The following selected financial data should be read in connection with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and notes thereto that are included in this Form 10-K. Financial information in the table reflects the results of operations and financial position of OdysseyRe.
As further described in Note 2 to the consolidated financial statements, we have restated our consolidated financial statements as of and for the years ended December 31, 2000 through 2004, as well as our statements as of and for the nine months ended September 30, 2005. Accordingly, the following selected financial data includes the effects of the restatement adjustments. A reconciliation of previously reported consolidated financial statements to the restated consolidated financial statements as of and for the years ended December 31, 2000 through 2002 follows the table. A reconciliation of previously reported consolidated financial statements to our restated consolidated financial statements as of and for the years ended December 31, 2003 and 2004 and as of and for the nine months ended September 30, 2005 is included in Note 2 to our consolidated financial statements.
Based on our common shares outstanding of: 69,127,532 as of December 31, 2005; 64,754,978 as of December 31, 2004; 64,996,166 as of December 31, 2003; 65,003,963 as of December 31, 2002; and 65,142,857 as of December 31, 2001.
The following discussion and analysis should be read in conjunction with the Selected Financial Data, consolidated financial statements and related notes and the discussion under “Critical Accounting Estimates” and “Safe Harbor Disclosure.” As further described in Note 2 to the consolidated financial statements and Item 6 - “Selected Financial Data,” we have restated our consolidated financial statements as of and for the years ended December 31, 2000 through 2004, as well as our results as of and for the nine months ended September 30, 2005. Management’s Discussion and Analysis has been updated to reflect the effect of the restatement.
Odyssey Re Holdings Corp. is a holding company, incorporated in the state of Delaware, which owns all of the common shares of Odyssey America Reinsurance Corporation, its primary operating subsidiary. Odyssey America directly or indirectly owns all of the capital stock of the following companies: Clearwater Insurance Company; Clearwater Select Insurance Company; Odyssey UK Holdings Corporation; Newline Underwriting
Management Ltd., which owns and manages Newline Syndicate 1218 at Lloyd’s; Hudson Insurance Company; and Hudson Specialty Insurance Company.
We are a leading United States based underwriter of reinsurance, providing a full range of property and casualty products on a worldwide basis. We offer a broad range of both treaty and facultative reinsurance to property and casualty insurers and reinsurers. We also write specialty insurance in the United States.
The Americas division is our largest division and writes casualty, surety and property treaty reinsurance, and facultative casualty reinsurance, in the United States and Canada, and primarily treaty and facultative property reinsurance in Central and South America.
The EuroAsia division consists of our international reinsurance business, which is geographically dispersed, mainly throughout the European Union, followed by Japan, Eastern Europe, the Pacific Rim, and the Middle East.
The London Market division is comprised of our Lloyd’s of London business, in which we participate through our 100% ownership of Newline and our London branch office. The London Market division writes insurance and reinsurance business worldwide, principally through brokers.
(i) Timing differences as to how premiums and unearned profit commissions under property catastrophe reinsurance contracts were recognized over the coverage periods on seven reinsurance contracts purchased by us and two reinsurance contracts written by us. All of these contracts satisfied risk transfer requirements and were multi-year, retrospectively-rated contracts, or included certain features that had the effect of allowing the contracts to operate as multi-year, retrospectively-rated contracts. The contracts were restated to correct the application of Emerging Issues Task Force Issue No: 93-6 “Accounting for Multiple-Year Retrospectively-Rated Contracts by Ceding and Assuming Enterprises” (“EITF 93-6”). The two reinsurance contracts written by us remained in force as of December 31, 2005. The restated contracts involve eight unaffiliated counterparties. The corrections under these contracts resulted in a $1.3 million after-tax cumulative increase to shareholders’ equity as of September 30, 2005, with the net effect of decreasing the net loss for the nine months ended September 30, 2005 by $2.3 million, increasing 2004 net income by $10.5 million, increasing 2003 net income by $10.9 million, increasing 2002 net income by $8.4 million, increasing 2001 net loss by $29.2 million and decreasing 2000 net income by $1.6 million.
gain rather than as a benefit in the applicable periods. As part of the restatement, the deferred gain attributable to loss cessions made under the contract in 2002 and subsequent years is amortized into income over the estimated remaining settlement period.
As it was our intention at the time of the assignment to nSpire Re to continue to have the contract be accounted for as prospective reinsurance, we requested that nSpire Re pay $78.0 million due under the contract prior to the expected settlement period, which would allow us to record a portion of the benefit for losses ceded under the contract. We received $78.0 million in cash from nSpire Re on March 29, 2006, which reduces the outstanding recoverable. In connection with the receipt of this cash, we will recognize a deferred gain of $12.5 million after-tax in income for the three months ended March 31, 2006. The cash payment represents a permanent reduction in the amount of reinsurance recoverable from nSpire Re. The remaining reinsurance recoverable related to this contract of $97.0 million as of March 31, 2006 is collateralized by letters of credit and will be received in future periods as the underlying claims are settled.
The corrections under this contract resulted in a $28.6 million after-tax cumulative decrease to shareholders’ equity as of September 30, 2005, with the effect of increasing the net loss for the nine months ended September 30, 2005 by $3.0 million, decreasing 2004 net income by $5.7 million, decreasing 2003 net income by $7.2 million and decreasing 2002 net income by $12.7 million. The $28.6 million after-tax cumulative decrease to shareholders’ equity as of September 30, 2005 will be offset by a gain of $12.5 million after-tax associated with the recognition of a deferred gain to be recognized for the three months ended March 31, 2006 and the future amortization of the deferred gain into income.
(iv) The treatment of a proportional automobile reinsurance contract written by us in Latin America in 2003 and subsequently renewed in 2004 and 2005, relating to the potential existence of an oral side agreement that could limit the risk transfer under the contract. Following an internal review and investigation by our outside counsel, we were unable to conclude as to whether there was an oral side agreement that would limit the risk transfer under the contract. After consideration of information from the investigation, we are unable to conclude that there is a reasonable possibility of a significant loss under the contracts and have therefore restated the contract to apply the deposit method of accounting in accordance with Statement of Position 98-7, “Deposit Accounting: Accounting for Insurance and Reinsurance Contracts that Do Not Transfer Risk” rather than reinsurance accounting. The corrections under this contract resulted in a $144 thousand after-tax cumulative increase to shareholders’ equity as of September 30, 2005, with the net effect of decreasing the net loss for the nine months ended September 30, 2005 by $220 thousand, decreasing 2004 net income by $18 thousand and decreasing 2003 net income by $58 thousand.
We review our critical accounting estimates and assumptions quarterly. These reviews include the estimate of reinsurance premiums and premium related amounts, establishing deferred acquisition costs, an evaluation of the adequacy of reserves for unpaid losses and LAE, review of our reinsurance and retrocession agreements, an analysis of the recoverability of deferred income tax assets and an evaluation of the investment portfolio for other-than-temporary declines in estimated fair value. Actual results may differ materially from the estimates and assumptions used in preparing the consolidated financial statements.
The following table displays, by division, the estimates included in our consolidated financial statements for the years ended December 31, 2005, 2004 and 2003 related to gross premiums written, acquisition costs, premiums receivable and unearned premium reserves (in millions):
Our estimates are based on contract and policy terms. Estimates are based on information typically received in the form of a bordereau, broker notifications and/or discussions with ceding companies. These estimates, by necessity, are based on assumptions regarding numerous factors. These can include premium or loss trends, which can be influenced by local conditions in a particular region, or other economic factors and legal or legislative developments which can develop over time. The risk associated with estimating the performance under our contracts with our ceding companies is the impact of events or trends that could not have been reasonably anticipated at the time the estimates were performed. Our business is diversified across ceding companies and there is no individual non-affiliated ceding company which represents more than 1.5% of our gross premiums written in 2005. As a result, we believe the risks of material changes over time are mitigated.
We rely on initial and subsequent claims reports received from ceding companies to establish our estimate of losses and LAE. The types of information that we receive from ceding companies generally vary by the type of contract. Proportional, or quota share, contracts are typically reported on a quarterly basis, providing premium and loss activity as estimated by the ceding company. Reporting for excess of loss and facultative contracts includes detailed individual claim information, including a description of the loss, confirmation of liability by the cedant and the cedant’s current estimate of the ultimate liability under the claim. Upon receipt of claims notices from cedants, we review the nature of the claim against the scope of coverage provided under the contract. Questions arise from time to time regarding the interpretation of the characteristics of a particular claim measured against the scope of contract terms and conditions. Reinsurance contracts under which we assume business generally contain specific dispute resolution provisions in the event that there is a coverage dispute with the ceding company. The resolution of any individual dispute may impact estimates of ultimate claim liabilities. Reported claims are in various stages of the settlement process. Each claim is settled individually based on its merits, and certain claims may take several years to ultimately settle, particularly where legal action is involved. Based on an assessment of the circumstances supporting the claim, we may choose to establish additional case reserves over the amount reported by the ceding company. Aggregate case reserves established in addition to reserves recommended by the ceding company were $14.6 million and $26.4 million as of December 31, 2005 and 2004, respectively. Due to potential differences in ceding company reserving and reporting practices, we perform periodic audits of our ceding companies to ensure the underwriting and claims procedures of the cedant are consistent with representations made by the cedant during the underwriting process and meet the terms of the reinsurance contract. Our estimates of ultimate loss liabilities make appropriate adjustment for inconsistencies uncovered in this audit process. We also monitor our internal processes to ensure that information received from ceding companies is processed in a timely manner.
The reserve methodologies employed by us are dependent on the nature and quality of the data that we collect from ceding companies. This data primarily consists of loss amounts reported by the ceding companies, loss payments made by the ceding companies, and premiums written and earned reported by the ceding companies or estimated by us. For many classes of business, the actuarial methods used by us to project our liabilities recorded presently but that will be paid in the future (future liabilities) generally do not include methodologies that are dependent on claim counts reported, claim counts settled or claim counts open. Due to the nature of our business, this information is not routinely provided by the ceding companies for every treaty. Consequently, actuarial methods relying on this information generally cannot be relied on by us for much of our loss reserve estimation process.
Underwriting and claim information provided by our ceding companies is aggregated by the year in which each treaty is written into groups of business by geographic region and type of business to facilitate analysis, generally referred to as “reserve cells.” These reserve cell groupings of business are reviewed annually and change over time as our business mix changes. We supplement this information with claims and underwriting audits of specific contracts, internally developed pricing, as well as loss trend data developed from industry sources. This information is used to develop point estimates of carried reserves for each business segment. These individual point estimates, when aggregated, represent the total carried losses and LAE reserves carried in our consolidated financial statements. Due to the uncertainty involving estimates of ultimate loss exposures, we do not attempt to produce a range around our point estimate of loss. The actuarial techniques for projecting losses and LAE reserves by reserve cell rely on historical paid and case reserve loss emergence patterns and insurance and reinsurance pricing trends to establish the claims emergence of future periods with respect to all reported and unreported insured events that have occurred on or before the balance sheet date. The process relies upon the assumption that past experience, supplemented by qualitative judgment where quantitative methods provide incomplete results, is an appropriate basis for predicting future events. The estimation of loss reserves is a complex process, especially in view of changes in the legal, social and economic environment which impact the development of loss reserves. Qualitative reassessments by management may be required where emerging trends and issues in claims frequency and severity and litigation, and in the social, economic, legislative and regulatory environments cannot be fully addressed or contemplated by past experience trends. Examples of events that could require qualitative reassessments of loss estimates by management would include shifts in laws, such as asbestos litigation reform, or developments involving the Terrorism Risk Insurance Act of 2002 that could affect claims related to future terrorism-related losses. Our best reasoned judgment on the impact of these types of trends and events will necessarily be based upon our evaluation of the historical effects of events of similar scope or magnitude that have occurred in the past.
emergence of new classes of losses or types of losses not sufficiently represented in our historical data base or that are not yet quantifiable.
A) Frequency and Severity of Outstanding Claim Reserves as of December 31, 2005:
Historically, our actual results have varied considerably in certain instances from our estimates of losses and LAE because historical loss emergence trends have not been indicative of future emergence for certain segments of our business. For calendar years 2003 through 2005, we experienced claim frequency and severity greater than expectations that were established based on a review of the prior years’ loss trends, particularly for business written in the period 1997 through 2000. General liability and excess workers’ compensation classes of business during these years were adversely impacted by the highly competitive conditions in the industry at that time, which resulted in price competition and relatively broader coverage terms, thereby affecting the ability of standard actuarial techniques to generate reliable estimates of ultimate loss. Similarly, directors’ and officers’ professional liability lines were impacted by the increase in frequency and severity of claims resulting from an increase in shareholder lawsuits against corporations and their officers and directors, corporate bankruptcies and other financial and management improprieties in the late 1990s through the early 2000s. For calendar years 2005 through 2003, the net impact of changes in losses and LAE estimates for all segments reduced pre-tax income by $172.7 million, $190.0 million and $127.9 million, respectively.
The Americas division reported net adverse loss development for prior years of $214.0 million, $184.8 million, and $92.9 million for calendar years 2005, 2004 and 2003, respectively. These increases were principally related to increased loss estimates for United States casualty business written in the period 1997 through 2001. Partially offsetting this increase was a decline in loss estimates for United States casualty business written in 2003 and 2004. Based on the review of cedant reported losses received during 2005, 2004 and 2003, we revised our loss development and expected loss ratio assumptions we use in performing our actuarial analysis, which generated a substantial increase in ultimate losses on United States casualty business written in the period 1997 through 2001, partially offset by a decline in U.S. casualty ultimate losses in more recent years. The specific lines of business generating most of the increase include general liability, professional liability and excess workers’ compensation. The difficulty in anticipating the ultimate losses attributable to business written during 1997 through 2001 for these lines of business is due to an increase in the frequency and severity of claims over
expectations that were established based on information available in prior years. This includes estimating the cost of known claims and, more importantly, estimating the cost of claims where no reports have yet been made. In addition, the ability to anticipate the ultimate value of losses is made difficult by the long period of time which elapses before an actual loss is known and determinable, particularly for professional liability lines, where claims are often litigated to achieve a settlement. Competitive market conditions during the 1997 to 2001 period have resulted in unexpectedly prolonged emergence patterns as a result of: (i) an increasing level of deductibles, (ii) expanded coverage, (iii) expanded policy terms and (iv) a proliferation of corporate improprieties and bankruptcies. Losses attributable to general liability and excess workers’ compensation classes of business during the 1997 to 2001 period have also demonstrated a higher incidence of severity due to relatively broad coverage available under policy forms used during these periods. These factors have adversely impacted our ability to estimate losses and LAE in subsequent periods attributable to business written during this period. Additionally, in calendar year 2005, the annual review of internal and external trends in asbestos loss reporting and claim payments caused us to increase our asbestos loss development assumptions. As a result of these changes to assumptions, asbestos ultimate loss increased by $41.2 million.
The EuroAsia division reported net favorable loss development for prior years of $8.7 million in calendar year 2005, and net adverse loss development for calendar years 2004 and 2003 of $6.6 million and $11.0 million, respectively. The reduction in prior year loss estimates for calendar year 2005 is driven by favorable loss emergence trends in miscellaneous property lines including property risk (non-catastrophe), aviation and bonding. These reserve reductions more than offset prior year loss estimate increases for property catastrophe and French motor liability coverages. The increase in prior period loss estimates during calendar years 2004 and 2003 are principally related to greater than expected loss emergence on bond and facultative exposures, respectively.
The following table provides detail on loss and LAE development, by division, for the calendar years 2005 through 2003 (in millions):
We have exposure to asbestos, environmental pollution and other latent injury damage claims resulting from policies written prior to 1986. Exposure arises from reinsurance contracts under which we assumed liabilities, on an indemnity or assumption basis, from ceding companies, primarily in connection with general liability insurance policies issued by such ceding companies. Our estimate of our ultimate liability for such exposures includes case basis reserves and a provision for IBNR claims. The provision for asbestos loss liabilities is established based on an annual review of Company and external trends in reported loss and claim payments.
We believe that these uncertainties and factors make projections of these exposures, particularly asbestos, subject to less predictability relative to non-environmental and non-asbestos exposures. Current estimates, as of December 31, 2005, of our asbestos and environmental losses and LAE, net of reinsurance, are $119.3 million and $13.5 million, respectively. See Note 9 to the consolidated financial statements for additional historical information on losses and LAE reserves for these exposures.
The following tables provide the historical gross and net asbestos and environmental losses and LAE incurred for the years ending December 31, 2005, 2004 and 2003 (in millions).
Asbestos open claims as of December 31, 2005 are 1,532, amounting to $206.0 million in gross case losses and LAE reserves. The largest 10 reported claims account for 15.7% of the gross case reserves, with an average reserve of $3.2 million. As of December, 31, 2004, there were 1,482 open claims with an aggregate case reserve of $191.8 million. The largest 10 reported claims in 2004 account for 18.5% of gross case reserves, with an average reserve of $3.5 million. Gross case reserves increased in 2005, as newly reported claims and additional reported reserves on existing claims more than offset claim payments in the year. Based on an aggregation of claims by insured, our 10 largest insured involvements account for 47.8% of our gross case reserves at December 2005, compared to 50.2% at year end 2004. Based on our annual reserve study, we increased net asbestos loss reserves by $41.2 million based on the observed trends in our internal loss data as well as external loss trends.
Environmental open claims as of December 31, 2005 are 1,373, amounting to $32.2 million in gross case losses and LAE reserves. The largest 10 reported claims account for 24.2% of the gross case reserves, with an average case reserve of $0.8 million. At December, 31, 2004, there were 1,431 open claims with an aggregate case reserve of $26.5 million. The largest 10 reported claims in 2004 account for 22.0% of gross case reserves, with an average case reserve of $0.6 million. Overall gross case reserves increased in 2005, as newly reported claims and additional reported reserves on existing claims more than offset claim payments in the year. Based on an aggregation of claims by insured, our 10 largest insured involvements account for 45.1% of our gross case reserve as of December 2005, compared to 44.3% as of December 31, 2004. Based on our annual reserve study, we decreased environmental net loss reserves by $(0.9) million based on the observed trends in our internal loss data.
The following table provides historical gross asbestos and environmental outstanding claim information for the years ended December 31, 2005 and 2004 (in millions):
We previously purchased whole account aggregate excess of loss retrocessional coverage (“Whole Account Excess of Loss Agreements”) to manage our exposures, including catastrophic occurrences and the potential accumulation of exposures. The Whole Account Excess of Loss Agreements are broad in coverage, and include property and casualty insurance and reinsurance business written on a worldwide basis, as applicable. Classes of business excluded from coverage primarily include non-traditional business. In each calendar year, we have the ability to cede losses attributable to certain prior periods to the Whole Account Excess of Loss Agreements to the extent there are limits remaining for the period. These agreements cover business written or incepting during a
defined period of time (underwriting year), which is typically twelve months, or in other cases, business earned during a defined period of time (accident year). The Whole Account Excess of Loss Agreements were purchased on an underwriting year basis for 1996 through 2004 and on an accident year basis for 1994 and 1995. Accident year agreements were also purchased to supplement the 1996 and 1997 underwriting year agreements. Each agreement provides for recoveries from the retrocessionaires, subject to a limit, in the event that the net subject business results in a composite ratio (the sum of the commission and loss ratios), or in some agreements a loss ratio, in excess of a specified attachment point. The attachment point is net of other inuring third party reinsurance. The premium paid, net of commission, by us is calculated based on a contractual fixed rate that is applied to the total premiums covered by the retrocession agreements. Each agreement includes a provision for additional premium, subject to a maximum, based on the amount of loss activity under the agreement. Reinsurance recoverables on paid and unpaid losses are fully secured by letters of credit or funds held by OdysseyRe. The principal reinsurers under these agreements are London Life and Casualty Reinsurance Corporation and Underwriters Reinsurance Company (Barbados) Inc.
The following table shows the amount of loss and LAE attributable to each coverage period ceded to the Whole Account Excess of Loss Agreements for the years ended December 31, 2005, 2004 and 2003 (in millions):
We have recorded interest expense associated with other ceded reinsurance agreements, and not reflected in the table above, of $44 thousand, $18 thousand and $775 thousand for the years ended December 31, 2005, 2004 and 2003, respectively.
On a quarterly basis, we review our investment portfolio for declines in value, and specifically consider securities, the market values of which have declined to less than 80% of their amortized cost at the time of review. Generally, a change in the market or interest rate environment does not constitute an impairment of an investment, but rather a temporary decline in value. Temporary declines in investments will be recorded as unrealized depreciation in accumulated other comprehensive income. If we determine that a decline is “other-than-temporary,” the carrying value of the investment will be written down to the fair value and a realized loss will be recorded in our consolidated statements of operations.
In assessing the value of our debt and equity securities held as investments, and possible impairments of such securities, we review (i) the issuer’s current financial position and disclosures related thereto, (ii) general and specific market and industry developments, (iii) the timely payment by the issuer of its principal, interest and other obligations, (iv) the outlook and expected financial performance of the issuer, (v) current and historical valuation parameters for the issuer and similar companies, (vi) relevant forecasts, analyses and recommendations by research analysts, rating agencies and investment advisors, and (vii) other information we may consider relevant. In addition, we consider our intent and ability to hold the security to recovery when evaluating possible impairments. Risks and uncertainties are inherent in our other-than-temporary decline in value assessment methodology.
Total reinsurance gross premiums written for the year ended December 31, 2005 were $1,863.6 million compared to $1,968.8 million for 2004, a decrease of 5.3%. Total insurance gross premiums written for the year ended December 31, 2005, which includes our U.S. Insurance division and our Lloyd’s syndicate (which is part of London Market), were $763.3 million, compared to $682.0 million for 2004, an increase of 11.9%. For the year ended December 31, 2005, total reinsurance gross premiums written represented 71.0% (74.3% in 2004) of our business and insurance represented the remaining 29.0% (25.7% in 2004) of our business.
Katrina, Rita and Wilma in 2005. Excluding reinstatement premiums in each period, gross premiums written would be $2,556.5 million and $2,634.0 million for the years ended December 31, 2005 and 2004, respectively, representing a decrease of $77.5 million, or 2.9%.
United States - Gross premiums written of $929.9 million for the year ended December 31, 2005 decreased $117.9 million, or 11.3%, compared to $1,047.8 million for the year ended December 31, 2004. The decrease in the United States is primarily attributable to the non-renewal of a large workers compensation quota share treaty, which accounted for a decrease in gross premiums written of $93.2 million in 2005. Gross premiums written across casualty classes of business decreased by $64.9 million, or 13.0%, as compared to 2004, due to more competitive market conditions, particularly in professional liability classes and non standard auto. This decrease is partially offset by increased gross premiums written relating to higher reinstatement premiums of $28.0 for the year ended December 31, 2005 compared to $3.2 million for 2004, which contributed to the overall increase in property gross premiums written of $36.5 million over the period.
EuroAsia. Gross premiums written in the EuroAsia division for the year ended December 31, 2005 were $543.8 million, a decrease of $9.9 million, or 1.8%, as compared to $553.7 million for the year ended December 31, 2004. These amounts represented 20.7% of our gross premiums written for the year ended December 31, 2005 and 20.9% in 2004. These amounts include $5.2 million of reinstatement premiums for the year ended December 31, 2005, as compared to none in 2004. Gross premiums written for the year ended December 31, 2004 included $24.9 million related to the consolidation of a wholly owned subsidiary, First Capital Insurance Limited (“First Capital”), which writes business in Singapore. Starting in the fourth quarter of 2004, our economic interest in First Capital declined below 50% and it is no longer consolidated in our consolidated financial statements. Excluding this amount, gross premiums written for the year ended December 31, 2005 increased $15.0 million, or 2.8%, as compared to the year ended December 31, 2004. This increase is primarily attributable to higher volume of property and motor business, offset by lower volume in accident and health and credit and bonds. Gross premiums written from property business, which represents 60.0% of EuroAsia in 2005, increased by $21.8 million, or 7.2%, for the years ended December 31, 2005 and 2004, driven by greater penetration in the French market. Motor business, which represents 16.3% of EuroAsia in 2005, increased $8.8 million, or 11.1%, in 2005 and was primarily attributable to a $17.3 million increase in France, offset by a decline in other parts of Europe and the Middle East. Accident and health business, which represents 2.1% of EuroAsia in 2005, decreased $12.3 million, or 51.7%, in 2005 over 2004 primarily due to the non renewal of selected proportional accounts.
London Market. Gross premiums written in the London Market division for the year ended December 31, 2005 were $431.6 million, a decrease of $16.1 million or 3.6% as compared to $447.7 million for the year ended December 31, 2004. These amounts represented 16.4% of our gross premiums written for the year ended December 31, 2005 and 16.9% in 2004. These amounts include reinstatement premiums of $33.2 million and $11.8 million (all related to the London Branch) for the years ended December 31, 2005 and 2004, respectively, which principally relate to Hurricanes Katrina, Rita and Wilma in 2005, and the 2004 Florida Hurricanes. Excluding reinstatement premiums in each period, gross premiums written would be $398.4 million and $435.9 million for the years ended December 31, 2005 and 2004, respectively, representing a decrease of $37.5 million, or 8.6% over the period. Gross premiums written across each unit of the London Market division are as follows:
London Branch - Gross premiums written of $189.3 million for the year ended December 31, 2005 increased $6.8 million, or 3.8%, compared to $182.5 million for the year ended December 31, 2004. Excluding reinstatement premiums in each period, gross premiums written for the year ended December 31, 2005 were $156.2 million, a decrease of $14.5 million or 8.5%, compared to $170.7 million for the year ended December 31, 2004. Gross premiums written from property business, which represents 46.3% of London Branch in 2005, increased by $14.6 million, or 20.0%, in 2005 over 2004, entirely driven by higher reinstatement premiums in 2005 as ceding companies are choosing to retain more business. Casualty business showed little change in 2005 but reflects more business written on an excess of loss basis versus proportional.
Newline - Gross premiums written of $242.3 million for the year ended December 31, 2005 decreased $22.9 million, or 8.6%, compared to $265.2 million for the year ended December 31, 2004. The decrease was primarily attributable to lower directors and officers and error and omissions business. The decline in premiums generally reflects more competitive conditions in the market, where we were experiencing lower prices in certain classes or choosing to non-renew business that does not meet our underwriting criteria.
Medical malpractice gross premiums written were $150.6 million for the year ended December 31, 2005, an increase of $12.9 million, or 9.4%, from $137.7 million for the year ended December 31, 2004. Medical malpractice, our largest line of business in the U.S. Insurance division, represented 28.9% of gross premiums written in U.S. Insurance for the year ended December 31, 2005. Growth was driven by increases in our select markets and hospital coverages and partially offset by reductions in physician groups business, which reflects more competitive market conditions.
Losses and Loss Adjustment Expenses. Losses and LAE increased 26.4% to $2,061.6 million for the year ended December 31, 2005, from $1,631.1 million for the year ended December 31, 2004 as follows (in millions):
The increase in losses and LAE was principally related to losses of $537.9 million (23.7% of net premiums earned) related to current year catastrophe events, of which $445.9 million (19.6% of net premiums earned) is attributable to Hurricanes Katrina, Rita and Wilma. The remaining catastrophe losses are principally related to other events occurring in the year, including Hurricanes Emily, Dennis and Stanley, Windstorm Erwin and floods in India and Europe. Losses and LAE in 2005 include unfavorable development of $172.7 million attributable to
The following table reflects total losses and LAE as reported and includes the impact of catastrophe losses and prior period reserve development, expressed as a percentage of net premiums earned, for the years ended December 31, 2005 and 2004 (in millions):
For the Americas division, losses and LAE increased $278.6 million, or 30.7%, to $1,186.2 million for the year ended December 31, 2005, from $907.6 million for the year ended December 31, 2004. This resulted in a loss and LAE ratio of 112.8% for the year ended December 31, 2005, compared to 73.8% for the year ended December 31, 2004. The increase in losses and LAE was due to losses of $354.2 million related to catastrophe events, of which $313.1 million is attributable to Hurricanes Katrina, Rita and Wilma, with the remainder principally related to other events occurring in 2005, including Hurricanes Emily and Dennis. Losses and LAE in the 2005 period include an increase of $214.0 million attributable to 2004 and prior years, principally related to U.S. casualty classes of business written in 2001 and prior, (includes $5.9 million of prior period catastrophe losses). For the year ended December 31, 2004, losses and LAE reflect $100.3 million for property catastrophe events including the 2004 Florida Hurricanes. Losses and LAE in the 2004 period include an increase of $184.8 million attributable to 2003 and prior years, principally related to U.S. casualty classes of business written in 2001 and prior (includes $5.7 million of prior period catastrophe losses).
The following table reflects losses and LAE for the EuroAsia division as reported, and includes the impact of catastrophe losses and prior period reserve development, expressed as a percentage of net premiums earned for the years ended December 31, 2005 and 2004 (in millions):
For the EuroAsia division, losses and LAE increased $26.2 million, or 8.7%, to $326.0 million for the year ended December 31, 2005, from $299.8 million for the year ended December 31, 2004. This resulted in a loss and LAE ratio of 63.2% for the year ended December 31, 2005, compared to 62.2% for the year ended December 31, 2004. The increase in losses and LAE was related to the 7.0% increase in net premiums earned, $56.7 million of catastrophe losses, principally Windstorm Erwin and floods in India and Europe. Losses and LAE in the 2005 period include a benefit of $8.7 million attributable to 2004 and prior years, principally related to miscellaneous property lines including non-catastrophe property risk, aviation and bonding (includes $7.4 million of prior period catastrophe losses). For the year ended December 31, 2004, losses and LAE include $24.8 million for property catastrophe events, including Typhoon Songda and the Indonesian earthquake and resulting tsunami. Losses and LAE in the 2004 period include an increase of $6.6 million attributable to 2003 and prior years, principally related to bond exposures (includes $2.2 million of prior period catastrophe losses).
The following table reflects losses and LAE for the U.S. Insurance division as reported, and includes the impact of catastrophe losses and prior period reserve development, expressed as a percentage of net premiums earned for the years ended December 31, 2005 and 2004 (in millions):
For the U.S. Insurance division, losses and LAE increased 54.2% to $200.6 million for the year ended December 31, 2005, from $130.1 million for the year ended December 31, 2004. This resulted in a loss and LAE ratio of 62.0% for the year ended December 31, 2005, compared to 65.6% for the year ended December 31, 2004. The increase in losses and LAE was related to the 63.0% increase in net premiums earned, losses of $0.4 million related to Hurricane Katrina and a benefit of $9.0 million on losses and LAE attributable to 2004 and prior years. For the year ended December 31, 2004, losses and LAE related to 2003 and prior years decreased $1.2 million.
Other Underwriting Expenses. Other underwriting expenses for the year ended December 31, 2005 were $146.0 million, compared to $120.8 million for the year ended December 31, 2004. The other underwriting expense ratio, expressed as a percentage of net premiums earned, was 6.4% for the year ended December 31, 2005, compared to 5.2% for the year ended December 31, 2004. Other underwriting expenses increased while net premiums earned decreased, resulting in a higher other underwriting expense ratio in 2005 as compared to 2004. In addition, legal expenses of $8.4 million for the year ending December 31, 2005, primarily attributable to outstanding litigation matters, increased by $4.5 million over 2004. This increase in other underwriting expenses
The following table reflects the acquisition and other underwriting expenses, expressed as a percentage of net premiums earned, for the years ended December 31, 2005 and 2004 for each of our divisions:
Net Investment Income. Net investment income for the year ended December 31, 2005 increased by $55.0 million, or 33.9%, to $217.3 million, from $162.3 million for the year ended December 31, 2004 driven by an $853.1 million or 16.8% increase in total investments and cash over the period. Net investment income is comprised of gross investment income of $245.0 million less investment expenses of $27.7 million for the year ended December 31, 2005, compared to gross investment income of $192.9 million less investment expenses of $30.6 million for the year ended December 31, 2004. Higher net investment income for the year ended December 31, 2005 is primarily attributable to the following:
During the year ended December 31, 2005, net realized investment gains were reduced by other-than-temporary impairment losses in the amount of $54.9 million, with $37.3 million relating to fixed income
Other Expenses, Net. Other expenses, net, for the year ended December 31, 2005, were $27.0 million, compared to $17.2 million for the year ended December 31, 2004. The other expense is primarily comprised of operating expenses of our holding company and includes audit related fees, Sarbanes-Oxley compliance consulting fees, corporate-related legal fees, consulting fees, and compensation expense, including the amortization of restricted share grants. The increase of $9.8 million for the year ended December 31, 2005 over 2004 is primarily comprised of: (i) an increase of $4.1 million related to consulting fees in implementing procedures and documentation for Sarbanes-Oxley, (ii) an increase of $1.4 million as a result of higher amortization expense of restricted stock, (iii) $2.1 million related to the renewal of the employment contract of our Chief Executive Officer, which is reflected in 2005 and (iv) $1.7 million related to the amortization of information technology development costs during 2005.
Federal and Foreign Income Tax Benefit/ Provision. As a result of our loss for the year ended December 31, 2005, our federal and foreign income tax provision for the year ended December 31, 2005 decreased by $157.5 million, to a benefit of $59.5 million, compared to a provision of $98.0 million for the year ended December 31, 2004. Our effective tax rates were 36.5% and 33.1% for the years ended December 31, 2005 and 2004, respectively.
Preferred Dividends. We recorded preferred dividends related to our series A and series B non-cumulative perpetual preferred shares of $1.9 million after-tax for the year ended December 31, 2005. There were no amounts in 2004, as the preferred shares were first issued in October 2005.
Total reinsurance gross premiums written for the year ended December 31, 2004 were $1,968.8 million compared to $1,960.5 million for the year ended December 31, 2003, a decrease of 0.4%. Total insurance gross premiums written for the year ended December 31, 2004, which include our U.S. Insurance division, First Capital, (which is part of EuroAsia) and our Lloyd’s syndicate (which is part of London Market), were $682.0 million, compared to $591.8 million for the year ended December 31, 2003, an increase of 15.2%. For the
year ended December 31, 2004, total reinsurance gross premiums represented 74.3% (76.8% in 2003) of our business and insurance represented the remaining 25.7% (23.2% in 2003) of our business.
Gross premiums written include reinstatement premiums of $16.8 million for the year ended December 31, 2004. Reinstatement premiums were primarily related to reinstating the coverage under property catastrophe excess of loss reinsurance contracts following the Florida Hurricanes in 2004. Excluding reinstatement premiums in 2004, gross premiums written would be $2,634.0 million and $2,552.3 million for the years ended December 31, 2004 and 2003, respectively, representing an increase of $81.7 million, or 3.2%.
United States - Gross premiums written of $1,047.8 million for the year ended December 31, 2004 decreased $140.2 million, or 11.8%, compared to $1,188.0 million for the year ended December 31, 2003. The decrease in the United States is primarily attributable to a reduction in the casualty treaty business of $109.0 million due to ceding companies increasing their net retentions, our non-renewal of certain business which did not meet our underwriting standards, and market competition. The decrease is partially offset by the higher reinstatement premiums resulting from increased storm activity in 2004.
EuroAsia. Gross premiums written in the EuroAsia division for the year ended December 31, 2004 were $553.7 million, an increase of $145.6 million or 35.7% as compared to $408.1 million for the year ended December 31, 2003. These amounts represented 20.9% of our gross premiums written for the year ended December 31, 2004 and 16.0% in 2003. Gross premiums written for the years ended December 31, 2004 and 2003 included $24.9 million and $17.6, respectively, related to the consolidation of a wholly owned subsidiary, First Capital. The increase in gross premiums written is primarily attributable to new business and increased participations on existing client business, combined with continued strong renewal rates across most lines of business. Growth has been most notable in the property, motor and credit classes of business.
London Branch - Gross premiums written of $182.5 million for the year ended December 31, 2004 increased $28.0 million, or 18.1%, compared to $154.5 million for the year ended December 31, 2003. Excluding reinstatement premiums in 2004, gross premiums written for the year ended December 31, 2004 were $170.7 million, an increase of $16.2 million or 10.5%, compared to $154.5 million for the year ended December 31, 2003. The increase in premiums generally reflects more favorable terms and conditions in the treaty property and treaty casualty markets.
U.S. Insurance. Gross premiums written in the U.S. Insurance division for the year ended December 31, 2004 were $391.9 million, an increase of $101.1 million or 34.8% as compared to $290.8 million for the year ended December 31, 2003. These amounts represented 14.8% of our gross premiums written for the year ended December 31, 2004 and 11.4% in 2003. Gross premiums written by our U.S. Insurance division are reduced by amounts which are ceded to the Americas division of $20.1 million and $43.0 million for the years ended December 31, 2004 and 2003, respectively. Excluding the impact of amounts ceded to the Americas division, gross premiums written for the year ended December 31, 2004 increased by $78.2 million, or 23.4% over 2003. Gross premiums written across each unit of the U.S. Insurance division are as follows:
Gross premiums written from speciality lines distributed through program administrators were $254.2 million for the year ended December 31, 2004, an increase of $74.0 million or 41.1%, from $180.2 million for the year ended December 31, 2003. New professional liability and personal automobile business contributed to the increase in gross premiums written.
Net Premiums Written. Net premiums written for the year ended December 31, 2004 increased by $205.7 million, or 9.5%, to $2,361.8 million from $2,156.1 million for the year ended December 31, 2003. Net premiums written represent gross premiums written less ceded premiums written. The percentage increase in net premiums written is greater than the gross premiums written as a result of the reduction in ceded premiums written, as discussed above.
The increase in losses and LAE was principally related to the 18.3% increase in net premiums earned in 2004 over 2003. The 2004 Florida Hurricanes resulted in $93.4 million of property catastrophe losses, which also contributed to the increase in loss and LAE. Casualty classes of business written for years prior to 2001 contributed $190.0 million of losses and LAE for the year ended December 31, 2004, compared to $127.9 million for the year ended December 31, 2003. These amounts also include increases in net asbestos and environmental liabilities of $8.9 million and $11.0 million for 2004 and 2003, respectively. The following table reflects losses and LAE, expressed as a percentage of net premiums earned, for the years ended December 31, 2004 and 2003:
years decreased by $0.2 million. For the year ended December 31, 2003, there were $22.6 million of reserve adjustments, principally related to casualty exposures in the Lloyd’s syndicate.
Acquisition Costs. Acquisition costs for the year ended December 31, 2004 were $515.9 million, an increase of $39.4 million or 8.3%, compared to $476.5 million for the year ended December 31, 2003, with the increase due to premium growth. The resulting acquisition cost ratio, expressed as a percentage of net premiums earned, was 22.1% for the year ended December 31, 2004, compared to 24.2% for the year ended December 31, 2003, a decrease of 2.1 percentage points. The decrease in the acquisition expense ratio is attributable to the increase in premium volume in the EuroAsia, London Market, and U.S. Insurance divisions, which have lower overall acquisition ratios compared to the Americas division, which had an overall decrease in net premium volume in 2004 compared to 2003.
The property and casualty reinsurance and insurance industries use the combined ratio as a measure of underwriting profitability. The GAAP combined ratio is the sum of losses and LAE as a percentage of net premiums earned, plus underwriting expenses, which include acquisition costs and other underwriting expenses,
as a percentage of net premiums earned. The combined ratio reflects only underwriting results, and does not include investment results. Underwriting profitability is subject to significant fluctuations due to catastrophic events, competition, economic and social conditions, foreign currency fluctuations and other factors. Our combined ratio was 96.8% for the year ended December 31, 2004, as compared to 96.5% for the year ended December 31, 2003. The following table reflects the combined ratio for the years ended December 31, 2004 and 2003 for each of our divisions:
a decrease of $28.2 million for the year ended December 31, 2004 over 2003 in net income under equity accounting of HWIC Asia, an investment vehicle which is included in common stock, at equity. Net investment income on equity securities includes, in accordance with the equity method of accounting, realized investment gains attributable to our equity investment in HWIC Asia. Our equity in the net income of HWIC Asia Fund is comprised of the following items (in millions):
Net Realized Investment Gains. Net realized investment gains of $111.1 million for the year ended December 31, 2004 decreased by $91.6 million from $202.7 million for the year ended December 31, 2003. The decrease in net realized gains is comprised of increases in net gains related to equity securities of $54.9 million and an increase in net gains related to other investments of $3.7 million, offset by decreases in net gains related to fixed income securities, short-term investments, cash and cash equivalents of $100.6 million. During 2003, we sold fixed income securities in anticipation of a rising interest rate environment and, as a result, recognized net realized investment gains of $161.9 million. These gains represented 79.8% of our total net realized investment gains during 2003. The proceeds from the sales of fixed income securities were largely invested in cash and cash equivalents, providing us with greater liquidity and an opportunity to earn a higher amount of investment income on cash from any potential increase in interest rates. Additionally, during 2004, we entered into derivative and short sale transactions to provide an economic hedge against a decline in the equity markets. Realized gains include mark-to-market movements on derivative securities, including credit default swaps and total return swaps on indexes. The net investment loss on derivative securities and short sale transactions was $49.6 million for the year ended December 31, 2004.
Other Expenses, Net. Other expenses, net, for the year ended December 31, 2004 were $17.2 million, compared to $7.6 million for the year ended December 31, 2003. The other expenses are primarily comprised of the operating expenses of our holding company. The increase of $9.6 million for the year ended December 31, 2004 over 2003 is principally comprised of: (i) an increase of $2.8 million related to charitable donations, (ii) $2.1 million of consulting fees, primarily associated with the implementation of Sarbanes-Oxley compliance, (iii) fees paid to an affiliate in conjunction with the acquisition of Opus Re of $2.5 million, (iv) $2.3 million expense related to an office lease termination and (v) $1.2 million related to the amortization of our restricted share grants. These increases were offset by a reduction in overall compensation expense of $4.1 million.
October 2005 of $199.6 million, offset by a net loss available to common shareholders of $105.4 million and a decrease in accumulated other comprehensive income of $18.2 million after-tax. Our common shareholders’ equity decreased by $29.1 million, or 1.9%, to $1,525.9 million as of December 31, 2005, from $1,550.0 million as of December 31, 2004, and increased by $9.5 million, or 0.6%, over shareholders’ equity of $1,516.4 million as of September 30, 2005. Our book value per common share was $22.07 as of December 31, 2005, representing a decrease of $1.94 from the book value per share of $24.01 as of December 31, 2004 and a decrease of $1.22 from the book value per share of $23.29 as of September 30, 2005.
On October 12, 2005, we completed the sale of 4.1 million of our common shares at a price of $24.96 per share, resulting in total common shares outstanding as of December 31, 2005 of 69.1 million shares. Fairfax purchased 3.1 million shares in the offering. Net proceeds to us, net of underwriting discounts and commissions, were $102.1 million. Also in October 2005, we completed the sale of $100.0 million of non-cumulative perpetual preferred shares through the sale of 2.0 million of our 8.125% series A preferred shares, with a liquidation preference of $25.00 per share, and 2.0 million of our floating rate series B preferred shares, with a liquidation preference of $25.00 per share. The aggregate net proceeds from the series A and series B preferred share offerings were $97.5 million. The proceeds from these transactions were used for general corporate purposes, including capital contributions to our operating subsidiaries.
Although the obligations of our reinsurers to make payments to us are based on specific contract provisions, these amounts only become recoverable when we make a payment of the associated loss amount, which may be
Our total reinsurance recoverable on paid losses at December 31, 2005, net of the reserve for uncollectible reinsurance, is $140.9 million. The top ten reinsurers measured on total reinsurance recoverables represent $78.5 million, or 56.1% of the total paid loss recoverable, of which $40.8 million is fully collateralized and the remaining $37.7 million is with highly rated companies. The remaining $62.4 million recoverable on paid losses is with numerous companies, and no single company has a balance greater than $3.8 million net of the reserve on uncollectible reinsurance.
Approximately $110.4 million of our total reinsurance recoverable is current billings, and $30.5 million is over 120 days past due. The change in the economic conditions of any of our retrocessionaires may impact their ability to meet their obligations and negatively impact our liquidity.
During the second quarter of 2005, we issued $125.0 million aggregate principal amount of senior notes due May 1, 2015. The issue was sold at a discount of $0.8 million, which is being amortized over the life of the notes. Interest accrues on the senior notes at a fixed rate of 6.875% per annum which is due semi-annually on May 1 and November 1. These senior notes are reflected on our December 31, 2005 consolidated balance sheet at a value of $124.2 million.
Convertible Notes held by such holder; however, as of December 31, 2005, such circumstances had not occurred and therefore the Convertible Notes were not convertible as of such date. Upon conversion of the Convertible Notes, we may choose to deliver, in lieu of our common shares, cash or a combination of cash and common shares. For the year ended December 31, 2005, we repurchased $30.4 million principal value of our Convertible Notes for $34.2 million, representing a premium of $3.8 million.
right to withdraw the pledged assets at any time upon 180 days written notice to nSpire Re. nSpire Re retains the obligation to pledge assets on behalf of Advent. In any event, the placement of funds at Lloyd’s will automatically terminate effective no later than December 31, 2008 and any remaining pledged assets will revert to Odyssey America at that time. The pledge of assets is not considered material to our liquidity and capital resources. In January 2006, Odyssey America received assets with a value of approximately £38 million, representing a permanent reduction and unconditional release of such amount, prior to the stated termination date, following the deposit by Advent of £38 million in new funds at Lloyd’s. The capital resources of Advent, including its newly deposited funds at Lloyd’s, are available first to support Advent’s underwriting activities. Following this return of assets, Odyssey America continues to have approximately £72.0 million pledged to Lloyd’s in support of Advent and will continue to receive a fee for these pledged assets. We believe that the financial resources of Advent provide adequate protection to support its liabilities in the ordinary course of business.
On February 17, 2006, our Board of Directors declared a quarterly cash dividend of $0.03125 per common share to be paid on or before March 31, 2006 to all common shareholders of record as of March 17, 2006. During each of the four quarters of 2005, our Board of Directors declared quarterly cash dividends of $0.03125 per common share, resulting in an aggregate dividend of $2.0 million paid in each quarter.
On December 21, 2005, the Board of Directors declared quarterly dividends of $0.5078125 per share on our 8.125% series A preferred shares and $0.4640081 per share on our floating rate series B preferred shares. The total dividends of $1.9 million were paid on January 20, 2006 to series A and series B preferred shareholders of record on December 31, 2005.
On September 23, 2005, we entered into a credit agreement that provides for a three-year revolving credit facility of $150.0 million, which is available for direct, unsecured borrowings. The credit facility is available for working capital and other corporate purposes, and for the issuance of secured or unsecured letters of credit. Wachovia Bank, N.A. is the administrative agent for the credit facility. As of December 31, 2005, there was $49.5 million outstanding under the credit agreement, all of which was in support of letters of credit. Loans under the credit facility will bear interest at a fluctuating rate per annum equal to the higher of (a) the federal funds rate plus 0.5% and (b) Wachovia Bank, N.A.’s publicly announced prime rate. Alternatively, at our option, loans will bear interest at the London Interbank Offer Rate (LIBOR) plus 0.85%. This credit facility replaced our $90.0 million facility, which terminated on September 23, 2005 and had a maturity date of September 27, 2005.
On February 22, 2006, we completed the private sale of $100 million of our floating rate senior notes. The notes were sold in two tranches, $50.0 million of Series A due 2021, and $50.0 million of Series B due 2016. The interest rate on each series of notes is equal to 3-month LIBOR, which will be recalculated on a quarterly basis, plus 2.20%. The interest rate from February 22 through March 16, 2006 on each series of notes was 6.97% per annum. Pursuant to the terms of the indentures under which each series of notes were issued, as a result of our delay in completing the restatement of our financial results and in completing this annual report on Form 10-K, the annual interest rate on each series of notes has been increased to 3-month LIBOR (calculated as of March 15, 2006) plus 3.20%, which equals 8.12%. This interest rate remained in effect until March 31, 2006, after which it will revert to 3-month LIBOR plus 2.20%, recalculated quarterly. The series A notes are callable by us in 2011 at their par value, plus accrued and unpaid interest, and the series B notes are callable by us in 2009 at their par value, plus accrued and unpaid interest.
Our senior unsecured debt is currently rated “bbb” by A.M. Best, “BBB-” by Standard & Poor’s and “Baa3” by Moody’s. Our series A and series B preferred shares is currently rated “bb+” by A.M. Best, “BB” by Standard & Poor’s and “Ba2” by Moody’s.
On April 21, 2005, the Securities and Exchange Commission amended Rule 210.4-01(a) of Regulation S-X regarding the implementation date for SFAS 123R. This amendment modified the effective dates of SFAS 123R, requiring adoption of this standard on the first interim or annual reporting period of the first fiscal year beginning on or after June 15, 2005. Accordingly, we will adopt SFAS 123R effective January 1, 2006. We believe that the implementation of SFAS 123R will not have a significant impact on our results of operations or shareholders’ equity.
We have certain business arrangements with affiliated companies that have financial implications. A description of these arrangements is provided in Note 15 to our consolidated financial statements included in this Form 10-K.
The preceding table indicates an asymmetric market value response to equivalent basis point shifts, up and down, in interest rates. This partly reflects exposure to fixed income securities containing a put feature. In total, securities with a put feature represent approximately 5% and 4% of the fair market value of the total fixed income portfolio as of December 31, 2005 and December 31, 2004, respectively. The asymmetric market value response reflects our ability to put these bonds back to the issuer for early maturity in a rising interest rate environment (thereby limiting market value loss) but to hold these bonds to their much longer full maturity dates in a falling interest rate environment (thereby maximizing the full benefit of higher market values in that environment).
As of December 31, 2005, we had net unrealized gains of $164.7 million, before taxes, of our total investments and cash, consisting of gross unrealized appreciation of $299.0 million, which is offset by gross unrealized depreciation of $134.3 million, which includes $193.5 million related to common stocks carried at equity and other invested assets. We purchase interest rate options from time to time to protect us from movements in interest rates.
During the second quarter of 2005, we purchased a 10-year swaption contract, which provides an economic hedge against a decline in our fixed income portfolio as a result of an increase in interest rates. The swaption gives us the option, but not the obligation, to enter into an interest rate swap contract under which we would receive a floating interest rate and pay a fixed interest rate based on the notional amount of the contract of $1.0 billion. The option expires during the second quarter of 2006, and if exercised, the interest rate swap would mature during the second quarter of 2015. The cost of the swaption was $12.9 million. The swaption is recorded at fair value of $5.8 million as of December 31, 2005 in other invested assets and the change in fair value is recorded as a realized gain or loss in the consolidated statement of operations. For the year ended December 31, 2005, the change in the fair value of the swaption resulted in a realized loss of $7.1 million. The swaption was extended in February 2006 to the third quarter of 2006 at an additional cost of $5.5 million.
As of December 31, 2005 and December 31, 2004, 85.4% and 86.7%, respectively, of the aggregate fair value of our fixed income securities consisted of securities rated investment grade, with 14.6% and 13.3%, respectively, rated below investment grade.
As of December 31, 2005 and 2004, our holdings of financial instruments without quoted prices, or “non-traded investments,” consisted of two collateral loans totaling $7.3 million and $26.0 million, respectively, which are included in other investments. These collateral loans were recorded and valued at their unpaid principal balances, reduced by amounts recorded as an other-than-temporary write-down. We routinely evaluate the carrying value of these investments by reviewing the borrowers’ current financial position and the timeliness of their interest and principal payments. As a result of this review, we recognized an other-than-temporary write-down of $17.0 million for the year ended December 31, 2005 related to one of the loans, which is included in the total amount of other-than-temporary write-down of investments of $54.9 million for the year.
In connection with the swap transactions, we own SPDRs and XLF index call options at a cost of $13.6 million, with a strike price of approximately 120% of the notional amount of the swap transactions. A call option gives the purchaser the right, but not the obligation, to purchase an underlying security at a specific price or prices at or for a certain time. The call options limit our maximum potential loss on the swap transactions to 20% ($90.4 million) of the notional amount of the swap transactions. The call options are recorded at fair value in other liabilities, and changes in the fair value are recorded as a realized gain or loss in the consolidated statement of operations. As of December 31, 2005 and 2004, the net change in the fair value of these call options resulted in a net realized loss of $10.6 million and a net realized gain of $6.7 million, respectively.
In addition, as of December 31, 2005 and 2004, we sold short $83.5 million and $49.8 million, respectively, of primarily equity securities, for which we recorded a liability equal to the underlying fair value of the securities of $82.5 million and $56.1 million, respectively. A net realized gain of $4.3 million for the year ended December 31, 2005 and a net realized loss of $13.3 million for the year ended December 31, 2004 were recognized in our consolidated statements of operations. As of December 31, 2005 and 2004, we provided cash and fixed income securities of $161.7 million and $84.7 million, respectively, as collateral for the borrowed securities. Our net investment income for the year ended December 31, 2005 and 2004 was reduced by $5.0 million and $2.7 million, respectively, related to dividend and interest payments associated with the borrowed securities.
As of December 31, 2005 and December 31, 2004, 19.2% and 16.9%, respectively, of our total investments and cash was in common stocks (unaffiliated and affiliated). Marketable equity securities, which represented 17.7% and 15.1% as of December 31, 2005 and December 31, 2004, respectively, of our total investments and cash, are exposed to equity price risk, defined as the potential for loss in market value owing to a decline in equity prices. A 10% decline in the price of each of these marketable equity securities would result in a decline of $104.9 million and $76.4 million as of December 31, 2005 and December 31, 2004, respectively, in the fair market value of our total investments and cash.
We review our investment portfolio on a quarterly basis for declines in value, and specifically consider securities, the market value of which have declined to less than 80% of their amortized cost at the time of review. Temporary declines in investments will be recorded as unrealized depreciation in accumulated other comprehen-
Based on our review, we recognized other-than-temporary impairment losses in the amount of $54.9 million, before taxes, which were recognized in our consolidated statement of operations as a reduction to our net realized gains for the year ended December 31, 2005.
The following table reflects the fair value and gross unrealized depreciation of our fixed income securities and common stock investments, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, as of December 31, 2005 (in millions):
For further detail on our losses and LAE see Note 8 to our consolidated financial statements included in this Form 10-K. Our reserves for losses and LAE do not have contractual maturity dates. However, based on historical payment patterns, we have included an estimate of when we expect our losses and LAE to be paid in the table above. The exact timing of the payment of claims cannot be predicted with certainty. We maintain a portfolio of investments with varying maturities and a substantial amount of short-term investments to provide adequate cash flows for the payment of claims. The reserves for unpaid losses and LAE reflected in the table above have not been reduced for reinsurance recoverables on unpaid losses which are reflected in our consolidated balance sheet as an asset of $1.2 billion as of December 31, 2005. Based on historical patterns, we estimate that we will collect the recoveries as follows: $390.8 million in less than one year; $464.6 million in one to three years; $217.9 million between three and five years and $133.5 million in more than five years.
I. Summary of Investments - Other than Investments in Related Parties as of December 31, 2005
II. Condensed Financial Information of Registrant as of December 31, 2005 and 2004 and for the years ended December 31, 2005, 2004 and 2003
III. Supplementary Insurance Information as of December 31, 2005 and 2004 and for the years ended December 31, 2005, 2004 and 2003
In our opinion, the consolidated financial statements listed in the accompanying index, present fairly, in all material respects, the financial position of Odyssey Re Holdings Corp. and its subsidiaries (“Odyssey Re” or the “Company”) at December 31, 2005 and 2004, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2005 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedules listed in the accompanying index, present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit of financial statements includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance
A material weakness is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. The following material weakness has been identified and included in management’s assessment. As of December 31, 2005, the Company did not maintain effective controls over the accurate accounting for complex reinsurance transactions. Specifically, effective controls were not designed and in place over the consideration and application of relevant generally accepted accounting principles and the evaluation and documentation of risk transfer for complex reinsurance transactions. This control deficiency resulted in the restatement of the Company’s 2004 and 2003 consolidated financial statements and each of the quarters in the nine months ended September 30, 2005, as well as audit adjustments to the 2005 consolidated financial statements to correct gross premiums written, net premiums written, net premiums earned, losses and loss adjustment expenses, acquisition costs, other underwriting expenses, other expenses and the related balance sheet accounts. Additionally, this control deficiency could result in a misstatement of the aforementioned accounts that would result in a material misstatement to the annual or interim consolidated financial statements that would not be prevented or detected. Therefore, management has determined that this control deficiency constitutes a material weakness. This material weakness was considered in determining the nature, timing, and extent of audit tests applied in our audit of the 2005 consolidated financial statements, and our opinion regarding the effectiveness of the Company’s internal control over financial reporting does not affect our opinion on those consolidated financial statements.
In our opinion, management’s assessment that Odyssey Re Holdings Corp. did not maintain effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also, in our opinion, because of the effect of the material weakness described above on the achievement of the objectives of the control criteria, Odyssey Re Holdings Corp. has not maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
Odyssey Re Holdings Corp. (together with its subsidiaries, the “Company” or “OdysseyRe”) is an underwriter of reinsurance, providing a full range of property and casualty products on a worldwide basis, and an underwriter of specialty insurance, primarily in the United States. Odyssey Re Holdings Corp. was formed as a holding company and incorporated in Delaware in 2001 in conjunction with its initial public offering. Odyssey Re Holdings Corp. owns all of the common shares of Odyssey America Reinsurance Corporation (“Odyssey America”), its principal operating subsidiary, which is domiciled in the state of Connecticut. Odyssey America directly or indirectly owns all of the common shares of the following domestic and foreign subsidiaries: Clearwater Insurance Company (“Clearwater”); Clearwater Select Insurance Company (“Clearwater Select”); Odyssey UK Holdings Corporation (“UK Holdings”); Newline Underwriting Management Ltd., which owns and manages Newline Syndicate 1218, a member of Lloyd’s (collectively, “Newline”); Hudson Insurance Company (“Hudson”); and Hudson Specialty Insurance Company (“Hudson Specialty”). As of December 31, 2005, Fairfax Financial Holdings Limited (“Fairfax”), a publicly traded financial services holding company based in Canada, owned 80.2% of OdysseyRe.
(i) Timing differences as to how premiums and unearned profit commissions under property catastrophe reinsurance contracts were recognized over the coverage periods on seven reinsurance contracts purchased by the Company and two reinsurance contracts written by the Company. All of these contracts satisfied risk transfer requirements and were multi-year, retrospectively-rated contracts, or included certain features that had the effect of allowing the contracts to operate as multi-year, retrospectively-rated contracts. The contracts were restated to correct the application of Emerging Issues Task Force Issue No: 93-6 “Accounting for Multiple-Year Restrospectively-Rated Contracts by Ceding and Assuming Enterprises” (“EITF 93-6”). The two reinsurance contracts written by the Company remained in force as of December 31, 2005. The restated contracts involve eight unaffiliated counterparties. The corrections under these contracts resulted in a $1.3 million after-tax cumulative increase to shareholders’ equity as of September 30, 2005, with the net effect of decreasing the net loss for the nine months ended September 30, 2005 by $2.3 million, increasing 2004 net income by $10.5 million, increasing 2003 net income by $10.9 million, increasing 2002 net income by $8.4 million, increasing 2001 net loss by $29.2 million and decreasing 2000 net income by $1.6 million.
(ii) The accounting treatment of a ceded reinsurance contract entered into with Skandia Insurance Company Ltd. (“Skandia”) in 1995 in conjunction with the acquisition of Clearwater, a wholly owned subsidiary of the Company. The contract provides $175.0 million of protection in excess of Clearwater’s December 31, 1995 reserves for net unpaid losses and loss adjustment expenses and reserves for uncollectible reinsurance. In January 1999, the liabilities under the contract were assigned by Skandia to nSpire Re Limited (“nSpire Re”), a subsidiary of the Company’s majority shareholder, Fairfax, for $97.0 million in consideration. Following a re-evaluation of the accounting treatment for the contract by the Company’s independent registered public accountants and the Company, the Company has restated the accounting of the contract for 2002 and subsequent periods. The Company had accounted for the contract similar to prospective reinsurance for 2002 and subsequent periods, where a benefit had been recorded in each period equal to the loss cessions made under the contract. It has been determined that, in accordance with retroactive reinsurance accounting, losses ceded under the contract in 2002 and subsequent periods which were in excess of $97.0 million should have been recorded as a deferred gain rather than as a benefit in the applicable periods. As part of the restatement, the deferred gain attributable to loss cessions made under the contract in 2002 and subsequent years is amortized into income over the estimated remaining settlement period.
As it was the Company’s intention at the time of the assignment to nSpire Re to continue to have the contract be accounted for as prospective reinsurance, the Company requested that nSpire Re pay $78.0 million due under the contract prior to the expected settlement period, which would allow the Company to record a portion of the benefit for losses ceded under the contract. The Company received $78.0 million in cash from nSpire Re on March 29, 2006, which reduces the outstanding recoverable. In connection with the receipt of this cash, the Company will recognize a deferred gain of $12.5 million after-tax in income for the three months ended March 31, 2006. The cash payment represents a permanent reduction in the amount of reinsurance recoverable from nSpire Re. The remaining reinsurance recoverable related to this contract of $97.0 million as of March 31, 2006 is collateralized by letters of credit and will be received in future periods as the underlying claims are settled.
(b) Investments. All of the Company’s investments in fixed income securities and common stocks not accounted for under the equity method, are categorized as “available for sale,” and are recorded at their estimated fair value based on quoted market prices. Investment transactions are recorded on their trade date with balances pending settlement reflected in the consolidated balance sheet as a component of other assets or other liabilities. Short-term investments, which have a maturity of one year or less from the date of purchase, are carried at cost, which approximates fair value. The Company considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents.
The net amount of unrealized appreciation or depreciation of the Company’s investments, net of applicable deferred income taxes, is reflected in shareholders’ equity in accumulated other comprehensive income. A decline in the fair value of an investment below its cost that is deemed other-than-temporary is charged to net income as a realized capital loss, resulting in a new cost basis for the investment. Realized investment gains or losses are determined on the basis of average cost. Investment income, which is reported net of applicable investment expenses, is recorded as earned.
(c) Premium Revenue Recognition. Reinsurance premium estimates are made at the individual contract level. Reinsurance assumed premiums written and related costs are based upon reports received from ceding companies. Where reinsurance assumed premiums written have not been reported by the ceding company, they are estimated based on historical patterns and experience from the ceding company and judgments of the Company. Subsequent adjustments to premiums written, based on actual results or revised estimates from the ceding company, are recorded in the period in which they become known. Reinsurance assumed premiums written related to proportional treaty business are established on a basis that is consistent with the coverage periods under the terms of the underlying insurance contracts. Reinsurance assumed premiums written related to excess of loss and facultative reinsurance business are recorded over the coverage term of the contracts, which is
generally one year. Unearned premium reserves are established for the portion of reinsurance assumed premiums written to be recognized over the remaining contract period. Unearned premium reserves related to proportional treaty contracts are computed based on reports received from ceding companies, which show premiums written but not yet earned. Premium adjustments made over the life of the contract are recognized as earned premiums based on the applicable contract period to which they apply. Insurance premiums are earned on a pro rata basis over the policy period, which is generally one year. A reserve for uncollectible premiums is established when considered appropriate.
The cost of reinsurance purchased by the Company (reinsurance premiums ceded) is reported as prepaid reinsurance premiums and amortized over the contract period in proportion to the amount of insurance protection provided. The ultimate amount of premiums, including adjustments, is recognized as premiums ceded, and amortized over the applicable contract period to which they apply. Reserves are established for the unexpired portion of premiums ceded and recorded as an asset in prepaid reinsurance premiums. Premiums earned are reported net of reinsurance ceded premiums earned in the consolidated statements of operations. Amounts paid by the Company for retroactive reinsurance that meets the conditions for reinsurance accounting are reported as reinsurance receivables to the extent those amounts do not exceed the associated recorded liabilities. If the recorded liabilities exceed the amounts paid, reinsurance receivables are increased to reflect the difference, and the resulting gain is deferred and amortized over the estimated settlement period. If the amounts paid for retroactive reinsurance exceed the recorded liabilities, the Company will increase the related liabilities or reduce the reinsurance receivable, or both, at the time the reinsurance contract is effective, and the excess is charged to net income. Changes in the estimated amount of liabilities relating to the underlying reinsured contracts are recognized in net income in the period of the change. Prospective and retroactive provisions within a single contract are accounted for separately unless impracticable, in which case, the contract will be accounted for as a retroactive contract.
(d) Deferred Acquisition Costs. Acquisition costs, which are reported net of acquisition costs ceded, consist of commissions and brokerage expenses incurred on insurance and reinsurance business written, and are deferred and amortized over the period in which the related premiums are earned, which is generally one year. Commission adjustments are accrued based on changes in premiums and losses recorded by the Company in the period in which they become known. Deferred acquisition costs are limited to their estimated realizable value based on the related unearned premium, which considers anticipated losses and loss adjustment expenses and estimated remaining costs of servicing the business, all based on historical experience. The realizable value of deferred acquisition costs is determined without consideration of investment income.
(f) Unpaid losses and loss adjustment expenses. The reserve for unpaid losses and loss adjustment expenses is based on the Company’s evaluations of reported claims and individual case estimates received from ceding companies for reinsurance business or the estimates advised by the Company’s outside claims adjusters for insurance business. The Company utilizes generally accepted actuarial methodologies to determine reserves
for losses and loss adjustment expenses on the basis of historical experience and other estimates. The reserves are reviewed continually during the year and changes in estimates in losses and loss adjustment expenses are reflected as an expense in the consolidated statements of operations in the period the adjustment is made. Reinsurance recoverables on unpaid losses and loss adjustment expenses are reported as assets. A reserve for uncollectible reinsurance recoverables is established based on an evaluation of each retrocessionaire and historical experience. The Company uses tabular reserving for workers’ compensation liabilities that are considered fixed and determinable, and discounts such reserves using an interest rate of 3.5% and standard mortality assumptions.
The reserves for losses and loss adjustment expenses are estimates of amounts needed to pay reported and unreported claims and related loss adjustment expenses. The estimates are based on assumptions related to the ultimate cost to settle such claims. The inherent uncertainties of estimating reserves are greater for reinsurers than for primary insurers, due to the diversity of development patterns among different types of reinsurance contracts and the necessary reliance on ceding companies for information regarding reported claims. As a result, there can be no assurance that the ultimate liability will not exceed amounts reserved, with a resulting adverse effect on the Company.
(g) Deposit Assets and Liabilities. The Company may enter into reinsurance contracts that contain certain loss limiting provisions and, as a result, do not meet the risk transfer provisions of Statement of Financial Accounting Standards (“SFAS”) No. 113, “Accounting for Reinsurance of Short-Duration and Long-Duration Contracts.” These contracts are accounted for using the deposit accounting method in accordance with Statement of Position 98-7, “Deposit Accounting: Accounting for Insurance and Reinsurance Contracts That Do Not Transfer Risk” (“SOP 98-7”). Under the deposit method of accounting, revenues and expenses from reinsurance contracts are not recognized as written premium and incurred losses. Instead, the profits or losses from these contracts are recognized net, as investment income or other underwriting income over the contract or contractual settlement periods. In accordance with SOP 98-7, these contracts are deemed as either transferring only significant timing risk or transferring only significant underwriting risk. Income or loss associated with contracts determined to transfer only significant timing risk is recognized as a component of net investment income over the contractual settlement period. Income or loss associated with contracts determined to transfer only significant underwriting risk is recognized as other underwriting income or expense over the contract period.
of the Company in Fairfax’s tax group does not have an effect on the Company’s tax position. The Company filed a separate consolidated tax return for the period January 1 through March 3, 2003.
(i) Derivatives. The Company utilizes derivative instruments to manage against adverse changes in the value of its assets and liabilities. Derivatives include credit default swaps, total return swaps, interest rate swaps and other equity and credit derivatives. All derivative instruments are recognized as either assets or liabilities on the consolidated balance sheet and are measured at their fair value. Gains or losses from changes in the derivative values are accounted for based on how the derivative is used and whether it qualifies for hedge accounting. When derivative instruments do not qualify for hedge accounting, changes in fair value are included in realized investment gains and losses in the consolidated statements of operations. Margin balances required by counterparties in support of derivative positions are included in collateral for borrowed securities.
The Emerging Issues Task Force (“EITF”) Issue 4-08 “The Effect of Contingently Convertible Instruments on Diluted Earnings Per Share,” which was effective for periods ending after December 15, 2004, requires that the dilutive effect of contingently convertible debt securities, with a market price threshold, should be included in diluted earnings per share. The terms of the Company’s convertible senior debentures meet the criteria defined in EITF Issue 4-08, and accordingly, the effect of conversion of the Company’s convertible senior debentures to common shares has been assumed when calculating its diluted earnings per share. The diluted earnings per share for the year ended December 31, 2003 have been restated to conform to the requirements of EITF Issue 4-08.
based method as prescribed in SFAS 123 for all outstanding stock-based compensation awards (occurring both before and after adoption of the recognition provisions of SFAS 123), the Company’s net income (loss) and net income (loss) per share (on a pro forma basis) would have been as follows (in thousands, except per share amounts):
In December 2004, the Financial Accounting Standards Board issued SFAS 123R (revised 2004), “Share-Based Payment,” which is a revision of SFAS 123 and supersedes APB 25. The approach to account for share-based payments in SFAS 123R is similar to the approach described in SFAS 123. Nevertheless, SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the consolidated financial statements based on their fair values. Pro forma disclosure of the impact of fair value of share-based payments is no longer an alternative to financial statement recognition.
(n) Payments. Payments of claims by the Company, as reinsurer, to a broker on behalf of a reinsured company, are recorded on the Company’s books as a paid loss at the time the cash is disbursed. The payment is treated as a paid claim to the reinsured. Premiums due to the Company from the reinsured are recorded as receivables from the reinsured until the cash is received by the Company, either directly from the reinsured or from the broker.
On October 1, 2004, the Company exchanged all of its common shares of First Capital Insurance Ltd. (“First Capital”), which represented 97.7% of the total common shares of First Capital, for Class B non-voting common shares of Fairfax Asia Limited (“Fairfax Asia”), representing a 44.0% economic interest in Fairfax Asia. Following the transaction, Fairfax Asia owns 97.7% of the common shares of First Capital. The transaction valued the Company’s interest in First Capital at $38.6 million, which was based on First Capital’s GAAP shareholders’ equity as of September 30, 2004, subject to certain adjustments, in exchange for Class B shares of Fairfax Asia based on its fair value as of September 30, 2004. In recording the exchange, there was no gain or loss recorded by the Company. Fairfax owns the remaining Class A and Class B common shares of Fairfax Asia. Prior to the exchange, the Company’s interest in First Capital was consolidated in the Company’s financial statements. Following the exchange, the Company records its investment in Fairfax Asia in accordance with the equity method of accounting. The results of First Capital, including its underwriting activity, will now be reflected in the Company’s investment income through its proportionate share of the net income of Fairfax Asia.
On October 28, 2003, the Company purchased General Security Indemnity Company (“General Security”), an excess and surplus lines company domiciled in New York. General Security’s name has been changed to Hudson Specialty Insurance Company. The purchase price of $37.6 million was attributable to investment assets of $33.7 million held by General Security at the purchase date. The Company recorded an intangible asset of $3.9 million, which as of December 31, 2005 and 2004 was not impaired and had an indefinite life. There was no goodwill recognized related to the acquisition of General Security. In December 2003, Hudson Specialty was contributed to Clearwater and Clearwater subsequently contributed $18.0 million of capital to Hudson Specialty.
The number of weighted average common shares outstanding used in calculating the Company’s diluted earnings per share for the year ended December 31, 2005 excludes the effect of dilutive shares because their inclusion would be anti-dilutive. The common shares attributable to the Company’s 4.375% convertible senior debentures were 4,473,924 for the year ended December 31, 2005. The total common shares attributable to the Company’s stock options and restricted shares were 485,340 for the year ended December 31, 2005.
A summary of the Company’s investment portfolio as of December 31, 2005, excluding common stocks at equity and other invested assets, is as follows (in thousands):
Common stocks under equity accounting were carried at $534.4 million as of December 31, 2005, reflecting gross unrealized appreciation of $189.8 million and no gross unrealized depreciation. Other invested assets, including amounts that were accounted for under the equity method of accounting, were carried at $188.8 million as of December 31, 2005, reflecting gross unrealized appreciation of $5.8 million and gross unrealized depreciation of $2.1 million.
A summary of the Company’s investment portfolio as of December 31, 2004, excluding common stocks at equity and other invested assets, is as follows (in thousands):
The amortized cost and fair value of fixed income securities as of December 31, 2005, by contractual maturity, are shown below (in thousands).
The following table sets forth the components of net investment income for the years ended December 31, 2005, 2004, and 2003 (in thousands):
The facts and circumstances involved in making a decision regarding an other-than-temporary-impairment are those which exist at that time. Should the facts and circumstances change such that an other-than-temporary impairment is considered appropriate, the Company will recognize the impairment as a realized investment loss in its consolidated statement of operations. Upon the disposition of a security where an other-than-temporary impairment has been taken, the Company will record a gain or loss that reflects the impairment previously taken.
The following table reflects the fair value and gross unrealized depreciation of the Company’s fixed income securities and common stocks, at fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized depreciation position, as of December 31, 2005 (in thousands):
For common stocks, at equity, as of December 31, 2005, the relative ownership of OdysseyRe is: HWIC Asia Fund Class A shares (97.3% owned by Fairfax, which includes a 56.2% economic interest owned by OdysseyRe), Hub International Limited (25.9% owned by Fairfax, which includes 13.3% owned by OdysseyRe), Fairfax Asia Limited (100% owned by Fairfax, which includes a 44.0% economic interest owned by OdysseyRe), TRG Holding Corporation (100% owned by Fairfax, which includes 13.0% owned by the Company), Advent Capital (Holdings) PLC (46.8% owned by Fairfax, which includes 15.0% owned by the Company) and MFXchange Holdings Inc. (“MFX”) (100% owned by Fairfax, which includes 7.4% owned by OdysseyRe). Common stocks, at equity, and certain other invested assets are recorded under the equity method of accounting based on OdysseyRe’s proportionate share of income or loss of the investee. Due to the timing of when financial information is reported by investees, results are generally reported by OdysseyRe on a one quarter lag. Dividends received by the Company from these entities were $6.0 million, $6.1 million, and $5.3 million for the years ended December 31, 2005, 2004, and 2003, respectively. The Company routinely evaluates the carrying value of these investments by reviewing, among other things, each investee’s current and expected operating performance and current and historical trading values of the issuer’s securities, where applicable.
As of December 31, 2005 and 2004, the Company’s holdings of financial instruments without quoted prices, or “non-traded investments,” consisted of two collateral loans totaling $7.3 million and $26.0 million, respectively, which are included in other investments. These collateral loans were valued at their unpaid principal balances, reduced by amounts recorded as an other-than-temporary write down. The Company routinely evaluates the carrying values of these investments by reviewing the borrowers’ current financial position and the timeliness of their interest and principal payments. As a result of this review, the Company recognized an other-than-temporary write-down of $17.0 million during the year ended December 31, 2005 related to one of the loans, which is included in the total amount of other-than-temporary write-down of investments of $54.9 million for the year.
The Company uses credit default swaps, total return swaps, interest rate swaps, call option contracts and short sales to manage against adverse changes in the values of assets and liabilities.
In the third quarter of 2004, the Company sold short Standard & Poor’s 500 depository receipts (“SPDRs”) and the Financial Select SPDR Fund (“XLF”) as an economic hedge against a decline in its equity portfolio. The aggregate notional amount of the transactions was $451.8 million. In order to reduce the margin maintenance requirements for these short positions, the Company replaced the short positions with total return swaps. The margin maintenance requirement related to the total return swaps was $96.4 million and $99.2 million as of December 31, 2005 and 2004, respectively. The swap transactions terminate during 2006. As of December 31, 2005 and 2004, the Company has provided $104.3 million and $99.2 million, respectively, of U.S. Treasury bills
as collateral for the swap transactions. The swap transactions are recorded at fair value in other liabilities and changes in the fair value are recorded as realized gains or losses in the consolidated statement of operations in the period in which they occur. For the years ended December 31, 2005 and 2004, the net change in the fair value of the swap transactions resulted in a net realized loss of $11.8 million and $44.9 million, respectively.
In connection with the swap transactions, the Company owns SPDRs and XLF call options at a cost of $13.6 million, with a strike price of approximately 120% of the notional amount of the swap transactions. A call option gives the purchaser the right, but not the obligation, to purchase an underlying security at a specific price or prices at or for a certain time. The call options limit the maximum potential loss on the swap transactions to 20% ($90.4 million) of the notional amount of the swap transactions. The call options are recorded at fair value in other liabilities, and changes in the fair value are recorded as a realized gain or loss in the consolidated statement of operations. As of December 31, 2005 and 2004, the net change in the fair value of these call options resulted in a net realized loss of $10.6 million and a net realized gain of $6.7 million, respectively.
In addition, as of December 31, 2005 and 2004, the Company had sold short $83.5 million and $49.8 million, respectively, of primarily equity securities, for which it recorded a liability equal to the underlying fair value of the securities of $82.5 million and $56.1 million, respectively. A net realized gain of $4.3 million for the year ended December 31, 2005 and a net realized loss of $13.3 million for the year ended December 31, 2004 were recognized in the Company’s statements of operations. As of December 31, 2005 and 2004, the Company provided cash and fixed income securities of $161.7 million and $84.7 million, respectively, as collateral for the borrowed securities. The Company’s net investment income for the year ended December 31, 2005 and 2004 was reduced by $5.0 million and $2.7 million, respectively, related to dividend and interest payments associated with the borrowed securities.
The Company has purchased credit default swaps, which are included in other invested assets, that provide a hedge against adverse movements in the fair value of investments and other corporate assets resulting from systemic financial and credit risk. Under a credit default swap, the Company agrees to pay at specified periods fixed premium amounts based on an agreed notional principal amount in exchange for the credit default protection on a specified asset. Credit default swaps are recorded at fair value, with the related changes in fair value recognized as a realized gain or loss in the period in which they occur. The total cost of the credit default swaps was $75.6 million and $11.5 million, and the fair value was $36.2 million and $4.1 million, as of December 31, 2005 and 2004, respectively. The notional amount of the credit default swaps was $3.3 billion and $420.3 million as of December 31, 2005 and 2004, respectively. The net change in the fair value of the credit default swaps resulted in a net realized loss of $36.2 million and $4.5 million for the years ended December 31, 2005 and 2004, respectively.
The Company is required to maintain assets on deposit with various regulatory authorities to support its insurance and reinsurance operations. These requirements are generally promulgated in the statutes and regulations of the individual jurisdictions. The assets on deposit are available to settle insurance and reinsurance liabilities. The Company utilizes trust funds in certain transactions where the trust funds are set up for the benefit of the ceding companies and generally take the place of letter of credit requirements. As of December 31, 2005, restricted assets totaled $1.2 billion, with $792.9 million included in fixed income securities and the remaining balance of $399.9 million included in short term investments, cash and cash equivalents.
The following table shows the components of the change in accumulated other comprehensive income (loss) for the years ending December 31, 2005, 2004 and 2003 (in thousands):
The following table sets forth the activity in the liability for unpaid losses and loss adjustment expenses for the years ended December 31, 2005, 2004 and 2003 (in thousands):
Losses and loss adjustment expenses incurred related to prior years were $172.7 million, $190.0 million and $127.9 million for the years ended December 31, 2005, 2004 and 2003, respectively. Prior period losses and loss adjustment expenses for the year ended December 31, 2005 includes $15.0 million related to 2004 and prior catastrophe activity. Catastrophe activity in 2004 includes Hurricanes Charley, Frances, Ivan and Jeanne, which occurred in the third quarter of 2004 (the “2004 Florida Hurricanes”), Typhoon Songda and the Indonesian earthquake and resulting tsunami. Prior year catastrophe losses accounted for $7.6 million and $10.9 million of the development for the years ended December 31, 2004 and 2003, respectively. For the years ended December 31, 2005, 2004 and 2003, the remaining increases of $157.7 million, $182.4 million and $117.0 mil-
lion, respectively, were predominantly attributable to U.S. casualty classes of business written in 2001 and prior, including asbestos exposures, which were partially offset by favorable reserve movements related to business written in 2003 and 2004.
The Company is exposed to losses arising from a variety of catastrophic events, such as hurricanes, windstorms and floods. The Company’s consolidated statements of operations for the year ended December 31, 2005 include an underwriting loss of $436.0 million from Hurricanes Katrina, Rita and Wilma, which occurred during the third and fourth quarters of 2005. The underwriting loss from Hurricanes Katrina, Rita and Wilma is comprised of net losses and loss adjustment expenses of $445.9 million, which is after reinsurance of $241.1 million, reduced by $9.9 million in net reinstatement premiums received. The loss estimate represents the Company’s best estimate based on the most recent information available. The Company used various approaches in estimating its loss, including a detailed review of exposed contracts and information from ceding companies. As additional information becomes available, including information from ceding companies, actual losses may exceed the Company’s estimated losses, potentially resulting in adverse effects to the Company’s financial results. The extraordinary nature of these losses, including potential legal and regulatory implications, creates substantial uncertainty and complexity in estimating these losses. Considerable time may elapse before the adequacy of the Company’s estimates can be determined.
The Company uses tabular reserving for workers’ compensation indemnity reserves, and discounts such reserves using an interest rate of 3.5%. Losses have been discounted using the Life Table for Total Population: United States, 2002. Reserves reported at the discounted value were $126.1 million and $89.0 million as of December 31, 2005 and 2004, respectively. The amount of case reserve discount was $61.1 million and $52.6 million as of December 31, 2005 and 2004, respectively. The amount of incurred but not reported reserve discount was $29.2 million and $24.1 million as of December 31, 2005 and 2004, respectively.
The Company has exposure to losses from asbestos, environmental pollution and latent injury damage claims and resulting exposures. Gross unpaid asbestos and environmental losses and loss adjustment expenses as of December 31, 2005 were $315.1 million, representing 6.2% of total gross unpaid losses and loss adjustment expenses. Exposure arises from reinsurance contracts under which the Company has assumed liabilities, on an indemnity or assumption basis, from ceding companies, primarily in connection with general liability insurance policies issued by such ceding companies. The Company’s estimate of its ultimate liability for such exposures includes “case basis” reserves and a provision for liabilities incurred but not reported. Case basis reserves are a combination of reserves reported to the Company by ceding companies and additional case reserves determined by the Company. The provision for liabilities incurred but not reported is established based on an annual review of Company and external trends in reported loss and claim payments.
The Company is the beneficiary of the 1995 Stop Loss Agreement with nSpire Re. This 1995 Stop Loss Agreement was originally entered into with Skandia Insurance Company Ltd. in conjunction with the purchase of Clearwater in 1996. In January 1999, the liabilities under the contract were assigned by Skandia to nSpire Re. Pursuant to the agreement, the Company ceded premium of $60.5 million in 1995 for protection of $175.0 million in excess of Clearwater’s December 31, 1995 reserves for net unpaid losses and loss adjustment expenses and reserves for uncollectible reinsurance. The Company accounts for the 1995 Stop Loss Agreement as retroactive reinsurance. The Company ceded losses of $17.5 million to the agreement in each of the years ended December 31, 2005, 2004 and 2003, which are deferred over the estimated remaining settlement period. The
income before income taxes reflected in the Company’s statements of operations related to the amortization of the cumulative deferred gain under the 1995 Stop Loss Agreement for the years ended December 31, 2005, 2004 and 2003 is $11.3 million, $8.7 million and $6.5 million, respectively. The remaining deferred amortization included in the Company’s consolidated balance sheet for the years ended December 31, 2005, 2004 and 2003 is $45.6 million, $39.3 million, and $30.5 million, respectively. Reinsurance recoverables on paid and unpaid losses related to this agreement were $175.0 million and $157.5 million as of December 31, 2005 and 2004, respectively, and are reflected in the Company’s consolidated balance sheets, fully secured by letters of credit and cash. As of December 31, 2005, the Company has utilized the full limit of this cover.
In each calendar year, subject to certain limits, the Company has the ability to cede losses that are attributable to the covered period until all applicable losses are paid and settled, which is typically several years beyond the covered period, or until the contract is terminated by the Company. The ability of the Company to cede losses in any given calendar year that are attributable to prior periods will depend on the nature of the risk which generated the loss, the time period from which the losses originate and whether there are limits remaining covering the subject period. Losses attributable to prior periods are ceded to the treaties and recorded in the period in which they are ceded. Additional premiums, if any, are determined and recorded in the period when losses are ceded. When additional premiums are due, the interest on the funds attributable to the additional premiums ceded is typically calculated based on the inception period of the contract and the cumulative interest expense is recognized in the period when additional premiums are due.
The Whole Account Excess of Loss Agreements provide that the Company may withhold a significant portion of the premium payable to the retrocessionaires in funds held accounts, which, under certain circumstances, may be set-off against the retrocessionaires’ losses and other obligations owed to the Company. These funds are shown as a liability in the Company’s consolidated balance sheets as funds held under reinsurance contracts. Interest on the funds held account, calculated using a contractual fixed interest rate of approximately 7.0% for those agreements with amounts ceded, is credited quarterly by the Company, which results in an increase in the funds held account balance and is recorded as an expense, reducing the Company’s
investment income. Loss payments are deducted from the funds held account balance, which reduces the liability as such payments are made.
As indicated by the table above, for the years ended December 31, 2005 and 2004, the Company ceded $18.7 million and $5.6 million, respectively, of losses and loss adjustment expenses, primarily to its 2001 aggregate excess of loss treaty. The increase in losses ceded to our Whole Account Excess of Loss Agreements was attributable to adverse loss development on casualty business written in 2001. For the year ended December 31, 2003, the Company ceded total losses and loss adjustment expenses of $104.7 million relating to prior period losses, which included (i) $65.9 million ceded to the 2001 aggregate excess of loss treaty, principally due to the 2001 World Trade Center disaster, (ii) $39.0 million ceded to the 2000 aggregate excess of loss treaty, principally due to adverse loss development on U.S. casualty business written in 2000, (iii) a reduction in ceded losses of $4.5 million related to business written in prior years that was previously ceded, and (iv) $4.3 million ceded related to facultative casualty business. The higher level of losses ceded to the Company’s aggregate excess of loss treaties during 2003 as compared to 2005 and 2004 resulted in a benefit to net income in 2003 as compared to a net loss in 2005 and 2004. Losses ceded to the Company’s Whole Account Excess of Loss and Facultative Agreements in 2005 represented 11.5% of its pre-tax loss and 1.9% and 28.0% of the Company’s pre-tax income in 2004 and 2003, respectively.
2005 and 2004, respectively. Funds held under reinsurance contracts related to these agreements, shown as a liability on the Company’s consolidated balance sheets, reflect $150.7 million and $152.7 million as of December 31, 2005 and 2004, respectively. Other collateral related to these agreements is $124.8 million and $130.6 million as of December 31, 2005 and 2004, respectively.
The Company’s ten largest reinsurers represent 54.6% of its total reinsurance recoverables as of December 31, 2005. Amounts due from all other reinsurers are diversified, with no other individual reinsurer representing more than $28.1 million of reinsurance recoverables as of December 31, 2005, and the average balance is less than $2.0 million. The Company held total collateral of $755.7 million as of December 31, 2005, representing 56.1% of total reinsurance recoverables. The following table shows the total amount that is recoverable from each of the Company’s ten largest reinsurers for paid and unpaid losses as of December 31, 2005, the amount of collateral held, and each reinsurer’s A.M. Best rating (in thousands).
The Company is the beneficiary of letters of credit, cash, and other forms of collateral to secure certain amounts due from its reinsurers. The total amount of collateral held by the Company as of December 31, 2005 is $755.7 million, which represents 56.1% of the total amount of reinsurance recoverables, comprised of the following forms of collateral (in thousands):
In June 2002, the Company issued $110.0 million aggregate principal amount of convertible senior debentures (the “Convertible Notes”) due 2022. Interest accrues on the Convertible Notes at a fixed rate of 4.375% per annum, which is due semi-annually on June 15 and December 15. The Convertible Notes have been redeemable at the Company’s option since June 22, 2005. Each holder of Convertible Notes may, at its option, require the Company to repurchase all or a portion of its Convertible Notes on June 22, 2007, 2009, 2012 and 2017. Under certain circumstances specified in the indenture under which the Convertible Notes were issued, each Convertible Notes holder has the right to convert its Convertible Notes into 46.9925 of the Company’s common shares for every $1,000 principal amount of the Convertible Notes held by such holder; however, as of December 31, 2005 such circumstances had not occurred and therefore the Convertible Notes were not convertible as of such date. Upon conversion of the Convertible Notes, the Company may choose to deliver, in lieu of the Company’s common shares, cash or a combination of cash and common shares. For the year ended December 31, 2005, the Company repurchased $30.4 million principal value of the Convertible Notes for $34.2 million, representing a premium of $3.8 million.
On October 12, 2005, the Company completed the sale of 4.1 million common shares at a price of $24.96 per share, resulting in total common shares outstanding as of December 31, 2005 of 69.1 million shares. Fairfax purchased 3.1 million shares in the offering. Proceeds to the Company, net of underwriting discounts and commissions, were $102.1 million.
On October 20, 2005, the Company issued 2.0 million 8.125% series A perpetual preferred shares and 2.0 million floating rate series B perpetual preferred shares, for total net proceeds of $97.5 million. The series A preferred shares have a liquidation preference of $25.00 per share and are redeemable at $25.00 per share at the Company’s option in whole, or in part from time to time starting on or after October 20, 2010. Dividends on the series B preferred shares are payable at an annual rate equal to 3.25% above the three-month LIBOR on the applicable determination date. The series B preferred shares have a liquidation preference of $25.00 per share and are redeemable at the redemption prices below (in thousands, except per share amounts):
Dividends on each series are deferrable on a non-cumulative basis, provided that no dividends or other distributions have been declared or paid or set apart for payment on any other class or series of the Company’s capital shares ranking junior to or pari passu with the preferred shares. Dividends on series A and B preferred shares will each be payable when, as and if declared by the Company’s Board of Directors, quarterly in arrears on the 20th day of January, April, July, and October of each year. Deferred dividends on either series will not accrue interest prior to the date of redemption. On December 21, 2005, the Company’s Board of Directors declared quarterly dividends of $0.5078125 per share on the Company’s 8.125% series A preferred shares and $0.4640081 per share on the Company’s floating rate series B preferred shares. The total dividends of $1.9 million were paid on January 20, 2006 to series A and series B preferred shareholders of record on December 31, 2005.
The financial results of these divisions for the years ended December 31, 2005, 2004 and 2003 are as follows (in thousands):
Pre-tax income (loss) from domestic companies was ($180.6) million, $151.5 million and $235.1 million for the years ended December 31, 2005, 2004 and 2003, respectively. Pre-tax income from foreign operations was $17.6 million, $144.9 million and $139.6 million for the years ended December 31, 2005, 2004 and 2003, respectively.
The following table reconciles federal and foreign income taxes at the statutory federal income tax rate to the Company’s tax provision (benefit) (in thousands):
The Company filed a separate consolidated tax return for the period January 1 through March 3, 2003. On March 4, 2003, Fairfax advised the Company that it increased its ownership interest in the Company to approximately 81%, and its ownership interest in the Company has remained above 80% since that date. As a result, the Company is a member of the United States tax group of Fairfax. Inclusion of the Company in Fairfax’s United States tax group does not have an effect on the Company’s tax position. The federal income tax provision is allocated to each of the Company’s subsidiaries in the consolidated group pursuant to a written agreement, on the basis of each subsidiary’s separate taxable income.
predicted at the present time; however, such effects could be material and adverse. No assurance can be made that the Company will not be subject to further requests or other regulatory proceedings of a similar kind.
assets on behalf of Advent. In any event, the placement of funds at Lloyd’s will automatically terminate effective no later than December 31, 2008 and any remaining pledged assets will revert to Odyssey America at that time. The pledge of assets is not considered material to the OdysseyRe’s liquidity and capital resources. In January 2006, Odyssey America received assets with a value of approximately £38 million, representing a permanent reduction and unconditional release of such amount, prior to the stated termination date, following the deposit by Advent of £38 million in new funds at Lloyd’s. The capital resources of Advent, including its newly deposited funds at Lloyd’s, are available first to support Advent’s underwriting activities. Following this return of assets, Odyssey America continues to have approximately £72.0 million pledged to Lloyd’s in support of Advent and will continue to receive a fee for these pledged assets. OdysseyRe believes that the financial resources of Advent provide adequate protection to support its liabilities in the ordinary course of business.
As of July 14, 2000, Odyssey America agreed to guarantee the performance of all the insurance and reinsurance contract obligations, whether incurred before or after the agreement, of Compagnie Transcontinentale de Réassurance (“CTR”), a subsidiary of Fairfax, in the event CTR became insolvent and CTR was not otherwise
Odyssey America, the Company’s principal operating subsidiary, is subject to state regulatory restrictions that limit the maximum amount of dividends payable. In any 12-month period, Odyssey America may pay dividends equal to the greater of (i) 10% of statutory capital and surplus as of the prior year end or (ii) net income for such prior year without prior approval of the Insurance Commissioner of the State of Connecticut (the “Connecticut Commissioner”). The maximum amount of dividends which Odyssey America may pay in 2006, without such prior approval, is $207.1 million. Connecticut law further provides that (i) Odyssey America must report to the Connecticut Commissioner, for informational purposes, all dividends and other distributions within five business days after the declaration thereof and at least ten days prior to payment and (ii) Odyssey America may not pay any dividend or distribution in excess of its earned surplus, as reflected in its most recent statutory annual statement on file with the Connecticut Commissioner, without the Connecticut Commissioner’s approval.
Odyssey America paid dividends to the Company of $22.5 million and $55.0 million during 2005 and 2004, respectively, and did not pay any dividends during 2003. During 2005, the Company contributed $185.0 million to Odyssey America. Effective December 31, 2005, the Company received approval from the Connecticut Commissioner to make a $200 million capital contribution to Odyssey America, to be completed prior to February 28, 2006. In February 2006, the Company completed the $200 million capital contribution to Odyssey America.
The statutory provision for potentially uncollectible reinsurance recoverables due from unauthorized companies is reduced to the extent collateral is held by Clearwater or Hudson. Pursuant to indemnification
agreements between the Company and Clearwater, and between the Company and Hudson, the Company provides letters of credit and/or cash in respect of uncollateralized balances due from unauthorized reinsurers. The use of such collateral provided by the Company is a permitted accounting practice approved by the Insurance Department of the State of Delaware, the domiciliary state of Clearwater and Hudson. As of December 31, 2004, $7.3 million of funds held under reinsurance contracts related to cash collateral has been provided in support of indemnification agreements for Clearwater and Hudson. This amount has been reduced to zero as of December 31, 2005. The Company has also provided a $20.5 million letter of credit to Clearwater and a $0.5 million letter of credit to Hudson as of December 31, 2005, which have been used as collateral in regard to the indemnification agreements. The indemnification agreements do not affect the accompanying consolidated financial statements.
The Company has entered into various reinsurance arrangements with Fairfax and its affiliates. The approximate amounts included in or deducted from income, expense, assets and liabilities in the accompanying consolidated financial statements, with respect to reinsurance assumed and ceded, follow (in thousands):
The Company’s subsidiaries have entered into investment management agreements with Fairfax and its wholly-owned subsidiary, Hamblin Watsa Investment Counsel Ltd. These agreements provide for an annual base fee of 0.20% (20 basis points), calculated and paid quarterly based upon the subsidiary’s average invested assets for the preceding three months. The agreements also include incentive fees of 0.10% (10 basis points), which are payable if realized gains exceed 1% of the average investment portfolio in any given year, subject to cumulative realized gains on investments exceeding 1% of the average investment portfolio. Additional incentive fees are paid based upon the performance of the subsidiary’s equity portfolio equal to 10% of the return on equities (subject to an annual maximum) in excess of the Standard & Poor’s 500 index plus 200 basis points, provided that the equity portfolio has achieved such excess on a cumulative basis. If the performance of the equity portfolio does not equal or exceed this benchmark in a given year, the annual base fee is reduced to 0.18% (18 basis points). The aggregate annual investment management fee payable by each subsidiary, including incentive fees, is capped at 0.40% (40 basis points) of its investment portfolio, with any excess amounts carried into the following year. These agreements may be terminated by either party on 30 days’ notice. For the years ended December 31, 2005, 2004 and 2003, total fees, including incentive fees, of $16.2 million, $7.5 million, and $13.3 million, respectively, are included in the consolidated statements of operations.
For the years ended December 31, 2005, 2004 and 2003, the Company paid $0.3 million, $0.3 million and $1.0 million of intranet fees, respectively, to MFX, an affiliate. Included in other expense, net, for the years ended December 31, 2005 and 2004, respectively, are charitable contributions of $0.7 million and $2.8 million related to the Sixty Four Foundation, a not-for-profit entity affiliated with Fairfax. There were no charitable contributions to the Sixty Four Foundation for the year ended December 31, 2003. In connection with the acquisition of Opus Re (now known as Clearwater Select Insurance Company), the Company incurred a $2.5 million pre-tax expense for each of the years ended December 31, 2005 and 2004, which is included in other expense, net, to RiverStone Group LLC, an affiliate, for services provided to the Company in connection with the acquisition.
The following tables set forth the Plan’s funded status, which uses a measurement date of October 1, and amounts recognized in the Company’s consolidated financial statements as of December 31, 2005 and 2004 (in thousands):
The Company also maintains two non-qualified excess benefit plans (“Excess Plans”) that provide more highly compensated officers and employees with defined retirement benefits in excess of qualified plan limits imposed by federal tax law. The following tables set forth the combined amounts recognized for the Supplemental Plan, which has a measurement date of October 1, and the Supplemental Employee Retirement
Plan, which has a measurement date of December 31, in the Company’s consolidated financial statements as of December 31, 2005 and 2004 (in thousands):
Net periodic benefit cost included in the Company’s consolidated statement of operations is comprised of the following components (in thousands):
The accumulated benefit obligation for the Excess Plans is $11.4 million and $10.4 million as of December 31, 2005 and 2004, respectively. A total additional minimum pension liability of $1.9 million, pre-tax, representing the total amount that the accumulated benefit obligation for the Excess Plans exceeds the accrued pension cost, has been reflected in accumulated other comprehensive income as of December 31, 2005 and 2004.
The annual assumed rate of increase in the per capita cost of covered benefits (i.e., health care cost trend rate) is assumed to be 10.0% in 2005 and decreasing to 5% in 2013 and remaining constant thereafter. The health care cost trend rate assumption has a significant effect on the amounts reported. For example, increasing the assumed health care cost trend rates by one percentage point in each year would increase the accumulated postretirement benefit obligation by $1.8 million (16.3% of benefit obligation as of December 31, 2005) and the service and interest cost components of net periodic postretirement benefit costs by $0.4 million for 2005. Decreasing the assumed health care cost trend rates by one percentage point in each year would decrease the accumulated postretirement benefit obligation, and the service and interest cost components of net periodic postretirement benefit cost for 2005 by $1.5 million and $0.3 million, respectively.
The Company also maintains a defined contribution profit sharing plan for all eligible employees. Each year, the Board of Directors may authorize payment of an amount equal to a percentage of each participant’s basic annual earnings based on the experience of the Company for that year. These amounts are credited to the employee’s account maintained by a third party, which has contracted to provide benefits under the plan. No contributions were authorized in 2005, 2004, or 2003.
In April 2002, the Company’s shareholders approved the Odyssey Re Holdings Corp. 2002 Stock Incentive Plan (the “2002 Plan”). An aggregate of 1.5 million of the Company’s common shares may be granted under the 2002 Plan. The 2002 Plan provides for the grant of non-qualified stock options to officers, key employees and directors who are employed by, or provide services to, the Company or its subsidiaries. Pursuant to the 2002 Plan, 25% of the options granted become exercisable on each annual anniversary of the grant in each of the four years following the grant and expire 10 years from the date of grant, and shall be exercisable at the grant price. As of December 31, 2005 and 2004, a total of 800,750 and 793,250, respectively, stock options have been granted under the 2002 Plan at a weighted average price of $18.74 and $18.68 per share, respectively. There were 7,500 stock options granted during 2005 and no options were granted in 2004 pursuant to the 2002 Plan. As of December 31, 2005 and 2004, there were 699,250 and 706,750, respectively, remaining stock options available to be granted. The Company has reflected, in other expense, net, $0.5 million, $0.5 million and $0.3 million for the years ended December 31, 2005, 2004 and 2003, respectively, which represents the vested portion of the value of the options.
for each grant. The weighted average fair value of options granted during the year ended December 31, 2005 was $6.89.
The following table summarizes the options outstanding and options exercisable as of December 31, 2005 that relate to the 2002 Plan:
Common stocks, at cost are $538,651, $518,640 and $473,390 as of March 31, June 30 and September 30, respectively, on an as previously reported and restated basis and $589,394 as of December 31, 2005. Common stocks, at cost are $397,401, $394,252, $458,658 and $435,279 as of March 31, June 30, September 30 and December 31, 2004, respectively, on an as previously reported and restated basis.
Preferred shares, par value $0.01 per share: 200,000,000 shares authorized; 2,000,000 series A shares and 2,000,000 series B shares issued and outstanding as of December 31, 2005.
Common shares, $0.01 par value per share: 500,000,000 shares authorized; 65,142,857 shares issued as of March 31, June 30, and September 30, and 69,252,857 shares issued as of December 31, 2005. Common shares issued as of March 31, June 30, September 30 and December 31, 2004 are 65,142,857.
Treasury shares: 295,592 shares, 277,177 shares, 34,156 shares and 115,325 shares in treasury as of March 31, June 30, September 30 and December 31, 2005, respectively. Treasury shares: 161,769 shares, 359,031 shares, 364,873 shares and 387,879 shares in treasury as of March 31, June 30, September 30 and December 31, 2004, respectively.
Due to changes in the number of weighted average common shares outstanding during 2005 and 2004, the sum of quarterly earnings per common share amounts will not equal the total for the year.
Certain prior year amounts have been reclassified to conform to the balance sheet presentation as of December 31, 2005.