You should read the following selected consolidated financial information along with the information contained in this Annual Report on Form 10-K, including ''
The Company’s Insurance and Reinsurance segments both include property related coverages which provide insurance or reinsurance of an insurable interest in tangible property for property loss, damage or loss of use. In addition, the Company’s Insurance and Reinsurance segments include various casualty insurance and reinsurance coverages, which are primarily concerned with the losses caused by injuries to third parties, i.e., not the insured, or to property owned by third parties and the legal liability imposed on the insured resulting from such injuries.
The Company’s revenues also include income generated from its investment portfolio. The Company’s investment portfolio is comprised of fixed maturity investments, short-term investments and preferred equity securities that are held as available for sale and other inestments that are accounted for under the equity method of accounting. In accordance with accounting principles generally accepted in the United States (“U.S. GAAP”), the available for sale investments are carried at fair market value and unrealized gains and losses on the Company’s investments are generally excluded from earnings. These unrealized gains and losses are included on the Company’s balance sheet in accumulated other comprehensive income (loss) as a separate component of shareholders’ equity. If unrealized losses are considered to be other-than-temporarily impaired due to credit related factors, such losses are included in earnings as a realized loss. For other investments, the Company increases or decreases the value of these investments for the Company’s share of income or loss, less dividends, which is included in net investment income.
Proportional reinsurance contracts accounted for approximately 20%, 14%, and 27% of the Company’s gross premiums written during the years ended December 31, 2009, 2008, and 2007, respectively.
The Company’s limited historical experience has shown that estimated premiums from proportional contracts have varied and have been adjusted by up to approximately 10%, although larger variations, both positive and negative, are possible as a result of changes in one or more of the premium assumptions as noted above. A 10% variation in the Company’s proportional premiums receivable, net as of December 31, 2009, after considering the related expected losses and loss expenses, acquisition expenses and taxes, would result in an impact of approximately $2.1 million on the Company’s net income.
Under U.S. GAAP, the Company is not permitted to establish loss reserves until the occurrence of an actual loss event. Once such an event occurs, the Company establishes reserves based upon estimates of total losses incurred by the ceding companies or insureds as a result of the event, its estimate of the potential losses incurred, and its estimate of the portion of such loss the Company has insured or reinsured. As a result, only loss reserves applicable to losses incurred up to the financial statement date may be recorded, with no allowance for the provision of a contingency reserve to account for expected future losses. Losses arising from future events will be estimated and recognized at the time the loss is incurred and could be substantial. See ''Reserve for Losses and Loss Expenses’’ below for further discussion.
Significant Assumptions Employed in the Estimation of Loss and Loss Expense Reserves. The most significant assumptions used as of December 31, 2009 to estimate the reserve for losses and loss expenses within the Company’s Insurance and Reinsurance segments are as follows:
the diversity of loss development patterns among different types of reinsurance treaties or contracts, and
Investments. The Company currently classifies all of its fixed income investments, which consist of fixed maturity investments, short-term investments and preferred equity securities, as “available for sale” and, accordingly, they are carried at estimated fair value, with related net unrealized gains or losses excluded from earnings and included in shareholders’ equity as a component of accumulated other comprehensive income (loss). The Company determines the fair value of its fixed income investments in accordance with current accounting guidance, which defines fair value and establishes a fair value hierarchy based on inputs to the various valuation techniques used for each fair value measurement. The use of valuation techniques for any given investment requires a significant amount of judgment and consideration of factors specific to the underlying investment. Fair value measurements determined by the Company seek to maximize observable inputs and minimize the use of unobservable inputs. Current accounting guidance establishes three levels as follows:
Level 1: Unadjusted quoted prices in active markets for identical assets or liabilities.
Broker/Dealers. Generally, the Company obtains quotes directly from broker/dealers who are active in the corresponding markets when prices are unavailable from independent pricing services or index providers. Broker/dealer quotes may also be used if the pricing from pricing services or index providers is not reflective of current market levels, as detected by our pricing control tolerance procedures. Generally, broker/dealers value securities through their trading desks based on observable market inputs. Their pricing methodologies include mapping securities based on trade data, bids or offers, observed spreads and performance on newly issued securities. They may also establish pricing through observing secondary trading of similar securities. Quotes from broker/dealers are all non-binding. At December 31, 2009, the Company has not adjusted any pricing provided by broker/dealers and has classified all such securities as Level 2.
Based on the above review, the Company will challenge any prices for a security, which are not considered representative of fair value.
For mortgage-backed and other asset-backed debt securities, fair value includes estimates regarding prepayment assumptions, which are based on current market conditions. Amortized cost in relation to these securities is calculated using a constant effective yield based on anticipated prepayments and the estimated economic life of the security. When actual prepayments differ significantly from anticipated prepayments, the effective yield is recalculated to reflect actual payments to date. For the majority of these securities, changes in estimated yield are recorded on a retrospective basis, resulting in future cash flows determining current book value.
Other than Temporary Impairment. Following a determination of fair value, the Company reviews its fixed income investments to determine whether any declines in the fair value below the amortized cost basis of its fixed income investments are other-than-temporary. If the Company determines that a decision to sell the security has been made or that it is more likely than not that the Company will be required to sell the security, the Company deems the security to be other-than-temporarily impaired and writes down the value to fair value, thereby establishing a new cost basis. The amount of the write-down is recognized in earnings as an other-than-temporary impairment (“OTTI”) loss.
To the extent the Company determines that the amortized cost of the Company’s fixed income investments is likely to be recovered and related to other factors (such as interest rates, market conditions, etc.) and not due to credit related factors, that remaining non-credit portion of the unrealized loss is recorded as a part of accumulated other comprehensive income (loss) in the shareholders’ equity section of the Company’s balance sheet.
Goodwill. The Company is required to make an annual assessment as to whether the value of the Company’s goodwill asset is impaired. Impairment, which can be either partial or full, is based on a fair value analysis by individual reporting unit. Based upon the Company’s assessment at the reporting unit level, there was no impairment of its goodwill asset of $86.2 million as of December 31, 2009.
Reclassifications. Certain comparative information has been reclassified to conform to current year presentation.
Growth in net premiums written in the professional lines and casualty line of the Insurance segment resulting from expanded underwriting capabilities and increased market penetration; and
Growth in the casualty and property lines of the Reinsurance segment, primarily as a result of new business written and increased pricing on renewal contracts, partially offset by the absence of $21.4 million of reinstatement premiums in the catastrophe line which were recorded in the third quarter of 2008 as a result of Hurricanes Ike and Gustav.
Increase in agriculture net premiums written in the Insurance segment as a result of a full year of premiums written by ARMtech, which was acquired in December 2007, partially offset by expected attrition in the Reinsurance Segment’s agriculture premiums;
Net premiums earned decreased in 2009 compared to 2008 due to the decline in net premiums written by the Insurance segment. Net premiums earned increased in 2009 compared to 2007 consistent with increases in net premiums written in the agriculture line of the Insurance segment year over year. The following table provides the distribution of gross premiums written by the geographic location in which the risk originated for the years ended December 31, 2009, 2008 and 2007:
The internal rate of return of the security based on the given market price or the single discount rate that equates a security price (inclusive of accrued interest) with its projected cash flows. Includes only cash and cash equivalents and fixed income investments held by the Company’s investment managers. Excludes other investments and operating cash.
Includes only cash and cash equivalents and fixed income investments held by the Company’s investment managers. Excludes other investments and operating cash.
During 2009, the yield on the benchmark five year U.S. Treasury bond fluctuated within a 157 basis points range, with a high of 2.92% and a low of 1.35%. Investment grade corporate and agency structured security spreads narrowed approximately 414 and 59 basis points, respectively, during the year ended December 31, 2009. Trading activity in the Company’s portfolio included a reduction of agency and non-agency residential mortgages, commercial mortgages, cash equivalents, foreign government securities, and an increase in U.S. government guaranteed corporate securities and corporate securities from prior periods and was aimed at selectively adding yield while continuing to keep the portfolio short in duration and conservatively positioned. The duration of the fixed income investments held at December 31, 2009 was largely consistent with 2008.
Our investment portfolio is managed to generate attractive economic returns and income while providing the Company with liquidity. Movements in financial markets and interest rates influence the timing and recognition of net realized investment gains or losses as the portfolio is adjusted and rebalanced. Proceeds from sales of investments classified as available for sale for the year ended December 31, 2009 were $2,587.5 million compared to $3,142.8 million for the year ended December 31, 2008. Net realized investment gains (losses) on investment sales for the years ended December 31, 2009, 2008 and 2007 were as follows:
The Company’s reported net losses and loss expenses are characterized by various factors and are significantly impacted by the occurrence or absence of catastrophic events and subsequent loss emergence related to such events. For 2009, the Company’s net loss ratio benefited from the absence of major catastrophes compared to 2008 which was adversely impacted by losses from Hurricanes Gustav and Ike and severe weather and worse than expected growing conditions and lower prices for major crops in the U.S., which adversely impacted the agriculture line of the Insurance segment for 2008. The Company recorded losses, net of reinstatement premiums, related to Hurricanes Gustav and Ike during 2008 of $148.0 million primarily in the Reinsurance segment. Losses from Hurricanes Gustav and Ike added 8.9 percentage points to the Company’s net loss ratio for 2008. The 2009 net loss ratio, however, included higher current accident year losses compared to 2008 and 2007 primarily in the Company’s recently exited workers’ compensation insurance line, reflecting the Company’s cautious view of current year loss reporting and deteriorating industry trends as a result of legal and regulatory changes and potential claim cost changes.
The Company’s acquisition expense ratio decreased in 2009 as compared to 2008 and 2007 primarily due to shifts in the earned premium mix, notably within the Insurance segment, partially offset by higher profit commissions payable to ceding companies in the Reinsurance segment as a result of improved performance and favorable loss emergence.
The Company’s general and administrative expense ratio for 2009 increased as compared to 2008 and 2007 primarily due to above target incentive compensation expenses across the Company in 2009, lower expense reimbursements in the agriculture line of the Insurance segment and from lower earned premiums. At December 31, 2009, the Company had a total of 759 employees as compared to 781 employees at December 31, 2008 and 709 employees at December 31, 2007.
Premiums. Net premiums written in the Insurance segment decreased in 2009 by 24.5% compared to 2008 and increased 34.1% compared to 2007. Gross and net premiums written for each line of business in the Insurance segment for the years ended December 31, 2009, 2008 and 2007 were as follows:
The change in the Insurance business segment net premiums written in 2009 compared to 2008 was driven by the following factors:
A decline in workers’ compensation and property net premiums written as a result of the Company’s exit from the California workers’ compensation and U.K. property insurance markets in the first quarter of 2009. These lines contributed $254.5 million of net premiums written in 2008;
Growth in net premiums written in the professional lines and casualty line resulting from expanded underwriting capabilities and increased market penetration.
The change in the Insurance business segment net premiums written in 2009 compared to 2007 was driven by the full year impact of the Company’s acquisition of ARMtech, which was acquired in the fourth quarter of 2007. Partially offsetting this growth in 2009 compared to 2007, was the Company’s exit from the California workers’ compensation and U.K. property insurance markets in the first quarter of 2009 that contributed $273.0 million of net premiums written in 2007.
The net loss ratio also benefited from higher favorable prior year loss reserve development recorded for 2009 as compared to 2008 and 2007. Prior year loss reserves were reduced in 2009 by $92.1 million as compared to reductions of $71.0 million and $80.4 million for the years ended December 31, 2008 and 2007. Of the lines of business in the Company’s Insurance segment, the short tail property, long tail healthcare liability and other agriculture lines experienced net reductions in the Company’s estimated losses for prior accident years in 2009 as claims have not materialized as originally estimated by the Company.
Premiums. Net premiums written in the Reinsurance segment increased in 2009 by 7.7% over 2008 and decreased 15.4% over 2007. Gross and net premiums written for each line of business in the Reinsurance segment for the years ended December 31, 2009, 2008 and 2007 were as follows:
The change in the Reinsurance business segment net premiums written during 2009 compared to 2008 and 2007 was driven by the following factors:
A decline in the marine portion of the aerospace and marine line of business from non-renewals, as this international book was reduced in the first quarter of 2009; and
A decline in the agriculture portion of the surety and other specialty line due to expected attrition stemming from the Company’s acqusition of ARMtech within the Insurance segment in the fourth quarter of 2007.
Net premiums earned decreased in 2009 compared to 2008 and 2007 primarily due to a lag in recognizing earned premium on business written in more recent periods.
The Company experienced lower favorable loss reserve development from prior years in its Reinsurance segment in 2009 compared to 2008 and 2007, with the majority of the current year favorable loss reserve development emanating from this segment’s short tail catastrophe, property and surety and other specialty lines of business. During 2009, 2008 and 2007, the Company’s previously estimated ultimate losses for the Reinsurance segment for prior accident years were reduced by $58.8 million, $85.5 million and $79.0 million, respectively. Favorable prior year loss reserve development resulted as claims have not materialized as originally estimated by the Company.
On December 7, 2007, Endurance Holdings’ U.S. based holding company acquired all outstanding stock of ARMtech and its affiliates. The base purchase price was $120 million, plus additional amounts as determined in accordance with the terms of the purchase agreement. The Company has paid additional amounts of $22.7 million in settlement of its obligations under the purchase agreement with ARMtech. ARMtech underwrites crop insurance primarily through the U.S. federally sponsored Multiple Peril Crop Insurance Program. The Company recorded total goodwill and other intangible assets of $45.2 million and $96.7 million, respectively, related to certain licenses, internally developed software, non-compete agreements and customer relationships.
At December 31, 2009, letters of credit totaling $605.3 million were outstanding, $200.0 million face value of 6.15% Senior Notes were outstanding and $250.0 million face value of 7% Senior Notes (the “7% Senior Notes”) were outstanding.
The Company entered into investment agreements to invest additional amounts in other investments.
In order to capture the key dynamics of loss development and expected volatility that may arise within the disclosed amounts for the reserve for losses and loss expenses, the key lines of business within each business segment are aggregated based on their potential expected length of loss emergence. The period over which loss emergence occurs is typically referred to as the tail. The Company has classified its lines of business as either having a “short,” “long” or “other” tail pattern. The Company views short tail business as that for which development typically emerges within a period of several quarters while long tail business would emerge over many years. The Company’s short tail lines of business in the Insurance segment includes property; long tail lines of business include casualty, healthcare liability, workers’ compensation and professional lines. The Company’s short tail lines of business in the Reinsurance segment include catastrophe, property, marine, aerospace and surety while the long tail line of business is casualty related business. Within the Company’s Reinsurance segment, the Company writes certain specialty lines of business for which the loss emergence is considered unique in nature and thus, has been included as “other” in the table below.
Short Tail Insurance. The prior year favorable loss development in the short tail insurance category was primarily as a result of lower than expected claims reported and favorable case reserve development in the Company’s property line of business. As a result, the Company reduced its estimated losses and loss expenses related to prior years in this reserve category during 2009.
Long Tail Insurance. The favorable loss emergence within the long tail insurance reserve category was primarily due to lower than expected claims activity and favorable case settlement within the healthcare liability line of business. During the latter part of the year the favorable loss emergence in healthcare liability was partially offset by adverse loss development in the recently exited workers’ compensation line of business resulting from the Company’s cautious view of industry trends and potential claim cost changes due to medical inflation. In addition, the Company also experienced adverse loss emergence related to credit crisis exposures within the professional lines of business.
Long Tail Reinsurance. The Company recorded a modest amount of favorable loss emergence within this reserve category during 2009. For the year the Company experienced favorable prior period development within the direct casualty and professional laibility lines of business due to lower than anticipated claim activity. This was offset to some degree by adverse development within the treaty casualty line of business, primarily due to higher than expected reported loss activity from prior years.
Two key inputs utilized in determining loss and loss expense reserves for the Company’s two business segments are the initial expected loss ratio and the speed of the loss reporting pattern. The following tables illustrate the possible percentage effects on current estimates of the reserve for losses and loss expenses due to 10% changes in the initial expected loss ratio and the speed of the loss reporting pattern as of December 31, 2009. The 10% changes in the initial expected loss ratio and the speed of the loss reporting pattern in the tables below were chosen consistent with commonly accepted actuarial practice, due to the Company’s limited empirical data regarding loss and loss expense reserves variability. In order to capture the key dynamics of loss development and expected volatility that may arise within the disclosed amounts for the reserve for losses and loss expenses, the lines of business within each business segment are aggregated based on their potential expected length of loss emergence or tail.
As a part of our acquisition of Armtech in 2007, we recorded total goodwill of $45.2 and intangible assets of $96.7 million, which included licenses, customer relationships, internally developed software and non-compete agreements. The finite lived intangibles are being amortized over terms ranging from five to fifteen years.
The Company’s balance sheet at December 31, 2009 contains a net deferred tax asset in the amount of $17.3 million (2008 - $20.7 million deferred tax asset). The current year net deferred tax asset consists of gross deferred tax assets of $100.7 million, gross deferred tax liabilities of $73.8 million and a valuation allowance of $9.6 million. Of the Company’s gross deferred tax assets, $16.5 million (2008 - $23.0 million) relates to net operating loss carryforwards that are available to offset future taxable income generated by the Company’s U.K. subsidiary. The Company’s net operating losses may be carried forward indefinitely.
The Company has established a valuation allowance of $9.6 million (2008 - $15.7 million) against realized capital losses, including securities write downs, and certain operating loss carryforwards at December 31, 2009. Of the $9.6 million valuation allowance, $3.7 million was established against realized investment losses as the Company cannot reasonably predict the occurrence of future realized investment gains and $5.9 million was established against net operating loss carryforwards in the United Kingdom as the Company does not expect to generate enough operating income in the short-term to offset the full amount of the carryforwards. Management believes the net deferred tax assets, less the valuation allowance noted, are more likely than not to be fully realized in corresponding future periods, and the Company’s net deferred tax asset has been stated appropriately as at December 31, 2009. In the event that management determines in the future that it is more likely than not that the net deferred tax assets will not be fully realized in the near term and prior to their expiration, the Company will reassess the valuation allowance against the net deferred tax assets and record any changes to income tax expense in the period determined.
We have audited Endurance Specialty Holdings Ltd.’s internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Endurance Specialty Holdings Ltd.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit.
In our opinion, Endurance Specialty Holdings Ltd. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2009, based on the COSO criteria.
Consolidated Statements of Income and Comprehensive income (loss) for the years ended December 31, 2009, 2008 and 2007
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Endurance Specialty Holdings Ltd. at December 31, 2009 and 2008, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2009, in conformity with U.S. generally accepted accounting principles.
As described in Note 2, on April 1, 2009 the Company adopted FSP FAS 115-2, Recognition and Presentation of Other-Than-Temporary Impairments (Codified in FASB ASC Topic 320, Investments-Debt and Equity Securities.)
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Endurance Specialty Holdings Ltd.’s internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 26, 2010 expressed an unqualified opinion thereon.
The Company currently classifies all of its fixed income investments, which consist of fixed maturity investments, short-term investments and preferred equity securities, as “available for sale” and accordingly, they are carried at estimated fair value, with related net unrealized gains or losses excluded from earnings and included in shareholders’ equity as a component of accumulated other comprehensive income (loss). The Company determines the fair value of its fixed income investments in accordance with current accounting guidance, which defines fair value and establishes a fair value hierarchy based on inputs to the various valuation techniques used for each fair value measurement. The use of valuation techniques for any given investment requires a significant amount of judgment and consideration of factors specific to the underlying investment. Fair value measurements determined by the Company seek to maximize observable inputs and minimize the use of unobservable inputs. Current accounting guidance establishes three levels as follows:
Level 3: Unobservable inputs that are supported by little or no market activity and are significant to the fair value of the assets or liabilities. Unobservable inputs reflect the Company’s own view about the assumptions that market participants would use in pricing the asset or liability. Level 3 assets and liabilities include financial instruments whose values are determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation.
review of the payment structure of the security, whether scheduled interest and principal payments have been made, current levels of subordination and any guarantees, if applicable.
To the extent the Company determines that the amortized cost of the Company’s fixed income investments is likely to be recovered and the decline in value is related to non-credit factors (such as interest rates, market conditions, etc.) and not due to credit related factors, that remaining non-credit portion of the unrealized loss is recorded as a part of accumulated other comprehensive income (loss) in the shareholders’ equity section of the Company’s balance sheet.
The Company has a stock-based employee and non-employee Director incentive plan (“2007 Equity Incentive Plan”) and other stock plans which are described more fully in Note 15. The fair value of the compensation cost incurred under these plans is measured at the grant date and is expensed over the period for which the employee is required to provide services in exchange for the award. Forfeiture benefits are estimated at the time of grant and incorporated in the determination of share-based compensation costs. Awards under the 2007 Equity Incentive Plan vest over periods of up to four years.
The following are recently released accounting pronouncements that impact the Company’s financial statements.
In February 2008, the Financial Accounting Standards Board (“FASB”) issued new accounting guidance, which permitted a one-year deferral of the application of fair value accounting on non-financial assets and non-financial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis. The Company adopted the provisions of this guidance for non-financial assets and non-financial liabilities on January 1, 2009 with no impact on its results of operations and financial condition.
In April 2008, the FASB issued new accounting guidance amending the factors considered in developing renewal or extension assumptions used to determine the useful life of an intangible asset. This new guidance was effective for fiscal years beginning after December 15, 2008 and interim periods within those fiscal years. The Company adopted this guidance as of January 1, 2009, which had no impact on its results of operations and financial condition.
In June 2008, the FASB issued new guidance on determining whether an instrument (or embedded feature) is indexed to an entity’s own stock. The guidance established criteria for evaluation of an instrument, including assessing the instrument’s contingent exercise provisions, if any, and the instrument’s settlement provisions in order to conclude if such an instrument is indexed to an entity’s own stock. This guidance was effective for fiscal years beginning after December 15, 2008 and must be applied to outstanding instruments as of the beginning of the fiscal year of adoption as a cumulative-effect adjustment to the opening balance of retained earnings. The Company adopted the provisions of this guidance for all periods beginning January 1, 2009, which did not have an impact on the Company’s financial condition or results of operations.
recognition and presentation of OTTI, which amended OTTI guidance for debt securities to clarify the guidance and to improve the presentation and disclosure of OTTI on debt and equity securities in the financial statements. The Company now evaluates each debt security whose fair value is below its amortized cost and determines if the Company intends to sell the security or will more than likely be required to sell the security before the recovery of its cost basis. If no decision to sell has been made and it is not likely that the Company will be required to sell the debt security, the Company evaluates whether it expects to recover the amortized cost of the security. If the Company does not expect to recover the amortized cost, the Company deems the security to be other-than-temporarily impaired and must separate the total OTTI into: (i) credit related OTTI; and (ii) OTTI due to non-credit related factors. The credit related OTTI losses are recognized in earnings and non-credit related OTTI losses are included in accumulated other comprehensive income. Prior to April 1, 2009, in analyzing whether a security was other-than-temporarily impaired, the Company determined whether it had the intent and ability to hold each security for a sufficient period of time for the value to recover;
In June 2009, the FASB issued accounting guidance that established the Accounting Standards Codification as the official single source of authoritative accounting principles recognized by the FASB to be applied by nongovernmental entities in the preparation of financial statements in accordance with U.S. GAAP. All existing accounting standard documents are superseded by the Codification and any accounting literature not included in the Codification will not be authoritative. However, rules and interpretive releases of the Securities and Exchange Commission (“SEC”) issued under the authority of federal securities laws will continue to be sources of authoritative U.S. GAAP for SEC registrants. The Codification was effective for interim and annual reporting periods ending after September 15, 2009. There was no impact on the Company’s financial condition or results of operations due to its implementation.
The amortized cost, fair value and related gross unrealized gains and losses and OTTI on the Company’s securities classified as available for sale at December 31, 2009 and 2008 are as follows:
Balances include amounts related to collateralized debt obligations held with total fair values of $2.5 million.
Gross unrealized losses include unrealized losses on non-OTTI and OTTI securities recognized in accumulated other comprehensive income (loss) at December 31, 2009.
As of December 31, 2009, 410 available for sale securities were in an unrealized loss position. Of those, 210 securities had been in a continuous unrealized loss position for twelve months or greater.
At December 31, 2008, 672 available for sale securities were in an unrealized loss position. Of those, 174 securities had been in a continuous unrealized loss position for twelve months or greater. The unrealized loss position of these securities was principally a result of credit spread widening.
The $20.3 million of OTTI losses recognized by the Company in 2009 relating to specific credit events occurred primarily due to reductions in expected recovery values on mortgage and asset-backed securities during the year, along with certain credit related downgrades in corporate securities. OTTI of $30.7 million was recognized by the Company in 2009 that related to non-credit factors.
The following table provides a roll-forward of the amount related to credit losses recognized in earnings for which a portion of an OTTI was recognized in accumulated other comprehensive income (loss) for the period April 1, 2009 to December 31, 2009:
The Company also participates in a securities lending program whereby fixed maturity investments are loaned by the Company to third parties, primarily major brokerage firms and commercial banks. The borrowers of the Company’s securities provide the Company with collateral, typically cash, which the Company separately maintains. The Company invests such cash collateral in other securities. In the first quarter of 2008, the Company restricted future investment of cash collateral in its securities lending program to overnight repurchase agreements. Previously, the Company allowed investments in U.S. Treasuries, securities of U.S. government agencies, mortgage-backed securities, asset-backed securities and corporate fixed maturity securities. At December 31, 2009, the cash collateral was invested in senior credit card and auto asset-backed securities, bank notes, debentures and overnight repurchase agreements. Securities with an estimated fair value of $65.7 million and $112.6 million were on loan under the program at December 31, 2009 and 2008, respectively. The Company was liable for cash collateral under the Company’s control of $67.0 million and $115.6 million at December 31, 2009 and 2008, respectively. As of December 31, 2009 and 2008, the fair value of the investments purchased with the cash collateral received from the borrower was $66.9 million and $112.9 million. The investments purchased with the cash collateral had an average credit quality rating of “Aa2” by Moody’s and “AA” by Standard & Poor’s at December 31, 2009. All securities on loan are issued on a term or overnight basis and are subject to daily recall at the Company’s discretion.
The following tables present the securities lending collateral reinvested by the Company in connection with its securities lending program, categorized by the level within the hierarchy in which the fair value measurements fall, on a recurring basis at December 31, 2009 and 2008, respectively:
The following tables present a reconciliation of the beginning and ending balances for all available for sale securities measured at fair value on a recurring basis using Level 3 inputs during the years ended December 31, 2009 and 2008. Level three assets included below are related to our fixed maturity investments including corporate debt securities, non-agency residential and non-agency commercial mortgage-backed securities.
At December 31, 2009 and 2008, the carrying value of the Company’s other investments was $351.4 million and $284.3 million, respectively, which approximates fair value.
During 2009, the Company’s estimated ultimate losses for prior accident years were reduced by $150.9 million (2008 - $156.5 million; 2007 - $159.4 million) due to lower claims emergence than originally estimated by the Company. During 2009, the Company experienced favorable development in the Reinsurance segment of $58.8 million in the short tail, long tail and other lines of business. In the Insurance segment, the Company experienced $92.1 million of favorable development across the long tail, short tail and other lines of business. During 2008, the Company experienced favorable development in the Reinsurance segment of $85.5 million in the short tail, long tail and other lines of business. In the Insurance segment, the Company experienced $71.0 million of favorable development primarily in relation to the long tail line of business during 2008. During 2007, the Company experienced favorable development in the Insurance segment of $80.4 million in the short and long tail lines of business and $79.0 million of favorable development in the Company’s Reinsurance segment primarily in relation to the short tail lines of business.
During the year ended December 31, 2009, the Company recorded ceded losses of $299.0 million (2008 - $574.4 million; 2007 - $58.6 million). At December 31, 2009, the Company has an allowance for estimated uncollectible premiums receivable of $12.8 million (2008 - $2.4 million) and no allowance for estimated uncollectible losses recoverable (2008 - Nil).
The indentures governing each of the Senior Notes contain customary covenants and events of default for senior unsecured indebtedness, including events of default for non-payment of principal or interest, breaches of covenants, insolvency of the Company or a default by the Company under other outstanding indebtedness. At December 31, 2009, the carrying value of the Senior Notes stood at $447.4 million (2008 - $447.3 million) while the fair value as determined by quoted market valuation was $439.1 million (2008 - $334.2 million). The Company was in compliance with all covenants contained within the indentures governing the Senior Notes as of December 31, 2009.
The Company made aggregate interest payments of $29.8 million during the year ended December 31, 2009 (2008 - $29.9 million, 2007 - $29.8 million).
The Company currently uses foreign currency forward contracts in its investment portfolios to minimize the effect of fluctuating foreign currencies and to gain exposure to interest rate differentials between differing market rates. For the years ended December 31, 2009, 2008 and 2007, the Company recognized realized foreign exchange (losses) gains on forward contracts of approximately ($543,000), $544,000, and ($527,100), respectively.
The following table provides the geographic distribution of gross premiums written for the years ended December 31, 2009, 2008 and 2007:
No impairment of the Company’s goodwill or intangible assets was noted following the annual impairment review for the years ended December 31, 2009 and 2008. The Company expects the amortization of the intangible assets with finite lives to approximate $10.4 million for years 2010 to 2011, $9.6 million for 2012, $6.3 million for 2013, $5.8 million for 2014 and $45.7 million for all years thereafter.
As of December 31, 2009, substantially all the Company’s cash and investments were held by four custodians. The Company’s investment guidelines limit the amount of credit exposure to any one issuer other than the U.S. Treasury and certain other foreign government obligations rated AAA.
On November 11, 2008, Aon Corporation completed its acquisition of Benfield Group Limited. The table above shows the gross premiums brokered by these entities on a consolidated basis for all years presented.
Letters of credit. As of December 31, 2009, the Company had issued letters of credit of $605.3 million (December 31, 2008 - $635.5 million) under its credit facility in favor of certain ceding companies.
Investment commitments. As of December 31, 2009 and 2008, the Company had pledged cash and cash equivalents and fixed maturity investments of $158.5 million and $147.9 million, respectively, in favor of certain ceding companies to collateralize obligations. As of December 31, 2009 and 2008, the Company had also pledged $664.0 million and $591.9 million of its cash and fixed maturity investments as required to meet collateral obligations for $605.3 million and $550.8 million in letters of credit outstanding under its credit facility, respectively. In addition, at December 31, 2009 and 2008, cash and fixed maturity investments with fair values of $361.6 million and $234.8 million were on deposit with U.S. state regulators, respectively, and cash and fixed maturity investments with fair values of $12.4 million and $14.2 million were on deposit with Canadian regulators, respectively.
The Company is subject to certain commitments with respect to other investments at December 31, 2009 and 2008. The Company is generally subject to redemption restriction provisions of between one to five years from the date of acquisition and rolling redemption restrictions on a one or two year basis thereafter. Due to redemption restrictions, the Company is prohibited from requesting redemptions during 2010 of $72.1 million of its other investments held at December 31, 2009. In addition, as of December 31, 2009, the Company was committed to investing a further $1.7 million (2008 - $1.7 million) in various investment funds classified as other investments.
Reinsurance commitments. In the ordinary course of business, the Company enters into reinsurance agreements which may include terms which could require the Company to collateralize certain of its obligations as a result of certain triggering events, as defined in such agreements.
Total rent expense under operating leases for the year ended December 31, 2009 was $11.4 million (2008 - $10.1 million; 2007 - $10.2 million).
The following tables set forth the computation of basic and diluted earnings per share for the years ended December 31, 2009, 2008 and 2007.
Since 2002, subsidiaries of BlackRock Inc. (“Blackrock”) have provided the Company and its subsidiaries with various investment management, investment accounting and risk analysis services. During December 2009, BlackRock acquired Barclays Global Investors. As a result, BlackRock owned 5.2 million or 9.09% of Endurance Holdings’ ordinary shares outstanding at December 31, 2009. The Company incurred expenses totaling $3.6 million (2008: $3.5 million; 2007: $3.7 million) of which $1.6 million was accrued in relation to investment services rendered by Blackrock during the year ended December 31, 2009 (2008: $0.9 million).
Certain founding shareholders, including Aon Corporation and its affiliates (“Aon”), received warrants in conjunction with the capitalization of the Company. During 2009, the balance of warrants held by Aon, were net exercised into Endurance Holdings’ ordinary shares.
At its meeting on February 28, 2007, the Company’s Board of Directors adopted the 2007 Equity Incentive Plan (“2007 Plan”) to allow for the issuance of equity incentives to non-employee directors of the Company and eligible employees of the Company and its subsidiaries. The 2007 Plan was approved by the Company’s shareholders at the Annual General Meeting of Shareholders held on May 9, 2007. As such, the Company’s existing Amended and Restated 2002 Stock Option Plan and the Amended and Restated 2003 Non-Employee Director Incentive Plan were merged into the new 2007 Plan.
At the Company’s exclusive option, restricted share units may be settled in cash, ordinary shares or in a combination thereof. With respect to certain subsidiaries, the Company generally withholds an amount sufficient to satisfy any federal, state or local withholding tax requirements associated with awards under the 2007 Plan.
A summary of option activity, including options held by employees and non-employee directors, during the year ended December 31, 2009 is presented below:
No options were granted during the years ended December 31, 2009, 2008 and 2007. The total intrinsic value of options exercised during the years ended December 31, 2009, 2008, and 2007 was $4.2 million, $0.6 million, and $11.3 million, respectively. The Company received proceeds of $4.3 million from the exercise of options during the year ended December 31, 2009. The Company issued new ordinary shares in connection with the exercise of the above options.
No options expired during the year ended December 31, 2009. The total grant date fair value of options vested during the years ended December 31, 2009, 2008, and 2007 was Nil, Nil, and $0.3 million, respectively. There were no unrecognized stock-based compensation expenses related to unvested stock options at December 31, 2009.
For the years ended December 31, 2009, 2008 and 2007, compensation costs recognized in earnings for all restricted shares and restricted share units were $13.3 million, $17.3 million, and $10.9 million, respectively. At December 31, 2009, compensation costs not yet recognized related to non-vested awards was $9.4 million (2008 - $15.6 million). This expense is expected to be recognized between 2010 and 2013, with approximately 67.0% expected to be recognized during 2010.
The Company provides pension benefits to eligible employees through various defined contribution plans sponsored by the Company. Under the Company’s defined contribution plans, the Company makes contributions to its employees’ accounts in amounts ranging from 4% to 10% of its employees’ eligible earnings. In addition, under certain defined contribution plans, employee contributions may be supplemented by matching contributions made by the Company based on the level of employee contribution. Lastly, the Company may provide additional contributions, depending on its annual financial performance. The employee and Company contributions in the defined contribution plans are invested at the election of each employee in one or more of several investment portfolios offered by third party investment advisors. Contributions for the year ended December 31, 2009 resulted in an expense of $9.2 million being recorded in earnings (2008 - $6.4 million; 2007 - $6.4 million).
The combined statutory capital and surplus and combined statutory net income (loss) for our principal operating subsidiaries in their respective jurisdictions were as follows:
Endurance U.K. and Endurance Bermuda’s Singapore branch are currently completing 2009 statutory profit and loss statements. Endurance Bermuda’s Zurich branch had no statutory filing requirement at or for the year ended December 31, 2009 and 2008.
As a holding company, Endurance Holdings relies on dividends from Endurance Bermuda to provide cash flow required for debt service and dividends to shareholders. Endurance Bermuda’s ability to pay dividends and make capital distributions is subject to certain regulatory restrictions based on the enhanced capital requirement calculated using the Bermuda standard model in addition to limits on the amount of Endurance Bermuda’s premiums written and net reserves for losses and loss expenses, subject to an overall minimum capital and surplus requirement of $100 million. The Bermuda Solvency Capital Requirement (“BSCR”) employs a standard mathematical model that correlates the risk underwritten to the capital that is dedicated to the business. The regulatory requirements are designed to have insurers operate at or above a threshold capital level, which exceeds the BSCR. The Company is currently completing the 2009 BSCR for Endurance Bermuda and believes that Endurance Bermuda will exceed the target level of required capital as of December 31, 2009. At December 31, 2009, Endurance Bermuda can pay approximately $610 million (2008 - $339 million) to Endurance Holdings without prior approval under Bermuda law. In addition, Endurance Bermuda is required to maintain a minimum statutory liquidity ratio and solvency margin.
Endurance U.S. Reinsurance, Endurance American, Endurance American Specialty and Endurance Risk Solutions are subject to regulation by the Delaware Department of Insurance. ARMtech is subject to regulation by the Texas Department of Insurance. Dividends for each U.S. operating subsidiary are limited to the greater of 10% of policyholders’ surplus or statutory net income, excluding realized capital gains. In addition, dividends may only be declared or distributed out of earned surplus. At December 31, 2009, Endurance U.S. Reinsurance, Endurance American and Endurance American Specialty did not have earned surplus and thus were precluded from declaring or distributing dividends during 2010 without the prior approval of the applicable insurance regulator. If the parent company is also an insurer, as is the case with Endurance American, Endurance American Specialty and Endurance Risk Solutions, the parent company or companies must also meet their own dividend eligibility requirements in order to pass along any dividends received from subsidiary insurance companies. At December 31, 2009, Endurance Risk Solutions and ARMtech (with notice to the Texas Department of Insurance) could pay dividends of $3.8 million and $2.6 million (2008 - $5.7 million and $3.5 million), respectively, without prior regulatory approval.
The Company is not required to pay any income or capital gains taxes in Bermuda. The Company has received an assurance from the Minister of Finance of Bermuda under the Exempted Undertakings Tax Protection Act of 1966 of Bermuda, as amended, that in the event any legislation is enacted in Bermuda imposing any tax computed on profits or income, or computed on any capital asset, gain or appreciation or any tax in the nature of estate duty or inheritance tax, such tax shall not be applicable to the Company until March 28, 2016 provided that the assurance is subject to the condition that it will not prevent the application of any taxes payable by the Company in respect of real property or leasehold interests in Bermuda held by it. Endurance Bermuda intends to operate in a manner such that it will owe no United States tax other than premium excise tax and withholding taxes on certain investments.
The income tax benefit (expense) was as follows for the years ended December 31, 2009, 2008 and 2007, respectively:
The actual income tax benefit (expense) attributable to income for the years ended December 31, 2009, 2008 and 2007 differed from the amount computed by applying the combined effective rate of 0% under Bermuda law to income before income tax benefit, as a result of the following:
Deferred income taxes represent the tax effect of the differences between the book and tax bases of assets and liabilities. Net deferred income tax assets and liabilities consisted of the following as of December 31, 2009 and 2008:
A valuation allowance is provided when it is more likely than not that some portion of the deferred tax assets will not be realized. At December 31, 2009, management has established a valuation allowance of $9.6 million (2008 - $15.7 million) against realized investment losses and other items for which the Company does not have current plans to produce future realized investment gains and other income.