The following table sets forth certain of our selected financial data as of and for the years ended December 31, 2012, 2011, 2010, 2009 and 2008. Our data as of December 31, 2012 and 2011 and for the years ended December 31, 2012, 2011 and 2010 were derived from our consolidated financial statements beginning on page of this Form 10-K. Our data as of December 31, 2010, 2009 and 2008 and for the years ended December 31, 2009 and 2008 were derived from our audited consolidated financial statements not included in this Form 10-K. The selected financial data should be read in conjunction with our consolidated financial statements as of December 31, 2012 and 2011 and for each of the years in the three year period ended December 31, 2012 beginning on page of this Form 10-K, and the related “Management's Discussion and Analysis of Financial Condition and Results of Operations” beginning on page 31 of this Form 10-K.
In presenting the Company's results, in the table above, as well as, in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations in this Form 10-K, management has included certain schedules containing financial measures that are not calculated under standards and rules that comprise U.S. GAAP. Such measures, including segment underwriting income or loss, related underwriting ratios, book value per common share and fully converted book value per common share, are referred to as non-GAAP. These non-GAAP measures may be defined or calculated differently by other companies. Management believes these measures, which are used to monitor our results of operations, allow for a more complete understanding of the underlying business and are important financial measures to investors, analysts, rating agencies and others who use the Company’s financial information in evaluating the performance of our Company. In addition, return on equity is used as a financial performance measure in determining compensation, as discussed in items incorporated herein by reference to our definitive proxy statement to be filed pursuant to Regulation 14A of the Exchange Act for our 2013 Annual General Meeting of Shareholders (our “Proxy Statement”). These measures should not be viewed as a substitute for those determined in accordance with U.S. GAAP. Reconciliations of such measures to the most comparable U.S. GAAP figures are included below or are included elsewhere within this Form 10-K in accordance with Regulation G.
Underwriting income or loss measures the performance of the Company’s underwriting function and consists of net premiums earned less net losses and LAE and net underwriting expenses. Net underwriting expenses include net acquisition expenses and operating costs related to underwriting.
Underwriting ratios are calculated for net losses and LAE, net acquisition expense and net underwriting expense. The ratios are calculated by dividing the related expense by net earned premiums. The combined ratio is the sum of the net losses and LAE, net acquisition expense and net underwriting expense ratios. The Company believes that underwriting income or loss and ratios highlight the profitability of our reinsurance operations.
In managing our three operating segments, we use measures such as net underwriting income and loss and underwriting ratios to evaluate segment performance. Underwriting income or loss excludes revenues and expenses related to net investment income, net realized gains or losses on investments, net impairment losses on investments, corporate expenses not allocated to underwriting segments, net foreign exchange gains or losses, net changes in fair value of derivatives, interest expense and other revenues and expenses.
Fully converted book value per common share represents total shareholders’ equity, adjusted for the assumed proceeds from the exercise of share options, divided by the number of common shares outstanding, adjusted for the assumed exercise or vesting of all outstanding share options and restricted share units.
The following summary sets forth the calculation of book value and fully converted book value per common share for the years ended December 31, 2012 and 2011 ($ and amounts in thousands, except per share amounts):
Return on equity represents net income available to common shareholders divided by the beginning shareholders' equity for the year, adjusted for material capital transactions during the year. Management uses return on equity as a financial performance measure in determining compensation as set forth in the Proxy Statement.
Our net premiums written for the years ended December 31, 2012, 2011 and 2010 were $565.0 million, $651.5 million, and $760.6 million, respectively. The decreases in net premiums written were primarily due to the non-renewal of business that did not meet our minimum pricing standards and our desire to reduce our exposure to catastrophe events.
In reviewing the trend in underwriting capacity for the last five years, we have seen a decrease in capacity in 2008 (due to the financial crisis and substantial catastrophe losses), strong financial results for 2009 (reflecting the absence of major catastrophes and the favorable performance of investment portfolios), a significant growth in shareholders’ equity in 2010 despite increased catastrophe activity, and minimal impact on capacity in 2011 and 2012, despite a high level of global catastrophe activity.
We anticipate that 2013 will be characterized by ample capacity for insurance risk.
Due to the nature of reinsurance, ceding companies routinely report and remit premiums to us subsequent to the contract coverage period. Consequently, premiums written and receivable include amounts reported and billed by the ceding companies, supplemented by our estimates of premiums that are written but not reported. Our premium estimation process considers the terms and conditions of the reinsurance contracts and assumes that the contracts will remain in-force until expiration. Our estimates of written premiums may be affected by early cancellation, election of contract provisions for cut-off and return of unearned premiums or other contract disruptions. The time lag involved in the process of reporting premiums is shorter than the lag in reporting losses. Premiums are generally reported to us in full within two years from the inception of the contract.
In addition to estimating premiums written, we estimate the unearned portion of premiums. Earned premiums, which are recorded in revenues, are premiums written less unearned premiums. The potential net impact of changes in premiums earned on our results of operations is reduced by the accrual of losses and acquisition expenses related to such premiums earned.
The amounts we recorded as unearned premiums and estimated premiums receivable are estimates based on estimated written premiums and are subject to judgment and uncertainty. Any adjustments to written and earned premiums, and the related losses and acquisition expenses, are accounted for as changes in estimates and are reflected in the results of operations in the period in which they are made. These adjustments could be material and could significantly impact earnings in the period they are recorded.
When estimating premiums written and unearned premiums, we segregate the business into classes by reinsurance subsidiary, by type of coverage and by type of contract (resulting in approximately 64 classes). Within each class, business is further segregated by the year in which the contract incepted (the “Underwriting Year”), starting with 2002, our first year of operations. Classes that are similar in both the nature of their business and estimation process may be grouped for purposes of estimating premiums. Estimates are made for each class or group of classes and Underwriting Year. Premiums are estimated based on ceding company estimates and our own judgment after considering factors such as: (1) the ceding company’s historical premium versus projected premium, (2) the ceding company’s history of providing accurate estimates, (3) anticipated changes in the marketplace and the ceding company’s competitive position therein, (4) reported premiums to date and (5) the anticipated impact of proposed underwriting changes. Estimates of ultimate premium are made by our underwriters for each contract and Underwriting Year. Management reviews these estimates with our underwriters and actuaries and selects an ultimate premium estimate. Estimates of premiums written and unearned premiums are based on the selected ultimate premium estimate and the structure of the reinsurance contracts. We evaluate the appropriateness of these estimates in light of the actual premium reported by the ceding companies, information obtained during audits and other information received from ceding companies.
Estimated premiums receivable and unearned premiums at December 31, 2012 were lower than at December 31, 2011 due to a decrease in both the property and marine and casualty business written in 2012 as compared with 2011. As of December 31, 2012, the selected estimates of premiums receivable and unearned premiums were lower than the initial estimates made by our underwriters by $6.1 million or 4.7% and by $2.4 million or 2.1%, respectively. We believe that we reasonably could have made a decrease of between $0 and $6.1 million for premiums receivable and between $0 and $2.4 million for unearned premiums. As of December 31, 2011, the selected estimates of premiums receivable and unearned premiums were lower than the initial estimates made by our underwriters by $14.6 million or 9.2% and by $5.2 million or 4.3%, respectively. We believe that we reasonably could have made a decrease of between $0 and $14.6 million for premiums receivable and between $0 and $5.2 million for unearned premiums. Key factors that affect premium estimates of our underwriters and management include: (1) the competition in many classes of business that make it difficult for ceding companies to achieve their premium targets, and (2) the lack of a historical track record for some ceding companies writing new programs.
The liabilities recorded on our consolidated balance sheets as of December 31, 2012 and 2011 for unpaid losses and LAE were $2.0 billion and $2.4 billion, respectively. These amounts exclude any amounts we may recover from our retrocessionaires under coverage we purchased for such losses. We record estimates of amounts we expect to recover from retrocessionaires as assets on the consolidated balance sheets. The following table sets forth our case reserves, additional case reserves and IBNR by segment as of December 31, 2012 and 2011 ($ in thousands):
Reserves, excluding major catastrophes, were $1.6 billion as of December 31, 2012, representing 79% of our unpaid losses and LAE. When estimating unpaid losses and LAE, we segregate the business into classes by reinsurance subsidiary, by type of coverage and by type of contract (resulting in approximately 64 classes). Within each class, the business is further segregated by Underwriting Year, starting with 2002, our first year of operations.
Generally, estimates of ultimate losses that are not related to a specific event are initially determined based on the loss ratio method applied to each Underwriting Year and to each class of business. The selected ultimate losses are determined by multiplying the initial expected loss ratio by the earned premium. The initial expected loss ratios are key inputs that involve management judgment and are based on a variety of factors, including: (1) contract by contract expected loss ratios developed during our pricing process, (2) our historical loss ratios and combined ratios (loss plus acquisition cost ratios), and (3) when available, updated and appropriately adjusted, loss information on business previously underwritten by the reinsurance division of our predecessor, for the reasons described below. These judgments take into account management’s view of past, current and future factors that may influence ultimate losses, including: (1) market conditions, (2) changes in the business underwritten, (3) changes in timing of the emergence of claims and (4) other factors that may influence ultimate loss ratios and losses.
While we commenced operations in 2002, the business we write is sufficiently similar to the historical reinsurance business of our predecessor, the former reinsurance segment of The St. Paul Companies, Inc., such that we review the historical loss experience of this business when we estimate our own initial expected loss ratios and loss development patterns. Loss development patterns can span more than a decade. Therefore, this data is a valuable supplement to our own and industry data. The historical experience of our predecessor also included information for the administrative costs of managing claims and the related ULAE factors. In 2010, we conducted a review of our administrative expenses of managing claims that resulted in a $13.2 million reduction of ULAE reserves.
Generally, an event causing more than $1 billion of property losses to the insurance industry or $10 million of property losses to the Company is considered and tracked as a major catastrophe. Unpaid losses and LAE related to major catastrophes were $403.3 million, which represented 21% of our total unpaid losses and LAE, as of December 31, 2012.
As losses from catastrophes mature, our actuaries generally consider losses reported to us relative to loss development patterns from prior catastrophe events. Our estimate of ultimate liability for losses and LAE related to a catastrophe event will generally be based on these development patterns after approximately twelve months following the event. However, since loss development patterns may be inconsistent between events, for very large catastrophes, such as the 2011 earthquake in Japan, we will generally review information on a contract-by-contract basis for a longer period. Ultimate losses for a catastrophe event are typically reasonably well known within 12 to 24 months following the event, although ultimate losses from an earthquake may take longer to develop. As an example, as of December 31, 2012, the paid and reported losses as a percentage of the current estimated ultimate loss were 67% and 95%, respectively, for the 2011 earthquake in Japan and 96% and 98%, respectively, for the 2010 earthquake in Chile.
The loss development patterns are also key inputs to our loss estimation process. Loss development patterns reflect the time lag between the occurrence and settlement of a loss. The time lag in reporting can be several years in some cases and may be attributed to a number of reasons, including the time it takes to investigate a claim, delays associated with the litigation process, and the deterioration, in connection with health related claims, in a claimant’s physical condition many years after an accident occurs. As a predominantly broker market reinsurer for both excess-of-loss and proportional contracts, we are subject to potential additional time lags in the receipt of information as the primary insurer reports to the broker who in turn reports to us. As of December 31, 2012, we did not have any significant back-log related to our processing of assumed reinsurance information. All of the foregoing factors can impact the loss development patterns. A key assumption that our estimates are based on is that past loss development patterns are reasonably predictive of future loss development patterns. However, it may be difficult to identify differences in business reinsured from Underwriting Year to Underwriting Year and how such differences can affect loss development patterns. This difficulty adds to uncertainty in estimates that use these patterns.
In property classes, there can be additional uncertainty in loss estimation related to large catastrophe events. With wind events, such as hurricanes, the damage assessment process may take more than a year. The cost of rebuilding may increase due to various factors including supply shortages for construction materials and labor. In the case of earthquakes, the damage assessment process may take several years to discover structural weaknesses not initially detected in buildings. The uncertainty inherent in loss estimation is particularly pronounced for casualty coverages, such as umbrella liability, general and product liability, professional liability and automobile liability, where information, such as required medical treatment and costs for bodily injury claims, emerges over time. In the overall loss estimation process, provisions for economic inflation and changes in the social and legal environment are considered.
Changes in estimates of prior years’ earned premiums can also affect prior years’ ultimate losses. Our actuaries consider factors affecting all key inputs to actuarial techniques when determining the credibility of indications.
We regularly engage internationally recognized independent actuarial firms to review our loss reserves. An actuarial review was performed in 2006 by an independent actuarial firm. In 2009, another actuarial review was performed by a different independent actuarial firm. Each of these reviews provided a low and a high estimate of the Company’s loss reserves and indicated that the Company’s loss reserves at the time of the review were within the low and high estimates indicated by the review.
Each of the independent actuarial firms provided low and high loss development patterns in their respective 2012 reviews. Generally, these loss development patterns were shorter than the patterns produced in the 2006 and 2009 reviews, indicating that losses were expected to be reported faster than previously estimated by the firms. The shorter patterns generally resulted in lower indicated loss ratios. We applied these low and high loss development patterns for certain of our North American casualty excess-of-loss classes to develop alternative indications of ultimate losses.
In its 2012 review, the independent actuarial firm that performed the 2006 review also provided a range of reasonable estimates for the Company’s loss reserves as of March 31, 2012. The Company’s loss reserves as of March 31, 2012 were at the high end of this range of reasonable estimates, mainly due to two factors: (1) the shorter loss development patterns used by the independent actuarial firm and (2) faster recognition of favorable reported loss experience by the independent actuarial firm in the selection of ultimate loss ratios. We determined to incorporate these factors in developing alternative indications of ultimate losses, which, together with the favorable variance in reported losses during 2012 and prior years, led to significant favorable development of our loss reserves in the third and fourth quarters of 2012.
During 2012, 2011, and 2010, approximately $151.9 million, $107.4 million, and $145.7 million, respectively, of the net favorable loss development was attributable to lower reported loss experience than we expected. In addition, in the fourth quarter of 2012 we began reflecting favorable variances in reported losses in our selection of ultimate loss ratios at an earlier point in the loss development timeline than we had previously. This earlier recognition accounted for $57.6 million of the net favorable loss development for the year ended December 31, 2012. Conditions and trends that have affected development of reserves in the past may not necessarily occur in the future. The factors that may result in differences between our current estimates of loss liability and our ultimate loss liability are set forth above under “Uncertainty of Estimates” in this Form 10-K.
Total investments and cash and cash equivalents were $2.2 billion and $1.7 billion, respectively, as at December 31, 2012. The valuation process for our financial assets and liabilities, comprised primarily of our investments, requires significant judgment and involves analyzing specific factors to each security. When determining the fair value of a security we generally obtain prices from several sources and establish a hierarchy based on the reliability of information. The determination of whether unrealized losses represent temporary changes in fair value or were the result of other than temporary impairments also involves judgment.
The number of prices we obtain per security varies based on the type of asset class and particular reporting period. Prices are generally obtained from multiple sources when a new security is purchased and a pricing source is assigned to the particular security. A hierarchy is maintained that prioritizes pricing sources based on availability and reliability of information, with preference generally given to prices provided by pricing vendors and index providers. Pricing sources may be assigned to a particular security based upon the provider’s expertise. Generally, the initial pricing source selected is consistently used for each reporting period. We have not adjusted any prices that we have obtained from pricing sources. However, if we determine that a price appears unreasonable, we investigate and assess whether the price should be adjusted.
We receive pricing documentation that describes the methodologies used by various pricing sources. The prices we obtain from pricing sources are validated by performing price comparisons against multiple pricing sources for certain securities as may be available, periodic back-testing of sales to the previously reported fair value, an in-depth review of specific securities when evaluating stale prices, large price movements and other factors, as well as other validation procedures and continuously monitoring market data that relates to our investment portfolio.
In addition, we evaluate projected cash flows in order to determine if a credit impairment has occurred. The amount of the credit loss of an impaired debt security is the difference between the amortized cost and the greater of (i) the present value of expected future cash flows and (ii) the fair value of the security. We recognize the portion of OTTI related to a credit loss in net income or loss in the consolidated statements of operations and the portion of OTTI related to all other factors is recognized in accumulated other comprehensive income in the consolidated balance sheets.
We believe that the gross unrealized losses in our available-for-sale portfolio of $4.8 million represent temporary declines in fair value. We believe that the unrealized losses are not necessarily predictive of ultimate performance and that the provisions we have made for net impairment losses are adequate. However, economic conditions may deteriorate more than expected and may adversely affect the expected cash flows of our securities, which in turn may lead to impairment losses recorded in future periods. Conversely, economic conditions may improve more than expected and favorably increase the cash flows expected from these impaired securities, which would be earned through net investment income over the remaining life of the security.
For additional information on our investment portfolio including the credit quality and the net unrealized gain and loss of our investments as at December 31, 2012, see the “Financial Condition - Liquidity - Sources of Liquidity” section in this Form 10-K.
We provide for income taxes for our subsidiaries operating in income tax paying jurisdictions. Our provision relies on estimates and interpretations of currently enacted tax laws. We recognize deferred tax assets and liabilities based on the temporary differences between the financial statement carrying amounts and the tax bases of assets and liabilities. Such temporary differences are primarily due to tax basis discounts on unpaid losses and LAE and unearned premiums, deferred acquisition costs and investments. A valuation allowance against deferred tax assets is recorded if it is more likely than not that all, or some portion, of the benefits related to deferred tax assets will not be realized. Any adjustments to deferred income taxes are accounted for as changes in estimates and are reflected in the results of operations in the period in which they are made. Any adjustments could be material and could significantly impact earnings in the period they are recorded.
Net deferred tax assets were $22.8 million and $31.6 million for the years ended December 31, 2012 and 2011, respectively. At each balance sheet date, we evaluate the recoverability of the net deferred tax assets, considering the timing of the reversal of deferred income and expense items as well as the likelihood that we will generate sufficient taxable income to realize the future tax benefits. We believe that it is more likely than not we will generate sufficient taxable income and realize the future tax benefits in order to recover the deferred assets and accordingly, no valuation allowance was established as of December 31, 2012 and 2011. See Note 8 to the “Consolidated Financial Statements” contained elsewhere in this Form 10-K for additional information on income taxes.
All of our assumed and ceded contracts are reviewed by underwriters. Contracts that trigger certain criteria are subjected to a more detailed risk transfer analysis by management. This analysis involves evaluating significant assumptions relating to the amount and timing of expected cash flows, as well as the interpretation of underlying contract terms. The outcome of our risk transfer analysis can be influenced by our own judgment, experience, and interpretations. See Note 1 to the “Consolidated Financial Statements” contained elsewhere in this Form 10-K for additional information regarding our accounting for reinsurance contracts that do not transfer sufficient insurance risk.
Net income (loss) and diluted earnings (loss) per common share for the years ended December 31, 2012, 2011 and 2010 were as follows ($ and amounts in thousands, except diluted earnings (loss) per common share):
2012 versus 2011: The net income and diluted earnings per common share for the year ended December 31, 2012 as compared with the net loss and diluted loss per common share for the year ended December 31, 2011 was primarily due to an increase in the net underwriting result attributable to a significant decrease in net losses from major catastrophe activity and an increase in net favorable development. In addition, there was an increase in net realized gains on investments and a decrease in net impairment losses on investments, partially offset by a decrease in net investment income and higher income taxes. As the year ended December 31, 2011 resulted in a net loss, the basic weighted average common shares outstanding is used in the denominator of the diluted loss per common share computation.
2011 versus 2010: Net underwriting loss was $296.7 million for the year ended December 31, 2011, which compares with net underwriting income of $108.9 million for the year ended December 31, 2010. The change in the net underwriting result was due to an increase in net losses from major catastrophes in 2011 and a decrease in net favorable development.
Net losses from major catastrophes were $510.0 million and $214.8 million for the years ended December 31, 2011 and 2010, respectively. Net favorable development was $104.4 million and $151.9 million for the years ended December 31, 2011 and 2010, respectively.
2012 versus 2011: The Property and Marine segment underwriting result improved by $403.6 million for the year ended December 31, 2012 as compared with the year ended December 31, 2011, primarily due to a decrease in net losses from major catastrophes. Net losses from major catastrophes were $68.9 million and $510.0 million for the years ended December 31, 2012 and 2011, respectively.
Net losses from major catastrophes for the year ended December 31, 2012 were primarily attributable to Hurricane Sandy and Property Claims Services (“PCS”) Catastrophes 66 and 67, tornado and hailstorm events affecting primarily Kentucky and Tennessee that occurred in February and March 2012. Net losses from major catastrophes for the year ended December 31, 2011 were primarily attributable to the February and June earthquakes in New Zealand, the earthquake in Japan, U.S. tornadoes and the floods in Thailand.
Net favorable development was $40.5 million and $33.3 million for the years ended December 31, 2011 and 2010, respectively.
The Property and Marine segment generated 45.3%, 52.9% and 54.3% of our net premiums written for the years ended December 31, 2012, 2011 and 2010, respectively.
2012 versus 2011: Gross premiums written decreased by $119.6 million for the year ended December 31, 2012 as compared with the year ended December 31, 2011, and by $99.0 million when considering reinstatement premiums written related to major catastrophes of $10.5 million and $31.1 million for the years ended December 31, 2012 and 2011, respectively. The decrease in gross premiums written, excluding reinstatement premiums, was due to decreases across most classes of business, most significantly in the catastrophe excess-of-loss classes and the North American crop class as compared with 2011 and resulted from fewer opportunities that met our underwriting standards and our desire to reduce our exposure to catastrophe events. The decrease in ceded premiums written was due to a decrease in retrocessional reinsurance purchased for the year ended December 31, 2012 as compared with 2011. Net premiums earned decreased by $103.4 million for the year ended December 31, 2012 as compared with 2011, primarily as a result of decreases in net premiums written in current and prior periods. Net premiums written and earned were also impacted by changes in the mix of business and the structure of the underlying reinsurance contracts.
2012 versus 2011: Net losses and LAE decreased by $495.5 million for the year ended December 31, 2012 as compared with the year ended December 31, 2011. The decrease in net losses and LAE was primarily due to a decrease in net losses from major catastrophes of $461.7 million and a decrease in non-major catastrophe losses, partially offset by underwriting losses on our 2012 underwriting year North American crop business as a result of the severe drought conditions in the United States.
The following table sets forth the components of pre-tax net losses for 2012 major catastrophes for the year ended December 31, 2012 ($ in thousands):
The following table sets forth the components of pre-tax net losses for 2011 major catastrophes for the year ended December 31, 2011 ($ in thousands):
The above table excludes any favorable or unfavorable development subsequent to December 31, 2010. Any material development is discussed below under Prior Year Loss Development.
The following table sets forth the net favorable (unfavorable) development for the year ended December 31, 2011 by class of business ($ in thousands):
Net favorable development in the major catastrophes class arose primarily from the February 2010 earthquake in Chile, the September 2010 earthquake in New Zealand and the December 2010 floods in Australia. Net favorable development in the property per risk excess-of-loss class arose from the 2007 through 2010 underwriting years. Net favorable development in the property proportional class arose primarily from the 2008 and 2009 underwriting years, with a change in the initial expected loss ratios contributing $0.7 million of the net favorable development. Net favorable development in the crop class arose primarily from North American business in the 2010 underwriting year. Net favorable development in the marine, aviation and satellite class arose primarily from the 2007 and 2008 underwriting years. This was partially offset by unfavorable development in the 2009 underwriting year primarily from the loss related to the explosion on the Deepwater Horizon oil rig. Net unfavorable development in the catastrophe excess-of-loss (non-major events) class arose primarily from an increase in loss advices from ceding companies related to fourth quarter 2010 events in Europe and Australia, partially offset by an improvement in North American and international business prior to 2010.
Net favorable development in the property per-risk excess-of-loss class arose primarily from the 2007 and 2009 underwriting years. Net favorable loss development in the crop class arose primarily from North American business in the 2009 underwriting year. Net favorable development in the catastrophe excess-of-loss (non-major events) class arose primarily from the 2009 underwriting year. Net favorable development in the property proportional class arose primarily from North American business in the 2005 through 2008 underwriting years. Net unfavorable development in the marine, aviation and satellite class arose primarily from the 2003 and 2006 underwriting years, partially offset by favorable development primarily from the 2007 and 2008 underwriting years. A change in the loss development patterns in the marine excess-of-loss class contributed $2.5 million of unfavorable development. Net unfavorable development in the major catastrophes class arose primarily from Hurricane Ike in the 2008 underwriting year.
Calendar Year Losses - Excluding Major Catastrophes and Prior Years’ Loss Development
Calendar year losses and related loss ratios, excluding losses from major catastrophes and prior years’ loss development, were also impacted by changes in the mix of business.
2011 versus 2010: The calendar year loss ratios, excluding major catastrophes and prior years' loss development, were 39.5% and 37.1% for the years ended December 31, 2011 and 2010, respectively. The increase in the loss ratio was primarily due to the North American catastrophe class (non-major events) which had a higher loss ratio in 2011 as compared with 2010.
Calendar year losses and related loss ratios, excluding losses from major catastrophes and loss development, were also impacted by changes in the mix of business.
2012 versus 2011: Net acquisition expenses and related net acquisition expense ratios were $34.3 million and 13.5%, respectively, for the year ended December 31, 2012 and $49.3 million and 13.8%, respectively, for the year ended December 31, 2011. The decrease in net acquisition expenses was primarily due to the decrease in net premiums earned as compared with the same period in 2011. Net acquisition expenses and related net acquisition expense ratios were also impacted by changes in the mix of business.
2011 versus 2010: Net favorable loss development was $59.4 million and $113.3 million for the years ended December 31, 2011 and 2010, respectively. Net favorable loss development and related premium adjustments decreased the net loss and LAE ratios by 18.8 points and 33.6 points for the years ended December 31, 2011 and 2010, respectively. Net favorable loss development for the years ended December 31, 2011 and 2010 was primarily attributable to a level of cumulative losses reported by our ceding companies that was lower than expected and that, in our judgment, resulted in sufficient credibility in the loss experience to change our previously selected loss ratios. Net favorable development of $15.5 million related to changes in loss development patterns for the year ended December 31, 2010. In addition, changes in our estimate of the administrative costs of managing claims of $13.2 million decreased the net loss and LAE ratio by 3.5 points in 2010.
Net favorable development in the North American claims made class arose primarily from the 2003 through 2007 underwriting years. Net favorable development in the North American umbrella class arose primarily from the 2003 through 2008 underwriting years. The net favorable development in the 2008 underwriting year resulted from improved loss experience in the current year after adverse experience led us to increase the selected loss ratio from the initial expected loss ratio in prior years. Net favorable development in the North American occurrence excess-of-loss class arose primarily from the 2002 through 2007 underwriting years, with a change in the loss development patterns contributing approximately $2.1 million of net favorable development. Net favorable development in the financial lines class arose primarily from North American surety business across most prior underwriting years, with a change in the loss development patterns resulting in approximately $1.5 million of net favorable development. Net unfavorable development in the accident and health class arose primarily from the 2004 through 2006 underwriting years partially offset by favorable development on the 2008 underwriting year. Net unfavorable development in the international casualty class arose primarily from the 2008 and 2010 underwriting years arising from wildfires in Australia and energy related claims in the United States written under global covers. This was partially offset by favorable development on the 2005 and 2006 underwriting years. Changes in the loss development patterns in this class resulted in approximately $1.6 million of net favorable development.
Net favorable development in the North American claims made class arose primarily from the 2003 through 2007 underwriting years. Net favorable development in the North American occurrence excess-of-loss class arose primarily from the 2002 through 2006 underwriting years. A review of historical results in the North American clash class resulted in a change to the initial expected loss ratios in all prior underwriting years. This change in initial expected loss ratios contributed $13.7 million to the net favorable development in this class. Net favorable development in the financial lines class arose primarily from the North American surety business in the 2004 through 2008 underwriting years. Net favorable development in the North American umbrella class arose primarily from the 2003, 2004 and 2006 underwriting years, partially offset by net unfavorable development in the 2008 underwriting year. Net favorable development in the accident and health class arose primarily from the 2005 and 2008 underwriting years. The international casualty class was impacted by net unfavorable development from financial institutions business and utility companies’ exposure to wildfires in Australia in the 2008 underwriting year. This was partially offset by net favorable development in all other underwriting years. This class also benefited by $2.0 million of favorable development from changes in loss development patterns and initial expected loss ratios.
2011 versus 2010: The calendar year loss ratios, excluding prior years’ loss development, were 74.8% and 68.4% for the years ended December 31, 2011 and 2010, respectively. Calendar year losses and related ratios, excluding prior years’ loss development, were impacted by changes in the mix of business.
2012 versus 2011: Net acquisition expenses and related net acquisition expense ratios were $69.0 million and 23.5%, respectively, for the year ended December 31, 2012 and $72.7 million and 22.8%, respectively, for the year ended December 31, 2011. Net acquisition expenses and related net acquisition expense ratios were impacted by changes in the mix of business.
2011 versus 2010: Net acquisition expenses and related net acquisition expense ratios were $72.7 million and 22.8%, respectively, for the year ended December 31, 2011 and $71.5 million and 20.8%, respectively, for the year ended December 31, 2010. The increase in the acquisition expense ratio was due to an increase in commissions related to prior years’ loss development for the year ended December 31, 2011 as compared with the same period in 2010. The increase in commissions related to prior years’ loss development was $0.2 million and had no effect on the net acquisition expense ratio for the year ended December 31, 2011. The decrease in commissions related to prior years’ loss development was $4.8 million and decreased the net acquisition expense ratio by 1.6 points for the year ended December 31, 2010. Net acquisition expenses and related net acquisition expense ratios were also impacted by changes in the mix of business.
2012 versus 2011: Other underwriting expenses were $22.9 million and $19.0 million for the years ended December 31, 2012 and 2011, respectively. The increase was primarily the result of an increase in performance-based compensation accruals in 2012 versus 2011.
2011 versus 2010: Other underwriting expenses were $19.0 million and $23.1 million for the years ended December 31, 2011 and 2010, respectively. The decrease was primarily the result of a decrease in performance-based compensation accruals in 2011 versus 2010.
During the years ended December 31, 2012, 2011 and 2010, the in-force Finite Risk portfolio consisted of one contract and we expect minor activity in this segment in the foreseeable future due to the relatively low level of demand for finite risk products. Due to the inverse relationship between losses and commissions for this segment, we believe it is important to evaluate the overall combined ratio, rather than its component parts of net loss and LAE ratio and net acquisition expense ratio. Due to the decline in premium volume in recent years, current year ratios may be significantly impacted by relatively small adjustments of prior years’ reserves.
The Finite Risk segment generated 3.9%, 1.5% and 2.4% of our net premiums written for the years ended December 31, 2012, 2011 and 2010, respectively.
2011 versus 2010: Net premiums written decreased by $8.7 million for the year ended December 31, 2011 as compared with the year ended December 31, 2010, primarily as a result of a decrease in the premiums written relating to the one in-force contract.
2012 versus 2011: Net losses, LAE and acquisition expenses increased by $9.6 million for the year ended December 31, 2012 as compared with the year ended December 31, 2011 primarily due to an increase in premiums earned. Also, net unfavorable development was $0.2 million for the year ended December 31, 2012 and net favorable development was $4.0 for the year ended December 31, 2011. Net favorable development for the year ended December 31, 2011 was primarily related to contracts from the 2004 underwriting year offset by net unfavorable development related to a contract from the 2003 underwriting year. The net unfavorable development increased the net loss and LAE and acquisition expense ratio by 1.3 points for the year ended December 31, 2012 and the net favorable development decreased the net loss and LAE and acquisition expense ratio by 29.0 points for the year ended December 31, 2011. In addition, a change in underwriting conditions resulted in an increase in the loss and loss adjustment expense ratio for the current period.
2011 versus 2010: Net losses, LAE and acquisition expenses decreased by $9.4 million for the year ended December 31, 2011 as compared with the year ended December 31, 2010, primarily due to net favorable development in 2011 as compared with net unfavorable development in 2010. Net favorable development was $4.0 million for the year ended December 31, 2011 compared with net unfavorable development of $2.5 million for the year ended December 31, 2010. Net unfavorable development for the year ended December 31, 2010 was primarily related to a contract from the 2003 underwriting year. The net favorable development decreased the net loss and LAE and acquisition expense ratio by 29.0 points for the year ended December 31, 2011 and the net unfavorable development increased the ratio by 14.3 points for the year ended December 31, 2010.
2012 versus 2011: Net investment income was $99.9 million and $125.9 million for the years ended December 31, 2012 and 2011, respectively. Net investment income decreased during the year ended December 31, 2012 as compared with 2011 primarily from a decrease in the average book yield for the portfolio from 3.1% to 2.6%. We also had a reduction of approximately $242.0 million in the average book value of our investments and cash and cash equivalents for the year ended December 31, 2012 as compared with 2011.
2011 versus 2010: Net realized gains on investments were $3.9 million and $107.8 million for the years ended December 31, 2011 and 2010, respectively. Sales of investments resulted in net realized gains of $106.4 million for the year ended December 31, 2010, primarily from U.S. Government securities, U.S. Government agency residential mortgage-backed securities ("RMBS") and non-U.S. government securities. The net positive impact from mark-to-market adjustments on trading securities of $1.4 million for the year ended December 31, 2010 were related primarily to non-U.S. government securities.
2012 versus 2011: Non-underwriting operating expenses were $25.3 million and $15.6 million for the years ended December 31, 2012 and 2011, respectively, and related to costs such as compensation and other corporate expenses associated with operating as a publicly-traded company. The increase was primarily the result of an increase in performance-based compensation accruals in 2012 versus 2011.
2012 versus 2011: There were no net changes in the fair value of derivatives for the year ended December 31, 2012 as we did not hold any derivatives during this period. Net changes in the fair value of derivatives resulted in an expense of $4.3 million for the year ended December 31, 2011. The net changes in the fair value of derivatives for the year ended December 31, 2011 were primarily attributable to expenses of $2.5 million related to a decrease in the fair value of a derivative agreement that was used to manage our exposure to certain underwriting risks until it expired on July 31, 2011 and expenses of $1.6 million related to put options on treasury futures that were purchased to temporarily protect our investment portfolio against a sudden increase in interest rates.
2012 versus 2011: Interest expense was $19.1 million for both the years ended December 31, 2012 and 2011 and related to our $250.0 million of debt obligations.
2011 versus 2010: Interest expense was $19.1 million and $19.0 million for the years ended December 31, 2011 and 2010, respectively, and related to our $250.0 million of debt obligations.
Pre-tax income was $272.2 million and $80.3 million in our Bermuda and U.S. companies, respectively, for the year ended December 31, 2012. Pre-tax loss was $235.6 million in our Bermuda companies and pre-tax income was $7.4 million in our U.S. companies for the year ended December 31, 2011. In 2011, pre-tax loss in our Bermuda companies resulted primarily from an increase in losses related to major catastrophe activity.
2011 versus 2010: Income tax benefit was $3.1 million and income tax expense was $43.2 million for the years ended December 31, 2011 and 2010, respectively. Our effective tax rate was (1.4%) and 16.7% for the years ended December 31, 2011 and 2010, respectively. Income tax expense or benefit is primarily driven by the taxable income or loss generated by our U.S.-based subsidiaries.
Platinum Holdings is a holding company, the assets of which consist primarily of shares of its subsidiaries. Platinum Holdings’ liquidity requirements, and those of Platinum Finance, include the payment of operating expenses, debt service obligations and income taxes. Our reinsurance subsidiaries’ principal liquidity requirements are the payment of losses and LAE, commissions, brokerage, operating expenses, income taxes and dividends to Platinum Holdings and Platinum Finance. We consider the impact of dividends and other distributions from our reinsurance subsidiaries on their respective capital levels, which may impact the financial strength rating assigned to our subsidiaries by A.M. Best and S&P.
Platinum Bermuda is not licensed, approved or accredited as a reinsurer in the United States and, therefore, under the terms of most of its contracts with U.S. ceding companies, it is required to provide collateral to its ceding companies for unpaid losses and LAE and unearned premiums in a form acceptable to state insurance commissioners. Platinum Bermuda and Platinum US also provide reinsurance coverage in many other international jurisdictions, several of which require us to provide collateral. Typically, this type of collateral takes the form of letters of credit issued by a bank, the establishment of a trust or funds held by ceding companies. See “Sources of Liquidity - Credit Facilities” below for additional information on our credit facilities and the collateral required by us under these facilities.
As at December 31, 2012, we had consolidated cash and cash equivalents of $1.7 billion, including $70.6 million at Platinum Holdings. We expect that Platinum Holdings’ liquidity needs for the next twelve months will be met by our cash and cash equivalents and available dividend capacity from our subsidiaries. We expect that our reinsurance subsidiaries’ liquidity needs for the next twelve months will be met by our cash and cash equivalents, cash flows from operations, investment income and proceeds from the sale, redemption or maturity of our investments.
Net cash flows used in operating activities were $165.3 million, or $178.8 million excluding trading securities, and $33.7 million, or $65.1 million excluding trading securities, for the years ended December 31, 2012 and 2011, respectively. Cash flows used in operating activities resulted primarily from an increase in the payment of losses and LAE and a reduction in premium volume in the years ended December 31, 2012 and 2011. Our reinsurance subsidiaries generally have liquidity from premiums, which are received in advance of the time losses are paid. The period of time from the occurrence of a claim through the settlement of the liability may extend many years into the future. However, due to the nature of our reinsurance operations, cash flows are affected by claim payments that can fluctuate from year to year. The amount and timing of actual claim payments can vary based on many factors, including the severity of individual losses, changes in the legal environment and general market conditions. As a result of a reduction in premium volume and expected loss payments resulting from major catastrophe activity that has occurred since the beginning of 2010, we anticipate that our operating cash flows will be negative for at least the next 12 months.
As part of our investment strategy, we seek to establish a level of cash and liquid short-term and intermediate-term securities which, including expected cash outflows from our operating activities, we believe to be adequate to meet our foreseeable payment obligations. The ultimate amount and timing of claim payments could differ materially from our estimates and create significant variations in cash flows from operations between periods, which may require us to make payments from other sources of liquidity, such as sales of investments, borrowings from credit facilities or proceeds from capital market transactions. If we need to sell investments to meet liquidity requirements, the sale of such investments may be at a material loss.
The following table provides additional detail on the fair value and amortized cost of our portfolio of non-U.S. government fixed maturity available-for-sale securities, fixed maturity trading securities and short-term investments converted to U.S. dollars as of December 31, 2012 ($ in thousands):
We invest in non-U.S. dollar denominated securities for purposes of hedging our non-U.S. dollar denominated net reinsurance liabilities.
The net unrealized gain position of our municipal bond and corporate bond portfolios was $129.7 million and $20.9 million, respectively, as of December 31, 2012 as compared with a net unrealized gain position of $150.1 million and $20.3 million, respectively, as of December 31, 2011. The decrease in the net unrealized gain position in our municipal bond portfolio was the result of sales activities partially offset by the narrowing of interest rate spreads. While the net unrealized gain position of our corporate bond portfolio was relatively unchanged, it was impacted by the narrowing of interest rate spreads offset by sales activities. We analyze the creditworthiness of our municipal bond and corporate bond portfolios by reviewing various performance metrics of the issuer, including financial condition, credit ratings and other public information.
The net unrealized loss position of our RMBS portfolio was $0.7 million, with non-agency RMBS representing $2.9 million, as of December 31, 2012 as compared with $9.6 million, with non-agency RMBS representing $11.3 million, as of December 31, 2011. Approximately 91% of the RMBS in our investment portfolio were issued or are guaranteed by the Government National Mortgage Association, the Federal National Mortgage Association, Federal Home Loan Mortgage Corporation, or the Federal Deposit Insurance Corporation and are referred to as U.S. Government agency RMBS. The remaining 9% of our RMBS were issued by non-agency institutions and included securities with underlying Alt-A mortgages. The net unrealized loss position of our non-agency RMBS was impacted by a narrowing of interest rate spreads and the recognition of net impairment losses. Securities with underlying sub-prime mortgages as collateral are included in ABS. The net unrealized gain position of our portfolio of sub-prime ABS was $0.5 million as of December 31, 2012 as compared with our net unrealized loss position of $2.3 million as of December 31, 2011. We analyze our non-agency RMBS and sub-prime ABS on a periodic basis using default loss models based on the performance of the underlying loans. Performance metrics include, but are not limited to, delinquencies, defaults, foreclosures, prepayment speeds and cumulative losses incurred. The expected losses for a mortgage pool are compared with the current level of credit support, which generally represents the point at which our security would experience losses. We evaluate projected cash flows as well as other factors in order to determine if a credit impairment has occurred.
On June 24, 2011, we entered into an amended and restated three-year, $300.0 million credit facility with various financial institutions (the "Syndicated Credit Facility") that consists of a $100.0 million unsecured senior credit facility available for revolving borrowings and letters of credit and a $200.0 million secured senior credit facility available for letters of credit. Borrowings and letters of credit under the Syndicated Credit Facility are available for the working capital, liquidity and general corporate requirements of Platinum Holdings, Platinum Finance and our reinsurance subsidiaries. Platinum Holdings and Platinum Finance have unconditionally guaranteed the obligations of our reinsurance subsidiaries under the Syndicated Credit Facility. The Syndicated Credit Facility provides that we may increase the lender commitments by up to $150.0 million subject to the participation of lenders.
The Syndicated Credit Facility contains customary representations, warranties and covenants, including requirements to maintain a ratio of consolidated indebtedness to total capitalization of not greater than 0.35 to 1.0 and to maintain a consolidated tangible net worth of not less than the higher of (i) $1.25 billion or (ii) the sum of $1.258 billion plus 50% of positive net income for each fiscal year plus 75% of the aggregate increases in shareholders’ equity resulting from the issuance or sale of shares minus the amount of any extraordinary dividend payment or repurchase of shares during the facility agreement. Our consolidated tangible net worth was $1.76 billion, or $506.8 million greater than the minimum consolidated tangible net worth covenant of $1.25 billion, as of December 31, 2012. In addition, each of our reinsurance subsidiaries must maintain a financial strength rating from A.M. Best of at least “B++” at all times. As at December 31, 2012, we were in compliance with the covenants under the Syndicated Credit Facility.
On June 30, 2011, our reinsurance subsidiaries entered into a letter of credit (“LOC”) facility with a financial institution in the maximum aggregate amount of $100.0 million that expires on December 31, 2013. Under the terms of the facility, up to $100.0 million is available for the issuance of letters of credit to support reinsurance obligations of our reinsurance subsidiaries. We also have the ability to request a supplemental LOC facility for up to $150.0 million subject to agreement with the lender. The facility contains customary representations, warranties and covenants. As at December 31, 2012, we were in compliance with the covenants under the facility.
On July 31, 2012, Platinum Bermuda entered into a one-year uncommitted LOC facility with a financial institution in the maximum aggregate amount of $75.0 million. Under the terms of the facility, up to $75.0 million is available for the issuance of letters of credit to support reinsurance obligations of Platinum Bermuda. We also have the ability to request a supplemental LOC facility for up to $75.0 million subject to agreement with the lender. The facility contains customary representations, warranties and covenants.
We had no cash borrowings under the Syndicated Credit Facility during the years ended December 31, 2012 and 2011. The following table summarizes the outstanding letters of credit and the cash and cash equivalents held in trust to collateralize letters of credit issued as of December 31, 2012 ($ in thousands):
During the year ended December 31, 2012, dividends of $207.9 million were paid by the reinsurance subsidiaries of Platinum Holdings, of which $155.0 million was paid by Platinum Bermuda to Platinum Holdings and $52.9 million was paid by Platinum US to Platinum Finance. Subsequent to December 31, 2012, Platinum Bermuda declared and paid a dividend of $42.5 million to Platinum Holdings. The remaining amount available for payment of dividends by our reinsurance subsidiaries without prior regulatory approval is $306.6 million.
We monitor our capital adequacy on a regular basis and seek to adjust our capital according to the needs of our business. In particular, we require capital sufficient to meet or exceed: (1) the capital adequacy ratios established by rating agencies for maintenance of appropriate financial strength ratings; (2) the surplus requirements established by our ceding companies; (3) the capital adequacy tests performed by regulatory authorities; and (4) the capital requirements under our credit facilities.
We do not have any material commitments for capital expenditures as of December 31, 2012.
Our Board of Directors has authorized the repurchase of our common shares through a share repurchase program. Since the program was established, our Board of Directors has approved increases in the repurchase program from time to time, most recently on July 23, 2012, to result in authority as of such date to repurchase up to a total of $250.0 million of our common shares. The following table summarizes our repurchases of common shares for the years ended December 31, 2012, 2011 and 2010 ($ in thousands, except per share data):
Since 2007, we have repurchased 37,880,333 shares and purchased 8,500,000 share options for a total of $1.3 billion and $146.4 million, respectively.
We do not have any off-balance sheet arrangements, as defined for purposes of the SEC rules, which are not accounted for or disclosed in the consolidated financial statements as of December 31, 2012.
See Note 14 to the Consolidated Financial Statements contained elsewhere in this Form 10-K.
The schedules relating to our consolidated financial statements as of December 31, 2012 and 2011 and for each of the three years in the period ended December 31, 2012, together with the independent registered public accounting firm report thereon, are set forth on pages S-1 through S-9 hereto. Schedules not referred to have been omitted as inapplicable or not required by Regulation S-X or information required is provided elsewhere in the consolidated financial statements.