In addition, certain former employees have received benefit type guarantees, not formally a part of any established plan. The liability recorded with respect to these agreements as at December 31, 2008 and 2007 was $3.4 million and $5.5 million, respectively, representing the entire unfunded projected benefit obligations.
A contributory defined benefit pension plan exists in the U.K., but has been closed to new entrants since 1996. The Scheme has approximately 110 members, of whom approximately 70 are active or deferred members of the Scheme. Benefits are based on length of service and compensation as defined in the Trust Deed and Rules, and the Plan is subject to triennial funding valuations, the next of which will be conducted in 2009. Current contribution rates are 19.6% and 3% of pensionable salary for employer and employee respectively.
In addition, during 2003 six members who are still employed by the Company in the U.K. transferred from a defined benefit plan into a defined contribution plan. These employees have a contractual agreement with the Company that provides a “no worse than final salary pension” guarantee in the event that they are employed by the Company until retirement, whereby the Company guarantees to top-up their defined contribution pension to the level of pension that they would have been entitled to receive had they remained in the defined benefit scheme. The pension liability recorded with respect to these individuals was $2.6 million and $3.5 million at December 31, 2008 and 2007, respectively, representing the entire unfunded projected obligation.
The components of the net benefit cost for the years ended December 31, 2008 and 2007 are as follows:
In 2006, the Company paid dividends of $40.3 million, respectively, to Series A and Series B preference shareholders.
The income tax provisions for the years ended December 31, 2008, 2007 and 2006 are as follows:
Significant components of the Company’s deferred tax assets and liabilities as of December 31, 2008 and 2007 were as follows:
The valuation allowance at December 31, 2008 and December 31, 2007 of $551.6 million and $370.5 million, respectively, related to net operating loss carry forwards in Switzerland and net unrealized capital losses and realized capital loss carry forwards in the U.S. that may not be realized within a reasonable period. As of December 31, 2008, the Company had recorded a deferred tax asset in respect of net unrealized capital losses and realized capital loss carry forwards of approximately $134.6 million and $196.3 million respectively in the U.S., against which a valuation allowance of approximately $327.4 million was established. Included within the capitalized realized losses are $173.7 million of losses arising from the sale of investments to a group company, against which a valuation allowance of $173.7 million has been established. These losses cannot be utilized to offset any future U.S. realized capital gains until the underlying assets have been sold to unrelated parties. Management believes it is more likely than not that the tax benefit of the remaining net deferred tax assets will be realized.
Management is required to determine if there is sufficient positive evidence to conclude that it is more likely than not that the deferred tax asset attributable to its U.K. group net operating losses would be utilized within a reasonable period. Management has reviewed historical taxable income and future taxable income projections for its U.K. group and has determined that in its judgment, the net operating losses will more likely than not be realized as reductions of future taxable income within a reasonable period. Specifically with regard to the U.K. group, management has determined that the projected U.K. group taxable income (using U.K. rules for group loss relief) will be sufficient to utilize the net operating losses of approximately $247.9 million. Management will continue to evaluate income generated in future periods by the U.K. group in determining the reasonableness of its position. If management determines that future income generated by the U.K. group is insufficient to cause the realization of the net operating losses within a reasonable period, a valuation allowance would be required for the U.K. portion of the net deferred tax asset, in the amount of $69.4 million.
In early July, the Insurance Amendment Act of 2008 was passed, which introduced a number of changes to the Bermuda Insurance Act 1978, such as allowing the Bermuda Monetary Authority (BMA) to prescribe standards for an enhanced capital requirement and a capital and solvency return that insurers and
reinsurers must comply with. The Bermuda Solvency Capital Requirement (BSCR) employs a standard mathematical model that can relate more accurately the risks taken on by (re)insurers to the capital that is dedicated to their business. (Re)insurers may adopt the BSCR model or, where an insurer or reinsurer believes that its own internal model better reflects the inherent risk of its business, an in-house model approved by the BMA. Class 4 (re)insurers, such as the Company, were required to implement the new capital requirements under the BSCR model beginning with fiscal years ending on or after December 31, 2008. The Company’s capital requirements under the BSCR are highlighted in the table above. In addition to the BSCR based requirements, the BMA also prescribes minimum liquidity standards which must be met.
Under the Insurance Act 1978, amendments thereto and Related Regulations of Bermuda, the Company’s Bermuda subsidiaries, XL Re Ltd. Bermuda and XL Insurance Ltd. Bermuda, are restricted as to the payment of dividends for amounts greater than 25% of their prior year’s statutory capital and surplus whereby a signed affidavit by at least two members of the Board of Directors attesting that a dividend in excess of this amount would not cause the company to fail to meet its relevant margins is required. At December 31, 2008 and 2007, the maximum dividend that the Bermuda operating entities could pay, without a signed affidavit, having met minimum levels of statutory capital and surplus and liquidity requirements, was approximately $2.3 billion and $3.1 billion, respectively.
Unless permitted by the New York Superintendent of Insurance, the Company’s lead property and casualty subsidiary in the United States (“XLRA”) may not pay dividends to shareholders which in any twelve month period exceed the lesser of 10 percent of XLRA’s statutory policyholders’ surplus or 100 percent of its “adjusted net investment income,” as defined. The New York State insurance law also provides that any distribution that is a dividend may only be paid out of statutory earned surplus. At December 31, 2008 and 2007, XLRA had statutory earned surplus of $287.8 million and $91.3 million, respectively. At December 31, 2008, XLRA’s statutory policyholders’ surplus was $2.3 billion, and accordingly, the maximum amount of dividends XLRA can declare and pay in 2009, without prior regulatory approval, is $231.9 million. At December 31, 2008, one of the seven property and casualty subsidiaries directly or indirectly owned by XLRA had a statutory earned deficit of $5.8 million and three of the seven subsidiaries had statutory earned deficits ranging from $1.7 million to $21.5 million at December 31, 2007.
In addition to maintaining adequate levels of statutory capital at its principal operating subsidiaries, the Company’s ability to underwrite business is dependent upon the quality of its principal operating subsidiaries’ claims and financial strength ratings as evaluated by independent rating agencies. Should the principal operating subsidiaries be downgraded by two notches by these rating agencies the principal
operating subsidiaries could potentially be required to return premiums to cedents, post cash collateral, and in certain limited instances return cash or assets to counterparties. Such a downgrade (or potential downgrade) in the principal operating subsidiaries’ financial strength and credit ratings could materially and negatively impact the Company’s business, financial condition, results of operations and/or liquidity. Key determinants for financial strength and credit ratings are capital adequacy, liquidity and risk management.
In the normal course of business, the Company enters into certain quota share reinsurance contracts with a subsidiary of one of its other strategic affiliates, ARX Holding Corporation. During the year ended December 31, 2008, these contracts resulted in reported net premiums of $60.1 million, net paid claims of $30.0 million and reported acquisition costs of $37.2 million. During the year ended December 31, 2007, these contracts resulted in reported net premiums of $100.7 million, net paid claims of $29.7 million and reported acquisition costs of $52.9 million.
During the fourth quarter of 2007 the Company recorded significant losses related to the overall credit market conditions. These losses included the impairment in the value of the Company’s previous investment in Syncora and its investment in Primus, losses with respect to previous facultative and excess of loss reinsurance agreements with Syncora, and significant net realized losses on investments primarily related to estimated charges for OTTI related primarily to deterioration in structured credit assets during 2007. For details regarding these losses see Note 4 “Syncora Holdings Ltd. (“Syncora”)” and Note 9 “Investments”.