U.S. property reinsurance market conditions tightened, particularly within peak catastrophe zones, during 2006. This market hardening was particularly pronounced in third quarter renewals with incrementally higher rate changes and even more restrictive coverage terms than earlier in 2006. As a result, many reinsurance buyers
In light of its 2005 catastrophe experience, the Company reexamined its risk management practices, concluded that its control framework operated generally as intended and made appropriate portfolio adjustments to its property reinsurance operations during the first nine months of 2006. This portfolio repositioning, particularly within peak catastrophe zones, including Southeast U.S., Mexico and Gulf of Mexico, has enabled the Company to benefit from these dislocated markets by carefully shifting the mix of its writings toward the most profitable classes, lines, customers and territories and enhancing portfolio balance and diversification.
Overall, the Company believes that current marketplace conditions offer solid opportunities for the Company given its strong ratings, distribution system, reputation and expertise. The Company continues to employ its opportunistic strategy of targeting those segments offering the greatest profit potential, while maintaining balance and diversification in its overall portfolio.
The Company’s 2006 results were very strong with net income of $332.9 million compared to net income of $4.7 million for 2005. This significant earnings improvement reflects the favorable effect of a benign U.S. hurricane season relative to unprecedented Company and industry hurricane losses experienced in 2005, as well as favorable underlying underwriting fundamentals.
Investment income increased from the growth of the invested asset base and greater income from limited partnership investments.
Revenues. Gross and net written premiums declined 4.6% and 4.4%, respectively, for 2006 compared to 2005, while net premiums earned declined 7.4% in 2006 compared to 2005. The decrease in full year net premiums earned was primarily due to a decline in the U.S. insurance segment of 9.8%, reflective of: i) a reduction in credit business from an auto loan insurance program which is in run-off and ii) continued reductions in the California workers’ compensation writings due to competitive market conditions. In addition, net premiums earned for the worldwide reinsurance segments in the aggregate decreased by 6.5% for 2006, reflecting multiple segment level factors, including a significant return premium for a Florida property quota share contract cancelled in 2006, the absence of sizable reinstatement premiums triggered in 2005 from severe catastrophic events, as well as the exercise of continued underwriting disciplines which emphasizes potential profitability over volume.
Net realized capital gains were modest in relation to the Company’s invested asset base, mainly reflecting normal portfolio management activities in response to changes in interest rates and credit spreads.
Expenses. The Company’s incurred losses and loss adjustment expenses (“LAE”) decreased 29.3% in 2006 compared to 2005, primarily due to the relative absence of current year catastrophe losses.
The Company’s loss ratio improvement of 22 points for 2006 compared to 2005 resulted from a 25 point improvement in the catastrophe loss ratio.
Commission, brokerage, and tax expenses decreased by 14.6% in 2006 from 2005. The 7.4% decline in earned premiums in 2006 compared to 2005 was the principal driver of the decrease in this directly variable expense. Other underwriting expenses for 2006 decreased by 2.6% compared to 2005, primarily due to a decrease in corporate non-allocated expenses.
Ceded premiums decreased to $895.7 million in 2006 from $944.2 million in 2005, primarily due to the decline in gross written premiums. Ceded premiums relate primarily to quota share reinsurance agreements between Everest Re and Bermuda Re and Everest International.
Net written premiums decreased by 4% to $2,290.3 million in 2006 from $2,395.7 million in 2005, reflecting the $153.9 million decrease in gross written premiums and the $48.5 million decrease in ceded premiums.
Premium Revenues. Net premiums earned decreased by 7.4% to $2,247.2 million in 2006 from $2,426.1 million in 2005. Contributing to this decrease was a 21.5% ($48.2 million) decrease in the Specialty Underwriting operation, a 9.8% ($62.7 million) decrease in the U.S. Insurance operation and a 9.5% ($102.4 million) decrease in the U.S. Reinsurance operation, partially offset by a 7.1% ($34.4 million) increase in the International operation. Additional premiums related to catastrophe business, included in net earned premiums,
were $5.1 million and $52.5 million for 2006 and 2005, respectively. These changes reflect period to period changes in net written premiums and business mix, together with normal variability in earnings patterns. Business mix changes occur not only as the Company shifts emphasis between products, lines of business, distribution channels and markets, but also as individual contracts renew or non-renew, almost always with changes in coverage, structure, prices and/or terms and as new contracts are accepted. As premium reporting, earnings, loss and commission characteristics derive from the provisions of individual contracts, the continuous turnover of individual contracts, arising from both strategic shifts and daily underwriting decisions, results in appreciable variability in various underwriting line items. Changes in estimates of the reporting patterns of ceding companies also affect premiums earned.
The Company’s incurred losses and LAE decreased by 29.3% to $1,557.1 million in 2006 from $2,202.8 million in 2005, due to significantly reduced current year catastrophe losses and a reduction in current year attritional losses, partially offset by increased prior years reserve development on catastrophe and A&E loss reserves. Incurred losses and LAE in 2006 reflected ceded losses and LAE of $546.4 million compared to ceded losses and LAE in 2005 of $852.4 million reflecting the decline in gross losses.
The following table shows the U.S. Reinsurance segment components of incurred losses and LAE for 2006 and 2005:
The U.S. Insurance segment’s incurred losses and LAE increased 4.0%, or $16.8 million, for 2006 compared to 2005; primarily due to higher current year attritional losses resulting from losses on the run-off credit program, partially offset by decreased losses due to reduced earned premiums, and an increase in favorable prior years reserve development.
The International segment’s incurred losses and LAE decreased 31.9%, or $130.7 million, for 2006 as compared to 2005 reflecting lower catastrophe losses. The segment’s loss ratio improved by 30.8 points from 2005, primarily due to reduced current year catastrophe losses incurred in Canada, Asia and international.
The following table shows the expense ratios for each of the Company’s operating segments for 2006 and 2005.
Segment underwriting expenses decreased by 12.4% to $532.8 million for 2006 from $608.5 million in 2005. Commission, brokerage, taxes and fees decreased by $74.9 million, principally due to decreases in premium volume and changes in the mix of business. Segment other underwriting expenses were $0.1 million for both 2006 and 2005. Contributing to the segment underwriting expense decreases were a 19.7% ($56.0 million) decrease in the U.S. Reinsurance operation, a 17.5% ($10.9 million) decrease in the Specialty Underwriting operation and a 16.3% ($23.7 million) decrease in the U.S. Insurance operation, partially offset by a 12.7% ($14.9 million) increase in the International operation. The changes for each operation’s expenses principally resulted from changes in commission expenses due to changes in premium volume and business mix by class and type and, in some cases, changes in the use of specific reinsurance.
Investment Results. Net investment income increased 14.5% to $372.4 million in 2006 from $325.2 million in 2005, primarily reflecting the growth in invested assets to $8.5 billion in 2006 from $7.9 billion in 2005 and a $31.1 million increase in investment income from limited partnership investments. Investment income from equity investments in limited partnerships fluctuates from year to year depending on the performance of the individual investments made by the partnerships as well as the movement in the equity markets. Period to period changes in investment income are also impacted by changes in the level and mix of invested assets, prevailing interest rates and price movements in the equity markets.
The following table shows the components of net investment income for the years ended as indicated:
Imbedded after-tax yield of cash and invested assets at December 31 3.7 % 3.6 %
Corporate, Non-allocated Expenses. Corporate underwriting expenses not allocated to segments were $4.5 million for 2006 and $6.2 million for 2005, which included approximately $1.5 million of non-recurring expenses.
Interest, fees and bond issue cost amortization expense in 2006 and 2005 were $69.7 million and $74.2 million, respectively. Interest, fees and bond issue cost amortization expense in 2006 included $31.1 million related to the senior notes, $37.4 million related to the junior subordinated debt securities, $0.9 million related to the bond issue cost amortization and $0.2 million related to the credit line under the Company’s revolving credit facility. Interest, fees and bond issue cost amortization expense in 2005 included $35.5 million related to senior notes, $37.4 million related to the junior subordinated debt securities, $1.0 million related to the bond issue cost amortization and $0.2 million related to the credit line under the Company’s revolving credit facility. Interest expense on senior notes decreased due to the retirement on March 15, 2005 of the 8.5% senior notes issued on March 14, 2000.
Net Income. Net income was $332.9 million in 2006 compared to net income of $4.7 million in 2005, primarily caused by much larger catastrophe losses in 2005 than in 2006.
Specialty Underwriting operation, primarily due to a $145.4 million decrease in A&H business and a $47.9 million decrease in surety business, partially offset by a $20.9 million increase in marine and aviation business. The U.S. Insurance operation decreased 20.2% ($235.3 million), principally as a result of a $242.6 million decrease in workers’ compensation, resulting primarily from changes in the California workers’ compensation market. The U.S. Reinsurance operation decreased 6.2% ($92.0 million), principally related to a $173.1 million decrease in treaty casualty business and a $29.3 million decrease in facultative business, partially offset by a $118.9 million increase in treaty property business. The International operation increased 2.8% ($18.9 million), resulting primarily from a $75.0 million increase in Asian business, partially offset by a $43.6 million decrease in international business written through the Miami and New Jersey offices, representing primarily Latin American business and an $11.3 million decrease in Canadian business.
Ceded premiums decreased to $944.2 million in 2005 from $1,027.7 million in 2004, principally resulting from the decrease in gross written premiums in the U.S. Insurance operation. Ceded premiums relate primarily to quota share reinsurance agreements between Everest Re and Bermuda Re and Everest International.
Premium Revenues. Net premiums earned decreased by 10.5% to $2,426.1 million in 2005 from $2,710.3 million in 2004. Contributing to this decrease was a 37.0% ($132.1 million) decrease in the Specialty Underwriting operation, a 12.3% ($89.9 million) decrease in the U.S. Insurance operation and a 6.5% ($74.9 million) decrease in the U.S. Reinsurance operation, partially offset by a 2.6% ($12.4 million) increase in the International operation. Additional premiums, related to catastrophe business included in net earned premiums, were $52.5 million for 2005 of which $40.5 million were due to Hurricanes Katrina and Wilma. Generally, catastrophe reinsurance provides coverage for one event; however, when limits are exhausted some contractual arrangements provide for the availability of additional coverage upon the payment of additional premium. There were no such additional premiums for 2004. All of there changes reflect period to period changes in net written premiums and business mix, together with normal variability in earnings patterns. Business mix changes occur not only as the Company shifts emphasis between products, lines of business, distribution channels and markets, but also as individual contracts renew or non-renew, almost always with changes in coverage, structure, prices and/or terms, and as new contracts are accepted with coverages, structures, prices and/or terms different from those of expiring contracts. As premium reporting, earnings, loss and commission characteristics derive from the provisions of individual contracts, the continuous turnover of individual contracts, arising from both strategic shifts and day to day underwriting, results in appreciable background variability in various underwriting line items. Changes in estimates related to the reporting patterns of ceding companies also affect premiums earned.
Incurred Losses and LAE. The Company’s losses and LAE reserves reflect estimates of ultimate claim liability. Such estimates are regularly re-evaluated including re-estimates of prior period reserves, taking into consideration all available information and in particular, newly reported loss and claim experience. The effect of such re-evaluations impacts incurred losses for the period in which the adjustment was made.
The Company’s loss ratio, which is calculated by dividing incurred losses and LAE by current year net premiums earned, increased by 15.0 points to 90.8% in 2005 from 75.8% in 2004. This 15.0 point year over year loss ratio deterioration was primarily the result of 25.6 point increase due to catastrophe losses, partially offset by 13.7 point improvement in attritional prior years reserve development.
Net favorable prior years reserve adjustments for the year ended December 31, 2005 were $67.3 million compared to net unfavorable prior years reserve adjustments of $174.2 million in 2004. For the year ended December 31, 2005, the favorable reserve adjustments included net favorable attritional reserve adjustments of $156.3 million related primarily to property business classes, partially offset by net unfavorable prior years catastrophe adjustments of $77.6 million related primarily to the 2004 hurricanes and net unfavorable A&E
Aggregate reserve development related to A&E exposures was $11.5 million and $10.3 million for the years ended December 31, 2005 and 2004, respectively. The Company has A&E exposure related to contracts written by the Company prior to 1986 and to claim obligations acquired as part of the Mt. McKinley acquisition in September 2000. The reserve strengthening on business written by the Company, net of reinsurance, was $ 11.5 million. Substantially all of the Company’s A&E exposures relate to insurance and reinsurance contacts with coverage periods prior to 1986. Given the uncertainties surrounding the settlement of A&E losses, management is unable to establish a meaningful range for these obligations.
The following table shows the U.S. Reinsurance segment components of incurred losses and LAE for 2005 and 2004:
The following table shows the U.S. Insurance segment components of incurred losses and LAE for 2005 and 2004:
The U.S. Insurance segment’s incurred losses and LAE decreased 23.2%, or $125.4 million, for 2005 as compared to 2004. The segment’s loss ratio improved by 9.2 points from 2004 primarily due to favorable prior years adjustments in 2005 principally on the California workers’ compensation for the 2004 accident year as the results of the benefit reform have become clearer, whereas the unfavorable prior years reserve adjustments in 2004 related principally to the casualty classes for accident years 2000 through 2002, where the Company strengthened its reserves for California workers’ compensation insurance. While management believes the cumulative results through 2005 remain quite positive, there was some deterioration in claim frequency and severity related to accident years 2001 and 2002.
The International segment’s incurred losses and LAE increased 29.3%, or $92.8 million, for 2005 as compared to 2004. The segment’s loss ratio increased by 17.4 points over 2004 period, primarily reflective of the significant property catastrophe losses in 2005 and development on prior years’ catastrophes, partially offset by an improvement in attritional prior years reserves on the Canadian, Asian and international business.
The following table shows the combined ratios for each of the Company’s operating segments in 2005 and 2004. The segment combined ratios were impacted by the loss and expense ratio variability noted above.
Investment Results. Net investment income decreased 1.2% to $325.2 million in 2005 from $329.2 million in 2004, primarily reflecting lower returns from equity investments in limited partnerships. Investable assets increased by $0.4 billion to $7.9 billion in 2005, principally reflecting the effects of investing cash flow from operations during the year, partially offset by the repayment of $250.0 million of senior debt. Investment income for the limited partnerships for the years ended December 31, 2005 and 2004 was $7.5 million and $36.3 million, respectively.
Corporate, Non-allocated Expenses. Corporate underwriting expenses not allocated to segments were $6.2 million for 2005 as compared to corporate income of $2.0 million for 2004, as the Company expanded its infrastructure to support operations and incurred a one time expense of $1.5 million related to the transfer of the UK branch to Bermuda Re.
Net Income. Net income was $4.7 million in 2005 compared to net income of $175.5 million in 2004, primarily reflecting reduced underwriting profitability due to catastrophe losses, partially offset by favorable prior period reserve development and related tax benefits.