The following table sets forth our selected historical consolidated financial information as of and for the period ended December 31, 2005, and the years ended December 31, 2006 and December 31, 2007. The historical results are not necessarily indicative of results to be expected in any future period. This financial information is derived from our consolidated financial statements included elsewhere in this report. You should read the following selected historical financial information in conjunction with the information contained in this report, including “
We provide a broad range of products and services to the insurance industry. See “Item 1: Business.” We offer our products through our operating subsidiaries domiciled in Bermuda and in the United States. We offer our reinsurance products and insurance risk-sharing products to Tower and its subsidiaries as well as to other small insurance companies located in the United States with surplus of less than $100 million. We also conduct business with other insurance companies that are seeking to efficiently manage their capital as well as limit their concentration of risk in certain geographic areas through our insurance risk-sharing and quota share reinsurance solutions. In addition, we offer our insurance and unbundled insurance company services to program underwriting managers located in the United States. In order to form a close and continuing relationship with our clients or to enable clients to expand their business and therefore the amount of business they do with us, we may on occasion, make strategic investments in some of our clients, including Tower. See “Item a: Business-Strategic Investments, Including Investment in Tower.” We do not currently hold such investments.
see Measurement of Results for definition of non-GAAP measures and reconciliation to GAAP
At December 31, 2007 our total investments and cash and cash equivalents are comprised primarily of fixed maturities (70%), equity securities (6%) and cash (22 %) and an $8.5 million investment in a limited partnership investing primarily in AAA rated municipal bonds. The overall rating of our cash and fixed maturity portfolio is AA and the duration is 2.24 years. As of the filing date of this report, we sold an investment in a fund (classified in “Equity securities”) that had subprime exposure and we sold 3 individual asset backed securities that were backed by subprime home equity loans. We currently do not have subprime or alternative A exposure in our portfolio. The average credit rating of all mortgages held is AAA. We have the ability and intent to hold all fixed maturities, including mortgages until maturity, if necessary. Given the current state of the investment marketplace, we have provided substantial information regarding our portfolio in this section of the report.
Our revenues and underwriting results are impacted by Tower’s growth and loss ratios. We believe that Tower’s ability to grow its direct premiums written through its existing brokerage distribution network, to expand its brokerage distribution to new territories and to make acquisitions, such as Tower’s acquisition of Preserver in April 2007, will affect the magnitude and profitability of the business that will be subject to the arrangements with CastlePoint Insurance Company and that will be ceded to CastlePoint Re. Although we are a new Company, our relationship with Tower provides us with a steady, predictable flow of profitable and seasoned business.
Premiums. Premiums on insurance and reinsurance policies issued by our operating subsidiaries are usually considered short-duration contracts. Accordingly, premium revenue, including direct writings and reinsurance assumed, net of premiums ceded to reinsurers, is recognized as earned in proportion to the amount of insurance protection provided on a pro-rata basis over the terms of the underlying policies with the unearned portion being reported as unearned premium. Prepaid reinsurance premiums represent the unexpired portion of reinsurance premiums ceded.
Premiums written on assumed reinsurance (generally quota share reinsurance) are expected to be written primarily on a “policies attaching” basis and cover losses which attach to the underlying insurance policies written during the terms of the contracts. Premiums earned on a “policies attaching” basis usually extend beyond the calendar year in which the reinsurance contract is written, typically resulting in recognition of premiums earned over a 24 month period; this is because most policies have a term of 12 months, and policies written with an effective date in December, for instance, are not fully earned until December of the following year. We
may also assume premiums on contracts and policies written on a losses occurring basis, generally on catastrophe treaties, which cover losses that occur during the term of the contract or policy, typically 12 months, and the premium is earned evenly over the term.
While we attempt to obtain current assumed premiums written statements from ceding companies, it is common that the most recent month statements are not received on a timely basis from the ceding company. Therefore, assumed premiums written from these ceding companies are estimated for the most recent month or, in some cases, for several months. With respect to CastlePoint Re’s three quota share reinsurance agreements with Tower’s insurance companies, we obtain current quarterly statements and record assumed premiums written from Tower on an actual, rather than estimated, basis. For ceding companies from which we have not received current, monthly statements and therefore must estimate the most recent period’s assumed premiums written, the difference between the estimated assumed premiums written and actual assumed premiums written is reflected in the subsequent accounting period or as soon as the actual assumed premiums written are obtained. For the year ended December 31, 2007, approximately 3% of the assumed written premiums are based on estimates.
In addition to the assumptions disclosed under “-Critical Accounting Policies and Estimates” regarding premium and revenue recognition, data received from Tower has a significant impact on our results of operations. As of December 31, 2007, the premiums assumed from Tower’s contracts were updated to reflect the actual written premiums in 2007 and, therefore, no significant estimates were made. If Tower discloses the impact of any changes in its estimates on its direct book of business, this would affect our results of operations. At that time, we would be required to disclose the affect on our results of operations.
The types of information that we receive from program underwriting agencies, from companies for whom we are providing risk sharing, or from ceding companies generally vary by the type of contract. Our programs and risk-sharing business is either reported at the detail transaction level when our system is being utilized to administer the business, or reported on a monthly basis if the client is utilizing its own system to administer the business. In reinsurance, proportional, or quota share, contracts are typically reported on a monthly or quarterly basis, providing premium and loss activity as estimated by the ceding company. Reporting for excess of loss contracts includes detailed individual claim information, including a description of the loss, confirmation of liability by the cedent and the cedent’s current estimate of the ultimate liability under the claim. Generally, ceding companies are obligated to notify the reinsurer within
We may aggregate similar types of treaties and the claim information provided by our ceding companies or insurance companies with which we do business for analysis purposes by the year in which each treaty is written and the type of business included in the treaties. We also supplement this information with claims and underwriting audits of specific contracts, internally developed pricing trends, as well as loss trend data developed from industry sources. We audit both the underwriting and the claims practices of our ceding companies. As part of our underwriting audits, we seek to confirm that the ceding company is insuring the types of risks and achieving the level of pricing that we assumed in our underwriting of the treaty from that ceding company. As part of our claims audits, we seek to confirm the data accuracy of the claim information that we have received from the ceding company, and learn about changes in case reserving approach by the ceding company and any particular information about specific claims that may have a significant impact on the results reinsured in our treaty with the ceding company.
The reserve methodologies employed by us are dependent on the data that we collect from ceding companies and insurance companies with which we do business. This data primarily consists of loss amounts estimated by the claims adjusters handling the claims, loss payments made by the ceding companies or insurance companies with which we do business, and premiums written and earned reported by the ceding companies and insurance companies with which we do business.
Reserves for losses and loss adjustment expenses are also based in part upon the estimation of losses resulting from catastrophic events. Estimation of the losses and loss
Since we are a recently formed company and have a limited operating history, we do not have sufficient historical experience that reflects how our loss reserves estimates will likely develop. Moreover, past experience of how loss reserves estimates develop may not be indicative of future development of loss reserves estimates.
Investments. In accordance with our investment guidelines, our investments primarily consist of high-grade marketable fixed income securities. We invest a portion of our funds in equity securities (8% at December 31, 2007), including strategic investments that we may make in the insurance companies or program underwriting managers with whom we do business. See Note 4. “Investments” in the notes to our audited financial statements included elsewhere in this report. We do not expect our investment portfolio to include options, warrants, swaps, collars or similar derivative instruments. Also, our portfolio does not contain any direct investments in real estate or mortgage loans.
Impairment of investment securities results in a charge to income when a market decline below cost is deemed to be other-than-temporary. We regularly review our fixed maturity and equity security portfolios to evaluate the necessity of recording impairment losses for other-than-temporary declines in the fair value of investments. In evaluating potential impairment, we consider, among other criteria: the current fair value compared to amortized cost or cost, as appropriate; the length of time the security’s fair value has been below amortized cost or cost; our intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in value; specific credit issues related to the issuer; and current economic conditions.
Reinsurance accounting. We account for reinsurance in conformity with SFAS 113, “Accounting and Reporting for Reinsurance of Short Duration and Long Duration Contracts.” The requirements of this standard involve significant assumptions relating to the amount and timing of expected cash flows, as well as the interpretation of underlying contract terms. All of our ceded and assumed reinsurance meets the criteria in SFAS 113 for treatment as reinsurance. See Note 2 “Summary of Significant Accounting Policies-Premiums Earned and Reinsurance” to our audited financial statements included elsewhere in this report for a discussion of the related accounting policies.
Deferred taxes. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the
enactment date. See Note 9 “Taxation” to our audited financial statements included elsewhere in this report for a discussion of the related accounting policies.
The net deferred tax asset at December 31, 2007 was $7.1 million, which was comprised of a deferred tax asset of $16.2 million (primarily consisting of deferred taxes on 20% of the change in the unearned premium reserve and the non-utilization of the net operating loss carryforwards) offset by a deferred tax liability of $9.1 million (primarily consisting of the deferred tax on the deferred acquisition costs). In assessing the valuation of deferred tax assets, we consider whether it is more likely than not that some portion or all the deferred tax will be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income to offset previous operating losses during periods in which temporary differences become deductible. Our management currently believes that we will recover all of the deferred tax assets based primarily upon future profitability of our U.S. operations. In the future, if our U.S. subsidiaries do not generate taxable income, we would be required to write off the deferred tax asset by charging income in the year it is deemed that the generation of such income is not likely. If, at December 31, 2007, we deemed that the generation of future profits in our U.S. subsidiaries was not likely, we would have recorded a valuation allowance against the deferred tax asset and net income would have been reduced by $7.1 million.
Unpaid losses and loss adjustment expenses recoverable. Ceded losses recoverable from reinsurers is estimated using techniques and assumptions consistent with those used in estimating the liability for losses and loss adjustment expenses, and represent management’s best estimate of such amounts. However, as changes in the estimated ultimate liability for losses and loss adjustment expenses are determined, the estimated ultimate amount recoverable from reinsurers will also change. Accordingly, the ultimate recoverable could be significantly in excess of or less than the amount indicated in the consolidated financial statements, and adjustments to these estimates are reflected in current operations. See Note 2 “Summary of Significant Accounting Policies-Liability for Loss and Loss Adjustment Expense” to our audited financial statements included elsewhere in this report for a discussion of the related accounting policies.
Managed Premiums. We use managed premiums to measure the total amount of business which we produce. Managed premiums include gross written premiums in CastlePoint Insurance and CastlePoint Reinsurance companies plus program and risk sharing gross written premiums generated by CastlePoint Management that is written directly in other companies, e.g. Tower, and excluding all intercompany reinsurance.
Loss ratio. The loss ratio is the ratio of losses and loss adjustment expenses incurred to premiums earned and measures the underwriting profitability of our insurance and reinsurance business after the effect of any ceded reinsurance.
Combined ratio. We use the combined ratio to measure our underwriting performance. The combined ratio is the sum of the loss ratio and the underwriting expense ratio. We analyze the combined ratio on a gross (before the effect of reinsurance) and net basis (after the effect of reinsurance). If the combined ratio is at or above 100%, we are not underwriting profitably and may not be profitable unless investment income is sufficient to offset underwriting losses.
Consolidated combined ratio. One of our key measures of profitability is what we refer to as our consolidated combined ratio, which is calculated by dividing (i) the total expenses (excluding interest expenses) minus commission income by (ii) net premiums earned.
Net income and return on average equity. We use net income to measure our profits and return on average equity to measure our effectiveness in utilizing our shareholders’ equity to generate net income on a consolidated basis. In determining return on average equity for a given year, net income is divided by the average of shareholders’ equity for that year.
Operating net income, operating earnings per share, and operating return on average equity. Each of these terms exclude realized and unrealized gains and losses, and if subject to U.S. taxation, tax at a rate of 35%. This is a common measurement for property and casualty insurance companies. We believe this presentation enhances the understanding of our results of operations by highlighting the underlying profitability of our insurance business. Additionally, these measures are a key internal management performance standard.
The following table provides a reconciliation of operating net income to net income on a GAAP basis. The operating net income is used to calculate operating earnings per share and operating return on average equity.
We also calculate our loss and expense ratios, underwriting expense ratios and combined ratios by segment. See “-Insurance Segment Results of Operations,” “-Reinsurance Segment Results of Operations” and “-Insurance Services Segment Results of Operations” below.
CastlePoint Re commenced writing business as of April 6, 2006. Therefore, the results for the year ended December 31, 2006 are comprised of operations for the period April 6, 2006 through December 31, 2006. CastlePoint Insurance Company did not conduct any business in 2006.
The business assumed by CastlePoint Re and CastlePoint Insurance Company under our reinsurance agreements with Tower’s insurance companies and the business written directly using CastlePoint Insurance Company’s policies through Tower Risk Management represented 79.3% of net premiums earned for the year ended December 31, 2007 compared to 96.2% of net premiums earned for the year ended December 31, 2006.
Commission income. Commission income increased 219.3% to $7.5 million for the year ended December 31, 2007 compared to $2.3 million for the year ended December 31, 2006. We received this commission income from Tower and to a lesser extent from other companies as a result of CastlePoint Management’s management of the specialty and traditional programs. The higher fees are the result of binding three additional programs in 2007.
Net investment income and realized gains/(losses). Net investment income increased by 163.8% to $29.5 million for the year ended December 31, 2007 compared to $11.2 million for the year ended December 31, 2006. The growth resulted from an increase in cash and invested assets to $693.5 million as of December 31, 2007 compared to $425.0 million as of December 31, 2006. The increase in invested assets primarily resulted from our cash flow from operations, principally from growth in premiums written, which was $140.7 million in 2007 compared with $62.6 million in 2006 and the proceeds of approximately $114.5 million, from our IPO, in March 2007 after the deduction of underwriting discounts and other offering expenses and $30 million of cash received for the issuance of subordinated debentures in connection with the trust
Loss and loss adjustment expenses. Loss and loss adjustment expenses increased 220.7% to $131.3 million, which produced a 52.9% loss ratio for the year ended December 31, 2007 compared to $41.0 million which produced a 51.9% loss ratio for the year ended December 31, 2006. The 2007 calendar year loss ratio includes an accident year loss ratio of 53.4% and reflects $1.3 million of favorable revised estimates in loss reserves from the prior year. The change in prior year loss reserves resulted mainly from a reduction in the estimated ultimate losses on the Tower brokerage quota share reinsurance agreement and, to a lesser extent, a reduction in the estimated ultimate losses on various excess of loss reinsurance agreements assumed from Tower.
Expenses. Operating expenses increased 163.4% to $109.5 million for the year ended December 31, 2007, from $41.6 million for the year ended December 31, 2006. Operating expenses are comprised of commission expense and other operating expenses, including corporate expenses (primarily, salaries, audit, legal services and insurance expenses). The increase was due primarily to the increase in commission and other acquisition expenses resulting from the growth in premiums earned. In 2006 we recorded an expense of $4.6 million relating to warrants to purchase 1,127,000 of our common shares that we issued to Tower.
Income tax benefit. Our income tax benefit was $5.9 million for the year ended December 31, 2007 compared to $1.1 million for the year ended December 31, 2006. The effective income tax rate was negative 21.8% for the year ended December 31, 2007 compared to negative 11.6% for the same period in 2006. The realized loss of $8.2 million (including $9.0 million of impairment losses) and our equity share of the unrealized loss of $2.2 million on the limited
Consolidated combined ratio. Our consolidated combined ratio for the year ended December 31, 2007 was 93.9% compared to 101.5% for the same period in 2006. The improved combined ratio in 2007 was primarily the result of a lower underwriting expense ratio of 41.1% in 2007 compared with 49.6% in 2006. The improvement is the result of increased earned premiums in 2007 due to an increased amount of business written in 2007, as well as higher earned premiums from business written in 2006.
The following table summarizes the results of operations for our insurance operations for the year ended December 31, 2007. The insurance segment did not conduct any business and did not have any premium income, obligations relating to insurance policies, employees and operations for the year ended December 31, 2006.
Gross and net loss and loss adjustment expenses and loss ratio. Gross loss and loss adjustment expenses were $15.2 million, which produced a 60.7% gross loss ratio for the year ended December 31, 2007. Net loss and loss adjustment expenses were $11.8 million, which produced a 61.7% net loss ratio for the year ended December 31, 2007. The net loss ratio was negatively impacted by $2.6 million of ceded catastrophe premium written and earned with a zero percent loss ratio. The level of property catastrophe protection that was purchased was determined based upon our risk guidelines although the level of earned premiums currently is small due to the start-up nature of the segment, such that there was a relatively large impact on the net loss ratio due to the ceded property catastrophe premium.
Summary. The reinsurance segment is comprised of predominantly quota share reinsurance. The segment had excellent results in 2007 driven by a significant increase in premiums written and earned and a net combined ratio of 87.5%. Premiums from Tower represented 74.3%; third parties represented 25.7%. CastlePoint Re assumed 49% of Tower’s brokerage business for the first quarter of 2007 and 40% for the remainder of the year. The net loss ratio of 52.1% benefited by 0.5 points of favorable loss development of $1.3 million on prior accident years. The net expense ratio of 35.4% reflects ceding commissions of 36% to Tower and to clients other than Tower. Ceding commission includes profit-sharing commissions that are based upon loss ratios, and for Tower’s business the ceding commission was comprised of 34% ceding commission plus 2% profit-sharing commission.
regional insurance companies to full- service program underwriting managers. The non-standard auto business is comprised of minimum limits business written in the southeast, southwest and western United States. CastlePoint’s 2007 workers compensation clients emanate from two small insurance companies targeting small commercial businesses primarily located in the southeastern and midwestern United States.
Direct commission expense. Direct commission expense increased 269.4% to $6.2 million for the year ended December 31, 2007 from $1.7 million for the year ended December 31, 2006 due to the addition of three new programs. The increase in commission expense was greater than the increase in commission revenue due to the fact that commission expense can and will vary by program, whereas commission revenue is fixed at 30%. Direct commission expense consisted of the commission fees paid by us to producing agents for the placement of program business. Commission expenses can and will vary depending on such factors as loss ratio and underwriting systems used by producing agents.
Other insurance services expenses. Other insurance services expenses were $6.7 million for the year ended December 31, 2007 compared to $3.6 million for the same period in 2006. The increase was due primarily to the increase in expenses resulting from additional staffing, facility expenses and depreciation expense. Included in the amount above were $1.2 million for the year ended December 31, 2007, and $0.8 million for the year ended December 31, 2006, of costs incurred and charged by Tower’s insurance companies for services provided to us.
these obligations will come primarily from dividend payments from our operating subsidiaries; however, there are restrictions on the payment of dividends by our insurance subsidiaries.
Dividends and other permitted distributions from our operating subsidiaries are our sole source of funds to pay dividends to shareholders and meet ongoing cash requirements, including debt service payments, if any, and other expenses. Bermuda law and regulations, including, but not limited to, Bermuda insurance regulations, restrict the declaration and payment of dividends and the making of distributions by CastlePoint Re, unless specific regulatory requirements are met. In addition, CastlePoint Insurance Company is, and any other U.S. licensed insurance companies that we may acquire or form and capitalize will be subject to significant regulatory restrictions limiting their ability to declare and pay dividends. Furthermore, any dividends paid by CastlePoint Insurance Company or such other U.S. licensed insurance companies will be subject to a 30% withholding tax. Therefore, we intend that any dividends or other permitted distributions we expect to receive will be paid or otherwise made by CastlePoint Re, which is subject to Bermuda regulatory restrictions and any applicable contractual restrictions on any such payments. If we cannot receive dividends or other permitted distributions from our subsidiaries as a result of such restrictions, we will be unable to pay dividends as currently contemplated by our board of directors. However, cash and invested assets at CastlePoint Bermuda Holdings at December 31, 2007, currently available to pay dividends to CastlePoint Holdings, was $74.4 million.
We have historically paid an annual cash dividend of $0.10 per common share to our shareholders of record, payable on a quarterly basis. Any future determination to pay dividends is at the discretion of our board of directors and is dependent upon our results of operations and cash flows, our financial position and capital requirements, general business conditions, legal, tax, regulatory, rating agency and any contractual restrictions on the payment of dividends and any other factors our board of directors deems relevant, including Bermuda and U.S. state legal and regulatory constraints.
Under the Insurance Act of 1978, as amended (the “Insurance Act”), CastlePoint Re is required to maintain a specified solvency margin and a minimum liquidity ratio and is prohibited from declaring or paying any dividends if doing so would cause CastlePoint Re to fail to meet its solvency margin and its minimum liquidity ratio. Under the Insurance Act, CastlePoint Re is prohibited from declaring or paying dividends without the approval of the Bermuda Monetary Authority, if CastlePoint Re failed to meet its solvency margin and minimum liquidity ratio on the last day of the previous fiscal year. Under the Insurance Act, CastlePoint Re is prohibited, without the approval of the BMA, from reducing by 15% or more its total statutory capital as set forth on its audited statutory financial statements for the previous year.
The primary sources of cash of our operating subsidiaries are net premiums received, investment income and commission income. In addition, we may raise cash from public offerings and from the issuance of debt.
Our principal ongoing consolidated cash requirements are expected to be the capitalization of our existing operating subsidiaries, our operating expenses, our possible acquisition or formation of one or more additional U.S. licensed insurance companies, subject to receipt of regulatory approvals, net cash settlements under insurance risk sharing and reinsurance agreements, payment of losses and loss adjustment expenses, commissions paid to program underwriting managers, ceding commissions to insurance companies including Tower, excise taxes, operating expenses and payments under our service and expense sharing agreements with Tower. In addition, we will need cash to enable us to make strategic investments in some of our clients and potential clients, including Tower, as well as to pay dividends to our shareholders and to service the debt on the subordinated debentures of $103.1 million issued by CastlePoint Management in December 2006, and on the subordinated debentures of $30.9 million issued by CastlePoint Bermuda Holdings in September 2007.
Further, while insurance regulations differ by location, insurers and reinsurers are generally required to maintain certain minimum levels of capital and/or risk-based capital, the calculation of which typically includes numerous factors specified by the respective insurance regulatory authorities and the related insurance regulations. We may acquire or form and capitalize one or more additional U.S. licensed insurance companies in 2008. We anticipate that the purchase price for any additional U.S. licensed insurance companies that we may acquire would consist of the amount to be paid for the value of the target company’s insurance licenses (in our experience, typically no more than $200,000 per state license, depending upon lines of authority) and the amount of its statutory capital and surplus, as well as the value of the business if an ongoing operating insurance company is purchased. See “Item 1: Business-Licensing of U.S. Insurance Companies.”
The net cash flows provided by financing activities for the year ended December 31, 2007 were approximately $140.2 million, which primarily consisted of approximately $114.5 million in net proceeds from the IPO after all offering expenses and net proceeds from the issuance of subordinated debentures of approximately $29.0 million by CastlePoint Bermuda Holdings, less dividends paid to shareholders of $3.6 million, as compared to $357.9 for the year ended December 31, 2006, which primarily consisted of approximately $249.2 million in net proceeds from the private offering, net proceeds from issuance of subordinated debentures of
On March 28, 2007, the Company completed its initial public offering at an initial offering price per share of $14.50, in which (i) the Company sold 8,697,148 shares it registered on its own behalf, and (ii) selling shareholders sold 119,500 shares the Company registered on their behalf. The net proceeds to the Company, after deducting underwriting discounts of approximately $8.5 million and other offering expenses of approximately $3.6 million, were approximately $114 million. The gross proceeds to the selling shareholders were approximately $1.7 million in the aggregate, and net proceeds to the selling shareholders were approximately $1.6 million in the aggregate. The Company did not receive any of the proceeds of the sale by the selling shareholders. As of December 31, 2007, we have used approximately $70.0 million of these net proceeds to further capitalize CastlePoint Re, and we intend to use the remaining proceeds of the initial public offering to either further capitalize CastlePoint Re or capitalize any U.S. licensed insurance companies we may acquire or form in the future, to make strategic acquisitions or investments, or for general corporate purposes.
We or one of our subsidiaries may also enter into an unsecured revolving credit facility and a term loan facility with one or more syndicates of lenders, and we expect to use any such facilities for general corporate purposes, working capital requirements and issuances of letters of credit. We believe that any debt financing or credit facility will require compliance with financial covenants, such as a leverage ratio, a consolidated tangible net worth ratio and maintenance of ratings. Any debt financing or credit facility will likely contain additional covenants that restrict the activities of our operating subsidiaries, such as the incurrence of additional indebtedness and liens and the payment of dividends and other payments. In addition, the terms of any debt financings may require guarantees by CastlePoint Holdings or any of our subsidiaries. We currently have no commitment from any lender with respect to a credit facility. We cannot assure you that we will be able to obtain a credit facility on terms acceptable to us.
We estimate that, as of December 31, 2007 and as of December 31, 2006, CastlePoint Re’s probable maximum loss relating to a one in one hundred year property catastrophe event was approximately $28.2 million and $27 million, respectively, based upon computer modeling techniques utilized by us that are commonly used in the insurance industry. The comparable probable maximum loss for CastlePoint Insurance is estimated to be $15 million at December 31, 2007. As we grow our business, we anticipate that our probable maximum loss will increase.
Additionally, although we currently seek to limit our probable maximum loss to 10% of our policyholders’ surplus, in the event of such a property catastrophe event, we cannot predict what our actual losses would be.
Substantial future increases in inflation could also result in future increases in interest rates, which in turn are likely to result in a decline in the market value of the investment portfolio and produce unrealized losses.
All mortgages are directly held; there are no mortgages held in any funds
The fair value pricing of our fixed maturity and equity securities at December 31, 2007 is generally based on current marks provided by indices and reputable pricing services and, to a lesser extent, established broker-dealers who routinely make a market in the securities being priced. To the best of our management’s knowledge, substantially all of the prices represent observable prices, including similar securities in active markets, identical or similar securities in an inactive market or market corroborated inputs. Our investment managers and the funds in which we have invested have represented to us that no securities have been priced utilizing unobservable inputs.
At December 31, 2007, we held an investment of $8.5 million in a limited partnership that invests in municipal bonds. Approximately 82% of the fund securities are rated AAA and 18% are rated AA. Approximately 64% of the bonds are insured.
At December 31, 2007, we had gross unrealized gains of $4.8 million and gross unrealized losses of $5.9 million. Of the $5.9 million of gross unrealized losses, $1.4 million is attributable to corporate fixed maturities, $2.9 million is attributable to mortgage and asset backed securities, and $1.7 million is attributable to equities.
At December 31, 2007, we recorded charges for other-than-temporary impairments of $9.0 million primarily relating to an investment in a fund, an investment in three asset backed securities backed by subprime credit and in four equity securities.
The unrealized loss on the fund was $7.1 million and was in an unrealized loss position for 7-12 months. The market value at December 31, 2007 was 66% of cost. The fund consists of primarily floating rate mortgage and asset backed securities with 40% of the fund’s assets invested in home equity loans backed by subprime mortgages. The average credit rating of the fund, based on the ratings of the underlying securities, is BBB. We sold our position in the fund on February 1, 2008 and realized a loss of $0.2 million, after recording the other-than-temporary impairment charge at year end.
The unrealized loss on the three ABS backed by subprime credit was $33,000 at year end and were in an unrealized loss position for less than 6 months. They are rated AAA. We have subsequently sold these three securities in February 2008 and recorded a $65,000 realized loss, after recording the other-than-temporary impairment charge at year end.
As further described below, in December 2006 and September 2007, we borrowed $103.1 million and $30.9 million, respectively, the proceeds of which were used for general corporate purposes, including acquisition and capitalization of CastlePoint Insurance Company using the funds generated from the December 2006 borrowing. Also, in December 2006 we made a $40 million investment in Tower’s non-cumulative convertible perpetual preferred stock, all of which was redeemed by Tower in January 2007. We used the proceeds of such redemption to further capitalize CastlePoint Insurance Company. Further, we received approximately $114 million in net proceeds from our initial public offering in March 2007. We utilized $70 million of these proceeds to further capitalize CastlePoint Re, and we are holding the remainder at the holding company level for general corporate purposes.
In November and December 2006, our subsidiary, CastlePoint Management, formed two statutory trusts for the purpose of issuing trust preferred securities to institutional purchasers in transactions not requiring registration under the Securities Act. Additionally, in September 2007, our subsidiary, CastlePoint Bermuda Holdings, formed a statutory trust for the purpose of issuing trust preferred securities to institutional purchasers in transactions not requiring registration under the Securities Act. We own all of the common trust securities of these trusts. On December 1, 2006, the first trust issued $50.0 million of trust preferred securities in a private placement and invested the proceeds thereof and the proceeds from the sale of the common securities of the trust in exchange for approximately $51.5 million of junior subordinated debentures issued by CastlePoint Management. On December 14, 2006, the second trust issued $50.0 million of trust preferred securities in a private placement and invested the proceeds thereof and the proceeds from the sale of the common securities of the trust in exchange for approximately $51.5 million of junior subordinated debentures issued by CastlePoint Management. On September 27, 2007, the third trust issued $30.0 million of trust preferred securities in a private placement and invested the proceeds thereof and the proceeds from the sale of the common securities of the trust in exchange for approximately $30.9 million of junior subordinated debentures issued by CastlePoint Bermuda Holdings.
In 2007 we formed a third Delaware statutory business trust of which CastlePoint Bermuda Holdings owns all of the common trust securities, to facilitate the trust preferred financing completed in September 2007. For additional information, see Note 17 “Debt” to our audited financial statements as of and for the year ended December 31, 2007 included elsewhere in this report.
The following table summarizes our contractual obligations as of December 31, 2007 and the effect those obligations are expected to have on our liquidity in future periods. Changes in our business needs and other factors may cause these estimates to change.
For a description of the terms of the subordinated debentures, see “-Our Liquidity and Capital Resources” above.
2007, CastlePoint Re increased the amount of space at these premises it has been occupying since 2006, with a five-year term of such lease commencing on July 1, 2007. CastlePoint Re’s current sublease arrangement requires monthly payments of $14,599. CastlePoint also leased three residential premises (on behalf of certain of its employees located in Bermuda) on varying terms. CastlePoint Management and CastlePoint Insurance Company currently sublease office space in New York, New York from Tower Insurance Company of New York, at its cost, pursuant to an arrangement covered by the service and expense sharing agreement between these parties. CastlePoint Management currently leases office space in Lisle, Illinois which expires on June 30, 2008.