earthquakes, U.S. tornadoes, Australian Floods, Thailand Floods and losses related to aggregate contracts covering losses in Australia and New Zealand of $1,511 million, or 262.1 points on the loss ratio. The large catastrophic losses of $1,511 million, include a specific IBNR reserve of $48 million related to the 2011 catastrophic events, above the sum of the recorded point estimates, given the high frequency of, and uncertainty related to, these complex and volatile events;
an increase of $1,231 million in large catastrophic losses and losses related to aggregate contracts; partially offset by
an increase in large catastrophic losses and large losses related to an aggregate contract of $280 million;
an increase in losses and loss expenses of approximately $102 million resulting from an increase in losses and loss expenses related to business written by Paris Re, a higher level of mid-sized loss activity and an increase in the book of business and exposure, partially offset by normal fluctuations in profitability between periods; and
a decrease of $5 million in net favorable prior year loss development.
The decrease of $1,141 million in the technical result and the corresponding increase in the technical ratio in 2011 compared to 2010 was primarily due to an increase of $1,195 million, net of retrocession, reinstatement premiums and profit commissions, in large catastrophic losses and losses related to aggregate contracts, the decrease in the book of business and exposure and normal fluctuations in profitability between periods. These decreases in the technical result were partially offset by an increase of $52 million in net favorable prior year loss development, a decrease in losses and loss expenses related to business written by Paris Re and a lower level of mid-sized loss activity.
The decrease of $201 million in the technical result and corresponding increase in the technical ratio in 2010 compared to 2009 was primarily explained by an increase of $274 million, net of reinstatement premiums, in large catastrophic losses and losses related to an aggregate contract, a higher level of mid-sized loss activity and a decrease of $5 million in net favorable prior year loss development. These factors were partially offset by the inclusion of the technical result (before the impact of large catastrophic losses and prior year loss development) related to Paris Re’s business and normal fluctuations in profitability between periods.
(1) Allocated underwriting result is defined as net premiums earned, other income or loss and allocated net investment income less life policy benefits, acquisition costs and other operating expenses.
The Life segment represented 18%, 16% and 15% of total net premiums written in 2011, 2010 and 2009, respectively. The increase in the Life segment’s net premiums written as a percentage of total net premiums written in 2011 compared to 2010 and 2009 was primarily due to decreases in net premiums written in the Company’s Non-life segment, as described above, and also due to new business written in the Life segment, as described below.
Gross and net premiums written and net premiums earned increased by 5%, 6% and 7%, respectively, in 2011 compared to 2010. The increase in gross and net premiums written and net premiums earned was primarily due to new business written during 2010 in the longevity line, which is fully reflected in 2011 but was only partially reflected in 2010, as well as new business and growth in the mortality line and the impact of foreign exchange. Foreign exchange fluctuations increased gross and net premiums written and net premiums earned by 4% due to the impact of the weaker U.S. dollar in 2011 compared to 2010. These increases in gross and net premiums written and net premiums earned were partially offset by a decrease related to the restructuring of a longevity treaty.
Net investment income decreased by $5 million, from $71 million in 2010 to $66 million in 2011 primarily due to a decrease in the funds held balance related to the restructuring of a longevity treaty and lower positive adjustments on funds held contracts reported by cedants.
The allocated underwriting result decreased by $31 million, from $51 million in 2009 to $20 million in 2010. The decrease in the allocated underwriting result was primarily due to an increase of $27 million in net adverse prior year loss development and an increase in other operating expenses, which were partially offset by an increase in net investment income and normal fluctuations in profitability between periods.
Other operating expenses increased by $10 million, from $47 million in 2009 to $57 million in 2010 primarily due to higher personnel costs. Net investment income increased by $9 million, from $62 million in 2009 to $71 million in 2010 primarily as a result of positive adjustments on funds held contracts reported by cedants and higher invested assets, partially offset by lower interest rates.
The majority of the Life segment premium arises from in-force contracts that are written on a continuous basis. The active January 1 renewals impact a relatively limited portion of the in-force premium and are exclusively contained in the mortality line. For those treaties that actively renewed, pricing conditions and terms were generally unchanged leading to a modest level of cancellations and reductions in treaty participations where the offered terms were considered inadequate. These reductions were largely offset by improved terms on selected existing treaties and new business from both new and existing clients. Management expects moderate continued growth in 2012, assuming constant foreign exchange rates.
The changes in the distribution of net premiums written by line of business between 2011, 2010 and 2009 primarily reflected the Company’s response to existing market conditions, with the comparison between 2011 and 2010 specifically affected by the repositioning of its portfolio following the integration of Paris Re and the reduction of catastrophe exposed business. The comparison between 2010 and 2009 is specifically affected by the inclusion of Paris Re’s premiums for a full year in 2010 compared to the fourth quarter only of 2009. The distribution of net premiums written may also be affected by the timing of renewals of treaties, a change in treaty structure, premium adjustments reported by cedants and significant increases or decreases in other lines of business. In addition, foreign exchange fluctuations affected the comparison for all lines.
Property: the decrease in the distribution of net premiums written in 2011 compared to 2010 was driven primarily by the effects of the Company’s decisions to cancel or reduce business as a result of reductions in pricing and to reposition its portfolio following the integration of Paris Re’s business, which included reducing the level of catastrophe exposed business.
Catastrophe: the decrease in the distribution of net premiums written in 2011 compared to 2010 was driven by the repositioning of the Company’s portfolio following the integration of Paris Re, which included reducing the level of catastrophe exposed business. Given the absolute decrease in Catastrophe net premiums written was 13%, the percentage distribution by line of business only decreased by 1% in 2011 compared to 2010 due to significant decreases in other lines of business. The increase in the distribution of net premiums written in 2010 compared to 2009 is primarily due to the inclusion of Paris Re’s premiums, as described above. Paris Re’s catastrophe line of business represented a relatively higher percentage of its net premiums written compared to the Company’s.
Based on information received from cedants and brokers during the January 1, 2012 renewals and assuming that similar trends and conditions to those experienced during the January 1, 2012 renewals continue through the year, Management expects a further decrease in the relative distribution of net premiums written to the catastrophe line of business in 2012 compared to 2011, following further reductions in certain catastrophe exposures. Management expects other lines to be broadly comparable to 2011.
(1) Substantially all of the Life segment’s gross premiums written for all periods presented are proportional.
The distribution of gross premiums written by reinsurance type is affected by changes in the allocation of capacity among lines of business, the timing of receipt by the Company of cedant accounts and premium adjustments by cedants. In addition, foreign exchange fluctuations affected the comparison for all treaty types.
The changes in the distribution of gross premiums written by reinsurance type between 2011 and 2010 primarily reflect a shift from non-proportional business to facultative business in the Non-life segment and a shift in mix from the Non-life segment to the Life segment. The shift from non-proportional to facultative business was driven by a reduction in catastrophe exposed business and new business written and positive premium adjustments in the marine and engineering lines of business. The shift in the mix of business from the Non-life segment to the Life segment results from the decreases in gross premiums written following the cancellation and reduction of business and the repositioning of the Company’s portfolio in certain lines of the Non-life segment compared to increases in gross premiums written from the longevity line and mortality lines of business in the Life segment.
The changes in the distribution of gross premiums written by reinsurance type in the Non-life segment between 2010 and 2009 primarily reflected the inclusion of Paris Re’s premiums for a full year in 2010 compared
The decrease in the distribution of gross premiums written in Europe was primarily driven by the cancellation and reduction of business and the repositioning of the Company’s portfolio following the integration of Paris Re, and was partially offset by higher gross premiums written in the Company’s Life segment and the impact of foreign exchange fluctuations, as premiums denominated in currencies that have appreciated against U.S. dollar were converted into U.S. dollar at higher average exchange rates. While gross premiums written in the Company’s North America sub-segment increased in 2011 compared to 2010, the distribution of gross premiums written in North America in 2011 was comparable to 2010 due to the more pronounced increase in the distribution of gross premiums written in Asia, Australia and New Zealand, which was primarily due to reinstatement premiums associated with the Japan Earthquake and the February and June 2011 New Zealand Earthquakes.
The distribution of gross premiums written by production source was comparable between 2011, 2010 and 2009.
The table below provides net investment income by asset source for the years ended December 31, 2011, 2010 and 2009 (in millions of U.S. dollars):
the weakening of the U.S. dollar, on average, in 2011 compared to 2010 which contributed a 1% increase in net investment income.
an increase in net investment income from fixed maturities due to the purchase of higher yielding investments and the reinvestment of cash flows from operations. This increase was partially offset by the sale of fixed maturities to finance the Company’s repurchase of common shares of $1,083 million and to repay debt of $200 million during 2010;
an increase in net investment income from equities due to a higher level of equity exposures held, on average, in 2010 compared to 2009; partially offset by
The Company’s portfolio managers have dual investment objectives of optimizing current investment income and achieving capital appreciation. To meet these objectives, it is often desirable to buy and sell securities to take advantage of changing market conditions and to reposition the investment portfolios. Accordingly, recognition of realized gains and losses is considered by the Company to be a normal consequence of its ongoing investment management activities. In addition, the Company records changes in fair value for substantially all of its investments as unrealized investment gains or losses in its Consolidated Statements of Operations. Realized and unrealized investment gains and losses are generally a function of multiple factors, with the most significant being prevailing interest rates, credit spreads, and equity market conditions.
The components of net realized and unrealized investment gains for the years ended December 31, 2011, 2010 and 2009 were as follows (in millions of U.S. dollars):
The interest in the results of equity investments represents the Company’s aggregate share of earnings or losses related to several private placement investments and limited partnerships in which the Company has more than a minor interest.
The Company’s interest in the results of equity investments was $13 million in 2010 compared to $16 million in 2009.
Technical result and other income included in Corporate and Other primarily relates to certain insurance-linked securities and principal finance transactions.
The Company’s income tax expense and effective income tax rate for the years ended December 31, 2011, 2010 and 2009 were as follows (in millions of U.S. dollars):
Income tax expense and the effective income tax rate during 2011 were $69 million and (15.3)%, respectively. Income tax expense and the effective income tax rate during 2011 were primarily driven by the geographic distribution of the Company’s pre-tax net loss between its various taxable and non-taxable jurisdictions. Specifically, the income tax expense and the effective income tax rate included a significant portion of the Company’s pre-tax net loss recorded in non-taxable jurisdictions and jurisdictions with comparatively lower tax rates with no associated tax benefit, which were driven by the large catastrophic losses described in the Review of Net (Loss) Income. The Company’s taxable jurisdictions recorded pre-tax net income and an income tax expense, which resulted from a relatively low level of catastrophe losses and realized and unrealized investment gains. The income tax expense recorded by the Company’s taxable jurisdictions was partially offset by the recognition of a tax benefit during 2011 related to the expiration of the statute of limitations of uncertain tax positions following the completion of certain tax examinations.
Income tax expense and the effective income tax rate during 2010 were $129 million and 13.1%, respectively. Income tax expense and the effective income tax rate during 2010 were driven by the geographic distribution of the Company’s pre-tax net income between its various taxable and non-taxable jurisdictions. Specifically, the income tax expense and the effective income tax rate during 2010, included a relatively even distribution of the Company’s pre-tax net income between its various jurisdictions. The Company’s taxable jurisdictions recorded significant realized and unrealized investment gains, which were partially offset by significant catastrophe losses related to the Chile Earthquake and the 2010 New Zealand Earthquake, losses related to Deepwater Horizon, and charges related to the Company’s voluntary plan. The Company’s non-taxable jurisdictions benefitted from comparatively lower levels of catastrophe losses and realized and unrealized investment gains.
Income tax expense and the effective income tax rate during 2009 were $262 million and 14.6%, respectively. Income tax expense and the effective income tax rate during 2009 were primarily driven by the geographic distribution of the Company’s pre-tax net income between its various taxable and non-taxable jurisdictions. Specifically, the income tax expense and the effective income tax rate included a relatively even distribution of the Company’s pre-tax net income between its various jurisdictions. The Company’s non-taxable and taxable jurisdictions recorded a significant level of pre-tax net income, in the absence of significant catastrophe losses, and the taxable jurisdictions recorded a significant level of net realized and unrealized investment gains.
The Company employs a prudent investment philosophy. It maintains a high quality, well balanced and liquid portfolio having the dual objectives of optimizing current investment income and achieving capital appreciation. The Company’s invested assets are comprised of total investments, cash and cash equivalents and accrued investment income. From a risk management perspective, the Company allocates its invested assets into two categories: liability funds and capital funds.
Liability funds (including funds held - directly managed) represent invested assets supporting the net reinsurance liabilities, defined as the Company’s operating and reinsurance liabilities net of reinsurance assets, and are invested primarily in high quality fixed income securities. The preservation of liquidity and protection of capital are the primary investment objectives for these assets. The portfolio managers are required to adhere to investment guidelines as to minimum ratings and issuer and sector concentration limitations. Liability funds are invested in a way that generally matches them to the corresponding liabilities (referred to as asset-liability matching) in terms of both duration and major currency composition to provide the Company with a natural hedge against changes in interest and foreign exchange rates. In addition, the Company utilizes certain derivatives to further protect against changes in interest and foreign exchange rates.
The Company’s investment strategy allows for the use of derivative instruments, subject to strict limitations. The Company utilizes various derivative instruments such as treasury note and equity futures contracts, credit default swaps, foreign currency option contracts, foreign exchange forward contracts, total return and interest rate swaps, insurance-linked securities and to-be-announced mortgage-backed securities (TBAs) for the purpose of managing and hedging currency risk, market exposure and portfolio duration, hedging certain investments, mitigating the risk associated with underwriting operations, or enhancing investment performance that would be allowed under the Company’s investment policy if implemented in other ways. The use of financial leverage, whether achieved through derivatives or margin borrowing, requires approval from the Risk and Finance Committee of the Board.
Total investments and cash were $16.6 billion at December 31, 2011 compared to $16.4 billion at December 31, 2010. The major factors influencing the increase during 2011 were:
various factors, the primary one being the effect of a stronger U.S. dollar at December 31, 2011 relative to most major currencies, resulting in the conversion of non-U.S. dollar invested assets into U.S. dollars at lower exchange rates, amounting to approximately $169 million.
The Company has elected the fair value option for substantially all of its invested assets, including all of Paris Re’s fixed maturities, short-term investments and other invested assets. The market value of fixed maturities, short-term investments and equities classified as trading securities (excluding funds held - directly managed) was $14.9 billion at December 31, 2011 compared to $13.9 billion at December 31, 2010. Trading securities are carried at fair value with changes in fair value included in net realized and unrealized investment gains and losses in the Consolidated Statements of Operations. In addition, the market value of the Company’s other invested assets was $358 million at December 31, 2011 compared to $352 million at December 31, 2010. The Company’s other invested assets and the investments underlying the funds held - directly managed account are discussed separately below.
At December 31, 2011, approximately 93% of the Company’s fixed income and short-term investments, which includes fixed income type mutual funds, were rated investment grade (BBB- or higher) by Standard & Poor’s (or estimated equivalent) and 94% were publicly traded. The average credit quality of the Company’s fixed income and short-term investments at December 31, 2011 was AA, comparable to the position at December 31, 2010. The average credit quality at December 31, 2011 reflects the impact of Standard & Poor’s decision in August 2011 to downgrade U.S. government securities and other securities that carry either an explicit or implicit guarantee of the U.S. government from AAA to AA+ (the downgrade of U.S. government securities). While other ratings agencies did not take a similar rating action, it is the Company’s policy to use Standard & Poor’s ratings, when available, to rate its investments. The Company does not believe that the downgrade of U.S. government securities increased the risk level of its investment portfolio, with U.S. treasuries still generally considered to be a proxy for a risk-free investment.
The average duration of the Company’s investment portfolio was 2.9 years at December 31, 2011, comparable to 3.0 years at December 31, 2010. For the purposes of managing portfolio duration, the Company uses exchange traded treasury note futures. The use of treasury note futures reduced the duration of its investment portfolio from 3.5 years to 2.9 years at December 31, 2011, and reflects the Company’s decision to hedge against risk-free interest rates potentially rising.
The U.S. states, territories and municipalities category includes obligations of U.S. states, territories, or counties. At December 31, 2011, 10% of securities in this category were rated investment grade (BBB- or higher) by Standard & Poor’s (or estimated equivalent), with the remaining 90% not rated.
representing 11%, 3% and 1% of the total, respectively. If the Eurozone downgrade had occurred at December 31, 2011, the impact on the non-U.S. sovereign government, supranational and government related category would have been to decrease the AAA credit quality of this category from 82% to 58%, with a corresponding increase in AA credit quality from 15% to 39%.
At December 31, 2011, the Company did not have any investments in securities issued by peripheral European Union (EU) sovereign governments (Portugal, Italy, Ireland, Greece and Spain). At December 31, 2011, the Company had investments of $1.8 billion in other EU sovereign governments (including $7 million of investments in the short-term investments category), comprised of $879 million, $579 million, $194 million, $79 million and $54 million of German, French, Belgian, Austrian and Dutch sovereign government obligations, respectively, with no other EU sovereign government issuer comprising more than $15 million, less than 1% of the Company’s total EU sovereign government obligations. In addition to its EU sovereign government exposure, the Company also held $61 million of debt issued by French government agencies.
Corporate bonds are comprised of obligations of U.S. and foreign corporations. At December 31, 2011, 95% of these investments were rated investment grade (BBB- or higher) by Standard & Poor’s (or estimated equivalent), while 67% were rated A- or better. At December 31, 2011, the ten largest issuers accounted for 17% of the corporate bonds held by the Company (6% of total investments and cash) and no single issuer accounted for more than 3% of total corporate bonds (1% of total investments and cash). At December 31, 2011, U.S. bonds comprised 63% of this category and no other country accounted for more than 8% of this category. The main exposures by economic sector were 23% in finance (11% were banks), 14% in consumer noncyclical and 10% in each of communications and utilities. Within the finance sector, 99% of corporate bonds were rated investment grade and 85% were rated A- or better at December 31, 2011.
Residential mortgage-backed securities includes U.S. residential mortgage-backed securities, which accounted for 93% of this category at December 31, 2011. These securities generally have a low risk of default and 97% of the U.S. residential mortgage-backed securities are backed by U.S. government agencies, which set standards on the mortgages before accepting them into the program. Although these U.S. government backed agency securities do not carry a formal rating, they are generally considered to have a credit quality equivalent to or greater than AA+ corporate issues. They are considered prime mortgages and the major risk is uncertainty of the timing of prepayments. While there have been market concerns regarding sub-prime mortgages, the Company
Short-term investments consisted of non-U.S. sovereign government obligations, U.S. treasuries and U.S. corporate bonds which accounted for 70%, 19% and 11%, respectively, of this category at December 31, 2011. The non-U.S. sovereign government obligations were primarily related to Canada, France, and Singapore and were rated AAA. At December 31, 2011, the U.S. treasuries held were rated AA+ and the U.S. corporate bonds were rated investment grade (BBB- or higher) by Standard & Poor’s (or estimated equivalent).
If the Eurozone downgrade had occurred at December 31, 2011, the impact on the credit quality of the Company’s investment portfolio would have been to decrease the AAA credit quality from 25% to 20%, and increase the AA credit quality from 37% to 42%. The overall average credit quality of the Company’s investment portfolio at December 31, 2011 would have remained at AA.
At December 31, 2011, the Company’s other invested assets totaled $358 million. The Company’s other invested assets consisted primarily of investments in asset-backed securities, non-publicly traded companies, notes receivable, loans receivable, private placement equity and bond investments, and other specialty asset classes. These assets, together with the Company’s derivative financial instruments that were in a net unrealized gain or loss position at December 31, 2011, are reported within other invested assets in the Company’s Consolidated Balance Sheets.
At December 31, 2011, the Company’s principal finance activities included $168 million of investments classified as other invested assets, which were comprised primarily of asset-backed securities, notes receivable, loans receivable, total return, interest rate and credit default swaps (which are accounted for as derivative financial instruments), and private placement equity investments. At December 31, 2011, the carrying value of the Company’s investment in asset-backed securities, notes receivable, loans receivable and private placement equity investments was $100 million, $46 million, $21 million and $3 million, respectively, and were partially offset by the combined fair value of total return, interest rate and credit default swaps which was an unrealized loss of $2 million.
At December 31, 2011, 59% of the Company’s principal finance total return and interest rate swap portfolio was related to tax advantaged real estate income, 38% was related to apparel and retail future flow income or intellectual property backed transactions, for which the underlying investments were rated investment grade, and the remainder of the portfolio was distributed over a number of generally unrelated risks.
For credit default swaps within the principal finance portfolio, the Company uses externally modeled quoted prices that use observable market inputs to estimate the fair value. At December 31, 2011, the fair value of the Company’s assumed exposure in the form of credit default swaps was insignificant and the notional value was $13 million.
The Company has entered into certain indexed commodity futures contracts (which are accounted for as derivative financial instruments). The Company uses indexed commodity futures to hedge certain investments and to replicate the investment return on certain benchmarked commodities. The counterparties to the Company’s indexed commodity futures contracts are all highly rated financial institutions, rated A- or better by Standard & Poor’s at December 31, 2011. The Company uses quoted market prices to estimate the fair value of these contracts. The fair value and the notional value of the indexed commodity futures contracts was an unrealized loss of $2 million and $48 million, respectively, at December 31, 2011.
At December 31, 2011, the Company’s strategic investments of $197 million (of which $179 million were included in other invested assets) includes investments in non-publicly traded companies, private placement equity and bond investments and other specialty asset classes, including the investments in distressed asset vehicles comprised of sub-prime mortgages, which were discussed above in the residential mortgaged-backed securities category of Investments-Trading Securities.
PartnerRe Ltd. (the Company) provides reinsurance on a worldwide basis through its principal wholly-owned subsidiaries, including Partner Reinsurance Company Ltd. (PartnerRe Bermuda), Partner Reinsurance Europe plc (PartnerRe Europe) and Partner Reinsurance Company of the U.S (PartnerRe U.S.). Risks reinsured include, but are not limited to, property, casualty, motor, agriculture, aviation/space, catastrophe, credit/surety, engineering, energy, marine, specialty property, specialty casualty, multiline and other lines, mortality, longevity and health and alternative risk products. The Company’s alternative risk products include weather and credit protection to financial, industrial and service companies on a worldwide basis.
Effective October 2, 2009, the Company obtained a controlling interest in PARIS RE Holdings Limited (Paris Re), a French-listed, Swiss-based holding company and its operating subsidiaries. Subsequent to October 2, 2009, the Company acquired additional common shares of Paris Re and effected a statutory merger (Merger), resulting in the Company obtaining 100% ownership of Paris Re on December 7, 2009. The Consolidated Statements of Operations and Cash Flows include the results of Paris Re for the period from October 2, 2009, the date of acquisition of the controlling interest (Acquisition Date) (see Note 7).
Actual and anticipated losses and loss expenses, other costs and investment income related to underlying premiums are considered in determining the recoverability of Non-life deferred acquisition costs. Actual and anticipated loss experience, together with the present value of future gross premiums, the present value of future benefits, settlement and maintenance costs are considered in determining the recoverability of life deferred acquisition costs.
In certain circumstances, the Company may receive an investment return based upon either the result of a pool of assets held by the cedant, generally used to collateralize the funds held balance, or the investment return earned by the cedant on its entire investment portfolio. This is most common in the Company’s life reinsurance business. In these arrangements, gross investment returns are typically reflected in net investment income with a corresponding increase or decrease (net of a spread) being recorded as life policy benefits in the Company’s Consolidated Statements of Operations. In these arrangements, the Company is exposed, to a limited extent, to the underlying credit risk of the pool of assets inasmuch as the underlying life policies may have guaranteed minimum returns. In such cases, an embedded derivative exists and its fair value is recorded by the Company as an increase or decrease to the funds held balance.
The Company elects the fair value option for all of its fixed maturities, short-term investments, equities and certain other invested assets (excluding those that are accounted for using the cost or equity methods of accounting or investment company accounting). The Company defines fair value as the price received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The Company measures the fair value of financial instruments according to a fair value hierarchy that prioritizes the information used to measure fair value into three broad levels. Following the election of the fair value option for an eligible item, changes in that item’s fair value in subsequent reporting periods must be recognized in earnings. See Note 3 for additional information on fair value.
Net investment income includes interest and dividend income, amortization of premiums and discounts on fixed maturities and short-term investments and investment income on funds held and funds held - directly managed, and is net of investment expenses and withholding taxes. Investment income is recognized when earned. Realized gains and losses on the disposal of investments are determined on a first-in, first-out basis. Investment purchases and sales are recorded on a trade-date basis.
The Company obtained control of Paris Re on the Acquisition Date. The transaction was accounted for as an acquisition method business combination with the purchase price allocated to identifiable assets and liabilities, including certain intangible assets, based on their estimated fair value at the Acquisition Date. The fair value of noncontrolling interests was also recorded at fair value at the Acquisition Date. The estimates of fair values for assets and liabilities assumed were determined by management based on various market and income analyses and appraisals. All costs associated with the acquisition were expensed as incurred.
The Company has entered into weather and longevity related transactions that are structured as derivatives, which are recorded at fair value with the changes in fair value reported in net realized and unrealized investment gains and losses in the Consolidated Statements of Operations.
Diluted net income per common share is defined as net income available to common shareholders divided by the weighted average number of common shares and common share equivalents outstanding, calculated using the treasury stock method for all potentially dilutive securities. Net income available to common shareholders is defined as net income less preferred share dividends. When the effect of dilutive securities would be anti-dilutive, these securities are excluded from the calculation of diluted net income per share. Basic net income per share is defined as net income available to common shareholders divided by the weighted average number of common shares outstanding for the period, giving no effect to dilutive securities.
In October 2010, the Financial Accounting Standards Board (FASB) issued new accounting guidance clarifying that only acquisition costs related directly to the successful acquisition of new or renewal insurance contracts may be capitalized. Those acquisition costs that may be capitalized include incremental direct costs, such as commissions, and a portion of salaries and benefits of certain employees who are involved in underwriting and policy issuance, that are directly related to time spent on an acquired contract. This guidance is effective for interim and annual periods beginning after December 15, 2011. The Company does not expect the adoption of this guidance to have an impact on its consolidated shareholders’ equity or net income.
not expect the adoption of this guidance to have an impact on its consolidated shareholders’ equity or net income and is currently evaluating the impact of the adoption of this guidance on its disclosures.
The Company determines the appropriate level in the hierarchy for each financial instrument that it measures at fair value. In determining fair value, the Company uses various valuation approaches, including market, income and cost approaches. The hierarchy is broken down into three levels based on the observability of inputs as follows:
The Company’s financial instruments that it measures at fair value using Level 1 inputs generally include: equities listed on a major exchange, exchange traded funds and exchange traded derivatives, such as futures and weather derivatives that are actively traded.
The Company’s financial instruments that it measures at fair value using Level 2 inputs generally include: U.S. Government issued bonds; U.S. Government sponsored enterprises bonds; U.S. state, territory and municipal entities bonds; Non-U.S. sovereign government, supranational and government related bonds consisting primarily of bonds issued by non-U.S. national governments and their agencies, non-U.S. regional governments and supranational organizations; investment grade and high yield corporate bonds; catastrophe bonds; mortality bonds; asset-backed securities; mortgage-backed securities; certain equities traded on foreign exchanges; certain fixed income mutual funds; foreign exchange forward contracts; over-the-counter derivatives such as foreign currency option contracts, non-exchange traded futures, credit default swaps, interest rate swaps and TBAs.
issued corporate securities; special purpose financing asset-backed bonds; unlisted equities; real estate mutual fund investments; credit-linked notes; inactively traded weather derivatives; notes, annuities and loans receivable and longevity and other total return swaps.
At December 31, 2011 and 2010, the aggregate carrying amounts of items included in Other invested assets that the Company did not measure at fair value were $267.6 million and $241.0 million, respectively, which related to the Company’s investments that are accounted for using the cost method of accounting, equity method of accounting or investment company accounting.
At December 31, 2011 and 2010, substantially all of the accrued investment income in the Consolidated Balance Sheets related to the Company’s investments and the investments underlying the funds held - directly managed account for which the fair value option was elected.
Disclosures about the fair value of financial instruments that the Company does not measure at fair value exclude insurance contracts and certain other financial instruments. At December 31, 2011 and 2010, the fair values of financial instrument assets recorded in the Consolidated Balance Sheets not described above, approximate their carrying values.
(1) Purchases and issuances of derivatives includes issuances of $5.1 million. Sales and settlements of derivatives includes settlements of $21.2 million.
Changes in the fair value of the Company’s financial instruments subject to the fair value option during the years ended December 31, 2011, 2010 and 2009, respectively, were as follows (in thousands of U.S. dollars):
U.S. states, territories and municipalities-U.S. states, territories and municipalities securities consist primarily of bonds issued by U.S. states, territories and municipalities. These securities are generally priced by independent pricing services using the techniques described for U.S. government and government sponsored enterprises above. The Company generally classifies these securities in Level 2. Certain of the bonds that are issued by municipal housing authorities are not actively traded and are priced based on internal models using unobservable inputs. Accordingly, the Company classifies these securities in Level 3.
Other mortgage-backed securities-Other mortgage-backed securities primarily consist of commercial mortgage-backed securities. These securities are generally priced by independent pricing services and brokers. The pricing provider applies dealer quotes and other available trade information, prepayment speeds, yield curves and credit spreads to the valuation. The Company generally classifies these securities in Level 2. When a commercial mortgage-backed security is inactively traded or the valuation model uses unobservable inputs, the Company classifies the security in Level 3.
Equity securities include U.S. and foreign common and preferred stocks, mutual funds and exchange traded funds. Equities and exchange traded funds are generally classified in Level 1 as the Company uses prices received from independent pricing sources based on quoted prices in active markets. Equities categorized as Level 2 are generally mutual funds invested in fixed income securities, where the net asset value of the fund is provided on a daily basis, and common stocks traded in inactive markets. Equities categorized as Level 3 are generally mutual funds invested in securities other than the common stock of publicly traded companies, where the net asset value is not provided on a daily basis, and inactively traded common stocks.
Included in the Company’s Level 3 categorization, in general, are credit-linked notes, certain inactively traded weather derivatives, notes, annuities and loans receivable and longevity and other total return swaps. For Level 3 instruments, the Company will generally either (i) receive a price based on a manager’s or trustee’s valuation for the asset; or (ii) develop an internal discounted cash flow model to measure fair value. Where the Company receives prices from the manager or trustee, these prices are based on the manager’s or trustee’s estimate of fair value for the assets and are generally audited on an annual basis. Where the Company develops its own discounted cash flow models, the inputs will be specific to the asset in question, based on appropriate historical information, adjusted as necessary, and using appropriate discount rates. As part of the Company’s modeling to determine the fair value of an investment, the Company considers counterparty credit risk as an input to the model, however, the majority of the Company’s counterparties are highly rated institutions and the failure of any one counterparty would not have a significant impact on the Company’s consolidated financial statements.
At December 31, 2011 and 2010, the fair values of financial instrument liabilities recorded in the Consolidated Balance Sheets approximate their carrying values, with the exception of the debt related to senior notes (Senior Notes) and the debt related to capital efficient notes (CENts).
The distribution of fixed maturities and short-term investments at December 31, 2011, by contractual maturity date, is shown below (in thousands of U.S. dollars). Actual maturities may differ from contractual maturities because certain borrowers have the right to call or prepay certain obligations with or without call or prepayment penalties.
Included in net realized investment gains (losses) on equities for the year ended December 31, 2009 is a gain of $18.3 million related to the Company’s equity investment in Paris Re prior to the Acquisition Date (see Note 7).
Following Paris Re’s acquisition of substantially all of the reinsurance operations of Colisée Re (previously known as AXA RE), a subsidiary of AXA SA (AXA), in 2006, Paris Re and its subsidiaries entered into an issuance agreement and a quota share retrocession agreement to assume business written by Colisée Re from January 1, 2006 to September 30, 2007 as well as the in-force business at December 31, 2005. The agreements provided that the premium related to the transferred business was retained by Colisée Re and credited to a funds held account. During the year ended December 31, 2011, the Company and Colisée Re entered into an endorsement to the quota share retrocession agreement, which resulted in a release of assets of approximately $358 million from the funds held - directly managed account to the Company.
In addition to the investments underlying the funds held - directly managed account in the above table at December 31, 2011 and 2010, were cash and cash equivalents of $176.3 million and $129.2 million, respectively, other assets and liabilities of $20.3 million and $80.0 million, respectively, and accrued investment income of $13.7 million and $19.9 million, respectively. The other assets and liabilities represent working capital assets held by Colisée Re related to the underlying business.
The distribution of fixed maturities and short-term investments underlying the funds held - directly managed account at December 31, 2011, by contractual maturity date, is shown below (in thousands of U.S. dollars). Actual maturities may differ from contractual maturities because certain borrowers have the right to call or prepay certain obligations with or without call or prepayment penalties.
The components of the net realized and unrealized investment gains (losses) on the funds held - directly managed account for the years ended December 31, 2011 and 2010 and for the period from October 2, 2009 to December 31, 2009 were as follows (in thousands of U.S. dollars):
(1) At December 31, 2011, insurance-linked securities include a longevity swap for which the notional amount is not reflective of the overall potential exposure of the swap. As such, the Company has included the probable maximum loss under the swap within the net notional exposure as an approximation of the notional amount.
(2) The Company enters into interest rate swaps to mitigate notional exposures on certain total return swaps. Accordingly, the notional value of interest rate swaps is not presented separately in the table.
The gains and losses in the Consolidated Statements of Operations for derivatives not designated as hedges for the years ended December 31, 2011, 2010 and 2009 were as follows (in thousands of U.S. dollars):
On July 4, 2009, the Company entered into definitive agreements to effect a multi-step acquisition of all the outstanding common shares and warrants of Paris Re, a French listed, Swiss based holding company and its operating subsidiaries. In July 2009, the Company purchased approximately 6% of the outstanding Paris Re common shares. On October 2, 2009, the Company closed its block purchase of Paris Re’s common shares and warrants which represented, in the aggregate, approximately 77% of the outstanding common shares of Paris Re, resulting in the Company’s ownership of Paris Re’s common shares increasing to approximately 83%. Subsequent to October 2, 2009, the Company acquired additional common shares of Paris Re and effected a Merger, resulting in the Company obtaining 100% ownership of Paris Re on December 7, 2009. The Company issued its common shares, in exchange for Paris Re common shares and warrants, for all steps of the acquisition.
The Consolidated Statements of Operations and Cash Flows include results of Paris Re for the period from October 2, 2009, the Acquisition Date. For the period from October 2, 2009 to December 7, 2009, Paris Re had non-controlling interests. Net income attributable to Paris Re’s non-controlling interests during this period was $4.3 million, and has been recorded within other income in the Consolidated Statement of Operations.
Intangible asset amortization during the years ended December 31, 2011, 2010 and 2009 totaled $44.8 million, $68.6 million and $40.3 million, respectively, of which $8.4 million, $37.1 million and $46.4 million, respectively, is recorded within acquisition costs and $36.4 million, $31.5 million and $(6.1) million, respectively, is recorded within amortization of intangible assets in the Consolidated Statements of Operations. The amounts recorded within acquisition costs in the Consolidated Statements of Operations approximates the amount of Paris Re’s deferred acquisition costs that would have been recorded as acquisition costs had they not been fair valued under purchase accounting.
The gross carrying value and accumulated amortization of intangible assets by type at December 31, 2011 and 2010 is as follows (in thousands of U.S. dollars):
Unpaid losses and loss expenses are categorized into three types of reserves: reported outstanding loss reserves (case reserves), additional case reserves (ACRs) and incurred but not reported (IBNR) reserves. Case reserves represent unpaid losses reported by the Company’s cedants and recorded by the Company. ACRs are established for particular circumstances where, on the basis of individual loss reports, the Company estimates that the particular loss or collection of losses covered by a treaty may be greater than those advised by the cedant. IBNR reserves represent a provision for claims that have been incurred but not yet reported to the Company, as well as future loss development on losses already reported, in excess of the case reserves and ACRs. The following table shows the Company’s gross liability for unpaid losses and loss expenses reported by cedants (case reserves) and those estimated by the Company (ACRs and IBNR reserves) at December 31, 2011 and 2010 (in thousands of U.S. dollars):
The table below is a reconciliation of the beginning and ending gross and net liability for unpaid losses and loss expenses, excluding policy benefits for life and annuity contracts, for the years ended December 31, 2011, 2010 and 2009 (in thousands of U.S. dollars):
The following table summarizes the prior year net favorable development of loss reserves for each of the Company’s Non-life sub-segments for the years ended December 31, 2011, 2010 and 2009 (in thousands of U.S. dollars):
For the Global (Non-U.S.) P&C sub-segment, the Company reported net favorable loss development for prior accident years in 2011, 2010 and 2009. The net favorable loss development in 2011 included net favorable development for prior accident years in all lines of business and was most pronounced in the motor line. The net favorable loss development in 2010 included net favorable development for prior accident years in all lines of business, but was most pronounced in the property line. The net favorable loss development in 2009 included net favorable development for prior accident years in all lines of business, but was most pronounced in the motor and casualty lines. The net favorable loss development in each year was primarily due to favorable loss emergence. Loss information provided by cedants during each of these years for prior accident years was lower than the Company expected and included no individually significant losses or reductions but a series of attritional losses or reductions.
For the Global (Non-U.S.) Specialty sub-segment, the Company reported net favorable loss development for prior accident years in 2011, 2010 and 2009. The net favorable loss development in 2011 included net favorable development for prior accident years in most lines of business, except for the energy and engineering lines, which experienced combined adverse loss development for prior accident years of $13 million. The adverse loss development for prior accident years in the energy and engineering lines was driven by the increases in upward premium adjustments reported by cedants in 2011. The net favorable loss development in 2010 included net favorable development for prior accident years in all lines of business, except for the specialty casualty line, which experienced adverse loss development for prior accident years of $37 million. The net favorable loss development in 2009 included net favorable development for prior accident years in most lines of business, predominantly in the aviation and engineering lines, while the agriculture and credit/surety lines experienced combined adverse loss development for prior accident years. The net favorable loss development in each year was primarily due to favorable loss emergence. Loss information provided by cedants during each of these years for prior accident years was lower than the Company expected and included no individually significant losses or reductions but a series of attritional losses or reductions.
Favorable or adverse development related to the guaranteed reserves is recorded as a change in unpaid losses and loss expenses in the Consolidated Balance Sheets and as a change in the Reserve Agreement payable or receivable balance to/from Colisée Re, which is included within Other reinsurance balances payable in the Consolidated Balance Sheets. Accordingly, the reconciliation of the beginning and ending gross and net liability for unpaid losses and loss expenses for the years ended December 31, 2011, 2010 and 2009 includes the change in the Reserve Agreement. At December 31, 2011 and 2010, the Company’s net liability for unpaid losses and loss expenses includes $1,012 million and $1,239 million, respectively, of guaranteed reserves and Other reinsurance balances payable includes $183 million and $128 million, respectively, payable to Colisée Re related to the Reserve Agreement.
Loss estimates arising from earthquakes are inherently more uncertain than those from other catastrophic events. The Company’s actual losses from the earthquakes that occurred in New Zealand in September 2010 (2010 New Zealand Earthquake) and in February and June 2011 (February and June 2011 New Zealand Earthquakes) may materially exceed the estimated losses as a result of, among other things, an increase in industry insured loss estimates, the expected lengthy claims development period, in particular for earthquake related losses, and the receipt of additional information from cedants, brokers and loss adjusters. In addition, the Company’s loss estimate related to the Japan Earthquake is inherently more uncertain than those from other catastrophic events given the characteristics of the Company’s reinsurance portfolio in the region. Further, changes in loss assumptions for specific cedants may have a material impact on the Company’s loss estimate related to this event given a significant portion of the losses are concentrated with a few large cedants. The Company believes there remains a high degree of uncertainty regarding its loss estimates related to the 2010 and the February and June 2011 New Zealand Earthquakes and the Japan Earthquake, and the ultimate losses arising from these events may be materially in excess of, or less than, the amounts provided for in the Consolidated Balance Sheet at December 31, 2011. Any adjustments to the Company’s preliminary estimate of its ultimate losses related to these events will be reflected in the periods in which they are determined, which may affect the Company’s operating results in future periods.
The Company used interest rate assumptions to estimate its liabilities for policy benefits for life and annuity contracts which ranged from 1.0% to 7.0% and 1.0% to 6.0% at December 31, 2011 and 2010, respectively.
The Company uses retrocessional agreements to reduce its exposure to risk of loss on reinsurance assumed. These agreements provide for recovery from retrocessionaires of a portion of losses and loss expenses. The Company remains liable to its cedants to the extent that the retrocessionaires do not meet their obligations under these agreements, and therefore the Company evaluates the financial condition of its reinsurers and monitors concentration of credit risk on an ongoing basis. The Company actively manages its reinsurance exposures by generally selecting retrocessionaires having a credit rating of A- or higher. In certain cases where an otherwise suitable retrocessionaire has a credit rating lower than A-, the Company generally requires the posting of collateral, including escrow funds and letters of credit, as a condition to its entering into a retrocession agreement. The selection of retrocessionaires follows a precise qualitative and quantitative process. The Company regularly reviews its reinsurance recoverable balances to estimate an allowance for uncollectible amounts based on quantitative and qualitative factors. The allowance for uncollectible reinsurance recoverable was $12.5 million and $6.9 million at December 31, 2011 and 2010, respectively.
The 2010 Senior Notes are ranked as senior unsecured obligations of PartnerRe Finance B. The Company has fully and unconditionally guaranteed all obligations of PartnerRe Finance B under the 2010 Senior Notes. The Company’s obligations under this guarantee are senior and unsecured and rank equally with all other senior unsecured indebtedness of the Company.
In November 2006, PartnerRe Finance II Inc. (PartnerRe Finance II), an indirect wholly-owned subsidiary of the Company, issued $250 million aggregate principal amount of 6.440% Fixed-to-Floating Rate Junior Subordinated CENts. The CENts will mature on December 1, 2066 and may be redeemed at the option of the issuer, in whole or in part, after December 1, 2016 or earlier upon occurrence of specific rating agency or tax events. Interest on the CENts is payable semi-annually and commenced on June 1, 2007 through to December 1, 2016 at an annual fixed rate of 6.440% and will be payable quarterly thereafter until maturity at an annual rate of 3-month LIBOR plus a margin equal to 2.325%.
On March 13, 2009, PartnerRe Finance II, under the terms of a tender offer, paid holders $500 per $1,000 principal amount of CENts tendered, and purchased approximately 75% of the issue, or $186.6 million, for $93.3 million. Contemporaneously, under the terms of a cross receipt agreement, PartnerRe U.S. Holdings paid PartnerRe Finance II consideration of $93.3 million for the extinguishment of $186.6 million of the principal amount of PartnerRe U.S. Holdings’ 6.440% Fixed-to-Floating Rate promissory note due December 1, 2066. All other terms and conditions of the remaining CENts and promissory note remain unchanged. A pre-tax gain of $88.4 million, net of deferred issuance costs and fees, was realized on the foregoing transactions during the year ended December 31, 2009. The aggregate principal amount of the CENts and promissory note outstanding at December 31, 2011 and 2010 was $63.4 million and $71.0 million, respectively.
For the years ended December 31, 2010 and 2009, the Company incurred interest expense of $1.2 million and $3.9 million, respectively, and paid interest of $1.6 million and $6.3 million, respectively, in relation to this loan.
At December 31, 2011 and 2010, the total authorized shares of the Company were 200 million shares, par value $1.00 per share, as follows (in millions of shares):
During 2010, the Company repurchased, under its authorized share repurchase program, 14.0 million of its common shares at a total cost of $1,082.6 million, representing an average cost of $77.10 per share.
During 2009, pursuant to the acquisition of Paris Re, the Company issued 25.7 million common shares, of which 1.3 million common shares were reissued from treasury.
The reconciliation of basic and diluted net (loss) income per share for the years ended December 31, 2011, 2010 and 2009 is as follows (in thousands of U.S. dollars or shares, except per share amounts):
(2) Dilutive securities, in the form of share options and other, of 687.3 thousand shares were not included in the weighted average number of common shares and common share equivalents outstanding for the purpose of computing the diluted net loss per share because to do so would have been anti-dilutive for the year ended December 31, 2011. In addition, at December 31, 2011, 2010 and 2009, share based awards to purchase 2,854.4 thousand, 489.7 thousand and 387.0 thousand common shares, respectively, were excluded from the calculation of diluted weighted average number of common shares and common share equivalents outstanding because their exercise prices were greater than the average market price of the common shares.
At December 31, 2011 and 2010, the Company has Swiss and French operations that are branches of PartnerRe Europe and are regulated by the Central Bank of Ireland, as prescribed by the EU Reinsurance Directive.
Income tax returns are open for examination for the tax years 2007-2011 in Canada, Ireland, Singapore and Switzerland, 2008-2011 in the United States and 2010-2011 in France. As a global organization, the Company may be subject to a variety of transfer pricing or permanent establishment challenges by taxing authorities in various jurisdictions. While management believes that adequate provision has been made in the Consolidated Financial Statements for any potential assessments that may result from tax examinations for all open tax years, the completion of tax examinations for open years may result in changes to the amounts recognized in the Consolidated Financial Statements.
Income tax expense for the years ended December 31, 2011, 2010 and 2009 was as follows (in thousands of U.S. dollars):
Realization of the deferred tax asset is dependent on generating sufficient taxable income in future periods. Although realization is not assured, Management believes that it is more likely than not that the deferred tax asset will be realized. The valuation allowance recorded at December 31, 2011 related to a tax loss carryforward in Singapore, while the valuation allowance recorded at December 31, 2010 related to foreign tax credit carryforwards in Ireland of $17.8 million with the balance related to certain tax loss carryforwards.
At December 31, 2011, the deferred tax assets (after valuation allowance) primarily related to foreign tax credit carryforwards of $9.0 million in Ireland, which can be carried forward for an unlimited period of time, and deferred foreign tax credits of $6.0 million in Ireland and the United States. At December 31, 2010, the deferred tax assets (after valuation allowance) related to capital losses in the United States of $2.9 million, which can be carried forward for five years.
In May 2005, the shareholders approved the PartnerRe Ltd. Employee Equity Plan (EEP). The EEP permits the grant of share options, RS, RSUs, SSARs or other share-based awards to employees of the Company. The EEP is administered by the Compensation and Management Development Committee of the Board (the Committee).
The following table summarizes the activity related to options granted and exercised for the years ended December 31, 2011, 2010 and 2009.
The activity related to the Company’s share options for the year ended December 31, 2011 was as follows:
The Company values share options issued with a Black-Scholes valuation model and used the following assumptions for the years ended December 31, 2011, 2010 and 2009:
The expected life of the replacement share options issued as part of the acquisition of Paris Re in 2009 was assumed to be 3 years. The expected life of all other share options issued during the years ended December 31, 2011, 2010 and 2009 was assumed to be 6 years. Expected volatility is based on the historical volatility of the Company’s common shares over a period equivalent to the expected life of the Company’s share options. The risk-free interest rate is based on the market yield of U.S. treasury securities with maturities equivalent to the expected life of the Company’s share options. The dividend yield is based on the average dividend yield of the Company’s shares over the expected life of the Company’s share options.
The activity related to the Company’s RSUs for the year ended December 31, 2011 was as follows:
The RSUs that vested during the years ended December 31, 2011, 2010 and 2009 had a fair value of $18.3 million, $30.9 million and $9.6 million, respectively.
Of the 695,744 RSUs outstanding at December 31, 2011, 34,866 are subject to a five year delivery date restriction from the grant date and were not released for conversion into shares.
The activity related to the Company’s SSARs for the year ended December 31, 2011 was as follows:
The Company values SSARs issued with a Black-Scholes valuation model and used the following assumptions for the years ended December 31, 2011, 2010 and 2009:
In 2009, the Company issued 27,655 replacement warrants as part of the acquisition of Paris Re. At December 31, 2011, 15,270 warrants are outstanding and fully vested with a weighted average remaining contractual life of 4 years and a weighted average exercise price of $34.42. During the year ended December 31, 2011, 7,993 warrants were exercised with a weighted average exercise price of $35.33.
Contributions are made by the Company, and in some locations, these contributions are supplemented by the local plan participants. Contributions are based on a percentage of the participant’s base salary depending upon competitive local market practice and vesting provisions meeting legal compliance standards and market trends. The accumulated benefits for the majority of these plans vest immediately or over a four-year period. As required by law, certain retirement plans also provide for death and disability benefits and lump sum indemnities to employees upon retirement.
The net periodic benefit cost for the years ended December 31, 2011, 2010 and 2009 were $10.0 million, $6.1 million and $6.0 million, respectively.
European benchmark indices. The insured funds comprise the accumulated pension plan contributions and investment returns thereon, which are held in an insurance arrangement that provides at least a guaranteed minimum investment return. The insured funds are held by a collective foundation of AXA Life Ltd. and are guaranteed under the insurance arrangement.
The assumptions used to determine the pension obligation and net periodic benefit cost for the years ended December 31, 2011, 2010 and 2009 were as follows:
At December 31, 2011, estimated employer contributions to be paid in 2012 were $5.7 million and future benefit payments were estimated to be paid as follows (in thousands of U.S. dollars):
The Company’s investment portfolio is managed following prudent standards of diversification and a prudent investment philosophy. The Company is not exposed to any significant credit concentration risk on its investments, except for debt securities issued by the U.S. government and other highly rated sovereign governments’ securities. At December 31, 2011, the Company’s fixed maturity investments included $879 million, or 13.6% of the Company’s total shareholders’ equity, issued by the Government of Germany. At December 31, 2010, the Company’s fixed maturity investments included $846 million, or 11.7% of the Company’s total shareholders’ equity, issued by the Government of France. Other than the U.S. government and the Government of Germany at December 31, 2011 and the U.S. government and the Government of France at December 31, 2010, the Company’s fixed maturity portfolio did not contain exposure to any other sovereign government that accounted for more than 10% of the Company’s total shareholders’ equity. The Company keeps cash and cash equivalents in several banks and may keep up to $500 million, excluding custodial accounts, at any point in time in any one bank.
The Company’s investment strategy allows for the use of derivative instruments, subject to strict limitations. Derivative instruments may be used to replicate investment positions and manage currency, market exposure and duration risk, or to enhance investment performance that would be allowed under the Company’s investment policy if implemented in other ways. The Company is exposed to credit risk in the event of non-performance by the counterparties to the Company’s derivative contracts. However, the Company diversifies the counterparties to
its derivative contracts to reduce credit risk, and because the counterparties to these contracts are high credit quality international banks, the Company does not anticipate non-performance. These contracts are generally of short duration and settle on a net basis. The difference between the contract amounts and the related market value represents the Company’s maximum credit exposure.
Included in the Company’s Other invested assets are certain notes receivable which meet the definition of financing receivables and are accounted for using the cost method of accounting. These notes receivable are collateralized by commercial or residential property. The Company utilizes a third party consultant to determine the initial investment criteria and to monitor the subsequent performance of the notes receivable. The process undertaken prior to the investment in these notes receivable includes an examination of the underlying collateral. The Company reviews its receivable positions on at least a quarterly basis using actual redemption experience. Performance of these notes receivable to date has been within expectations. At December 31, 2011 and 2010, none of the Company’s notes receivable are past due or in default and, accordingly, the Company believes that an allowance for credit losses related to these notes receivable is not required.
The Company monitors the performance of the notes receivable based on the type of underlying collateral and by assigning a “performing” or a “non-performing” indicator of credit quality to each individual receivable. At December 31, 2011, the Company’s notes receivable of $80.4 million were all performing and were collateralized by residential property and commercial property of $45.9 million and $34.5 million, respectively. At December 31, 2010, the Company’s notes receivable of $55.6 million were all performing and were collateralized by residential property and commercial property of $28.9 million and $26.7 million, respectively.
Rent expense for the years ended December 31, 2011, 2010 and 2009 was $37.0 million, $36.1 million, and $30.9 million, respectively.
In 2010, as part of the Company’s integration of Paris Re, the Company announced a voluntary termination plan (voluntary plan) available to certain eligible employees in France. Following their departure from the Company, employees participating in the voluntary plan will continue to receive pre-determined payments related to employment benefits, which were accrued for by the Company under the terms of the voluntary plan during the year ended December 31, 2010. During the year ended December 31, 2010 the Company recorded a pre-tax charge of $40.7 million related to the costs of the voluntary plan within other operating expenses.
The Company has entered into service agreements and lease contracts that provide for business and information technology support and computer equipment. Future payments under these contracts amount to $16.1 million through 2015.
The Company’s reinsurance subsidiaries, and the insurance and reinsurance industry in general, are subject to litigation and arbitration in the normal course of their business operations. In addition to claims litigation, the Company and its subsidiaries may be subject to lawsuits and regulatory actions in the normal course of business that do not arise from or directly relate to claims on reinsurance treaties. This category of business litigation typically involves, among other things, allegations of underwriting errors or misconduct, employment claims or regulatory activity. While the outcome of business litigation cannot be predicted with certainty, the Company will dispute all allegations against the Company and/or its subsidiaries that Management believes are without merit.
In the normal course of its operations, the Company enters into agreements with financial institutions to obtain unsecured and secured credit facilities. At December 31, 2011, the total amount of such credit facilities available to the Company was $1,440 million, with each of the significant facilities described below. These facilities are used primarily for the issuance of letters of credit, although a portion of these facilities may also be used for liquidity purposes. Under the terms of certain reinsurance agreements, irrevocable letters of credit were issued on an unsecured and secured basis in the amount of $246 million and $524 million, respectively, at December 31, 2011, in respect of reported loss and unearned premium reserves.
Included in the total credit facilities available to the Company at December 31, 2011 is a $750 million three-year syndicated unsecured credit facility. This facility has the following terms: (i) a maturity date of July 16, 2013, (ii) a $250 million accordion feature, which enables the Company to potentially increase its available credit from $750 million to $1 billion, and (iii) a minimum consolidated tangible net worth requirement. The Company’s ability to increase its available credit to $1 billion is subject to the agreement of the credit facility participants. The Company’s breach of any of the covenants would result in an event of default, upon which the Company may be required to repay any outstanding borrowings and replace or cash collateralize letters of credit issued under this facility. The Company was in compliance with all of the covenants at December 31, 2011. This facility is predominantly used for the issuance of letters of credit, although the Company and its subsidiaries have access to a revolving line of credit of up to $375 million as part of this facility. During the year ended December 31, 2011, there were no borrowings under this revolving line of credit.
In the normal course of its underwriting activities, the Company and certain subsidiaries entered into reinsurance contracts with Atradius N.V. The activity included in the Consolidated Statements of Operations related to Atradius N.V. for the years ended December 31, 2011, 2010 and 2009 was as follows (in thousands of U.S. dollars):
In the normal course of its underwriting activities, the Company and certain subsidiaries entered into reinsurance contracts with Delta Lloyd. The activity included in the Consolidated Statements of Operations related to Delta Lloyd for the years ended December 31, 2011, 2010 and 2009 includes net premiums earned of $1.9 million, $1.2 million and $1.4 million, respectively, and losses and loss expenses and life policy benefits of $0.8 million, $0.3 million and $0.5 million, respectively. Included in the Consolidated Balance Sheets at December 31, 2011 and 2010 were unpaid losses and loss expenses of $7.5 million and $8.9 million, respectively.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of PartnerRe Ltd. and subsidiaries as of December 31, 2011 and 2010, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2011, in conformity with accounting principles generally accepted in the United States of America.