Estimated pre-tax net losses (net of reinstatement premiums) of $420 million for the February New Zealand earthquake and associated June aftershock and $221 million for the March Japanese earthquake and tsunami
Reserve for losses and loss expenses of $8.4 billion and reinsurance recoverable of $1.8 billion
Total debt of $995 million and a debt to total capital ratio of 15.4%
Common shareholders’ equity of $4.9 billion; diluted book value per common share of $38.08
$9.1 billion, or 67%, of our cash and investment portfolio invested in investment-grade, short-term and intermediate maturity fixed income holdings (excluding restricted investments), where cash proceeds from sales are expected to be available within one to three business days under normal market conditions
We are a Bermuda-based global provider of specialty lines insurance and treaty reinsurance products with operations in Bermuda, the United States, Europe, Singapore, Canada, Australia and Latin America. Our underwriting operations are organized around our two global underwriting platforms, AXIS Insurance and AXIS Re.
Our strategy is to leverage our expertise, experience and relationships to expand our business globally. We manage a book of business diversified both geographically and by product line. We seek to provide high-quality products and services to our clients, while maintaining profitability and generating superior returns on equity over the underwriting cycle. We are focused on organic growth, which we have supplemented with small acquisitions, while managing a portfolio of diversified and attractively priced risks. Our execution on this strategy in 2011 included:
taking advantage of select opportunities for premium growth, including in our newer geographies and business lines.
2010, though to a lesser extent and primarily impacting our reinsurance segment; we recognized estimated pre-tax net losses (net of related reinstatement premiums) of $138 million for the September New Zealand earthquake (“New Zealand I”) and $110 million for the Chilean earthquake.
Our insurance segment’s 2011 underwriting income included $157 million in pre-tax net losses (inclusive of related premiums to reinstate reinsurance protection) related to the events noted above; of this amount $40 million, $32 million, $29 million and $20 million, respectively, related to the series of U.S. storms in April/May, the Thai flooding, the Japanese earthquake and tsunami and New Zealand II. Higher acquisition costs and a $15 million reduction in net favorable prior period reserve development also contributed to the reduction in underwriting income, while reductions in ceded reinsurance costs and increases in gross premiums written contributed to higher net premiums earned and partially offset these reductions.
Underwriting results in our insurance segment benefited from a substantially reduced level of claim activity in our credit and political risk lines, as well as the continued consideration of our own loss experience in establishing our current accident year loss ratios, most notably for professional lines. Reduced ceded reinsurance costs due to the restructuring of certain programs on renewal in the second quarter of 2010 increased net premiums earned. These factors were partially offset by a $93 million reduction in net favorable prior period reserve development and increases in acquisition costs and general and administrative expenses. In addition, the segment’s 2010 underwriting results were not impacted by our indemnity contract exposed to longevity risk. During 2009, we recognized net losses of $133 million in relation to this contract, which was cancelled during the fourth quarter of that year.
2010 versus 2009: The $58 million decrease in 2010 primarily resulted from lower reinvestment yields on our fixed maturity portfolio. Our other investments also contributed to the decrease; although these investments performed well in both years, our hedge funds and credit funds generated higher returns in 2009.
The movements in other revenues and expenses were primarily due to foreign exchange rate movements. Depreciation in the euro and the Sterling against the U.S. dollar resulted in foreign exchange gains of $45 million and $16 million, respectively, on the remeasurement of our non-U.S. dollar net insurance-related liabilities during 2011 and 2010; appreciation in these currencies drove a $29 million loss recognized in 2009.
Following several years of price reductions across many property and casualty lines and a near record year in terms of global catastrophes and amid declining investment yields and an uncertain global economic environment, we believe the industry is in the early stages of a cycle change, where we anticipate that pricing adequacy will improve over the next few years. Currently, however, conditions are mixed, with increases in certain lines and markets while others are stable or still in negative territory. We intend to remain selective in our approach to risk. On the asset side, the persistence of the low interest rate environment continues to pressure our investment returns. We will continue to evaluate the risk and return characteristics of our existing business, as well as emerging opportunities, and focus on lines of business where we find the most attractive opportunities.
We believe the following financial indicators are important in evaluating our performance and measuring the overall growth in value we generate for our common shareholders:
(1) Return on average common equity (“ROACE”) is calculated by dividing net income available to common shareholders for the period by the average shareholders’ equity determined by using the common shareholders’ equity balances at the beginning and end of the period.
(3) Diluted book value (“DBV”) represents total common shareholders’ equity divided by the number of common shares and diluted common share equivalents outstanding, determined using the treasury stock method.
In addition to the changes noted above for operating ROACE, ROACE also includes net realized gains and foreign exchange gains. Our combined net realized and foreign exchange gains for 2011 were sufficient to recognize net income for the period; as such, our ROACE for the year was marginally positive.
As net realized gains and losses (and therefore ROACE) includes the impact of OTTI charges, improvement in our 2010 ROACE relative to 2009 was primarily due to the substantial reduction in OTTI charges.
2011 versus 2010: Our new accident and health line was the primary driver of the 11% increase in gross premiums written in our insurance segment. Geographic expansion and new business initiatives also contributed to the increase. Gross premiums written growth for our reinsurance segment was primarily driven by proportional motor reinsurance business, with the primary contributing factors being increases on renewal and new business. Gross premiums written for trade credit and bond reinsurance business also increased.
2010 versus 2009: The increase in net premiums earned for our insurance segment resulted from the previously discussed changes in our ceded reinsurance programs and an 8% increase in gross premiums written. The increase for our reinsurance segment reflected premium growth for motor and trade credit & bond business.
Australian loss events, including heavy rainfall leading to severe flooding in January and the landfall of Cyclone Yasi in February. We recognized estimated pre-tax net losses (net of related reinstatement premiums) of $75 million in relation to these events, largely exclusive to our reinsurance segment.
New Zealand III, a 6.3-magnitude aftershock on June 13th, again in the vicinity of Christchurch. This earthquake both amplified the damage caused by New Zealand II to both commercial and residential property and caused new damage. We recognized estimated pre-tax net losses (net of related reinstatement premiums) of $30 million in relation to this event, with the full amount recognized in our reinsurance segment.
Hurricane Irene, which made landfall in August and impacted numerous regions of the Eastern United States causing widespread property damage and flooding. We recognized estimated pre-tax net losses (net of related reinstatement premiums) of $23 million for this event, with the majority of the amount recognized in our insurance segment.
Major flooding across a widespread area of Thailand, including Bangkok, during the fourth quarter; a number of significant industrial complexes were impacted by property damage and business interruption. We recognized estimated pre-tax net losses (net of related reinstatement premiums) of $64 million for this event with approximately half of this amount recognized in each of our insurance and reinsurance segments.
Our estimated net losses in relation to the catastrophe events outlined above were derived from ground-up assessments of our in-force contracts and treaties providing coverage in the affected regions. We also considered current industry insured loss estimates, market share analyses and catastrophe modeling analyses, when appropriate, in addition to the information available to date from clients, brokers and loss adjusters. Industry-wide insured loss estimates for these events, as well as our own estimates, remain subject to change as additional actual loss data becomes available.
Significant loss adjustment work remains ongoing in New Zealand; this increases the inherent level of management judgment required to arrive at our estimates of net losses and the associated uncertainty for each of New Zealand I, II and III. In addition, it is expected that there will be some difficulty allocating individual losses amongst the three New Zealand events.
A number of factors also contribute to uncertainty in our estimate for the Japanese earthquake and tsunami including, but not limited to, the magnitude of the event and associated damage, uncertainties about the extent and nature of damages and corresponding coverages (including business interruption and contingent business interruption coverages), the ultimate size of losses to be assumed by Japan’s cooperative mutuals and limitations associated with modeled losses.
In addition, the proximity of the Thai flooding to our reporting date means that limited information is yet available to us, inherently increasing the amount of management judgment required to arrive at our estimate of net losses and the associated level of uncertainty. The severe flooding spanned several months and had a significant impact on the Thai economy. Due to the size, prolonged duration and complexity of the event, substantial uncertainty remains regarding total insured losses and actual losses will depend, to a great extent, on claims from contingent business interruption coverage.
2010 versus 2009: The 1.3 percentage point increase in the current accident year loss ratio was primarily driven by a higher level of catastrophe activity, most notably with respect to the Chilean and New Zealand I earthquakes, as described above. In addition, there were a number of other weather-related loss events of note during 2010. In contrast, catastrophe losses were notably lower in 2009.
For our medium-tail business, and in particular our professional lines (re)insurance business, our historical loss experience on prior accident years has generally been lower than the loss ratios we initially established. In recognition of the increasing maturity and credibility of our own loss experience, we assigned increased weight to our own loss experience when establishing our current accident year loss ratios for this business in 2010, with a corresponding reduction in the weight assigned to industry data. We also took into account the recovery from the global financial crisis. This, therefore, led to lower current accident year loss ratios on this business for 2010.
Our net favorable prior period reserve development was the result of several underlying developments on prior accident years, identified during our quarterly reserve review process. The following table provides a breakdown of net prior period reserve development by segment:
Approximately $105 million, $117 million and $143 million of the net favorable reserve development in 2011, 2010 and 2009, respectively, was generated from professional lines (re)insurance business. This favorable development was driven by increased incorporation of our own historical claims experience into our ultimate expected loss ratios for accident years 2007 and prior, with less weighting being given to information derived from industry benchmarks.
Refer to the ‘Critical Accounting Estimate - Reserve for Losses and Loss Expenses’ section for further details. We caution that conditions and trends that impacted the development of our reserve for losses and loss expenses in the past may not necessarily recur in the future.
In 2011, we recognized $103 million of net favorable prior period reserve development, the principal components of which were:
$56 million of net favorable prior period reserve development on our property business, the majority of which related to the 2010 ($27 million), 2009 ($9 million) and 2008 ($10 million) accident years. While the 2010 and 2009 amounts primarily related to better than expected loss emergence, the 2008 amount largely related to updated information from our client with respect to one large loss event.
$22 million of net favorable prior period reserve development on marine business, spanning a number of accident years and related to better than expected loss emergence. The majority of this, $21 million, related to offshore energy business.
$50 million of net favorable prior period reserve development on professional lines business. We recognized a total of $60 million of net favorable development for 2004 through 2007 accident years, largely due to the reasons discussed in the overview. This amount included $19 million reallocated from the 2007 accident year to the 2008 accident year, recognized after consideration of our claims history and other available information and data for accident years impacted by the global financial crisis; in the aggregate, our estimate for global financial crisis remained unchanged. Partially offsetting this was the recognition of $8 million of net adverse development on the 2010 accident year.
$12 million of net favorable prior period reserve development on aviation business, spanning several accident years and largely related to better than expected loss emergence.
$18 million of net adverse prior period reserve development on credit and political risk business. This balance consisted of net adverse development of $54 million on the 2009 accident year, as we finalized settlements for certain loss events and reduced our recovery estimates for the latest available information. Partially offsetting this amount was $36 million in net favorable prior period reserve development on the 2006 through 2008 accident years, in recognition of better than anticipated loss emergence on our CEND and credit business.
$7 million of net adverse development on liability business, primarily related to the 2007 through 2009 accident years and reflecting earlier than expected loss emergence on Excess & Surplus (“E&S”) umbrella business for those accident years during the year.
$65 million of net favorable prior period reserve development on property business, the majority of which emanated from the 2008 accident year and related to better than expected loss emergence. This amount included a $9 million reduction in our estimate for Hurricanes Ike and Gustav due to a reduction in reported losses.
$40 million of net favorable prior period reserve development on marine business, driven by better than expected loss emergence. This included favorable development on energy offshore business of $21 million, the largest component of which related to a $7 million reduction in a specific case reserve on the 2006 accident year.
$13 million of net favorable prior period reserve development on aviation business, spanning several accident years and resulting from better than expected loss emergence.
$16 million of net adverse prior period reserve development on liability lines of business. This was driven by $24 million of net adverse development on E&S liability business, primarily impacting the 2007 accident year, as well as the 2008 accident year to a lesser extent. We adjusted our loss development profiles for these accident years, having observed higher than expected frequency and severity of claims emergence on this business during the previous twelve months. This was partially offset by net favorable development on E&S umbrella business, predominately from the 2004 and 2005 accident years, reflecting the incorporation of more of our own actual experience with respect to reinsurance recoveries.
In 2011, we recognized $154 million of net favorable prior period reserve development, the principal components of which were:
$90 million of net favorable prior period reserve development on catastrophe and property business largely consisting of:
$38 million of net favorable prior period reserve development on property business, primarily related to per risk business. This development primarily related to the 2007 through 2009 accident years and reflected better than expected loss emergence.
$33 million of net favorable prior period reserve development on catastrophe business, emanating from property-related catastrophe business ($24 million) and workers compensation catastrophe business ($9 million). This development primarily related to the 2009 accident year due to better than expected loss emergence.
$21 million of net favorable prior period reserve development on crop reserves, principally related to the 2009 accident year and largely resulting from the reduction in reserves for Canadian crop losses following updated information from the cedant.
$38 million of net favorable prior period reserve development on trade credit and bond reinsurance lines of business, largely related to the 2009 accident year and, to a lesser extent the 2007 and 2008 accident years, in recognition of better than expected loss emergence and updated information from our cedants.
$18 million of net adverse prior period reserve development on our trade credit and bond reinsurance lines of business, driven by adverse development of $40 million on the 2008 accident year, reflecting updated loss information received from our cedants. This was partially offset by net favorable development on earlier accident years, in recognition of better than expected loss emergence.
2011 versus 2010: Our new accident & health line led the 11% growth in gross premiums written, with the increase being reflective of our investment in that platform over the past two years. A large portion of this growth was due to accident & health reinsurance business assumed.
2010 versus 2009: Gross premiums written growth was led by opportunities in the U.S. property market and select new business opportunities in the onshore energy market. The increase in professional lines premiums largely reflected select new business opportunities and the continued build-out of our platform in Europe, Australia and Canada. Rate increases on offshore energy business resulting from the Deepwater Horizon event, as well as increases in our share of certain policies and select new business opportunities resulted in increased marine premiums.
versus 2010: Our cession rates for 2011 and 2010 were comparable at 31% and 30% of gross premiums written, respectively.
2011 versus 2010: The 18% growth in net premiums earned is primarily reflective of the 11% growth in gross premiums written, as well as the aforementioned changes in our reinsurance purchasing effected during the second quarter of 2010.
The 14.1 percentage point reduction in our current accident year loss ratio primarily resulted from a lower level of claims activity in our credit and political risk business relative to 2009. Loss activity on this line was elevated in 2009 due to the global financial crisis, resulting in a 133% current accident year loss ratio. In 2010, we considered the recovery in global economic conditions and established a 70% current accident year loss ratio for this line. In addition, the lower current accident year loss ratio for the segment was driven by business mix changes and the previously discussed consideration of our own loss experience in establishing loss ratios for our medium-tail business in 2010, most notably for professional lines. We also considered the global economic recovery when establishing our 2010 current accident year loss ratio for our professional lines business. As a result of these factors, our current accident year loss ratio on professional lines business declined from 72% in 2009 to 61% in 2010.
Acquisition Cost Ratio: Growth in accident & health gross premiums written during 2011 introduced some upward movement in the acquisition cost ratio for the segment; excluding this business, the 2011 acquisition cost ratio was 13.2%. The changes in our reinsurance purchasing effected during the second quarter of 2010, previously discussed, were the primary driver of the acquisition cost ratio increase in 2010.
Other Insurance Related Income/Loss: During 2009, we recognized $133 million in net losses associated with our indemnity contract exposed to longevity risk. This was the only contract of its kind in our portfolio and we negotiated its cancellation during the fourth quarter of 2009; thus, there were no comparative amounts for 2010 and 2011.
2011 versus 2010: The 8% growth in gross premiums written was primarily driven by our motor reinsurance line of business, driven by a higher volume of European proportional motor reinsurance business; both increases on renewal and new business contributed to the higher volume. Gross premiums written for our trade credit and bond reinsurance business also increased, with both premium adjustments on prior year treaties and an increase in Latin American surety business contributing.
Refer to the ‘Critical Accounting Estimates - Premiums’ section for a further discussion of related estimates.
During 2011, we recognized estimated pre-tax net losses (net of related reinstatement premiums) for the following natural catastrophe events:
Comparatively, during 2010 we recognized pre-tax net losses (net of related reinstatement premiums) of $136 million for New Zealand I and $110 million for the Chilean earthquake. In addition, there were a number of other weather-related loss events of note, including Australian and U.S. storms and European Windstorm Xynthia in the first quarter and further Australian storms and flooding and U.S. storms in the fourth quarter.
The 12.2 percentage point increase in our current accident year loss ratio was also driven by a greater magnitude of natural catastrophe-related losses. As noted above, we recognized aggregate estimated catastrophe-related pre-tax net losses (net of related reinstatement premiums) of $295 million during 2010. In contrast, catastrophe losses were notably less significant in 2009.
The following factors partially offset the impact of the catastrophe-related increase:
Corporate Expenses: Our corporate expenses include holding company costs necessary to support our worldwide (re)insurance operations and costs associated with operating as a publicly-traded company. As a percentage of net premiums earned, corporate expenses were 2.4%, 2.5% and 2.7% for 2011, 2010 and 2009, respectively.
Foreign Exchange Losses (Gains): Some of our business is written in currencies other than the U.S. dollar. Movements in the rates of exchange for the euro and Sterling against the U.S. dollar were the primary drivers of the amounts in each period presented. Depreciation in these currencies against the U.S. dollar resulted in foreign exchange gains on the remeasurement of our net insurance-related liabilities during 2011 and 2010, whereas appreciation had the opposite effect in 2009.
Interest Expense and Financing Costs: Interest expense primarily relates to interest due on our senior notes. The increases noted were driven by our issuance of senior notes on March 23, 2010. See Item 8, Note 10(a) to the Consolidated Financial Statements for further details.
Income Tax Expense: Income tax expense primarily results from income generated by our foreign operations in the United States and Europe. Our effective tax rate, which is calculated as income tax expense divided by income before tax, was 24.8%, 4.3% and 7.8% in 2011, 2010 and 2009, respectively. This effective rate can vary between periods depending on the distribution of net income (loss) amongst tax jurisdictions, as well as other factors.
2011 versus 2010: The primary factor causing the 4% reduction in net investment income from fixed maturities was the continued declines in reinvestment yields, primarily due to downward shifts in U.S. and European risk-free yield curves. These declines were partially offset by widening credit spreads and growth of 7% on our average fixed maturities balances during 2011 as additional cash provided by operations was allocated partially to fixed maturities.
Other investments include hedge funds, credit funds and CLO equity tranched securities (“CLO Equities”). These investments are recorded at fair value, with the change in fair value reported in net investment income. Consequently, the pre-tax return on other investments may vary materially period over period, in particular during volatile credit and equity markets.
2011 versus 2010: The lower pre-tax return on other investments in 2011 is primarily due to modest negative returns from our investments in hedge and credit funds, compared to positive returns provided by these holdings in 2010. The negative returns of these funds were reflective of the underperformance of both global equities and bank loans during 2011. Partially offsetting the decline in the pre-tax return was the increase in the fair value for our investment in CLO Equities. This increase was driven primarily by lower than anticipated default rates and higher than anticipated recovery rates for the underlying collateral, resulting in higher cash distributions from CLO Equities than previously expected. Refer to the ‘Critical Accounting Estimates - Fair Value Measurements’ for further details on the fair value measurement.
2010 versus 2009: The pre-tax return on other investments declined by 3.7% to 12.1% in 2010 primarily due to lower returns from our investments in hedge and credit funds. Partially offsetting the decline in the pre-tax return was the recovery in fair value for our CLO Equities as a result of higher cash distributions than previously expected. The decline in income from short duration high yield fund was due to its full redemption in 2010.
2011 versus 2010: The large percentage increase in dividend income was driven mainly by the significant increase in our allocation to our global equities portfolios.
2010 versus 2009: The 23% reduction in dividend income in 2010 was driven by the sale of all preferred shares during 2009. These preferred shares had larger dividend yields than the remaining common stock holdings.
2011 versus 2010: The increase is primarily due to asset class changes. Additionally, third party investment manager fees increased due to higher investment balances as a result of improved valuations and additional allocations.
2010 versus 2009: The increase is driven primarily by third party investment manager fees due to higher investment balances due to improved valuations and additional allocations.
2011 versus 2010: The decrease in net realized gains was largely due to significant gains realized in 2010 as a result of significant credit spread tightening. In 2011, we realized net gains primarily on fixed maturities as a result of the lower U.S. and European risk-free rates. The primary sources of the net realized gains on fixed maturities in 2011 were investment-grade corporate debt, U.S. government and agency securities and agency MBS which is consistent with the sources of the 2010 net realized gains.
Our investment strategy is to take a long-term view by actively managing our investment portfolio to maximize total return within certain guidelines and constraints. In assessing returns under this approach, we include net investment income, net realized investment gains and losses and the change in unrealized gains and losses generated by our investment portfolio. The following table provides a breakdown of the total return on cash and investments, inclusive of foreign exchange impact, for the periods indicated:
(1) The average cash and investments balance is calculated by taking the average of the month-end fair value balances held for the periods indicated.
The amortized cost/cost of our total investments increased by $997 million from December 31, 2010, primarily due to investing a portion of our operating cash flows generated in 2011.
The fair value of our total investments increased by $943 million from December 31, 2010, primarily due to net contributions to our fixed maturities, equities and hedge funds. This growth was partially offset by lower valuations, particularly in our equities which were negatively impacted by volatile global equity markets and, to a lesser extent, negative movements in foreign exchange rates, mostly euro against the U.S. dollar.
During 2011, we changed our methodology for assigning credit ratings to our fixed maturities to be in line with the methodology used for the Barclay’s U.S. Aggregate Bond index. This methodology uses the middle of Standard & Poor’s (S&P), Moody’s and Fitch’s ratings. When ratings from only two of these agencies are available, the lower rating is used. When a rating from only one agency is available, it is used. Previously, we used S&P’s ratings; in the absence of a rating from S&P, we used the lower of the ratings established by Moody’s and Fitch. We have restated the December 31, 2010 comparatives to conform to the new methodology. This change did not impact the overall weighted average credit rating for fixed maturities previously reported in 2010.
As part of our ongoing risk management process, in addition to managing our credit risk exposure within our fixed maturity portfolio we also monitor the aggregation of country risk exposure on a group-wide basis (refer to Item 1 ‘Risk and Capital Management’ for further details). Country risk exposure is the risk that events within a country, such as currency crises, regulatory changes and other political events, will adversely affect the ability of obligors within the country to honor their obligations to us. For foreign corporate bonds and structured securities, we measure the country risk exposure based on the country of the obligor’s domicile. For debt issued by a foreign subsidiary with an implicit or explicit parental guarantee, the country of risk would be that of the parent.
The following table provides a breakdown of our total eurozone exposure within our fixed maturity portfolio:
We also have an indirect eurozone exposure through our investment of $116 million in foreign bond mutual funds.
Our holdings in non-U.S. government securities consisted of fixed income obligations of non-U.S. sovereigns, including government agencies, local governments and supranationals. The table below summarizes our aggregate fixed maturity exposures to governments in the eurozone and other non-U.S. government concentrations by fair value at December 31, 2011 and 2010:
At December 31, 2011, our non-U.S. sovereign debt portfolio had net unrealized losses of $29 million (2010: $4 million) which included gross unrealized foreign exchange losses of $50 million (2010: $16 million), mainly on euro-denominated securities. Of these gross unrealized foreign exchange losses, $23 million (2010: $11 million)
have been effectively hedged through our hedging program. The remaining unhedged foreign exchange losses relate to foreign currency exposures required to match with our foreign denominated insurance-related liabilities.
The decrease in corporate debt holdings during 2011 was mainly due to the disposition of all U.K. and European bank holdings. Our remaining exposure to non-U.S. banks amounted to $32 million at December 31, 2011, consisting primarily of highly-rated Canadian banks. Our holdings in the non-U.S. government guaranteed sector comprise corporate issues with the explicit guarantee of a non-U.S. government. Of these holdings, at December 31, 2011, $91 million (2010: $153 million) was guaranteed by certain governments within the eurozone, mainly Germany (51%) and France (43%).
At December 31, 2011, our corporate debt portfolio had a weighted average credit rating of BBB+ (2010: A-), a duration of 3.1 years (2010: 3.5 years), and weighted average life of 4.0 years (2010: 4.4 years). The decline in the weighted average credit rating for the portfolio in 2011 was largely due to the increase in our allocation to short duration high yield corporate debt securities. At December 31, 2011, our short duration high yield portfolio had a fair value of $499 million (2010: $277 million) and a weighted-average credit rating of BB- (2010: B+). The primary sector exposures for this high yield portfolio are consumer cyclical, industrials, communications, consumer non-cyclicals and energy. These five sectors comprise 76% (2010: 83%) of the total fair value of this portfolio.
The following table provides a breakdown of the fair value of our RMBS and CMBS portfolios by credit rating:
Our RMBS portfolio consists primarily of AAA-rated agency issues and is supported by loans that are diversified across geographical areas. Due to the impact of interest rate change on prepayment speed assumptions, the duration of our agency MBS holdings contracted from 3.5 years at December 31, 2010 to 1.8 years at December 31, 2011.
The following table provides a breakdown of the underlying collateral for our ABS by credit rating:
The average duration and weighted average life of our ABS portfolio at December 31, 2011 was 0.7 years (2010: 1.0 years) and 3.1 years (2010: 3.8 years), respectively. Based on fair value, our ABS securities primarily originate from years 2010 (24%) and 2011 (23%).
G.O. bonds are backed by the full faith and credit of the authority that issued the debt and are secured by the taxing powers of those authorities. Revenue bonds are backed by the revenue stream generated by the services provided by the issuer (e.g. sewer, water or utility projects). As issuers of revenue bonds do not have the ability to draw from tax revenues or levy taxes to fund obligations, revenue bonds may carry a greater risk of default than G.O. bonds. At December 31, 2011, the top three revenue streams related to transportation (20%), power (15%) and school (14%) (2010: transportation (16%), water & sewer (14%) and power (13%)).
The severity range of 10-20% consists primarily of corporate debt securities and ABS with weighted average credit ratings of A- and A+, respectively. The increase in this severity range from 2010 is due to negative price movements on certain corporate debt securities, partially offset by positive price movement in certain CLO debt tranched securities (part of our ABS).
During 2011, we increased our allocation to global equities, mainly to exchange traded funds (“ETFs”) which were introduced to our portfolio in 2011 to provide highly liquid and cost efficient exposure to the global equity markets. This increased allocation, together with the increased allocation to alternative investments (reported as other investments), provides a diversification benefit to our predominantly fixed income invested asset base.
At December 31, 2011, our equities portfolio had net unrealized losses of $22 million (2010: $22 million net unrealized gains) of which most relate to our ETFs that we purchased during 2011. The $44 million change in net unrealized gains/losses was caused primarily by the declines in the non-U.S. equity markets and, to a lesser extent, declines in foreign currencies.
The $170 million increase in the fair value of our total hedge and credit funds in 2011 reflects $183 million of net subscriptions primarily in long/short equity hedge funds, offset partially by declined valuations during the year as our hedge and credit funds tracked the volatility of the global equity and credit markets. Certain of these funds may be subject to restrictions on redemptions which may limit our ability to liquidate these investments in the short term. Refer to Item 8, Note 5(b) of our Consolidated Financial Statements for further details.
The $10 million increase in the fair value of the CLO - Equities since December 31, 2010, was primarily due to $45 million of improved valuations, offset partially by $35 million in cash distributions received during 2011.
The $154 million increase in restricted investments in 2011 was primarily due to an increase in the collateral required for securing insurance obligations established by certain U.S. subsidiaries that are recoverable under inter-company agreements.
All of the above restricted investments are available to settle (re)insurance liabilities.
AXIS Capital’s operating subsidiaries generally derive cash from investment income, as well as the net receipt of premiums less losses and loss expenses related to underwriting activities. Historically, these cash receipts have been sufficient to fund the operating expenses of these subsidiaries, as well as to fund dividend payments to AXIS Capital. The subsidiaries’ remaining cash flows are generally reinvested in our investment portfolio.
Compared to 2009, our 2010 cash flows from operating activities increased $338 million. The primary drivers of this increase were higher premium-related cash receipts, driven by gross premiums written increases, and lower reinsurance protection costs for our insurance segment largely driven by the previously mentioned changes in our reinsurance purchasing. Partially offsetting these increases were increased cash outflows for general and administrative expenses, previously noted, and an increase in our net paid losses as we continued to fund claim payments for lines of business impacted by the global financial crisis. While our 2011 cash flows from operating activities were comparable to 2010, there were certain notable underlying movements; net premium-related cash receipts increased but were partially offset by an increase in net paid losses. Premium receipts continued to increase due to growth in gross premiums written, as well as the changes in reinsurance purchasing effected in the second quarter of 2010. The high frequency and severity of natural catastrophe events in the most recent two years drove an increase in net paid losses, though this was partially offset by a continued reduction in payments related to lines of business impacted by the global financial crisis.
Net cash flows used in financing activities in 2011 primarily related to dividends paid on common shares of $206 million (2010: $108 million; 2009: $113 million). The increase in 2011 was largely due to payment of deferred dividends to certain warrant holders upon exercise (refer to Item 8, Note 13 to our Consolidated Financial Statements). Financing cash outflows also included common share repurchases of $66 million ($50 million from the market, with the remainder from employees to satisfy withholding tax liabilities upon vesting of restricted stock awards and stock option exercises) (2010: $710 million, including $699 million from the market; 2009: $176 million, including $170 million from the market) and dividends paid on preferred shares of $37 million (2010: $37 million; 2009: $37 million). During 2010, these outflows were partially offset by the $495 million net proceeds received from our senior notes issuance (discussed in Item 8, Note 10(a) of our Consolidated Financial Statements). We note that market share repurchases are completely discretionary (see ‘Capital Resources - Share Repurchases’ below).
Our diversified underwriting portfolio has demonstrated an ability to withstand catastrophic losses. Since 2003 and with the only exception being 2009, our annual cash flows from operations were in excess of $1 billion; operating cash flows of $850 billion for 2009 were adversely impacted by claims arising amidst the global
financial crisis and a non-recurring payment of $200 million to settle our insurance derivative contract. These positive cash flows were generated notwithstanding the impacts of the global financial crisis and the recognition of significant natural catastrophe-related losses during the period: our net losses and loss expenses included $266 million for Hurricanes Charley, Frances, Ivan and Jeanne in 2004; $1,019 million for Hurricanes Katrina, Rita and Wilma in 2005; $408 million for Hurricanes Gustav and Ike in 2008; $256 million for the Chilean earthquake and New Zealand I in 2010; and $944 million for 2011 natural catastrophe events described in ‘Underwriting Results - Group - Underwriting Expenses’. There remains significant uncertainty associated with our estimates of net losses for the most recent of these catastrophe events (see ‘Underwriting Results - Group - Underwriting Expenses’ for further details), as well as the timing of the associated cash outflows.
We routinely enter into agreements with financial institutions to obtain secured and unsecured credit facilities. These facilities are primarily used for the issuance of letters of credit, in the normal course of operations, to certain U.S.-based (re)insurance operations that purchase reinsurance protection from us. These letters of credit allow those operations to take credit, under U.S. insurance regulations, for reinsurance obtained in jurisdictions where AXIS Capital’s subsidiaries are not licensed or otherwise admitted as an insurer. The value of our letters of credit outstanding is driven by, amongst other factors, loss development on existing reserves, the payment patterns of such reserves, the expansion of our and the loss experience of such business. A portion of these facilities may also be used for liquidity purposes.
We also have a revolving $500 million credit facility (the “Credit Facility”), which provides us with combined borrowing and letter of credit issuance capacity up to the aggregate amount of the facility. At our request, and subject to certain conditions, the aggregate commitment of this facility may be increased by up to $250 million. Interest on loans issued under this facility is payable based on underlying market rates at the time of loan issuance. While any loans are unsecured, we have the option to issue letters of credit on a secured basis in order to reduce associated fees. This facility is subject to certain covenants that we believe are customary for facilities of this type, including limitations on fundamental changes, the incurrence of additional indebtedness and liens and certain transactions with affiliates and investments, as defined in the facility documents. Compliance with certain financial covenants that we believe are customary for (re)insurance companies in credit facilities of this type is also required. These covenants include:
At December 31, 2011, this facility required a minimum consolidated net worth of $3.900 billion and our actual consolidated net worth, as calculated under the provisions of the Credit Facility, was $5.328 billion. We had a consolidated debt to total capital ratio, calculated in accordance with the Credit Facility provisions, of 0.16 to 1 and each of our material insurance/reinsurance subsidiaries party to the agreement had an A.M. Best financial strength rating of A.
As part of our capital management program, our Board of Directors has authorized a share repurchase program. At December 31, 2011, the remaining authorization under the program was $544 million (refer to Item 5 ‘Market for Registrant’s Common Equity, Related Stockholder Matters and Issue Purchases of Equity Securities’ for additional information). As noted above, repurchases under this program are entirely discretionary; the timing and amount of the additional repurchase transactions will depend on a variety of factors including, but not limited to, global (re)insurance and financial market conditions and opportunities, capital management and regulatory considerations.
Our principal (re)insurance operating subsidiaries are assigned financial strength ratings from internationally recognized rating agencies, including Standard & Poor’s, A.M. Best and Moody’s Investors Service. These ratings are publicly announced and are available directly from the agencies, as well as on our website.
Such financial strength ratings represent the opinions of the rating agencies on the overall financial strength of a company and its capacity to meet the obligations of its (re)insurance contracts. Independent ratings are one of the important factors that establish our competitive position in (re)insurance markets. The rating agencies consider many factors in determining the financial strength rating of an insurance company, including the relative level of statutory surplus necessary to support the business operations of the company. These ratings are based upon factors considered by the rating agencies to be relevant to policyholders, agents and intermediaries and are not directed toward the protection of investors. Such ratings are not recommendations to buy, sell or hold securities.
The ‘A’ grouping is the third highest ratings category out of fifteen. Ratings outlooks (‘Positive’, ‘Negative’ and ‘Stable’) are assigned to indicate a rating’s potential direction over an intermediate term, generally defined as 12 - 36 months.
The following table provides a breakdown of our contractual obligations and commitments at December 31, 2011 by period due:
(1) We are obligated to pay claims for specified loss events covered by the (re)insurance contracts we write. Such loss payments represent our most significant future payment obligation. In contrast to our other contractual obligations, our cash payments are not determinable from the terms specified within the underlying contracts. The total amount in the table above reflects our best estimate of our reserve for losses and loss expenses. However, the actual amounts and timing may differ materially; refer to the ‘Critical Accounting Estimates - Reserve for Losses and Loss Expenses’ for further information. We have not taken into account corresponding reinsurance recoverable amounts that would be due to us. Given the limited loss development pattern information specific to our experience, we have generally estimated the timing of payment by applying industry benchmark payout patterns to each underlying reserving class.
(4) We have Supplemental Executive Retirement Plans (“SERPs”) for both the Chairman and the CEO. For further information, refer to Item 8, Note 14 to the Consolidated Financial Statements.
Our quarterly reserving process begins with the collection and analysis of paid and incurred claim data for each of our segments. The segmental data is disaggregated by reserving class and further disaggregated by accident year (i.e. the year in which the loss event occurred). We use underwriting year information (i.e. the year in which the contract incepted) to analyze some of our proportional reinsurance business and subsequently allocate reserves to the respective accident years. Our reserving classes are selected to ensure that the underlying contracts have homogeneous loss development characteristics, while remaining large enough to make the estimation of trends credible. We review our reserving classes on a regular basis and adjust them over time as our business evolves. This data serves as a key input to many of the methods employed by our actuaries. Given our relatively limited operating history, this data is also supplemented with industry benchmarks. The relative weights assigned to our own historical loss data versus industry data vary according to the length of the development profile for the reserving class being evaluated. At present, we generally give more weight to our own experience (and, correspondingly, less weight to industry data) for reserving classes with short and medium claim tails; the converse is true for reserving classes with longer claim tails. (See ‘Claim Tail Analysis’ below for more detailed information by claim tail class.)
Bornhuetter-Ferguson Method (“BF”): This method can be seen as a combination of the ELR and Loss Development Methods, under which the Loss Development Method is given progressively more weight as an accident year matures. The main advantage of the BF Method is that it provides a more stable estimate of ultimate losses than the Loss Development Method at earlier stages of development, while remaining more sensitive to emerging loss development than the ELR Method. In addition, the BF Method allows for the incorporation of external market information through the use of expected loss ratios, whereas the Loss Development Method does not incorporate such information.
As part of our quarterly loss reserve review process, our actuaries employ the estimation method(s) that they believe will produce the most reliable estimate of ultimate losses, at that particular evaluation date, for each reserving class and accident year combination. Often, this is a blend (i.e. weighted average) of the results of two or more appropriate actuarial methods. These ultimate loss estimates are generally utilized to evaluate the adequacy of our ultimate loss estimates for previous accident years, as established in the prior reporting period. For the initial estimate of the current accident year, the available claim data is typically insufficient to produce a reliable estimate of ultimate losses. As a result, our initial estimate for an accident year is generally based on the ELR Method. The initial ELR for each reserving class is established collaboratively by our actuaries, underwriters and management at the start of the accident year as part of the planning process, taking into consideration prior accident years’ experience and industry benchmarks, adjusted after considering factors such as exposure trends, rate differences, changes in contract terms and conditions, business mix changes and other known differences
between the current accident year and prior accident years. The initial expected loss ratios for a given accident year may be modified over time if the underlying assumptions, such as loss development or premium rate changes, differ from the original assumptions.
An important and distinguishing feature of many of these contracts, though, is our contractual right, subsequent to payment of a claim to our insured, to be subrogated to, or otherwise have an interest in, the insured’s rights of recovery under an insured loan or facility agreement. These estimated recoveries are recorded as an offset to our credit and political risk loss reserves. The lag between the date of a claim payment and our ultimate recovery from the corresponding security can result in negative case reserves at a point in time (as was the case at December 31, 2011 and 2010). The nature of the underlying collateral is specific to each transaction and we also estimate the value of this collateral on a contract-by-contract basis. This valuation process is inherently subjective and involves the application of management’s judgment because active markets for the collateral often do not exist. Our estimates of value are based on numerous inputs, including information provided by our insured, as well as third party sources including rating agencies, asset valuation specialists and other publicly available information. We also assess any post-event circumstances, including restructurings, liquidations and possession of asset proposals/agreements.
estimate of the ultimate losses arising from the catastrophic event. In subsequent reporting periods, we review changes in paid and incurred losses in relation to each significant catastrophe and adjust our estimates of ultimate losses for each event if there are developments that are different from our previous expectations; such adjustments are recorded in the period in which they are identified.
During both 2010 and 2011, our results of operations were significantly impacted by natural catastrophe activity. See Item 7 ‘Underwriting Results - Group, Underwriting Expenses’ for a discussion of these events and the remaining associated uncertainties.
Similarly, we also placed significant reliance on industry benchmarks in selecting our loss development patterns in earlier years. Over time, we have given varying degrees of weight given to our own historical loss experience, as further discussed in the ‘Claim Tail Analysis’ section.
Our quarterly reserving process involves the collaboration of our underwriting, claims, actuarial, legal and finance departments, includes various segmental committee meetings and culminates with the approval of a single point best estimate by our Group Reserving Committee, which comprises senior management. Informed judgment is applied throughout the process to consider many qualitative factors that may not be fully captured in the actuarial estimates. Such factors include, but are not limited to: the timing of the emergence of claims, volume and complexity of claims, social and judicial trends, potential severity of individual claims and the extent of internal
historical loss data versus industry information due to our relatively short operating history. While these qualitative factors are considered in arriving at the point estimate, no specific provisions for qualitative factors are established.
consideration in our loss reserve estimation process. As a result, commencing in 2005, we have gradually increased the weighting assigned to our own historical experience in selecting the expected loss ratios and loss development patterns utilized to establish our initial estimates of ultimate losses. Given that our own loss experience has generally been more favorable than we expected based on industry benchmarks, the incorporation of this data has generally led to a reduction in our loss ratios and the recognition of favorable development on prior accident years. See ‘Underwriting Results - Group - Prior Period Reserve Development’ for a discussion of the net favorable development recognized when re-estimating our ultimate losses for our short-tail business in the last three years.
Our initial estimates of ultimate losses for a given accident year are generally established by application of the ELR Method, due to the longer claim reporting and settlement periods for this business. We generally utilized industry expected loss ratio benchmarks to establish our initial estimates of ultimate losses for our earlier accident years. Due to the longer claim tail, the length of time required to develop our own credible historical loss history for utilization in the loss reserving process is greater for our medium-tail business than for our short-tail business. As a result, the number of accident years where we relied heavily on industry benchmarks to estimate our initial ultimate losses for our medium-tail business is greater. Our reserving approach for medium-tail business is tailored by line of business, with our significant lines being specifically addressed below.
For our professional lines business, claim payment and reporting patterns are typically medium to long-tail in nature. The underlying business is predominantly written on a claims-made basis, with the majority of reinsurance treaties being written on a risks attaching basis. Generally, when we believe the percentage of incurred losses for a particular accident year has reached 70% of ultimate losses, we gradually transition to sole reliance on the BF Method over the course of the next two calendar years.
Our transition from the ELR Method for estimating professional lines ultimate losses began during 2008, when we commenced the gradual transition from the ELR Method to the BF Method for the 2004 and prior accident years. As our loss history continues to develop, additional accident years are included in the transition process; at the end of 2011, the transition had begun for the 2008 and prior accident years. This transition means that our own historical loss experience is gradually incorporated when we re-estimate our ultimate losses for these accident years. As our actual loss experience has generally been more favorable than we expected when establishing the initial expected loss ratios, this transition has generally resulted in the recognition of net favorable prior period reserve development over the last three years. However, during 2009, we strengthened our 2008 accident year reserves in response to the continuing economic downturn. (See ‘Underwriting Results - Group - Prior Period Reserve Development’ for further details). As a result of the global financial crisis, there continues to be relatively high levels of uncertainty around ultimate losses for the 2007 - 2009 accident years. This is mainly attributable to both the higher than average volume of reported claims on these years, as well as the higher proportion of open claims, relative to earlier accident years at the same stage of development. As a result, we separately evaluate the loss reserves for each reserving class impacted by this ‘event’ in light of the latest available information. During 2011, after consideration of our loss experience to date and other available information, we re-allocated a portion of our reserves related to the global financial crisis from the 2007 accident year to the 2008 accident year (see ‘Underwriting Results - Group - Prior Period Reserve Development’.) Given the significance of the global financial crisis, development patterns for the 2007-2009 accident years may ultimately differ from other years.
As previously described, the estimation of the value of our recoveries on credit and political risk business requires significant management judgment. At December 31, 2011, our total estimated recoveries on credit insurance business were $158 million, of which $109 million related to contracts where we had already paid losses and $49 million related to contracts where case reserves were recognized. Comparatively, at December 31, 2010, our estimated recoveries were $163 million, with $135 million, $19 million and $9 million relating to paid losses, case reserves and IBNR, respectively. The slight overall reduction in 2011 reflects the settlement of one claim and the reduction in recovery estimates for certain claims, partially offset by an increase related to estimated recoveries on newly reported claims.
As a general rule, our estimates of accident year ultimate losses for our long-tail business are notably more uncertain than those for our short and medium-tail business. Factors that contribute additional uncertainty to estimates for our long-tail business include, but are not limited to:
The more significant weight given to industry benchmarks in forming our estimates.
The possibility of future litigation, legislative or judicial change that may impact future loss experience relative to the prior industry loss experience relied upon in reserve estimation.
As part of our quarterly reserving process, we monitor actual paid and incurred loss emergence relative to expected loss emergence based on industry-benchmark loss development patterns. At this stage, we generally believe that it remains too early to recognize any potentially favorable loss emergence that may be noted through this analysis. However, the drivers of any unfavorable loss emergence are investigated and, as a result, may lead to an immediate recognition of adverse development. During each of the past three years, we recognized net adverse development for our liability insurance business in light of earlier than expected loss emergence (see ‘Underwriting Results - Group - Prior Period Reserve Development’ for further details). In addition, during 2011 we recognized net adverse development on our motor reinsurance business mainly as a result of a change in our assumptions surrounding U.K. settlement practices. Specifically, we increased our assumptions relating to the frequency and cost of claims that are expected to settle using Periodical Payment Orders (“PPOs”), which are annuities designed to cover items such as the ongoing cost of care and loss of earnings for injured claimants. We do not discount our loss reserves in order to adjust for the time value of money associated with such annuity awards. See ‘Underwriting Results - Group - Prior Period Reserve Development’ for further details.
While we believe that our loss reserves at December 31, 2011 are adequate, new information, events or circumstances may result in ultimate losses that are materially greater or less than provided for in our loss reserves. As previously noted, there are many factors that may cause our reserves to increase or decrease, particularly those related to catastrophe losses and long-tail lines of business.
The results show the cumulative increase (decrease) in our loss reserves across all accident years. For example, if our assumed loss development pattern for our property insurance business was three months shorter with no accompanying change in our ELR assumption, our loss reserves may decrease by approximately $25 million. Each of the impacts set forth in the tables is estimated individually, without consideration for any correlation among key assumptions or among reserving classes. Therefore, it would be inappropriate to take each of the amounts and add them together in an attempt to estimate total volatility. While we believe the variations in the expected loss ratios and loss development patterns presented could be reasonably expected, our own historical data regarding variability is generally limited and actual variations may be greater or less than these amounts. It is also important to note that the variations are not meant to be a “best-case” or “worst-case” series of scenarios and, therefore, it is possible that future variations in our loss reserves may be more or less than the amounts presented. While we believe that these are reasonably likely scenarios, we do not believe this sensitivity analysis should be considered an actual reserve range.
Reinsurance recoverable as a percentage of gross loss reserve was comparable, at 21% and 22% for December 31, 2011 and 2010, respectively. At December 31, 2011 and 2010, respectively, 98.6% and 97.9% of our gross reinsurance recoverable (i.e. excluding the provision for uncollectible amounts) were collectible from reinsurers rated A- or better by A.M. Best. For an analysis of the credit risk associated with our reinsurance recoverable balances at December 31, 2011, refer to Item 8, Note 11 to the Consolidated Financial Statements.
A limited portion of our insurance business is written on a line slip or proportional basis, under which we assume a fixed percentage of the premiums and losses on a particular risk or group of risks along with numerous other unrelated insurers. Although premiums on this business are not contractually stated, we recognize gross premiums written based on an estimate provided by the client via the broker. For further details on the estimation process, see the discussion provided for the reinsurance segment below. We review these estimates on a quarterly basis and record significant adjustments in premium estimates when identified. Gross premiums written on a line
slip/proportional basis comprised 8%, 3% and 4% of the segment’s total for the years ended December 31, 2011, 2010 and 2009, respectively, and therefore the associated impact of these estimates on our pre-tax net income was immaterial. The increase during 2011 was driven by growth in our accident & health line, a large portion of which related to proportional reinsurance business.
Our excess of loss reinsurance contracts with cedants generally include provisions for a deposit or minimum premium payable to us. The minimum/deposit premium is generally adjusted at the end of the contract period to reflect changes in the underlying risks in force during the contract period. Minimum/deposit premiums generally cover the majority of premiums due under excess of loss contracts, with the adjustable portion typically comprising an insignificant portion of the total premium receivable by us. Therefore, the deposit/minimum premiums are generally considered to be the best estimate of the reinsurance contracts’ written premiums at inception. We record adjustments to the deposit/minimum premiums in the period during which they become determinable. Excess of loss contracts accounted for 53%, 55% and 60% of our reinsurance segment’s total gross premiums written for the years ended December 31, 2011, 2010 and 2009, respectively.
Line slip and proportional (re)insurance contracts are generally written on a “risks attaching” basis, covering claims that attach to the underlying policies written during the terms of such contracts. Generally, we earn these premiums evenly over a 24-month period as the underlying exposures incept throughout the contract term, which is typically one year, and such underlying exposures generally have a one year coverage period.
Since 2009, significant liquidity has returned to the financial markets, resulting in an increase in observable market prices for our financial instruments. At December 31, 2011, the fair value for 90% (2010: 87%) of our total fixed maturities and equities was based on prices provided by globally recognized independent pricing services. The remaining securities were priced by either non-binding broker quotes or internal valuation models.
Of these significant inputs, the default and loss severity rates are the most judgmental unobservable market inputs to which the valuation of CLO - Equities is most sensitive.
Actual default rates at November 30, 2011 for our CLO - Equities varied from 0.2% to 1.8% (November 30, 2010: 0.0% to 2.5%) on the remaining underlying collateral. While these default rates are much lower than our default rate assumptions noted above, we remain cautious on this favorable development given the continuing global economic uncertainty. However, during the fourth quarter of 2011, we have adjusted our loss severity rate downward to reflect current observable market trends where recoveries on loan defaults have improved significantly over previous years. Due to the use of significant unobservable inputs in our discounted cash flow model, we continue to classify the CLO - Equities as Level 3.
Because our AFS investment portfolio is the largest component of our consolidated assets and a multiple of shareholders’ equity, OTTI could be material to our financial condition and operating results particularly during periods of dislocation in the financial markets. During 2011, we recorded a total OTTI charge in earnings of $16 million (2010: $18 million; 2009: $337 million). Refer to the ‘Net Investment Income and Net Realized Investment Gains/Losses’ section above for further details.
3) do not anticipate to recover fully the amortized cost based on projected cash flows to be collected (i.e. a credit loss exits).
For impaired securities held within our high yield portfolios (i.e. managed under a mandate to invest exclusively in non-investment grade securities), we have established separate parameters for our credit loss assessment. Due to the additional volatility inherent in high yield securities relative to investment-grade securities, we focus on the severity of the impairment and work closely with our external high yield investment manager to identify securities with significant potential credit impairments.
We consider our “ability and intent” to hold an equity security in an unrealized position for a reasonable period of time to allow for a full recovery. As an equity security does not have a maturity date, the forecasted recovery for an equity security is inherently more judgmental than for a fixed maturity security.
In this report, we have presented operating income (loss), which is a “non-GAAP financial measure” as defined in Regulation G. Operating income (loss) represents after-tax operational results without consideration of after-tax net realized investment gains (losses) and foreign exchange losses (gains). In addition, we have presented diluted operating earnings (loss) per share and operating return on average common equity (“operating ROACE”), which are derived from the non-GAAP operating income (loss) measure. These measures can be reconciled to the nearest GAAP financial measures as follows:
(1) Tax (cost) benefit of ($1,703), ($1,974) and $6,354 for 2011, 2010 and 2009, respectively. Tax impact is estimated by applying the statutory rates of applicable jurisdictions, after consideration of other relevant factors including the ability to utilize capital losses.
(3) For operating loss per share purposes, we have excluded the impact of otherwise anti-dilutive securities.
Although the investment of premiums to generate income and realized investment gains (or losses) is an integral part of our operations, the determination to realize investment gains (or losses) is independent of the underwriting process and is heavily influenced by the availability of market opportunities. Furthermore, many users believe that the timing of the realization of investment gains (or losses) is somewhat opportunistic for many companies.
Foreign exchange losses (gains) in our Consolidated Statements of Operations are primarily driven by the impact of foreign exchange rate movements on net insurance related-liabilities. However, this movement is only one element of the overall impact of foreign exchange rate fluctuations on our financial position. In addition, we recognize unrealized foreign exchange losses (gains) on our available-for-sale investments in other comprehensive income and foreign exchange losses (gains) realized upon the sale of these investments in net realized investments gain (losses). These unrealized and realized foreign exchange rate movements generally offset a large portion of the foreign exchange losses (gains) reported separately in earnings, thereby minimizing the impact of foreign exchange rate movements on total shareholders’ equity. As such, the Statement of Operations foreign exchange losses (gains) in isolation are not a fair representation of the performance of our business.
We have audited the accompanying consolidated balance sheets of AXIS Capital Holdings Limited and subsidiaries (the “Company”) as of December 31, 2011 and 2010, and the related consolidated statements of operations, comprehensive income (loss), changes in shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2011. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the financial statements based on our audits.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2011, based on the criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 22, 2012 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
valuation of certain fixed maturities, other investments and derivatives that are measured using significant unobservable inputs.
On a quarterly basis, we assess whether unrealized losses on available for sale investments represent impairments that are other than temporary. Several factors are considered in this assessment including, but not limited to: (i) the extent and duration of the decline, (ii) the reason for the decline (e.g. credit spread widening, credit event), (iii) the historical and implied future volatility of the fair value, (iv) the financial condition and near-term prospects of the issuer and (v) the collateral structure and credit support of the security, if applicable.
We impair an equity security in an unrealized loss position when we do not have the ability and intent to hold the security for a reasonable period of time to allow for a full recovery. The full impairment is charged to earnings, in net realized investment gains (losses).
We record other investments at fair value (see Note 6 - Fair Value Measurements), with both changes in fair value and realized gains/losses reported in net investment income.
Insurance premiums written are recorded in accordance with the terms of the underlying policies. For multi-year policies where premiums are payable in annual installments, premiums are recorded at the inception of the policy based on management’s best estimate of total premiums to be received. However, this excludes premiums for the period during which the insured/reinsured has the ability to unilaterally commute or cancel coverage. Reinsurance premiums are recorded at the inception of the policy and are estimated based upon information received from ceding companies. Any subsequent differences arising on insurance and reinsurance premium estimates are recorded in the period they are determined.
(Re)insurance premiums are earned over the period during which we are exposed to the underlying risk, which is generally one to two years with the exception of multi-year policies. Unearned premiums represent the portion of premiums written which is applicable to the unexpired risks under contracts in force.
In the normal course of business, we purchase reinsurance protection to limit our ultimate losses from catastrophic events and to reduce our loss aggregation risk. The premiums paid to our reinsurers (i.e. premiums ceded) are expensed over the coverage period. Prepaid reinsurance premiums represent the portion of premiums ceded which
is applicable to the unexpired term of the contracts in force. Reinstatement-related premiums ceded are recorded at the time a loss event occurs and our coverage limits for the remaining life of a contract are reinstated under pre-defined contract terms; such premiums are expensed over the remaining risk period.
Reinsurance recoverable related to our case reserves is estimated on a case-by-case basis by applying the terms of any applicable reinsurance coverage to our individual case reserve estimates. Our estimate of reinsurance recoverable related to our IBNR reserves is generally developed as part of our loss reserving process.
The estimates of our reinsurance recoverable and the associated provision require management’s judgment and are reviewed in detail on a quarterly basis. Any adjustments to amounts recognized in prior periods are reported in our net losses and loss expenses in the Consolidated Statement of Operations for the period when the adjustments were identified. The charge-off of amounts previously reserved as uncollectible is also considered on a case-by-case basis as part of this quarterly process.
In recording foreign currency transactions, revenue and expense items are converted to the relevant functional currency at the exchange rate prevailing at the transaction date. Assets and liabilities originating in currencies other than the functional currency are translated into the functional currency at the rates of exchange in effect at the balance sheet date. The resulting foreign currency gains or losses are recognized in the Consolidated Statements of Operations, with the exception of those related to foreign-denominated available for sale investments. For these investments, exchange rate fluctuations represent an unrealized appreciation/depreciation in the value of the securities and are included in the related component of AOCI.
We amortize intangible assets with finite lives over their estimated useful lives in proportion to the estimated economic benefits of the intangible assets. We also test these assets for impairment if circumstances indicate that the carrying value may not be fully recoverable. Such circumstances may include an economic downturn in a geographic market or a change in the assessment of future operations. If, as a result of such an evaluation, we determine that the carrying value of the finite lived intangible assets is not recoverable, the value of the assets will be reduced to fair value with the difference being expensed in the Consolidated Statement of Operations.
In May 2011, the FASB amended its existing fair value measurement guidance by:
addressing the fair value measurement of instruments with offsetting market or counterparty credit risks,
clarifying that the “valuation premise” and “highest and best use” concepts are not relevant to financial instruments,
In September 2011, the FASB issued new guidance providing entities with the option to perform a qualitative assessment prior to calculating the estimated fair value of a reporting unit, the first step of the required annual goodwill impairment test. Entities able to qualitatively conclude that the fair value of a reporting unit more likely than not (a likelihood of more than 50%) exceeds its carrying amount can bypass the existing requirement to perform the quantitative annual impairment test. This guidance will become effective at January 1, 2012 and does not change how an entity measures a goodwill impairment loss; thus, the adoption of this guidance will not impact our results of operations, financial condition or liquidity.
Our insurance segment provides insurance coverage on a worldwide basis. The product lines in this segment are property, marine, terrorism, aviation, credit and political risk, professional lines, liability and accident & health.
Our reinsurance segment provides treaty and facultative property and casualty reinsurance to insurance companies on a worldwide basis. The product lines in this segment are catastrophe, property, professional lines, credit and bond, motor, liability, engineering and other.
(3) Asset-backed securities (ABS) include debt tranched securities collateralized primarily by auto loans, student loans, credit cards, and other asset types. This asset class also includes an insignificant position in collateralized loan obligations (CLOs) and collateralized debt obligations (CDOs).
(4) Municipals include bonds issued by states, municipalities and political subdivisions.
At December 31, 2011, 138 securities (2010: 206) have been in a continuous unrealized loss position for 12 months or greater and have a fair value of $177 million (2010: $410 million). Following our credit impairment review, we concluded that these securities as well as the remaining securities in an unrealized loss position in the above table were temporarily depressed at December 31, 2011, and are expected to recover in value as the securities approach maturity. Further, at December 31, 2011, we did not intend to sell these securities in an unrealized loss position and it is more likely than not that we will not be required to sell these securities before the anticipated recovery of their amortized costs.
Two common redemption restrictions which may impact our ability to redeem our hedge and credit funds are gates and lockups. A gate is a suspension of redemptions which may be implemented by the general partner or investment manager of the fund in order to defer, in whole or in part, the redemption request in the event the aggregate amount of redemption requests exceeds a predetermined percentage of the fund’s net assets which may otherwise hinder the general partner or investment manager’s ability to liquidate holdings in an orderly fashion in order to generate the cash necessary to fund extraordinarily large redemption payouts. A lockup period is the initial amount of time an investor is contractually required to hold the security before having the ability to redeem. During 2011 and 2010, neither of these restrictions impacted our redemption requests.
As disclosed in Note 2(a), we adopted an updated accounting standard related to the presentation and recognition of OTTI for fixed maturities in the second quarter of 2009. Because this standard does not allow for retrospective application, the $26 million of OTTI charge for the first quarter of 2009 was calculated based on the full difference between the fair value and carrying value of the impaired fixed maturities. The cumulative effect of the adoption resulted in a $38 million net after-tax increase to retained earnings with a corresponding decrease to AOCI, resulting in no change to our shareholders’ equity.
Our investments in CMBS are diversified and highly rated, with a weighted average estimated subordination percentage of 25% at December 31, 2011 (2010: 27%). Based on discounted cash flows at December 31, 2011, the current level of subordination is sufficient to cover the estimated loan losses on the underlying collateral of the CMBS.
Our assumptions on default and loss severity rates are established based on an assessment of actual experience to date for each CLO Debt and review of recent credit rating agencies’ default and loss severity forecasts. Based on the underlying collateral values and our projected cash flows at December 31, 2011, our CLO Debt had sufficient credit protection levels to receive all contractually obligated principal and interest payments.
The OTTI losses on equities in 2011 and 2010 are primarily due to the severity and duration of their unrealized loss positions, for which we concluded the forecasted recovery period was uncertain. The recognition of such losses does not necessarily indicate that sales will occur or that sales are imminent or planned. At December 31, 2011, the fair value of our equities was $678 million (2010: $349 million), which included $47 million (2010: $5 million) of gross unrealized losses.
Accordingly, the degree of judgment exercised by management in determining fair value is greatest for instruments categorized in Level 3. In periods of market dislocation, the observability of prices and inputs may be reduced for many instruments. This may lead us to change the selection of our valuation technique (from market to income approach) or may cause us to use multiple valuation techniques to estimate the fair value of a financial instrument. This circumstance could cause an instrument to be reclassified between levels.
Non-U.S. government securities comprise bonds issued by non-U.S. governments and their agencies along with supranational organizations (also known as sovereign debt securities). The fair value of these securities is based on prices obtained from international indices or a valuation model that includes the following inputs: interest rate yield curves, cross-currency basis index spreads, and country credit spreads for structures similar to the sovereign bond in terms of issuer, maturity and seniority. As the significant inputs are observable market inputs, the fair value of non-U.S. government securities are classified within Level 2.
Corporate debt securities consist primarily of investment-grade debt of a wide variety of corporate issuers and industries. The fair values of these securities are generally determined using the spread above the risk-free yield curve. These spreads are generally obtained from the new issue market, secondary trading and broker-dealer quotes. As these spreads and the yields for the risk-free yield curve are observable market inputs, the fair values of our corporate debt securities are classified within Level 2. Where pricing is unavailable from pricing services, we obtain non-binding quotes from broker-dealers to estimate fair value. This is generally the case when there is a low volume of trading activity and current transactions are not orderly. In this event, securities are classified within Level 3 and consisted of private corporate debt securities at December 31, 2011.
Our municipal portfolio comprises bonds issued by U.S. domiciled state and municipality entities. The fair value of these securities is determined using spreads obtained from broker-dealers, trade prices and the new issue market. As the significant inputs used to price the municipals are observable market inputs, municipals are classified within Level 2.
Equity securities include U.S. and foreign common stocks, exchange-traded funds, and foreign bond mutual funds. For common stocks and exchange-traded funds, we classified these within Level 1 as their fair values are based on quoted market prices in active markets. Our investments in foreign bond mutual funds have daily liquidity, with redemption based on the net asset value (NAV) of the funds. Accordingly, we have classified these investments as Level 2.
As a practical expedient, we estimate fair values for hedge and credit funds using NAVs as advised by external fund managers or third party administrators. For our hedge and credit fund investments with liquidity terms allowing us to fully redeem our holdings at the applicable NAV in the near term, we have classified these investments as Level 2. Certain investments in hedge and credit funds have redemption restrictions (see Note 5 for further details) that prevent us from redeeming in the near term and therefore we have classified these investments as Level 3.
During 2011 and 2010, we had no transfers between Levels 1 and 2.
During 2011, the transfer of fixed maturities from Level 3 to Level 2 relates to non-agency RMBS for which observable market inputs and multiple quotes from pricing vendors and broker-dealers became available during the year as a result of the return of liquidity in this asset class. We also transferred certain hedge and credit funds (included in “other investments”) from Level 3 to Level 2 during 2011 as we have the ability to liquidate these holdings at the reported NAV in the near term.
During 2010, the transfer relating to corporate debt was in relation to one issuer as a result of entering into an agreement to take delivery of a new corporate debt security, which its fair value measurement was based on observable market inputs. The remaining transfers out of Level 3 into Level 2 made in 2010 were primarily due to the availability of observable market inputs and multiple quotes from pricing vendors and broker-dealers as a result of the return of liquidity in the credit markets.
The following table summarizes the balance sheet classification of derivatives recorded at fair value. The notional amounts represent the basis upon which payments or receipts are calculated and are presented in the table in order to quantify the magnitude of our derivative activities. Notional amounts are not reflective of credit risk.
In addition, our external equity investment managers have the discretion to hold foreign currency exposures as part of their total return strategy.
The significant increase in the notional amount of investment related derivatives since December 31, 2010, was primarily due to hedging an increase in Canadian, Sterling, and Euro denominated fixed maturities whereby the portfolio managers hedge against foreign currency exposure in accordance with our investment guidelines.
The significant increase in the notional amount of underwriting related derivatives since December 31, 2010, was primarily due to hedging our foreign denominated liability exposure relating to the significant catastrophe losses from the New Zealand and Japanese earthquakes.
In addition to the factors noted for New Zealand, uncertainties associated with the Japanese earthquake and tsunami including, but not limited to, the magnitude of the event and associated damage, uncertainties about the extent and nature of damages and corresponding coverages (including business interruption and contingent business interruption coverages), the ultimate size of losses to be assumed by Japan’s cooperative mutuals and limitations associated with modeled losses.
The proximity of the Thai flooding to our reporting date means that limited information is yet available to us, inherently increasing the amount of management judgment required to arrive at our estimate of net losses and the associated level of uncertainty. The severe flooding spanned several months and had a significant impact on the Thai economy. Due to the size, prolonged duration and complexity of the event, substantial uncertainty remains regarding total insured losses and actual losses will depend, to a great extent, on claims from contingent business interruption coverage.
Overall, a significant portion of the net favorable prior period reserve development in each of the last three years was generated from the property, marine, and aviation lines of our insurance segment and the property and catastrophe lines of our reinsurance segment. These lines of business, the majority of which have short tail exposures, contributed 69%, 58% and 65% of the total net favorable reserve development in 2011, 2010 and 2009, respectively. The favorable development on these lines of business primarily reflects the recognition of better than expected loss emergence, rather than explicit changes in our actuarial assumptions.
We purchase treaty and facultative reinsurance to reduce exposure to significant losses. Facultative reinsurance provides coverage for all or a portion of the losses incurred for a single policy and we separately negotiate each facultative contract. Treaty reinsurance provides coverage for a specified type or category of risks. Our treaty reinsurance agreements provide this coverage on either an excess of loss or a proportional basis. Excess of loss covers provide a contractually set amount of coverage after a specified loss amount has been reached. This specified loss amount can be based on the size of an industry loss or on a Company-specific incurred loss amount. These covers can be purchased on a package policy basis, which provide us with coverage for a number of lines of business within one contract. In contrast, proportional covers provide us with a specified percentage of coverage from the first dollar of loss.
All of these reinsurance covers provide us the right to recover of a portion of specified losses and loss expenses from reinsurers. However, to the extent that our reinsurers do not meet their obligations under these agreements due to solvency issues, contractual disputes or other reasons, we remain liable. Under our reinsurance security policy, we predominantly cede our business to reinsurers rated A- or better by A.M. Best.
On March 23, 2010, AXIS Specialty Finance LLC (“AXIS Specialty Finance”), a wholly-owned finance subsidiary, issued $500 million aggregate principal amount of 5.875% senior unsecured debt (the “5.875% Senior Notes” and, together with the 5.75% Senior notes, the “Senior Notes”) at an issue price of 99.624%. The net proceeds of the issuance, after consideration of the offering discount and underwriting expenses and commissions, totaled approximately $495 million. Interest on the 5.875% Senior Notes is payable semi-annually in arrears on June 1 and December 1 of each year, beginning on June 1, 2010. Unless previously redeemed, the 5.875% Senior Notes will mature on June 1, 2020. The 5.875% Senior Notes are ranked as unsecured senior obligations of AXIS Specialty Finance. AXIS Capital has fully and unconditionally guaranteed all obligations of AXIS Specialty Finance under the 5.875% Senior Notes. AXIS Capital’s obligations under this guarantee are unsecured and senior and rank equally with all other senior obligations of AXIS Capital.
In order to mitigate concentration and operational risks related to cash and cash equivalents, we limit the maximum amount of cash that can be deposited with a single counterparty and additionally limit acceptable counterparties based on current rating, outlook and other relevant factors.
Our investment portfolio is managed by external investment managers in accordance with our investment guidelines. We limit credit risk through diversification, issuer exposure limitation graded by ratings and, with respect to custodians, through contractual and other legal remedies. Excluding U.S. government and agency securities, we limit our concentration of credit risk to any single corporate issuer to 2% or less of our fixed maturities portfolio for securities rated A- or above and 1% or less of our fixed maturities portfolio for securities rated below A-. At December 31, 2011, we were in compliance with these limits.
With respect to our reinsurance recoverable balances, we are exposed to the risk of a reinsurer failing to meet its obligations under coverage we have purchased. To mitigate this risk, all reinsurance coverage we purchase is subject to requirements established by our Reinsurance Security Committee. This Committee maintains a list of approved reinsurers, performs credit risk assessments for potential new reinsurers, regularly monitors approved reinsurers with consideration for events which may have a material impact on their creditworthiness, recommends counterparty tolerance levels for different types of ceded business and monitors concentrations of credit risk. The assessment of each reinsurer considers a range of attributes, including a review of financial strength, industry position and other qualitative factors. Generally, the Committee requires that reinsurers who do not meet specified requirements provide collateral.
Our reinsurers with the three largest balances accounted for 13%, 10% and 10%, respectively, of our total reinsurance recoverable on unpaid and paid losses balance at December 31, 2011 (2010: 13%, 11% and 11%, respectively). Amounts related to our reinsurers with the ten largest balances comprised 70% of December 31, 2011 balance (2010: 70%) and had a weighted average A.M. Best rating of A+ (2010: A).
The diversity of our client base limits the credit risk associated with our premiums receivable. In addition, for insurance contracts we have contractual rights to cancel coverage for non-payment of premiums and for reinsurance contracts we have contractual rights to offset premiums receivable with corresponding payments for losses and loss expenses. These contractual rights contribute to the mitigation of credit risk, as does our monitoring of aged receivable balances. In light of these mitigating factors, and considering that a significant portion of our premiums receivable are not currently due based on the terms of the underlying contracts, we do not utilize specific credit quality indicators to monitor our premiums receivable balance. At December 31, 2011, we recorded an allowance for estimated uncollectible premiums receivable of $4 million (2010: $3 million). The corresponding bad debts expense charges for 2011, 2010 and 2009 were insignificant.
We purchase reinsurance coverage for our insurance lines of business. The minimum reinsurance premiums are contractually due in advance on a quarterly basis. Accordingly at December 31, 2011, we have an outstanding reinsurance purchase commitment of $67 million.
Except as noted below, we are not a party to any material legal proceedings. From time to time, we are subject to routine legal proceedings, including arbitrations, arising in the ordinary course of business. These legal proceedings generally relate to claims asserted by or against us in the ordinary course of insurance or reinsurance operations; estimated amounts payable under such proceedings are included in the reserve for losses and loss expenses in our Consolidated Balance Sheets. In our opinion, the eventual outcome of these legal proceedings is not expected to have a material effect on our financial condition, results of operations, cash flows or liquidity.
In 2005, a putative class action lawsuit was filed against our U.S. insurance subsidiaries. In re Insurance Brokerage Antitrust Litigation was filed on August 15, 2005 in the United States District Court for the District of New Jersey and includes as defendants numerous insurance brokers and insurance companies. The lawsuit alleges antitrust and Racketeer Influenced and Corrupt Organizations Act (“RICO”) violations in connection with the payment of contingent commissions and manipulation of insurance bids and seeks damages in an unspecified amount. On October 3, 2006, the District Court granted, in part, motions to dismiss filed by the defendants, and ordered plaintiffs to file supplemental pleadings setting forth sufficient facts to allege their antitrust and RICO claims. After plaintiffs filed their supplemental pleadings, defendants renewed their motions to dismiss. On April 15, 2007, the District Court dismissed without prejudice plaintiffs’ complaint, as amended, and granted plaintiffs thirty (30) days to file another amended complaint and/or revised RICO Statement and Statements of Particularity. In May 2007, plaintiffs filed (i) a Second Consolidated Amended Commercial Class Action complaint, (ii) a Revised Particularized Statement Describing the Horizontal Conspiracies Alleged in the Second Consolidated Amended Commercial Class Action Complaint, and (iii) a Third Amended Commercial Insurance Plaintiffs’ RICO Case Statement Pursuant to Local Rule 16.1(B)(4). On June 21, 2007, the defendants filed renewed motions to dismiss. On September 28, 2007, the District Court dismissed with prejudice plaintiffs’ antitrust and RICO claims and declined to exercise supplemental jurisdiction over plaintiffs’ remaining state law claims. On October 10, 2007, plaintiffs filed a notice of appeal of all adverse orders and decisions to the United States Court of Appeals for the Third Circuit, and a hearing was held in April 2009. On August 16, 2010, the Third Circuit Court of Appeals affirmed the District Court’s dismissal of the antitrust and RICO claims arising from the contingent commission arrangements and remanded the case to the District Court with respect to the manipulation of insurance bids allegations. We continued to believe that the lawsuit was completely without merit and on that basis vigorously defended the filed action. However, for the sole purpose of avoiding additional litigation costs, we reached an agreement in principal with the plaintiffs during the first quarter of 2011 to settle all claims and causes of action in this matter for an immaterial amount. On June 27, 2011, the District Court preliminarily approved the terms and conditions of the settlement and are awaiting issuance of the final settlement order.
For the year ended December 31, 2011, there were 1,134,469 (2010: 186,792; 2009: 1,915,574) shares for stock compensation plans which were excluded in the computation of diluted earnings per share because the effect would be anti-dilutive.
At December 31, 2011, and 2010, our authorized share capital was 800,000,000 common shares, par value of $0.0125 per share.
on December 10, 2009, extend the above share repurchase plan until December 31, 2011, and a new share up to $500 million of our common shares until December 31, 2011; and
on September 24, 2010, a new share repurchase plan up to $750 million of our common shares until December 31, 2012.
At December 31, 2011, we had $544 million of capacity remaining under the share repurchase plans. Share repurchases may be effected from time to time in the open market or private negotiated transactions, depending on market conditions.
(3) During the fourth quarter of 2010, we privately negotiated with Trident II, L.P. and affiliated entities to repurchase 3,062,824 of our common shares.
The holders of the series A and B Preferred shares have no voting rights other than the right to elect a specified number of directors if preferred share dividends are not declared and paid for a specified period.
We provide defined contribution plans that are self directed to eligible employees through various plans sponsored by us. Generally, mutual funds are made available pursuant to which employees and we contribute a percentage of the employee’s gross salary into the plan each month.
We also provide a supplemental executive retirement plan (“SERP”) to both the Chairman and the CEO. At December 31, 2011, the accumulated SERP obligations were $17 million (2010: $16 million) and both SERPs were fully funded.
We currently issue restricted stock and restricted stock units to our employees with service conditions only, vesting generally over a period of four years with 25% of the award vesting annually. Grants provided under the 2007 Plan allows for accelerated vesting provisions upon the employee’s death, permanent disability, or certain
For our non-management directors, we issue common shares under the 2007 Plan with no restriction. Subsequent to December 31, 2011 and up to February 7, 2012 we granted a total of 1,850,607 restricted stock and restricted stock units to our employees and non-management directors. At February 7, 2012, 678,319 equity-based awards remain available for grant under the 2007 Plan.
We have granted stock options under the 2003 Plans; however none have been issued since 2005. All outstanding stock options are fully vested and exercisable. These options expire ten years from the date of grant.
The following table provides a reconciliation of the beginning and ending balance of nonvested restricted stock (including restricted stock units) for the year ended December 31, 2011:
During 2011, we incurred a compensation cost of $39 million (2010: $37 million; 2009: $48 million) in respect of restricted stock and restricted stock units, and recorded tax benefits thereon of $7 million (2010: $6 million; 2009: $6 million). The total fair value of shares vested during 2011 was $63 million (2010: $56 million; 2009: $57 million). At December 31, 2011, we had 3,815,975 (2010: 3,882,303) nonvested restricted stock outstanding with $86 million (2010: $61 million) of unrecognized compensation cost. These are expected to be recognized over the weighted average period of 2.6 years (2010: 2.6 years).
The total intrinsic value of stock options exercised during 2011 was $9 million (2010: $4 million) and we received proceeds of $5 million (2010: $8 million). For these exercised stock options, we issued new shares from the authorized share capital pool rather than from our treasury pool.
Although realization is not assured, management believes it is more likely than not that the tax benefit of the recorded net deferred tax assets will be realized. Other than the items discussed above, the remaining gross deferred tax assets relate to ordinary income items and substantially all of these deferred tax assets relate to our U.S. operations. In evaluating our ability to recover our deferred tax assets within the jurisdiction from which they arise, we consider all available positive and negative evidence, including historical results, operating loss carryback potential and scheduled reversals of deferred tax liabilities. Our U.S. operations have produced significant taxable income in prior periods and have deferred tax liabilities that will reverse in future periods such that we believe sufficient ordinary taxable income is available to utilize all remaining deferred tax assets. There were no unrecognized tax benefits at December 31, 2011 and 2010.
Our (re)insurance operations are subject to insurance and/or reinsurance laws and regulations in the jurisdictions in which they operate, including Bermuda, Ireland and the United States. These regulations include certain restrictions on the amount of dividends or other distributions, such as loans or cash advances, available to shareholders without prior approval of the insurance regulatory authorities.
may also be limited to statutory net income, net investment income or 10% of total statutory capital and surplus. At December 31, 2011, the maximum dividend that our U.S. insurance operations could pay without regulatory approval was approximately $124 million.
Our Irish subsidiaries, AXIS Specialty Europe and AXIS Re Ltd., are required to maintain minimum levels of statutory and capital surplus. At December 31, our subsidiaries were in compliance with these requirements. Our Irish subsidiaries may declare dividends out of retained earnings subject to meeting their solvency and capital requirements. At December 31, 2011, the maximum dividend our Irish subsidiaries could pay out of retained earnings, subject to regulatory approval, was approximately $89 million.
The following is an unaudited summary of our quarterly financial results: