of Part II of this report for a detailed discussion of the measures used by the Company to evaluate its financial performance.
(2) Operating return on beginning common shareholders’ equity (Operating ROE) is calculated using operating earnings or loss available to common shareholders, as defined above, divided by beginning common shareholders’ equity. The presentation of Operating ROE is a non-GAAP financial measure within the meaning of Regulation G. See Key Financial Measures in Item 7 of Part II of this report for a detailed discussion of the measures used by the Company to evaluate its financial performance.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Successful risk management is the foundation of the Company’s value proposition, with diversification of risks at the core of its risk management strategy. The Company’s ability to succeed in the risk assumption and management business is dependent on its ability to accurately analyze and quantify risk, to understand volatility and how risks aggregate or correlate, and to establish the appropriate capital requirements and limits for the risks assumed. All risks are managed by the Company within an integrated framework of policies and processes that ensure the intelligent and consistent evaluation and valuation of risk, and ultimately provide an appropriate return to shareholders.
The reinsurance markets have historically been highly cyclical in nature. The cycle is driven by competition, the amount of capital and capacity in the industry, loss events and investment returns. The Company’s long-term strategy to generate shareholder value focuses on broad product, asset and geographic diversification of risks, assuming a moderately greater degree of risk than the market average, actively managing its capital across its portfolio and over the duration of the cycle, adding value through underwriting and transactional excellence and achieving superior returns on invested assets in the context of a disciplined risk framework.
The acquisition of Paris Re, combined with a strong net income during 2009, resulted in the Company’s total capital increasing to approximately $8 billion at December 31, 2009. This acquisition provided the Company with enhanced strategic and financial flexibility in a less predictable and more limited growth environment. The Company’s larger premium base allows it to deploy capital to the lines of business and markets with the most attractive risk and return characteristics, and take advantage of opportunities as they arise.
diversification and balance of its portfolio, it will optimize returns. Individual lines of business and markets have their own unique characteristics and are at different stages of the reinsurance pricing cycle at any given point in time. Management believes it has achieved appropriate portfolio diversification by product, geography, line and type of business, length of tail, and distribution channel, and that this diversification, in addition to the financial strength of the Company and its strong global franchise, will help to mitigate cyclical declines in underwriting profitability and to achieve a more stable return over time.
The Company’s capital markets and investment operations, including public and private market investments, experienced a difficult year in 2008, with significant economic fallout resulting from the deterioration of the credit markets which began in 2007. In 2008, the financial markets experienced severe dislocation and unprecedented events, including extreme volatility in foreign exchange markets and worldwide equity markets, significant declines in risk-free interest rates and increases in credit spreads, risk assets under-performing risk-free assets and several financial institutions being subject to government bail-out packages both in the U.S. and Europe. During 2009, the improvements in equity and credit markets contributed to the Company’s return on its investment portfolio significantly outperforming risk-free rates compared to its returns in 2008, which were below risk-free rates. In 2010, the global economy and financial markets continued to improve reflecting rising equity markets. The Company believes that capital market risks managed in a disciplined and measured way will generate positive excess returns to the Company over time.
The Company generates revenue from its substantial and high quality investment portfolio, as well as the investments underlying the funds held - directly managed account. The Company follows prudent investment guidelines through a strategy that seeks to maximize returns while managing investment risk in line with the Company’s overall objectives of earnings stability and long-term book value growth. The Company allocates its invested assets into two categories: liability funds and capital funds. See the discussion of liability funds and capital funds in Financial Condition, Liquidity and Capital Resources. A key challenge for the Company is achieving the right balance between current investment income and total returns (that include price appreciation or depreciation) in changing market conditions. The Company regularly reviews the allocation of investments to asset classes within its investment portfolio and its funds held - directly managed account and allocates investments to those asset classes the Company anticipates will outperform in the near future, subject to limits and guidelines. Similarly, the Company reduces its exposure to risk asset classes where returns are underperforming. The Company may also lengthen or shorten the duration of its fixed income portfolio in anticipation of changes in interest rates, or increase or decrease the amount of credit risk it assumes, depending on credit spreads and anticipated economic conditions. During 2010, the Company took a measured approach to adding risk back into the investment portfolio, by increasing its allocation to equities, and it has shortened the duration of its fixed income portfolio given historically low interest rates and to limit the impact of a potential rise in interest rates.
(2) Operating earnings or loss available to common shareholders is calculated as net income or loss available to common shareholders excluding net realized and unrealized gains or losses on investments, net of tax, net realized gain on purchase of CENts, net of tax, and interest in earnings or losses of equity investments, net of tax, where the Company does not control the investee companies’ activities, and is calculated after preferred dividends. The presentation of operating earnings or loss available to common shareholders is a non-GAAP financial measure within the meaning of Regulation G (see Comment on Non-GAAP Measures below) and is reconciled to the nearest GAAP financial measure below.
(3) Operating return on beginning common shareholders’ equity (Operating ROE) is calculated using operating earnings or loss available to common shareholders, as defined above, divided by beginning common shareholders’ equity. For the year ended December 31, 2009, following the acquisition of Paris Re, Management adjusted Operating ROE to be the sum of the results for the nine months ended September 30, 2009 divided by beginning of year common shareholders’ equity plus the results for the three months ended December 31, 2009 divided by beginning of year common shareholders’ equity plus the equity issued related to the acquisition of Paris Re. The presentation of Operating ROE is a non-GAAP financial measure within the meaning of Regulation G (see Comment on Non-GAAP Measures below) and is reconciled to the nearest GAAP financial measure below.
Operating earnings or loss available to common shareholders (Operating Earnings or Loss): Management uses Operating Earnings or Loss to measure its financial performance as this measure focuses on the underlying fundamentals of the Company’s operations by excluding net realized and unrealized gains or losses on investments, net realized gain on purchase of CENts and interest in earnings or losses of equity investments. Net realized and unrealized gains or losses on investments in any particular period and net realized gain on purchase of CENts are not indicative of the performance of, and distort trends in, the Company’s business as they predominantly result from general economic and financial market conditions, and the timing of realized gains or losses on investments is largely opportunistic. Interest in earnings or losses of equity investments are also not indicative of the performance of, or trends in, the Company’s business as the Company does not control the investee companies’ activities. Management believes that the use of Operating Earnings or Loss enables investors and other users of the Company’s financial information to analyze its performance in a manner similar to how Management analyzes performance. Management also believes that this measure follows industry practice and, therefore, allows the users of financial information to compare the Company’s performance with its industry peer group, and that the equity analysts and certain rating agencies which follow the Company, and the insurance industry as a whole, generally exclude these items from their analyses for the same reasons.
Operating Earnings decreased by $427 million in 2010 compared to 2009 primarily due to a decrease in the Non-life underwriting result of $451 million, a decrease in Life underwriting result of $40 million, higher corporate operating expenses of $35 million and various other factors. These factors contributing to a decrease in Operating Earnings were partially offset by a lower tax expense that is attributable to Operating Earnings of $108 million and an increase in net investment income of $77 million. Operating Earnings increased by $463 million in 2009 compared to 2008 primarily due to an increase in the Non-life underwriting result of $456 million and an increase in the Life underwriting result of $39 million, which was partially offset by a higher tax expense that is attributable to Operating Earnings of $47 million. These factors contributing to the increases or decreases in Operating Earnings in 2010 compared to 2009 and in 2009 compared to 2008 are further described in Overview and Review of Net Income below.
Operating ROE decreased from 22.3% in 2009 to 7.1% in 2010 primarily due to a higher beginning common shareholders’ equity balance in 2010 compared to 2009, which also resulted in a reduction in the Company’s premium leverage, and the decrease in Operating Earnings described above. The higher beginning common shareholders’ equity balance in 2010 was due to the increase in the number of shares outstanding following the issuance of shares to acquire Paris Re in the fourth quarter of 2009 and strong net income during 2009. Operating ROE increased from 12.3% in 2008 to 22.3% in 2009 due to the increase in Operating Earnings described above, partially offset by an increase in the number of shares outstanding following the issuance of shares to acquire Paris Re.
Average Operating ROE for the past five years was 18.6%. The 5-year average reflects higher Operating ROE primarily in 2006, 2007 and 2009, which were not impacted by any significant catastrophic losses.
(1) For the year ended December 31, 2009, following the acquisition of Paris Re, Management adjusted the return on beginning common shareholders’ equity to be the sum of the results for the nine months ended September 30, 2009 divided by beginning of year common shareholders’ equity plus the results for the three months ended December 31, 2009 divided by beginning of year common shareholders’ equity plus the equity issued related to the acquisition of Paris Re.
Combined Ratio: The combined ratio is used industry-wide as a measure of underwriting profitability for Non-life business. A combined ratio under 100% indicates underwriting profitability, as the total losses and loss expenses, acquisition costs and other operating expenses are less than the premiums earned on that business. While an important metric of underwriting profitability, the combined ratio does not reflect all components of profitability, as it does not recognize the impact of interest income earned on premiums between the time premiums are received and the time loss payments are ultimately made to clients. The key challenges in managing the combined ratio metric consist of (i) focusing on underwriting profitable business even in the weaker part of the reinsurance cycle, as opposed to growing the book of business at the cost of profitability, (ii) diversifying the portfolio to achieve a good balance of business, with the expectation that underwriting losses in certain lines or markets may potentially be offset by underwriting profits in other lines or markets, and (iii) maintaining control over expenses.
Company’s Operating ROE. Consequently, Management closely monitors its capital needs and capital level throughout the cycle and in times of volatility and turmoil in global capital markets, and actively takes steps to increase or decrease the Company’s capital in order to achieve the proper balance of financial strength and shareholder returns. Capital management is achieved by either deploying capital to fund attractive business opportunities, or in times of excess capital and times when business opportunities are not so attractive, returning capital to shareholders by way of share repurchases and dividends. During 2010, the Company repurchased 14 million of its common shares for a total cost of $1.1 billion. In addition, the Company increased the quarterly dividends on its common shares by 17% during the year, from $0.47 per share for the three months ended December 31, 2009, to $0.55 per share for the three months ended December 31, 2010.
Strategic risks are managed by Executive Management and include the direction and governance of the Company, as well as its response to key external factors faced by the reinsurance industry.
The Company manages assumed risk at a strategic level through diversification, risk appetite, and limits. For each key risk, the Board approves a risk appetite that the Company defines as the percentage of economic capital the Company is willing to expose to economic loss with a modeled probability of occurring once every 15 years and once every 75 years. The Company manages its exposure to key risks such that the modeled economic loss at a 1 in 15 year and a 1 in 75 year return period are less than the economic capital the Company is willing to expose to the key risks at those return periods. In addition, the Risk and Finance Committee of the Board approves aggregate risk limits for the key risks.
The Company’s risk limits are stated as explicit numerical expressions, such as total aggregate limits in a catastrophe zone, earned premium for casualty business, the market value of equity and equity-like securities and an extreme scenario for longevity business. Executive and Business Unit Management set additional specific and aggregate risk limits within the limits approved by the Risk and Finance Committee. The actual level of risk is dependent on current market conditions and the need for balance in the Company’s portfolio of risks. On a quarterly basis, Management reviews and reports to the Board the actual utilization of limits against approved limits and modeled economic loss against approved appetite for the key risks.
In July 1997, the Company completed the acquisition of SAFR (subsequently renamed PartnerRe SA), and in December 1998, the Company completed the acquisition of the reinsurance operations of Winterthur Group (Winterthur Re).
The Company’s Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States (U.S. GAAP). The Consolidated Financial Statements include the accounts of the Company and its subsidiaries. Intercompany accounts and transactions have been eliminated. To facilitate comparison of information across periods, certain reclassifications have been made to prior year amounts to conform to the current year’s presentation.
sheet dates. The resulting foreign exchange gains or losses are included in net foreign exchange gains and losses in the Consolidated Statements of Operations. The Company also records realized and unrealized foreign exchange gains and losses on certain hedged items in net foreign exchange gains and losses in the Consolidated Statements of Operations (see Note 2(n)).
The Company has entered into total return and interest rate swaps. Margins related to these swaps are included in other income or loss in the Consolidated Statements of Operations and any changes in the fair value of the swaps are included in net realized and unrealized investment gains and losses in the Consolidated Statements of Operations.
Common shares repurchased by the Company and not cancelled are classified as treasury shares, and are recorded at cost. This results in a reduction of shareholders’ equity in the Consolidated Balance Sheets. When shares are reissued from treasury, the Company uses the average cost method to determine the cost of the reissued shares. Gains on sales of treasury shares are credited to additional paid-in capital, while losses are charged to additional paid-in capital to the extent that previous net gains from sales of treasury shares are included therein, otherwise losses are charged to retained earnings.
The Company currently uses five types of share-based compensation: share options, restricted shares (RS), restricted share units (RSUs), share-settled share appreciation rights (SSARs) and shares issued under the Company’s employee share purchase plans.
The Company also has three indirect wholly-owned subsidiaries, PartnerRe Finance A LLC, PartnerRe Finance B LLC and PartnerRe Finance II Inc., that are considered to be VIEs, which were utilized to issue the Company’s Senior Notes and Capital Efficient Notes (CENts). The Company determined that it was not the primary beneficiary of any of these VIEs as of December 31, 2010. As a result, the Company has not consolidated PartnerRe Finance A LLC, PartnerRe Finance B LLC and PartnerRe Finance II Inc., and has reflected the debt issued by the Company related to the Senior Notes and CENts as liabilities in the Consolidated Balance Sheets (see Note 11). The interest on the debt related to the Senior Notes and CENts is reported as interest expense in the Consolidated Statements of Operations.
In January 2010, the FASB issued new accounting guidance which requires the Company to disclose additional information about its fair value measurements at a greater level of disaggregation related to Level 3 activity, which will be effective for interim and annual periods beginning after December 15, 2010.
The Company’s financial instruments that it measures at fair value using Level 1 inputs generally include: equities listed on a major exchange, exchange traded funds and exchange traded derivatives, such as futures and certain weather derivatives, that are actively traded.
The Company’s financial instruments measured at fair value include investments classified as trading securities, certain other invested assets and the segregated investment portfolio underlying the funds held - directly managed account (see Notes 4 and 5). At December 31, 2010 and 2009, the Company’s financial instruments measured at fair value were categorized between Levels 1, 2 and 3 as follows (in thousands of U.S. dollars):
In addition to the investments underlying the funds held - directly managed account held at fair value of $1,542.9 million and $1,830.3 million at December 31, 2010 and 2009, respectively, the funds held - directly managed account also included cash and cash equivalents, carried at fair value, of $129.2 million and $145.4 million, respectively, and accrued investment income of $19.9 million and $25.2 million, respectively. At December 31, 2010 and 2009, the aggregate carrying amounts of items included in the funds held - directly managed account that the Company did not measure at fair value were $80.1 million and $123.9 million, respectively, which primarily related to other assets and liabilities held by Colisée Re related to the underlying business, which are carried at cost (see Note 5).
The following tables are reconciliations of the beginning and ending balances for all financial instruments measured at fair value using Level 3 inputs for the years ended December 31, 2010 and 2009 (in thousands of U.S. dollars):
(a) The Company’s policy is to recognize the transfers between the hierarchy levels at the beginning of the period.
During the year ended December 31, 2010, certain fixed maturities within the investments underlying the funds held - directly managed account with a fair value of $16.9 million were transferred from Level 2 into Level 3. The reclassification into Level 3 consisted of asset-backed securities and residential and commercial mortgage-backed securities. The transfers into Level 3 were the result of the lack of observable market inputs, leading the Company to apply inputs that were not directly observable.
All of the above changes in fair value are included in the Consolidated Statements of Operations under the caption Net realized and unrealized investment gains (losses).
Corporate-Corporate securities consist primarily of U.S. and foreign corporations covering a variety of industries. These securities are generally priced by independent pricing services and brokers. The pricing provider incorporates information including credit spreads, interest rate data and market news into the valuation of each security. The Company generally classifies these securities in Level 2. When a corporate security is inactively traded or the valuation model uses unobservable inputs, the Company classifies the security in Level 3.
Other mortgage-backed securities-Other mortgage-backed securities primarily consist of commercial mortgage-backed securities. These securities are generally priced by independent pricing services and brokers. The pricing provider applies dealer quotes and other available trade information, prepayment speeds, yield curves and credit spreads to the valuation. The Company generally classifies these securities in Level 2. When a commercial mortgage-backed security is inactively traded, or the valuation model uses unobservable inputs, the Company classifies the security in Level 3.
Equity securities include U.S. and foreign common and preferred stocks, exchange traded funds and a foreign bond mutual fund. Equities and exchange traded funds are generally classified in Level 1 as the Company uses prices received from independent pricing sources based on quoted prices in active markets. Equities categorized as Level 3 are generally mutual funds invested in securities other than the common stock of publicly traded companies, where the net asset value is not provided on a daily basis.
The Company’s exchange traded derivatives, such as futures and certain weather derivatives, are generally categorized as Level 1 as their fair values are quoted prices in active markets. The Company’s foreign exchange forward contracts, foreign currency option contracts, equity put and call options, interest rate swaps, and credit default swaps are generally categorized as Level 2 within the fair value hierarchy and are priced by independent pricing services.
the fair value of policy benefits for life and annuity contracts is equal to the cash value available to the policyholder should the policyholder surrender the policy;
the fair value of the Senior Notes was calculated using quoted market prices based on the aggregate principal amount outstanding of $250 million from PartnerRe Finance A LLC at December 31, 2010 and 2009 and $500 million from PartnerRe Finance B LLC at December 31, 2010 (see Note 11);
The carrying values and fair values of the financial instrument liabilities recorded in the Consolidated Balance Sheets as of December 31, 2010 and 2009 were as follows (in thousands of U.S. dollars):
(3) PartnerRe Finance II Inc., the issuer of the CENts, does not meet consolidation requirements under U.S. GAAP. Accordingly, the Company shows the related intercompany debt of $71 million in its Consolidated Balance Sheets at December 31, 2010 and 2009 (see Note 11).
(1) Cost is amortized cost for fixed maturities and short-term investments and cost for equity securities. For investments acquired from Paris Re, cost is based on the fair value at the date of acquisition and subsequently adjusted for amortization of fixed maturities and short-term investments.
The distribution of fixed maturities and short-term investments at December 31, 2010, by contractual maturity date, is shown below (in thousands of U.S. dollars). Actual maturities may differ from contractual maturities because certain borrowers have the right to call or prepay certain obligations with or without call or prepayment penalties.
The change in net unrealized gains on investments, net of applicable taxes, reflected in change in other accumulated comprehensive (loss) income for the years ended December 31, 2010, 2009 and 2008 was $(4.9) million (net of tax of $nil), $8.1 million (net of tax of $nil) and $15.2 million (net of tax benefit of $32.8 million), respectively.
Included within Accounts payable, accrued expenses and other in the Consolidated Balance Sheets at December 31, 2010 and 2009 were amounts of gross payable balances for securities purchased and gross receivable balances for securities sold as follows (in thousands of U.S. dollars):
losses and net investment income related to the underlying investment portfolio in the funds held - directly managed account inure to the benefit of the Company. The Company elected the fair value option as of the Acquisition Date for substantially all of the fixed maturities, short-term investments and certain other invested assets in the segregated investment portfolio underlying the funds held - directly managed account, and accordingly, all changes in the fair value of the segregated investment portfolio underlying the funds held - directly managed account subsequent to the Acquisition Date are recorded in net realized and unrealized investment gains and losses in the Consolidated Statements of Operations.
In addition to the investments underlying the funds held - directly managed account in the above table at December 31, 2010 and 2009, were cash and cash equivalents of $129.2 million and $145.4 million, respectively, other assets and liabilities of $80.0 million and $120.9 million, respectively, and accrued investment income of $19.9 million and $25.2 million, respectively. The other assets and liabilities represent working capital assets held by Colisée Re related to the underlying business.
The distribution of fixed maturities and short-term investments underlying the funds held - directly managed account at December 31, 2010, by contractual maturity date, is shown below (in thousands of U.S. dollars). Actual maturities may differ from contractual maturities because certain borrowers have the right to call or prepay certain obligations with or without call or prepayment penalties.
The components of the net realized and unrealized investment gains (losses) on the funds held - directly managed account for the year ended December 31, 2010 and for the period from October 2, 2009 to December 31, 2009 were as follows (in thousands of U.S. dollars):
The components of net investment income underlying the funds held - directly managed account for the year ended December 31, 2010 and for the period from October 2, 2009 to December 31, 2009 were as follows (in thousands of U.S. dollars):
The Company has entered into total return swaps referencing various project, investments and principal finance obligations. The Company has also entered into interest rate swaps to mitigate the interest rate risk on certain of the total return swaps. The Company may also use other interest rate derivatives to mitigate exposure to interest rate volatility.
The fair values and the related notional values of derivatives included in the Company’s Consolidated Balance Sheets at December 31, 2010 and 2009 were as follows (in thousands of U.S. dollars):
The fair value of all derivatives at December 31, 2010 and 2009 is recorded in Other invested assets in the Company’s Consolidated Balance Sheets. The effective portion of net investment hedging derivatives recognized in accumulated other comprehensive income at December 31, 2010 and 2009 was a loss of $1.2 million and $66.3 million, respectively. The effective portion of interest rate derivatives recognized in accumulated other comprehensive income at December 31, 2009 was a gain of $6.4 million. There were no interest rate derivatives outstanding at December 31, 2010.
The gross carrying value and accumulated amortization of intangible assets by type as of December 31, 2010 and 2009 is as follows (in thousands of U.S. dollars):
The estimated amortization expense for each of the five succeeding fiscal years related to the Company’s definite-lived intangible assets is as follows (in thousands of U.S. dollars):
9. Unpaid Losses and Loss Expenses and Policy Benefits for Life and Annuity Contracts
The table below is a reconciliation of losses and loss expenses including life policy benefits for the years ended December 31, 2010, 2009 and 2008 (in thousands of U.S. dollars):
The following table summarizes the net prior year favorable development of loss reserves for each of the Company’s Non-life sub-segments for the years ended December 31, 2010, 2009 and 2008 (in thousands of U.S. dollars):
For the Catastrophe sub-segment, the Company reported net favorable loss development for prior accident years in 2010, 2009 and 2008. The net favorable loss development in each year was primarily due to favorable loss emergence, as losses reported by cedants for prior accident years were lower than the Company expected.
Ultimate losses for lines impacted by the deteriorating financial condition of the world economies in 2008 and the first half of 2009 cannot be estimated by standard actuarial techniques alone. The majority of the Company’s underwriting exposure related to this issue arises from business written in North America and Global (Non-U.S.) specialty casualty and North America and Global (Non-U.S.) credit/surety lines of business and other potentially exposed classes of business during the underwriting years 2006 through 2009.
The potential ultimate liability for these exposures was evaluated through an analysis of the Company’s exposure to these risks, which include but are not limited to, sub-prime mortgage related exposures. For specialty casualty, the analysis was based on information received from cedants at the time the exposed business was written and supplemented by discussions with cedants, evaluation of known securities class action filings, current industry data regarding the likelihood of securities class actions and other potential suits against companies exposed to the effects of financial stress, estimates of exposed industry premium, estimates of the Company’s market share of exposed industry premium and estimates of industry-wide insured losses. For credit/surety, the analysis was based on information received from cedants both at the time the exposed business was written supplemented by discussions with cedants, historical experience in times of similar financial stress, reported claim information and internal modeling.
The Company’s net reserves for unpaid losses and loss expenses at December 31, 2010 and 2009 included $214 million and $232 million, respectively, that represent estimates of its net ultimate liability for asbestos and environmental claims. The gross liability for such claims at December 31, 2010 and 2009 was $222 million and $239 million, respectively, which primarily relate to Paris Re’s gross liability for asbestos and environmental claims for pre-2006 accident years of $144 million and $159 million, respectively, with any favorable or adverse
The net adverse prior year loss development of $12 million in 2010 was primarily driven by adverse development of $23 million due to an improvement in the mortality trend related to an impaired life annuity treaty in the longevity line and adverse development on certain mortality treaties. This adverse development was partially offset by favorable prior year loss development of $17 million resulting from the guaranteed minimum death benefit (GMDB) business, where the payout is linked to the performance of underlying capital market assets, driven by new cedant information and updated assumptions.
The Company used interest rate assumptions to estimate its liabilities for policy benefits for life and annuity contracts which ranged from 1.0% to 6.0% at December 31, 2010 and 2009.
Net premiums written, net premiums earned and losses and loss expenses and life policy benefits are reported net of reinsurance in the Company’s Consolidated Statements of Operations. Assumed, ceded and net amounts for the years ended December 31, 2010, 2009 and 2008 were as follows (in thousands of U.S. dollars):
In October 2005, the Company entered into a loan agreement with Citibank, N.A., under which the Company borrowed $400 million. The loan had an original maturity of April 27, 2009 and bore interest quarterly at a floating rate of 3-month LIBOR plus 0.50%. In July 2008, under the terms of a loan amendment entered into with Citibank N.A., the maturity of half of the original $400 million loan was extended to July 12, 2010 with interest quarterly at a floating rate of 3-month LIBOR plus 0.50% through April 27, 2009 and at a rate of 3-month LIBOR plus 0.85% thereafter.
On January 14, 2009, the Company elected to repay the first half of the original $400 million loan that was due on April 27, 2009.
The 2010 Senior Notes are ranked as senior unsecured obligations of PartnerRe Finance B. The Company has fully and unconditionally guaranteed all obligations of PartnerRe Finance B under the 2010 Senior Notes. The Company’s obligations under this guarantee are senior and unsecured and rank equally with all other senior unsecured indebtedness of the Company. The proceeds from the 2010 Senior Notes were used for general corporate purposes.
In May 2008, PartnerRe Finance A LLC (PartnerRe Finance A), an indirect wholly-owned subsidiary of the Company, issued $250 million aggregate principal amount of 6.875% Senior Notes (2008 Senior Notes, or collectively with 2010 Senior Notes referred to as Senior Notes). The 2008 Senior Notes will mature on June 1, 2018 and may be redeemed at the option of the issuer, in whole or in part, at any time. Interest on the 2008 Senior Notes is payable semi-annually and commenced on December 1, 2008 at an annual fixed rate of 6.875%, and cannot be deferred.
For the years ended December 31, 2010, 2009 and 2008, the Company incurred interest expense of $17.2 million, $17.2 million and $10.2 million, respectively, and paid interest of $17.2 million, $17.2 million and $8.8 million, respectively, in relation to the 2008 Senior Notes issued by PartnerRe Finance A.
During 2010, the Company repurchased, under its authorized share repurchase program, 14.0 million of its common shares at a total cost of $1,082.6 million, representing an average cost of $77.10 per share. At December 31, 2010, the Company had approximately 6.5 million common shares remaining under its current share repurchase authorization and approximately 14.0 million common shares were held in treasury and are available for reissuance (see Note 24).
In May 2003, the Company issued 11.6 million of 6.75% Series C cumulative redeemable preferred shares (Series C preferred shares) for a total consideration of $280.9 million after underwriting discounts and commissions totaling $9.1 million. The Company may redeem the Series C preferred shares at $25.00 per share plus accrued and unpaid dividends without interest. Dividends on the Series C preferred shares are cumulative from the date of issuance and are payable quarterly in arrears. In the event of liquidation of the Company, the holders of outstanding preferred shares would have preference over the common shareholders and would receive a distribution of $25.00 per share, or an aggregate value of $290 million, plus accrued and unpaid dividends.
The reconciliation of basic and diluted net income per share for the years ended December 31, 2010, 2009 and 2008 is as follows (in thousands of U.S. dollars or shares, except per share amounts):
(2) At December 31, 2010, 2009 and 2008, share options to purchase 489.7 thousand, 387.0 thousand and 870.1 thousand common shares, respectively, were excluded from the calculation of diluted weighted average number of common shares and common share equivalents outstanding because their exercise prices were greater than the average market price of the common shares.
The Company’s ability to pay common and preferred shareholders’ dividends and its corporate expenses is dependent mainly on cash dividends from Partner Reinsurance, PartnerRe Europe and PartnerRe U.S. (collectively, the reinsurance subsidiaries), which are the Company’s most significant subsidiaries. The payment of such dividends by the reinsurance subsidiaries to the Company is limited under Bermuda and Irish laws and certain statutes of various U.S. states in which PartnerRe U.S. is licensed to transact business. The restrictions are generally based on net income and/or certain levels of policyholders’ earned surplus as determined in accordance
The Company is currently under examination in Switzerland for the tax years 2008-2009, in the United States for tax year 2008, in Canada for tax years 2006-2007 and in France for tax years 2008-2009. Income tax returns are open for examination for the tax years 2006-2010 in Switzerland, Canada and Ireland, 2007-2010 in
Income tax expense for the years ended December 31, 2010, 2009 and 2008 was as follows (in thousands of U.S. dollars):
Deferred tax assets and liabilities reflect the tax impact of temporary differences between the carrying amounts of assets and liabilities for financial reporting and income tax purposes. Significant components of the net deferred tax assets and liabilities as of December 31, 2010 and 2009 were as follows (in thousands of U.S. dollars):
Realization of the deferred tax asset is dependent on generating sufficient taxable income in future periods. Although realization is not assured, Management believes that it is more likely than not that the deferred tax asset will be realized. The valuation allowance recorded as of December 31, 2010 related to foreign tax credit carryforwards in Ireland of $17.8 million, with the balance related to certain tax loss carryforwards.
The total amount of unrecognized tax benefits for the years ended December 31, 2010, 2009 and 2008 was as follows (in thousands of U.S. dollars):
The total amount of unrecognized tax benefits for which it is reasonably possible to change within twelve months was $31.1 million at December 31, 2010, which primarily relates to the expected expiration of the statute of limitations related to foreign exchange revaluation and various intra-group transactions in Europe.
Certain awards to certain senior executives will, if the Committee intends such award to qualify as “qualified performance based compensation” under Section 162(m) of the Internal Revenue Code (IRC), become earned and payable only if pre-established targets relating to one or more of the following performance measures are achieved: (i) earnings per share, (ii) financial year return on common equity, (iii) underwriting year return on equity, (iv) return on net assets, (v) organizational objectives, and (vi) premium growth. The individual maximum number of shares underlying any such share-denominated award granted in any year will be 0.8 million shares, and the individual maximum amount earned with respect to any such non-share denominated award granted in any year will be $5.0 million.
The 2003 Non-Employee Directors Stock Plan (Directors’ Stock Plan), which was approved by the Company’s shareholders, permits the grant of up to 0.8 million share options, RS, RSUs, alternative awards and other share-based awards. Under the Directors’ Stock Plan, the exercise price of the share options will be
equivalent to the fair value of the share options at the time of grant. The fair value is defined in the Directors’ Stock Plan as the closing price reported on the grant date. Option awards issued under the Directors’ Stock Plan generally vest at the time of grant and are expensed immediately and have a ten year contractual term. Prior to May 2010, RSU awards issued under the Directors’ Stock Plan generally vested at the time of grant with a delivery date restriction of one year and were expensed immediately. With effect from May 2010, RSUs are awarded on an annual basis and have a five year cliff vest with no delivery restrictions and are expensed over the vesting period. Before the grant date, directors must elect to receive their awards in the form of either 100% RSUs, or split, with 60% of the award being RSUs and 40% of the award being cash upon delivery. At December 31, 2010, 0.2 million shares remained available for issuance under this plan.
The Swiss Share Purchase Plan (SSPP) has two offering periods per year with two purchase periods of six months each. All full-time Swiss employees are eligible to participate in the SSPP and can contribute between 1% and 8% of their base salary toward the purchase of the Company’s shares up to a maximum of 5,000 Swiss francs per annum. Employees who enroll in the SSPP may purchase the Company’s shares at a 40% discount of the fair value on the purchase date. There is a restriction on transfer or sale of these shares for a period of two years following purchase. Participants in the SSPP are eligible to receive dividends on their shares as of the purchase date. A total of 0.2 million common shares may be issued under the SSPP.
Under each of the Company’s equity plans, the Company issues new shares upon the exercise of share options or the conversion of RSUs and SSARs into shares.
The following table summarizes the activity related to options granted and exercised for the years ended December 31, 2010, 2009 and 2008. There were no material tax impacts related to the options exercised by employees of the Company’s U.S. subsidiaries.
The weighted average remaining contractual term and the aggregate intrinsic value of share options outstanding, exercisable, vested and expected to vest at December 31, 2010, was 4.0 years and $36.3 million, respectively.
The expected life of the replacement share options issued as part of the acquisition of Paris Re in 2009 was assumed to be 3 years. The expected life of all other share options issued during the years ended December 31, 2010, 2009 and 2008 was assumed to be 6 years. Expected volatility is based on the historical volatility of the Company’s common shares over a period equivalent to the expected life of the Company’s share options. The risk-free interest rate is based on the market yield of U.S. treasury securities with maturities equivalent to the expected life of the Company’s share options. The dividend yield is based on the average dividend yield of the Company’s shares over the expected life of the Company’s share options.
The activity related to the Company’s RSUs for the year ended December 31, 2010 was as follows:
The RSUs that vested during the years ended December 31, 2010 and 2009 had a fair value of $30.9 million and $9.6 million, respectively.
Total unrecognized share-based compensation expense related to unvested RSUs was approximately $20.1 million at December 31, 2010, which is expected to be recognized over a weighted-average period of 2.0 years.
During the years ended December 31, 2010, 2009 and 2008, the Company issued 450,568 SSARs, 105,344 SSARs, and 339,920 SSARs with a weighted average grant date fair value of $10.45, $8.42 and $11.50, respectively.
Total unrecognized share-based compensation expense related to unvested SSARs was approximately $3.2 million at December 31, 2010, which is expected to be recognized over a weighted-average period of 2.1 years.
In 2009, the Company issued 27,655 replacement warrants as part of the acquisition of Paris Re. At December 31, 2010, 23,263 warrants are outstanding and fully vested with a weighted average remaining contractual life of 6 years and a weighted average exercise price of $36.58. During the year ended December 31, 2010, 4,268 warrants were exercised with a weighted average exercise price of $36.58.
The net periodic benefit cost for the years ended December 31, 2010, 2009 and 2008 were $6.1 million, $6.0 million and $4.1 million, respectively.
The fair values of the Zurich Plan’s assets at December 31, 2010 and 2009 were equity funds (Level 1) of $4.3 million and $4.0 million, respectively, and insured funds and cash (Level 2) of $92.9 million and $77.1 million, respectively. The equity funds are primarily publicly quoted open-end funds that invest in a full replication of European benchmark indices. The insured funds comprise the accumulated pension plan contributions and investment returns thereon, which are held in an insurance arrangement that provides at least a guaranteed minimum investment return. The insured funds are held by a collective foundation of AXA Life Ltd. and are guaranteed under the insurance arrangement.
At December 31, 2010, estimated employer contributions to be paid in 2011 were $6.0 million and future benefit payments were estimated to be paid as follows (in thousands of U.S. dollars):
The Company’s investment portfolio is managed following prudent standards of diversification and a prudent investment philosophy. The Company is not exposed to any significant credit concentration risk on its investments, except for debt securities issued or guaranteed by the U.S. government and other AAA rated sovereign governments. As of December 31, 2010, the Company’s fixed maturity investments included $846
Included in the Company’s Other invested assets are certain notes receivable which meet the definition of financing receivables and are accounted for using the cost method of accounting. These notes receivable are collateralized by commercial or residential property. The Company utilizes a third party consultant to determine the initial investment criteria and to monitor the subsequent performance of the notes receivable. The process undertaken prior to the investment in these notes receivables includes an examination of the potential debtors and the underlying collateral. The Company reviews its receivable positions on at least a quarterly basis using actual redemption experience.
The Company leases office space under operating leases expiring in various years through 2019. The leases are renewable at the option of the lessee under certain circumstances. The following is a schedule of future minimum rental payments, exclusive of escalation clauses, on non-cancelable leases as of December 31, 2010 (in thousands of U.S. dollars):
In April 2010, as part of the Company’s integration of Paris Re, the Company announced a voluntary termination plan (voluntary plan) available to certain eligible employees in France. Employees participating in the voluntary plan have no compulsory notice periods, however, their expected leaving dates are largely through mid 2012.
The Company has entered into strategic investments with unfunded capital commitments totaling $142.1 million through 2016. The Company expects to fund capital commitments of $54.2 million, $47.0 million, $23.0 million, $9.3 million, $4.3 million and $4.3 million during 2011, 2012, 2013, 2014, 2015 and 2016, respectively.
As of December 31, 2010, the Company was not a party to any litigation or arbitration that it believes could have a material adverse effect on the financial condition, results of operations or liquidity of the Company.
On April 28, 2010, under the terms of the amendment to the forward sale agreement with the forward counterparty, the remaining $200 million forward sale agreement matured. Subsequent to maturity and commencing on April 28, 2010, there was a 40 day valuation period, whereby the Company could deliver up to 3.4 million common shares over the valuation period, subject to a minimum price per share of $59.05 and a maximum price per share of $84.15. As a result of the Company’s share price trading between the minimum and the maximum price per share during the valuation period, the Company did not deliver any common shares to the forward counterparty (see Note 12).
On July 16, 2010, the Company terminated its existing $660 million five-year syndicated unsecured credit facility, which had a maturity date of September 30, 2010, and entered into a new $750 million three-year syndicated unsecured credit facility. The new facility has the following terms: (i) a maturity date of July 16, 2013, (ii) a $250 million accordion feature, which enables the Company to potentially increase its available credit from $750 million to $1 billion, and (iii) a minimum consolidated tangible net worth requirement. The Company’s ability to increase its available credit to $1 billion is subject to the agreement of the credit facility participants. The Company’s breach of any of the covenants would result in an event of default, upon which the Company may be required to repay any outstanding borrowings and replace or cash collateralize letters of credit issued under this facility. The Company was in compliance with all of the covenants as of December 31, 2010. The new facility is predominantly used for the issuance of letters of credit, although the Company and its subsidiaries have access to a revolving line of credit of up to $375 million as part of this facility. During the year ended December 31, 2010, there were no borrowings under this revolving line of credit.
On May 14, 2010, the Company entered into an agreement to modify an existing credit facility. Under the terms of the agreement, this credit facility was increased from a $100 million unsecured credit facility to a $250
million combined credit facility, with the initial $100 million being unsecured and any utilization above the initial $100 million being secured. This credit facility matures on May 14, 2011, and can be extended automatically to May 14, 2012.
In addition to the unsecured credit facilities available, the Company maintains two committed secured letter of credit facilities related to business written by Paris Re, with a total amount available of $350 million. The facilities are used for the issuance of letters of credit, which must be secured fully or partially with cash and/or government bonds and/or investment grade bonds. These credit facilities have maturity dates of January 20, 2012, with respect to a $150 million facility, and November 18, 2011, with respect to a $200 million facility. The agreements include default covenants, which could require the Company to fully secure the outstanding letters of credit to the extent that the facility is not already fully secured, and disallow the issuance of any new letters of credit. At December 31, 2010, no conditions of default existed under these facilities.
The Company monitors the performance of its operations in three segments, Non-life, Life and Corporate and Other. The Non-life segment is further divided into four sub-segments: North America, Global (Non-U.S.) P&C, Global (Non-U.S.) Specialty and Catastrophe. Segments and sub-segments represent markets that are reasonably homogeneous in terms of geography, client types, buying patterns, underlying risk patterns and approach to risk management. During the fourth quarter of 2010, the Company redefined its financial reporting segments following the completion of its integration of Paris Re into its other Non-life sub-segments and changes in management responsibilities for certain lines of business and treaties. As a result, segment data for prior periods has been recast to conform to the current year presentation.
Management measures results for the Non-life segment on the basis of the loss ratio, acquisition ratio, technical ratio, other operating expense ratio and combined ratio (defined below). Management measures results for the Non-life sub-segments on the basis of the loss ratio, acquisition ratio and technical ratio. Management measures results for the Life segment on the basis of the allocated underwriting result, which includes revenues from net premiums earned, other income or loss and allocated net investment income for Life, and expenses from life policy benefits, acquisition costs and other operating expenses.
The following tables provide a summary of the segment revenues and results for the years ended December 31, 2010, 2009 and 2008 (in millions of U.S. dollars, except ratios):
The Company produces its business both through brokers and through direct relationships with insurance company clients. None of the Company’s cedants accounted for more than 5% of total gross premiums written during the year ended December 31, 2010 and more than 6% and 7%, respectively, during the years ended December 31, 2009 and 2008.
The Company had two brokers that individually accounted for 10% or more of its gross premiums written during the years ended December 31, 2010, 2009 and 2008. The brokers accounted for 25%, 25%, and 23% and 21%, 19%, and 19% of gross premiums written for the years ended December 31, 2010, 2009 and 2008, respectively.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of PartnerRe Ltd. and subsidiaries as of December 31, 2010 and 2009, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2010, in conformity with accounting principles generally accepted in the United States of America.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2010, based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 28, 2011 expressed an unqualified opinion on the Company’s internal control over financial reporting.