Includes pre-tax net catastrophe costs of $55 million in 2007, $29 million in 2006, $544 million in 2005 and $215 million in 2004. There were no significant catastrophe losses occurring in 2003.
It is possible that TRH’s actual results, financial condition and expected outcomes may differ, possibly materially, from those anticipated in these forward-looking statements. Important factors that could cause TRH’s actual results to differ, possibly materially, from those discussed in the specific forward-looking statements may include, but are not limited to, uncertainties relating to economic conditions and cyclical industry conditions, credit quality, government, regulatory and accounting policies, volatile and unpredictable developments (including natural and man-made catastrophes), the legal environment, legal and regulatory proceedings, the reserving process, the competitive environment in which TRH operates, interest rate and foreign currency exchange rate fluctuations, and the uncertainties inherent in international operations.
These factors are further discussed throughout Management’s Discussion and Analysis of Financial Condition and Results of Operations and in Item 1A. Risk Factors of this Form 10-K. TRH is not under any obligation to (and expressly disclaims any such obligations to) update or alter any forward-looking statement, whether written or oral, that may be made from time to time, whether as a result of new information, future events or otherwise.
The following discussion refers to the consolidated financial statements of TRH as of December 31, 2007 and 2006 and for each of the three years in the period ended December 31, 2007, which are presented elsewhere herein. Financial data discussed below have been affected by certain transactions between TRH and related parties. (See Notes 6, 11, 12, 13 and 15 of Notes to Consolidated Financial Statements.)
The operations of Transatlantic Holdings, Inc. (the “Company”) are conducted principally by its three major operating subsidiaries-Transatlantic Reinsurance Company® (“TRC”), Trans Re Zurich (“TRZ”) and Putnam Reinsurance Company (“Putnam”)-and managed based on its geographic segments. Through its operations on six continents, TRH offers reinsurance capacity on both a treaty and facultative basis-structuring programs for a full range of property and casualty products, with an emphasis on specialty lines, which may exhibit greater volatility of results over time than most other lines. Such capacity is offered through reinsurance brokers and, to a lesser extent, directly to domestic and foreign insurance and reinsurance entities.
American International Group, Inc. (“AIG”), which through its subsidiaries is one of the largest providers of insurance and investment products and services to businesses and individuals around the world, beneficially owned approximately 59% of the Common Stock of the Company (“TRH shares”) as of December 31, 2007, 2006 and 2005. On September 28, 2007, AIG filed an amendment to its Schedule 13D relating to the Company stating, among other things, that it “intends to continuously evaluate their investment in the Company and may acquire or dispose of shares of Common Stock, other securities of the Company, or loans or other interests in the Company.”
Results for 2007 include pre-tax net catastrophe costs of $55 million principally arising from European Windstorm Kyrill and floods in the U.K. Catastrophe costs include losses and related reinstatement premiums, the details of which can be found in Note 9 of Notes to Consolidated Financial Statements (“Note 9”). Reinstatement premiums may arise on both assumed and ceded business as a result of contractual provisions found in certain catastrophe excess-of-loss reinsurance contracts that require additional premiums to be paid in the event of a loss to reinstate coverage for the remaining portion of the contract period. Net assumed (ceded) reinstatement premiums serve to increase (reduce) net premiums written and earned.
While there were no significant catastrophe losses occurring in 2006, the year 2006 includes pre-tax net catastrophe costs of $29 million relating to events which occurred in prior years.
The year 2005 was the worst year ever in recorded history for insured catastrophe losses. In addition, Hurricane Katrina was the largest insured catastrophe loss in reported history. An industry source projected insurance and reinsurance industry costs relating to Hurricane Katrina of approximately $40 billion.
Results for 2005 include pre-tax net catastrophe costs of $544 million, or $354 million after tax, principally arising from Hurricanes Katrina ($304 million on a pre-tax basis), Rita ($44 million on a pre-tax basis) and Wilma ($111 million on a pre-tax basis) and, to a lesser extent, from Central European floods and European Windstorm Erwin. Such catastrophe costs consist of pre-tax net catastrophe losses of $483 million (gross $870 million; ceded $387 million) and net ceded reinstatement premiums of $61 million (gross $72 million; ceded $133 million).
Income before income taxes and net income increased in 2007 as compared to 2006 principally due to increased underwriting profit and net investment income. Net income also benefited from a lower effective tax rate in 2007. The increased underwriting profit in 2007 reflects increased premiums earned and a lower combined ratio. The lower combined ratio reflected decreased net adverse loss reserve development, offset in part by a higher level of catastrophe costs in 2007. Lower net adverse loss reserve development and higher catastrophe costs in 2007 had the impact of improving underwriting profit (loss) in 2007 by $47.7 million compared to 2006. (See Note 16 of Notes to Consolidated Financial Statements for underwriting profit (loss) by segment.)
Underwriting profit (loss) is defined as net premiums earned less net losses and loss adjustment expenses (“LAE”) incurred, net commissions and other underwriting expenses, plus (minus) the increase (decrease) in deferred acquisition costs. (See Operational Review for further discussion.)
The market conditions in which TRH operates have historically been cyclical. For the period under discussion, the reinsurance market has been characterized by significant competition worldwide in most lines of business.
A large amount of capital flowed into the market after the major catastrophe events of 2005 with much of the capital raised going to existing reinsurers. Some of the capital also went to new reinsurance companies that were started in Bermuda in the fourth quarter of 2005. The capital raised by existing reinsurers was not just to replace some of the capital lost in the catastrophe events of 2005, but also to
Given the amount of capital attracted by year-end 2006, catastrophe exposed accounts renewing on January 1, 2007 saw a slowing of upward rate movements on programs. During the second half of 2007, property catastrophe rates began to decline as did the pricing for primary property risks in general. Nevertheless, TRH believes rates for U.S. catastrophe exposed business remained at an attractive level through 2007 and anticipates that will be the case in 2008. Internationally, catastrophe rates in the U.K. and Europe did improve on programs impacted by the storms and floods of 2007, while in other regions, rates exhibited modest downward trends.
Through 2007, casualty lines have experienced steady rate reductions in the insurance markets on a global basis for approximately two years, but reinsurance rates did not experience the same amount of downward pressure. However, the January 2008 renewals did see rates coming under additional strain, but other terms and conditions for casualty business have remained stable. Although casualty rates have generally declined in recent periods, TRH anticipates there will be a large amount of casualty business that will remain attractive throughout 2008.
rating agencies and favorable claims paying record has generally proven to be a competitive advantage. With fewer reinsurers qualified, in the market’s view, to write casualty reinsurance, capacity in these lines may be more restricted and may mitigate somewhat the downward pressure on rates.
Due to the favorable trading conditions for most insurance companies in recent years and strong industry results in 2006 and 2007, many insurance companies’ capitalization is now higher than ever. This factor has had a generally negative effect on pricing and has also caused certain ceding companies to choose to rely less on reinsurance as a form of capital and retain more business-thereby ceding less business to reinsurers. In formulating a reinsurance purchasing strategy, the ceding company will also consider the perceived volatility of the business to be ceded.
Estimates of loss reserves take into account TRH’s assumptions with respect to many factors that will affect ultimate loss costs but are not yet known. The ultimate process by which actual carried reserves are determined considers not only actuarial estimates but a myriad of other factors. Such factors, both internal and external, which contribute to the variability and unpredictability of loss costs, include trends relating to jury awards, social inflation, medical inflation, worldwide economic conditions, tort reforms, court interpretations of coverages, the regulatory environment, underlying policy pricing, terms and conditions and claims handling, among others. In addition, information gathered through underwriting and claims audits are also considered. To the extent that these assumptions underlying the loss reserve estimates are significantly incorrect, ultimate losses may be materially different from the estimates included in the financial statements and may have a material adverse effect on results of operations and financial condition. The impact of those differences is reflected in the period they become known.
techniques frequently have to be supplemented by subjective considerations and managerial judgment. In addition, trends that have affected development of liabilities in the past may not necessarily occur or affect development to the same degree in the future.
While this process is difficult and subjective for ceding companies, the inherent uncertainties of estimating loss reserves are even greater for reinsurers, due primarily to the longer term nature of much reinsurance business, the diversity of development patterns among different types of reinsurance treaties or facultative contracts, the necessary reliance on the ceding companies for information regarding reported claims and differing reserving practices among ceding companies, which are subject to change without notice. Nevertheless, data received from cedants is subjected to audits periodically by TRH claims and underwriting personnel, to help ensure that reported data is supported by proper documentation and conforms to contract terms, and analyzed, as appropriate, by TRH underwriting and actuarial personnel. Such analysis often includes a detailed review of reported data to assess the underwriting results of reinsurance assumed and to explain any significant departures from expected performance. Over time, reported loss information is ultimately corroborated when such information eventually attains paid status.
The methodologies that TRH employed in 2007 and 2006 to assess the reasonableness of loss reserve estimates included paid loss development, incurred loss development, paid Bornhuetter-Ferguson (“B-F”) and incurred B-F methods. The actuarial methods that TRH employs to determine the appropriate loss reserves for shorter tail lines of business are the same as those employed for longer tail lines. However, the judgments that are made with regard to factors such as loss trends, ELRs and loss development factors for shorter lines generally have much less of an effect on the determination of the loss reserve amount than when those same judgments are made regarding longer tailed lines of business. In contrast to the longer tailed lines of business, reported losses for the shorter tailed classes, such as the property lines of business (e.g., fire and homeowners) and certain marine and energy classes, generally reach the ultimate level of incurred losses in a relatively short period of time. Rather than having to rely on assumptions regarding ELRs and loss development factors for many accident years for a given line, these assumptions are generally only relevant for the most recent accident year or two.
Excess Casualty: The vast majority of this class, which is a key component of the other liability line of business, consists of domestic treaties, including pro rata and excess-of-loss contracts of general liability business. Excess casualty is dominated by umbrella business, some of which has very high attachment points. This business is generally very long tailed and characterized by relatively low frequency and high severity type losses. Therefore, expected loss ratio methods, such as the incurred B-F method, are heavily relied upon for most years due to the lack of mature reported experience available. The ELRs utilized for the most recent years are based on the projected ultimate loss ratios of prior years adjusted for rate level changes, estimated loss cost trends and other quantifiable changes, as well as actuarial pricing indications.
Shorter tailed lines: These would include the property lines of business, such as fire and homeowners, A&H and certain marine and energy classes. These lines are written out of several of TRH’s worldwide offices and the reserves are reviewed separately for each operating branch. Where sufficiently credible experience exists, these lines are generally reviewed after segregating pro rata contracts from excess-of-loss contracts. As a reinsurer, these lines do not develop to ultimate loss as quickly as when written on a primary basis; however, they are significantly shorter tailed than the casualty classes discussed earlier. For these classes, a combination of loss development methods and B-F methods are used. Generally, selections for all but the most recent few years are based on loss development methods with the most recent years based on weightings of loss development and expected loss ratio indications.
A comprehensive annual loss reserve review is conducted in the fourth quarter of each year. These reviews are conducted in full detail for each class or line of business for each underwriting office and consists of more than one hundred individual analyses. In completing these detailed actuarial reserve analyses significant actuarial judgment is often employed. TRH is required to make numerous assumptions, including the selection of loss development factors and ELRs. Additionally, TRH needs to select the most appropriate actuarial method(s) to employ for each class of business.
Triangles of written premium, paid losses and incurred losses are organized by underwriting year evaluated at six month intervals. The data triangles are split by branch, contract type (i.e., treaty versus
facultative), line of business and often between excess-of-loss and pro rata business. The line of business groupings vary by branch and are reviewed annually to ensure a proper balance between homogeneity and credibility of data. In the loss development methods, paid and incurred losses by underwriting year are projected to an ultimate basis by applying appropriate age to ultimate development factors to the inception to date paid and incurred losses. The development factors are selected based on curves fitted to the historical average which best represent the data. In the B-F methods, estimates of unpaid and unreported losses are arrived at by multiplying underwriting year earned premium by an ELR and an estimated percentage of unpaid or unreported losses. These percentages of unpaid or unreported losses are derived from the loss development factors described above. These methods yield an indication of the ultimate losses for each underwriting year. The indicated incurred but not reported (“IBNR”) reserve need is then determined (by year, by line of business) by subtracting the reported losses (which are equal to the sum of inception to date paid losses and the case reserves as of the balance sheet date) from the indicated ultimate losses.
TRH’s annual loss reserve review for 2007 did not include the calculation of a range of loss reserve estimates. Because management does not believe it can currently assign credible probabilistic values to a range, a better understanding of the volatility of loss reserve estimates can be gained via an analysis of the sensitivity of these estimates to changes in the critical assumptions used in the loss reserve review process as opposed to creating a range.
The degree of judgment used in measuring the fair value of financial instruments generally correlates with the level of pricing observability. Financial instruments with quoted prices in active markets generally have more pricing observability and less judgment is used in measuring fair value. Conversely, financial instruments traded in other than active markets or financial instruments that do not have quoted prices, have less observability and are measured at fair value using valuation models or other pricing techniques that require more judgment. Pricing observability is affected by a number of
TRH maximizes the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value. The large majority of TRH’s securities are valued using observable inputs. TRH obtains market price data to value financial instruments whenever such information is available. Market price data generally is obtained from market exchanges or dealer quotations. The types of instruments valued based on market price data include government and agency securities, equities listed in active markets and investments in publicly traded mutual funds with quoted market prices.
TRH estimates the fair value of fixed maturities not traded in active markets by referring to traded securities with similar attributes and using a matrix pricing methodology. This methodology considers such factors as the issuer’s industry, the security’s rating and tenor, its coupon rate, its position in the capital structure of the issuer and other relevant factors. The types of fixed maturities not traded in active markets include municipal bonds, most corporate bonds and most asset-backed and collateralized (including mortgage-backed) securities.
At each balance sheet date, TRH evaluates its securities holdings with unrealized losses. When TRH does not intend to hold such securities until they have fully recovered their cost basis, based on the circumstances at the date of evaluation, TRH records a realized capital loss. If a loss is recognized
TRH has the ability to hold any fixed maturity security to its stated maturity, including fixed maturities classified as available for sale. Therefore, the decision to sell any fixed maturity security classified as available for sale reflects the judgment of management that the security sold is unlikely to provide, on a relative value basis, as attractive a return in the future as alternative securities entailing comparable risks. With respect to distressed securities, the sale decision reflects management’s judgment that the risk-discounted anticipated ultimate recovery is less than the value achievable on sale.
The increase in net premiums written in 2006 compared to 2005 generally reflected prevailing market conditions in recent periods. Excluding the impact of the reduction in net ceded reinstatement premiums and the impact of changes in foreign currency exchange rates, net premiums written would have increased approximately 2.5% in 2006 compared to 2005. In 2007 and 2006, as compared to the respective immediately prior year, premium increases were primarily from treaty business. On a worldwide basis, casualty lines business represented 71.0% of net premiums written in 2007 versus 73.3% and 70.2% in 2006 and 2005, respectively. The balance represented property lines. Treaty business represented 96.3% of net premiums written in 2007 versus 95.3% and 95.5% in 2006 and 2005, respectively. The balance represented facultative accounts.
Domestic net premiums written increased in 2007 by $196.8 million, or 11.2%, from the prior year to $1,948.0 million, with the large majority of that increase emanating from domestic regional offices which were opened during 2006. Significant increases in domestic net premiums written were recorded in the property ($142.8 million), medical malpractice ($58.8 million) and auto liability ($48.2 million) lines. These increases were partially offset by a significant decrease in the A&H ($23.0 million) line.
International net premiums written in 2006 totaled $1,882.2 million, a decrease of $15.8 million from 2005 due in part to some weakness in market conditions in Europe and increased ceding company retentions. Significant decreases in TRZ ($26.6 million) and the Paris ($16.5 million) and London ($14.8 million) branches were mostly offset by significant increases in the Miami ($37.1 million) and Toronto ($14.6 million) branches. The increased premium volume in the Miami branch benefited from favorable market conditions in Latin America following significant catastrophe losses affecting the region in 2005. International net premiums written decreased significantly in the auto liability ($53.4 million) and property ($48.9 million) lines. These decreases were partially offset by significant increases in the ocean marine ($41.9 million), credit ($25.1 million) and A&H ($24.0 million) lines. The overall change in international net premiums written includes the impact of changes in foreign currency exchange rates
Reinstatement premiums were not significant in 2007 and 2006. Net premiums written and earned in 2005 include net ceded reinstatement premiums (relating to catastrophe losses) of $61.1 million (gross $72.3 million; ceded $133.4 million), principally relating to domestic operations, of which $19.1 million relates to gross adverse development on catastrophe events occurring in 2004. (See Note 9.)
Realized net capital gains totaled $9.4 million in 2007, $10.9 million in 2006 and $39.9 million in 2005. Realized net capital gains result in part from investment dispositions, which reflect TRH’s investment and tax planning strategies to maximize after-tax income, and write-downs of securities that, in the opinion of management, had experienced a decline in fair value that was other-than-temporary. Such write-downs in 2007 totaled $2.5 million relating to fixed maturities available for sale and $24.7 million relating to equities available for sale, principally common stocks. Given the unrest in the equity markets and uncertainty in the economy as a whole at year-end 2007 which caused declines in the fair
The property and casualty insurance and reinsurance industries use the combined ratio as a measure of underwriting profitability. The combined ratio reflects only underwriting results, and does not include income from investments. Generally, a combined ratio under 100% indicates an underwriting profit and a combined ratio exceeding 100% indicates an underwriting loss. Underwriting profitability is subject to significant fluctuations due to competition, natural and man-made catastrophic events, economic and social conditions, foreign currency exchange rate fluctuations, interest rates and other factors. The loss ratio represents net losses and LAE incurred expressed as a percentage of net premiums earned. The underwriting expense ratio represents the sum of net commissions and other underwriting expenses expressed as a percentage of net premiums written. The combined ratio represents the sum of the loss ratio and the underwriting expense ratio.
The improvement in the loss ratio for consolidated TRH in 2007 compared to 2006 reflects improvement from domestic operations partially offset by deterioration from international operations. The loss ratio for consolidated TRH in 2007 benefited from lower net adverse loss reserve development, partially offset by increased net catastrophe costs. The improvement in the loss ratio for consolidated TRH in 2006 as compared to 2005 reflects improvements from both domestic and international operations. Two factors in the improvement in the loss ratio for consolidated TRH in 2006 compared to 2005 are lower net catastrophe costs and, to a much lesser extent, lower net adverse loss reserve development, primarily from domestic operations. In the aggregate, catastrophe costs and estimated net adverse loss reserve development added 3.4%, 5.0% and 23.4% to the consolidated TRH combined ratio in 2007, 2006 and 2005, respectively.
As presented in the table above, the line of business with the most significant net adverse development recorded in 2007 was the other liability line, arising principally from losses occurring between 1998 and 2002. The other liability line includes certain specialty casualty classes, such as D&O and E&O, and general casualty classes. In addition, significant net adverse development was recorded in 2007 in the medical malpractice line, arising principally from losses occurring between 1998 and 2002. These increases to incurred losses were offset in part by net favorable development occurring most significantly in the fire line, arising principally from losses occurring in 2006, and in the allied lines and homeowners multiple peril lines, each arising principally from losses occurring between 2004 and 2006. (See Note 9 for amounts included in net adverse development that relate to catastrophe losses.)
TRH writes a significant amount of non-proportional assumed casualty reinsurance as well as proportional assumed reinsurance of excess liability business for such volatile classes as medical malpractice, D&O, E&O and general casualty. At the primary level, there are significant risk factors which contribute to the variability and unpredictability of the loss trend factors for this business such as jury awards, social inflation, medical inflation, tort reforms and court interpretations of coverage. In addition, as a reinsurer, TRH is also highly dependent upon the claims reserving and reporting practices of its cedants, which vary greatly by size, specialization and country of origin and whose practices are subject to change without notice.
inherent volatility in loss trend factors and variability of reporting practices for those classes, among other factors, and materially exceed the carried loss reserves as of December 31, 2007 and thus, have a material adverse effect on future net income, financial condition and cash flows.
However, in 2006, TRH determined that its estimates of the ultimate amounts of net losses occurring in 2005 and prior years needed to be increased as a result of greater than expected loss activity in 2006. As a result of that determination, TRH increased net losses and LAE incurred by $181.1 million, representing significant net adverse development in 2006 of losses occurring in all prior years. This net adverse development was comprised of $339.7 million relating to losses occurring in 2002 and prior, partially offset by favorable development of $158.6 million relating primarily to 2005. The detail of the $181.1 million net adverse development by line of business relating to all prior years is presented in the table below:
As presented in the table above, the line of business with the most significant net adverse development recorded in 2006 was the other liability line, arising principally from losses occurring in 2000 to 2002 for reasons similar to those discussed earlier for the other liability line development in 2007. The other liability line includes certain specialty casualty classes, such as D&O and E&O, and general casualty classes. In addition, significant net adverse development was recorded in 2006 in the medical malpractice line, arising principally from losses occurring between 1998 and 2002, the fidelity line, arising principally from losses occurring between 1999 and 2005, and the ocean marine and aviation line, arising principally from losses occurring in 2005. The large majority of such net adverse development related to domestic operations. These increases to incurred losses were offset in part by net favorable development occurring most significantly in the fire line, arising principally from losses occurring in 2005, and the homeowners multiple peril line, arising principally from losses occurring between 2004 and 2005. (See Note 9 for amounts included in net adverse development that relate to catastrophe losses.)
The main reason for the decrease in gross and ceded losses and LAE incurred in 2006 compared to 2005 is the decrease in gross and ceded catastrophe losses (see Note 9) in 2006 partially offset by a $199 million increase in gross and ceded losses and LAE incurred relating to business assumed from an affiliate which, by prearrangement with TRH, was then ceded in an equal amount to other affiliates.
In addition, in 2005, TRH determined that its estimates of the ultimate amounts of net losses occurring in 2004 and prior years needed to be increased as a result of greater than expected loss activity in 2005. As a result of that determination, TRH increased net losses and LAE incurred by $268.8 million, representing significant net adverse development in 2005 of losses occurring in all prior years. This net adverse development was comprised of $524.9 million relating to losses occurring in 2002 and prior, partially offset by favorable development of $256.1 million relating primarily to 2004 and, to a lesser extent, to 2003. The detail of the $268.8 million net adverse development by line of business relating to all prior years is presented in the table below:
As presented in the table above, the lines of business with the most significant net adverse development recorded in 2005 were the other liability line, arising principally from losses occurring in 1996 to 2002 for reasons similar to those discussed earlier for the other liability line development in 2007, and the medical malpractice line, arising principally from losses occurring between 1997 and 2001. The large majority of such net adverse development related to domestic operations. These increases to incurred losses were offset in part by net favorable development occurring most significantly in the fire line, which arose principally from losses occurring in 2004, and in the ocean marine and aviation line, which arose principally from losses occurring in 2001 through 2004. (See Note 9 for amounts included in net adverse development that relate to catastrophe losses.)
While TRH believes that it has taken appropriate steps to manage its exposure to possible future catastrophe losses, the occurrence of one or more natural or man-made catastrophic events of unanticipated frequency or severity, such as a terrorist attack, earthquake or hurricane, that causes insured losses could have a material adverse effect on TRH’s results of operations, liquidity or financial condition. Current techniques and models may not accurately predict the probability of catastrophic events in the future and the extent of the resulting losses (as was the case with Hurricane Katrina). Moreover, one or more catastrophe losses could weaken TRH’s retrocessionnaires and result in an inability of TRH to collect reinsurance recoverables.
Deferred acquisition costs vary as the components of net unearned premiums change and the deferral rate changes. Acquisition costs, consisting primarily of net commissions incurred, are charged to earnings over the period in which the related premiums are earned.
General corporate expenses, certain stock-based compensation costs and expenses relating to Professional Risk Management Services, Inc. (“PRMS”), which was acquired in 2007, are the primary components of “other, net” expenses on the Consolidated Statement of Operations. PRMS is an insurance program manager specializing in professional liability insurance services, including underwriting, claims, and risk management, for individual healthcare providers, group practices, facilities and organizations. The increase in “other, net” in 2007 compared to 2006 is due to PRMS expenses and an increase in general corporate expenses.
Income (loss) before income taxes was $595.8 million in 2007, $539.9 million in 2006 and $(46.1) million in 2005. The increase in income before income taxes in 2007 compared to 2006 resulted primarily from increased underwriting profit (loss) and net investment income. The increased underwriting profit (loss) in 2007 reflected increased net premiums earned together with a lower combined ratio benefiting largely from decreased net adverse loss reserve development offset in part from higher catastrophe costs in 2007 compared to 2006 which together had the impact of increasing income before income taxes in 2007 by $47.7 million. The increase in income (loss) before income taxes in 2006 compared to 2005 resulted primarily from increased underwriting profit (loss) and net investment income offset in part by increased interest expense and decreased realized net capital gains, each in 2006 as compared to 2005. The increased underwriting profit (loss) in 2006 resulted primarily from lower pre-tax net catastrophe costs and lower net adverse loss reserve development. The lower pre-tax net catastrophe costs and lower net adverse loss reserve development in the aggregate increased income (loss) before income taxes by approximately $618.4 million in 2006 compared to 2005.
Federal and foreign income tax expense (benefit) of $108.6 million, $111.8 million and $(84.0) million were recorded in 2007, 2006 and 2005, respectively. The 2005 tax benefit, which exceeds the amount of pre-tax loss in 2005, resulted from TRH carrying its current year tax net operating loss back to prior years ($61.2 million current tax benefit on the Consolidated Statement of Operations and a current tax recoverable in the same amount included in other assets on the Consolidated Balance Sheet) and recording a deferred tax benefit on the Consolidated Statement of Operations (also included on the Consolidated Balance Sheet as a deferred tax asset) of $20.9 million for a minimum tax credit carryforward. In 2007 and 2006, TRH generated an additional $32.9 million and $6.6 million, respectively, of deferred tax benefits from minimum tax credit carryforwards.
The Company and its domestic subsidiaries (which includes foreign operations) file consolidated federal income tax returns. The tax burden among the companies is allocated in accordance with a tax sharing agreement. TRC also includes as part of its taxable income or loss those items of income of the non-U.S. subsidiary, TRZ, which are subject to U.S. income tax currently, pursuant to Subpart F income rules of the Internal Revenue Code, and included, as appropriate, in the consolidated federal income tax return.
The effective tax rates, which represent the sum of current and deferred income taxes (benefits) divided by income (loss) before income taxes, were 18.2% in 2007, 20.7% in 2006 and 182.2% in 2005. The decrease in the effective tax rate in 2007 compared to 2006 was primarily attributable to the recognition of a previously uncertain tax benefit of $5.3 million, dividends received deduction and additional tax credits approximating $4.6 million and interest income anticipated of $4.3 million on net tax refunds. (See Note 4 of Notes to Consolidated Financial Statements.)
compared to 2006-Domestic revenues increased from the prior year due principally to increases in net premiums written, for reasons discussed earlier in MD&A, net of the difference in the change in unearned premiums between years and, to lesser extents, increased realized net capital gains, despite significant impairment write-downs in the equities portfolio, and net investment income. The increase in net premiums earned in 2007 occurred primarily in the property, other liability, medical malpractice and auto liability lines offset in part by a significant decrease in the fidelity and A&H lines. The increase in net investment income is due in part to continued positive operating cash flows, offset in part by a reduced investment return from the equities trading portfolio. Income before income taxes for 2007 increased due primarily to a decrease in underwriting loss and, to lesser extents, increases in realized net capital gains and net investment income, partially offset by increases in general corporate expenses and expenses relating to PRMS, acquired in 2007. The decrease in underwriting loss is due in part to improved loss experience in calendar year 2007.
Assets increased $247 million in 2006 as increases in investments and cash were partially offset by reductions in reinsurance recoverable on paid and unpaid losses and LAE. The increase in investments and cash was due largely to $445.4 million of net operating cash flows.
2007 compared to 2006-Revenues increased due to increases in net premiums earned and net investment income, partially offset by an increase in realized net capital losses, related in part to increased foreign exchange transaction losses. Revenues increased principally in the London and Paris branches. Net premiums earned increased principally in the other liability, A&H and medical
2007 includes net catastrophe costs of $47.4 million principally relating to Windstorm Kyrill in Europe and floods in the U.K. 2006 includes net catastrophe costs of $16.9 million relating to catastrophe events occurring in prior years.
2006 compared to 2005-Revenues decreased due principally to a decrease in net premiums earned in the London and Paris branches and, to a lesser extent, a decrease in realized net capital gains (losses), partially offset by increased net investment income. Net premiums earned decreased principally in the auto liability, other liability and property lines offset in part by increases in the ocean marine, A&H and credit lines. The decrease in net premiums earned is due in part to some weakness in market conditions and increased ceding company retentions. Income before income taxes for 2006 increased due primarily to an increase in underwriting profit (loss) in the London branch and TRZ and, to a lesser extent, to increased net investment income in each location. The increase in underwriting profit (loss) is caused principally by decreased net catastrophe costs, which totaled $16.9 million in 2006 compared to $119.6 million in 2005.
Sources of funds for the operating subsidiaries consist primarily of premiums, reinsurance recoverables, investment income, proceeds from sales, redemptions and the maturing of investments and the receipt of securities lending collateral. Funds are applied by the operating subsidiaries primarily to payments of claims, commissions, ceded reinsurance premiums, insurance operating expenses, income taxes and securities lending payables and the purchase of investments. Premiums are generally received substantially in advance of related claims payments. Cash and cash equivalents, which are principally interest-bearing, are maintained for the payment of claims and expenses as they become due. TRH does not anticipate any material capital expenditures in the foreseeable future.
At December 31, 2007, total investments and cash were $12.76 billion compared to $11.34 billion at December 31, 2006. The increase was caused, in large part, by $1,026.8 million of cash provided by operating activities and $306.0 million from the net receipt of collateral from securities lending activities, offset by changes in net unrealized appreciation (depreciation) of investments which decreased investments and cash by $155.6 million (see discussion of the change in unrealized appreciation of investments, net of tax, below). In addition, the impact of foreign currency exchange rate changes between the U.S. dollar and certain currencies in which investments and cash are denominated increased total investments and cash by approximately $255 million.
TRH’s fixed maturities classified as held to maturity and available for sale are predominantly investment grade, liquid securities, approximately 42.0% of which will mature in less than 10 years. The average duration of these fixed maturities was 5.8 years as of December 31, 2007. Activity within the fixed maturities available for sale portfolio for the years under discussion generally represented strategic portfolio realignments to maximize after-tax income. TRH adjusts its mix of taxable and tax-exempt investments, as appropriate, generally as a result of strategic investment and tax planning considerations. With respect to the fixed maturities which are classified as held to maturity and carried at amortized cost, TRH has the positive intent and ability to hold each of these securities to maturity.
TRH engages in a securities lending program managed by a subsidiary of AIG, whereby certain securities (principally fixed maturities and common stocks available for sale) from its portfolio are loaned to third parties. (See Note 2(c).) In these transactions, initial collateral, principally cash, is received by TRH in an amount exceeding the fair value of the loaned security. As of December 31, 2006, the collateral was invested in segregated pooled accounts of the program manager containing floating rate bonds, including asset-backed and collateralized securities, and interest-bearing cash equivalents. During the latter half of 2007, TRH’s interest in such pooled accounts was exchanged for separate portfolios containing floating rate bonds (i.e., fixed maturities), including asset-backed and collateralized securities, and interest-bearing cash equivalents which are maintained in segregated accounts for TRH by the program manager. The investment of securities lending collateral is shown on the balance sheet at fair value. A liability is recorded in an amount equal to the collateral received to recognize TRH’s obligation to return such funds when the related loaned securities are returned. The fair values of fixed maturities available for sale, common stocks available for sale and equities trading that are on loan are reflected parenthetically as pledged on the balance sheet and totaled $1,966.4 million, $21.9 million and $2.1 million, respectively, as of December 31, 2007. As of December 31, 2007, securities lending collateral consisted of $1.82 billion of fixed maturities available for sale and $196.7 million of cash equivalents. As of December 31, 2007, the average duration of fixed maturities available for sale included in the securities lending collateral caption on the Consolidated Balance Sheet was 0.3 years.
At December 31, 2007, TRH’s securities lending payables totaled $2.05 billion, $294 million of which were one-day tenor. These loans do not have a contractual end date but are terminable by either party on demand. In addition to the invested collateral, all of the assets of TRH are generally available to satisfy the liability for collateral received.
Gross unrealized gains and losses on all fixed maturities, equities and securities lending collateral at December 31, 2007 was as follows:
In general, uncertainty in the credit markets at year-end 2007 adversely impacted fair values of equities and fixed maturities, thus increasing gross unrealized losses. (See Disruption in Global Credit Markets in MD&A and Item 1A. Risk Factors.) The increase in gross unrealized losses on fixed maturities in 2007 compared to 2006 is due largely to an increase in interest rates on corporate fixed maturities, due mostly to credit spread widening resulting in part from the uncertainty in the credit markets. Gross unrealized losses on fixed maturities also increased due to an increase in interest rates on state, municipality and political subdivision fixed maturities.
A large majority of the amounts within the other liability line relates to complex risks such as E&O and D&O, to general casualty risks and, to a much lesser extent, environmental impairment liability.
Gross loss reserves represent the accumulation of estimates for losses occurring on or prior to the balance sheet date. Gross case reserves are principally based on reports and individual case estimates received from ceding companies. The IBNR portion of gross loss reserves is based on past experience and other factors. The methods used to determine such estimates and to establish the resulting reserves are continually reviewed and updated. Any adjustments are reflected in income currently.
At December 31, 2007, reinsurance recoverable on gross loss reserves totaled $1.01 billion (a component of reinsurance recoverable on paid and unpaid losses on the Consolidated Balance Sheet, which is net of an allowance for uncollectible reinsurance recoverable of approximately $12 million), a decrease of $234.2 million, or 18.8%, from the prior year-end. The decrease in reinsurance recoverable on gross loss reserves in 2007 was due largely to a decrease in reinsurance recoverable on ceded losses relating to catastrophes occurring in 2005 and a decrease in reinsurance recoverable on ceded losses relating to reinsurance business written by TRH that, by prearrangement with TRH, is almost entirely retroceded to non-affiliated retrocessionaires. Of the amount of reinsurance recoverable on paid and unpaid losses and LAE, which totaled $1.07 billion as of December 31, 2007, $609 million represented balances that were unsecured. Of such unsecured balances, $192 million was due from affiliates (which are rated AA+) and 92% of the remaining balance was due from companies rated A- or better. (See Note 15.)
Net loss reserves totaled $6.90 billion at December 31, 2007, an increase of $692.5 million, or 11.2%, from the prior year-end. The increase in net loss reserves includes the impacts of net changes in foreign currency exchange rates of $157 million and net loss reserve development. 2007 included paid losses and LAE, net of reinsurance recovered, relating to net catastrophe losses of approximately $89 million, relating to events occurring in 2007 and 2005. An analysis of the change in net loss reserves from year-end 2006 to year-end 2007 is included in Note 5 of Notes to Consolidated Financial Statements.
coverages rather than as standard general liability coverages, where the environmental or asbestos-related liabilities were neither clearly defined nor specifically excluded. The reserves carried for these claims, including IBNR, are based upon known facts and current law. However, significant uncertainty exists in determining the amount of ultimate liability for environmental impairment and asbestos-related losses, particularly for those occurring in 1985 and prior. This uncertainty is due to inconsistent court resolutions and judicial interpretations with respect to underlying policy intent and coverage and uncertainties as to the allocation of responsibility for resultant damages, among other things.
Because the reserving process is inherently difficult and subjective, actual losses may materially differ from reserves and related reinsurance recoverables reflected in TRH’s consolidated financial statements, and accordingly, may have a material effect on future results of operations, financial condition and cash flows. And while there is also the possibility of changes in statutes, laws, regulations and other factors that could have a material effect on these liabilities and, accordingly, the financial statement elements cited immediately above, TRH believes that its loss reserves carried at December 31, 2007 are adequate.
For 2007, TRH’s net operating cash inflows totaled $1,026.8 million, an increase of $181.4 million from 2006. The increase is due in large part to increased cash flows from underwriting activities, including increased collections of reinsurance recoverable, and investment income received, partially offset by increased income taxes paid.
For 2006, TRH’s net operating cash inflows totaled $845.4 million, an increase of $215.1 million from 2005. The increase, which emanated mainly from domestic sources, is due, in large part, to increased investment income received and increased recoveries of reinsurance recoverables, partially offset by interest paid on the Senior Notes.
As significant losses from catastrophes occurring in 2005 and 2007 remain unpaid, TRH expects that payments relating to these events will have a material adverse impact on operating cash flows in 2008 and perhaps thereafter.
Of total consolidated net operating cash inflows, $476.3 million, $400.1 million and $332.9 million were derived from international operations in 2007, 2006 and 2005, respectively. In each of such years, London was the most significant source of international net operating cash inflows.
TRH believes that its balance of cash and cash equivalents of $255.4 million as of December 31, 2007 and its future cash inflows will be sufficient to meet TRH’s cash requirements through the end of 2008 and thereafter for a period the length of which is difficult to predict, but which TRH believes will be at least one year.
The following table presents the year-end, average, high and low VaRs on a diversified basis and of each component of market risk for 2007 and 2006. The diversified VaR is usually smaller than the sum of its components due to correlation effects.
In December 2005, the Company completed a public offering of $750 million principal amount of 5.75% senior notes due 2015. At December 31, 2007 and 2006, the Senior Notes remained outstanding. Of the $750 million aggregate principal amount of the Senior Notes offered, $450 million principal amount was purchased by certain subsidiaries of AIG. The proceeds from the offering were used to increase the capital and surplus of TRC and for other general corporate purposes.
TRH’s stockholders’ equity totaled $3.35 billion at December 31, 2007, an increase of $390.8 million from year-end 2006. The net increase consisted primarily of net income of $487.1 million, partially offset by cash dividends declared of $40.6 million and a decrease in accumulated other comprehensive income of $77.3 million.
The Company did not repurchase shares of its common stock in 2007 or 2006. In 2005, the Company repurchased 104,800 shares of its common stock, pursuant to a previously announced buyback program, at an aggregate cost of $6.3 million.
Risk Based Capital (“RBC”) standards, promulgated by the National Association of Insurance Commissioners (“NAIC”), relate an individual company’s statutory policyholders’ surplus to the risk inherent in its overall operations and set thresholds at which certain company and regulatory corrective actions are mandated. At December 31, 2007 the statutory surpluses of TRC and Putnam each exceeded the level of surplus required under RBC requirements for regulatory attention.
are prone to catastrophic events, monitoring and modeling accumulated exposures and purchasing catastrophe reinsurance when deemed cost effective.
Natural disasters such as hurricanes, earthquakes and other catastrophes have the potential to adversely affect TRH’s operating results by material amounts. Other risks, such as an outbreak of a pandemic disease, the bankruptcy of a major company, or a marine and/or aviation disaster, could also have a materially adverse effect on TRH’s business and operating results to an extent that may be only partially offset by reinsurance.
Projections of potential catastrophe losses are typically expressed in terms of the probable maximum loss (“PML”). TRH defines PML as its anticipated maximum loss (taking into account contract limits) caused by a single catastrophic event affecting a broad contiguous area. These modeled losses are estimated as of December 31, 2007 based upon contracts in force. The values provided have a likelihood of being exceeded in any single year of 1.0% or 0.4%.
The following is an overview of such modeled PMLs from property, engineering, marine and energy exposures and the associated natural perils that TRH deems most significant. The estimated amount of these modeled losses are presented in three ways: 1) gross losses, 2) pre-tax net catastrophe costs (i.e., gross losses, net of reinsurance and the impact of net reinstatement premiums) and 3) after-tax net catastrophe costs (i.e., the net economic cost to TRH). The reduction for reinsurance assumes that all reinsurers fulfill their obligations to TRH in accordance with contract terms.
Such modeled after-tax net catastrophe costs arising out of events with a 1.0% or 0.4% probability of exceeding the amounts shown in the table above from European Wind, the costliest of the modeled events, would represent 11.2% and 13.6%, respectively, of TRH’s stockholders’ equity at December 31, 2007. If multiple severe catastrophic events occur in any one year, the potential economic cost to the company could be materially higher than any one of the amounts shown above.
There is much uncertainty and imprecision in the compilation of these estimates at many stages in the process. Moreover, the makeup of TRH’s in-force business is constantly changing as new business is added and existing contracts terminate or expire, including contracts for reinsurance coverage
In July 2006, the FASB issued FIN 48. TRH adopted FIN 48 on January 1, 2007.
In September 2006, the FASB issued SFAS 158. TRH adopted SFAS 158 in the fourth quarter of 2006.
(e) Adoption of FASB Staff Position (“FSP”) No. FAS 115-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” (“FSP FAS 115-1”)
(i) In June 2007, the American Institute of Certified Public Accountants (“AICPA”) issued Statement of Position No. 07-1, “Clarification of the Scope of the Audit and Accounting Guide ‘Audits of Investment Companies’ and Accounting by Parent Companies and Equity Method Investors for Investments in Investment Companies” (“SOP 07-1”). In February 2008, the FASB issued FSP No. SOP 07-1-1, “Effective Date of AICPA Statement of Position 07-1” (“FSP SOP 07-1-1”). FSP SOP 07-1-1 indefinitely deferred the effective date of SOP 07-1.
(ii) In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”).
(iii) In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS 157”).
Consolidated Statements of Comprehensive Income (Loss) For the Years Ended December 31, 2007, 2006 and 2005
I-Summary of Investments-Other than Investments in Related Parties As of December 31, 2007
II-Condensed Financial Information of Registrant As of December 31, 2007 and 2006 and For the Years Ended December 31, 2007, 2006 and 2005
III-Supplementary Insurance Information As of December 31, 2007, 2006 and 2005 and For the Years Then Ended
VI-Supplementary Information Concerning Property/Casualty Insurance Operations As of December 31, 2007, 2006 and 2005 and For the Years Then Ended
Transatlantic Holdings, Inc. (the “Company”) is a holding company, incorporated in the state of Delaware, which owns all of the common stock of Transatlantic Reinsurance Company® (“TRC”). TRC owns all of the common stock of Trans Re Zurich (“TRZ”) and Putnam Reinsurance Company (“Putnam”). As of December 31, 2007, 2006 and 2005, American International Group, Inc. (“AIG”, and collectively with its subsidiaries, the “AIG Group”) beneficially owned approximately 59% of the Company’s outstanding shares.
TRH engages in a securities lending program managed by a subsidiary of AIG, whereby certain securities (principally fixed maturities and common stocks available for sale) from its portfolio are loaned to third parties. In these transactions, initial collateral, principally cash, is received by TRH in an amount exceeding the fair value of the loaned security. At December 31, 2006, the collateral was invested in segregated pooled accounts of the program manager containing floating rate bonds,
Other invested assets primarily include investments in limited partnerships and TRH’s 40% interest in Kuwait Reinsurance Company (K.S.C.), which is accounted for on the equity method. Limited partnerships in which TRH holds less than a 5% interest are reported at fair value. With respect to limited partnerships in which TRH holds a 5% or greater interest or where TRH has more than a minor influence over the operations of the investee, TRH’s carrying value represents its share of the net asset value of the partnerships.
TRH measures financial instruments in its trading and available for sale securities portfolios at fair value and discloses the fair value of its fixed maturities held to maturity. Fair value is the amount that would be received to sell an asset in an orderly transaction between market participants at the measurement date.
The degree of judgment used in measuring the fair value of financial instruments generally correlates with the level of pricing observability. Financial instruments with quoted prices in active markets generally have more pricing observability and less judgment is used in measuring fair value. Conversely, financial instruments traded in other than active markets or financial instruments that do not have quoted prices have less observability and are measured at fair value using valuation models or other pricing techniques that require more judgment. Pricing observability is affected by a number of factors, including the type of financial instrument, whether the financial instrument is new to the market and not yet established, the characteristics specific to the transaction and general market conditions.
For fixed maturity and equity instruments that are not traded in active markets, valuations are adjusted to reflect illiquidity, and such adjustments generally are based on available market evidence. In the absence of such evidence, management’s best estimate is used.
TRH evaluates its investments for other-than-temporary impairments. The determination that a security has incurred an other-than-temporary impairment in value and the amount of any loss recognition requires the judgment of TRH’s management and a continual review of its investments.
TRH evaluates its investments for other-than-temporary impairment such that a security is considered a candidate for other-than-temporary impairment if it meets any of the following criteria:
At each balance sheet date, TRH evaluates its securities holdings with unrealized losses. When TRH does not intend to hold such securities until they have fully recovered their cost basis, based on the circumstances at the date of evaluation, TRH records a realized capital loss. If a loss is recognized from a sale subsequent to a balance sheet date pursuant to changes in circumstances, the loss is recognized in the period in which the intent to hold the securities to recovery no longer exists.
TRH has the ability to hold any fixed maturity security to its stated maturity, including those fixed maturity securities classified as available for sale. Therefore, the decision to sell any such fixed maturity security classified as available for sale reflects the judgment of management that the security sold is unlikely to provide, on a relative basis, as attractive a return in the future as alternative securities entailing comparable risks. With respect to distressed securities, the sale decision reflects management’s judgment that the risk-discounted anticipated ultimate recovery is less than the value achievable on sale.
(e) Deferred Acquisition Costs: Acquisition costs, consisting primarily of net commissions incurred on business conducted through reinsurance contracts or certificates, are deferred, and then amortized over the period in which the related premiums are earned, generally one year. Anticipated losses and loss adjustment expenses (“LAE”) and estimated remaining costs of servicing the contracts are considered in the evaluation of recoverability of acquisition costs to be deferred. Anticipated investment income is not considered in such evaluation.
(g) Net Investment Income: Net investment income represents income primarily from the following sources:
(1) Adoption of Financial Accounting Standards Board (“FASB”) Interpretation No. 48, “Accounting for Uncertainty in Income Taxes-an Interpretation of FASB Statement No. 109” (“FIN 48”)
(2) Adoption of SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans-an amendment of FASB Statements No. 87, 88, 106 and 132(R)” (“SFAS 158”)
In September 2006, the FASB issued SFAS 158. SFAS 158 requires an employer to prospectively recognize the over funded or under funded status of a defined benefit postretirement plan as an asset or liability in its statement of financial position and to recognize changes in that funded status in the year in which the changes occur through other comprehensive income. SFAS 158 also requires an employer to measure the funded status of a
In September 2006, the Securities and Exchange Commission (“SEC”) issued SAB 108. SAB 108 provides interpretive guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a current year misstatement. SAB 108 requires that registrants quantify errors using both a balance sheet and an income statement approach and evaluate whether either approach results in quantifying a misstatement that when all relevant quantitative and qualitative factors are considered, is material. TRH adopted SAB 108 in the fourth quarter of 2006. The adoption of SAB 108 did not have a material effect on TRH’s consolidated financial statements in the year of adoption.
In November 2005, the FASB issued FSP FAS 115-1. FSP FAS 115-1 replaces the measurement and recognition guidance set forth in FASB Emerging Issue Task Force (“EITF”) Issue No. 03- 1 and codifies certain existing guidance on impairment. TRH adopted FSP FAS 115-1 in the first quarter of 2006. The adoption of FSP FAS 115-1 did not have a material effect on TRH’s results of operations, financial position or cash flows in the year of adoption.
(a) In June 2007, the American Institute of Certified Public Accountants (“AICPA”) issued Statement of Position No. 07-1, “Clarification of the Scope of the Audit and Accounting Guide ‘Audits of Investment Companies’ and Accounting by Parent Companies and Equity Method Investors for Investments in Investment Companies” (“SOP 07-1”). SOP 07-1 amends the guidance for whether an entity may apply the provisions of the AICPA Audit and Accounting Guide, “Audits of Investment Companies” (the “Guide”). Investment companies
that are subject to the Guide must report all investments at fair value regardless of the nature of the investment or the level of ownership. SOP 07-1 also established new requirements for when TRH can retain specialized investment company accounting in its consolidated financial statements for its equity method investees that are covered by the Guide. Such investments are included in other invested assets on the balance sheet. In February 2008, the FASB issued FSP No. SOP 07-1-1, “Effective Date of AICPA Statement of Position 07-1” (“FSP SOP 07-1-1”). FSP SOP 07-1-1 indefinitely deferred the effective date of SOP 07-1-1.
(b) In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”). SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. Subsequent changes in fair value for designated items will be required to be reported in earnings in the current period. SFAS 159 also establishes presentation and disclosure requirements for similar types of assets and liabilities measured at fair value. SFAS 159 is effective for TRH on January 1, 2008. TRH does not plan to employ this standard to measure any assets or liabilities at fair value that are not presently required to be measured on that basis.
(d) In December 2007, the FASB issued SFAS No. 141R, “Business Combinations” (“SFAS 141R”). SFAS 141R broadens the transactions or events that are considered business combinations, requiring an acquirer to recognize 100% of the fair values of assets acquired, liabilities assumed, and noncontrolling interests in acquisitions of less than a 100% controlling interest when the acquisition constitutes a change in control of the acquired entity, recognizing contingent consideration arrangements at their acquisition-date fair values, with subsequent changes in fair value generally reflected in income, and recognizing preacquisition loss and gain contingencies at their acquisition-date fair values, among other changes. For TRH, SFAS 141R is required to be adopted for business combinations for which the acquisition date is on or after January 1, 2009. Early adoption is prohibited.
(a) Statutory Deposits: Investments with carrying values of $442 million and $351 million at December 31, 2007 and 2006, respectively, were deposited with governmental authorities as required by law. The substantial majority of these deposits are fixed maturities and common stocks available for sale.
Net unrealized (losses) gains included in net investment income from equities classified as trading securities in 2007, 2006 and 2005 were $(1.4) million, $2.5 million and $(1.6) million.
Includes net unrealized depreciation from securities lending collateral of $41.2 million in 2007.
Gross realized gains and gross realized losses on sales of TRH’s available for sale securities and securities lending collateral were as follows:
(e) Equities: At December 31, 2007 and 2006, net unrealized appreciation of equities available for sale (before applicable income taxes) included gross gains of $31.0 million and $56.8 million and gross losses of $42.5 million and $4.8 million, respectively. (See Note 3(g) for additional information about gross unrealized losses as of December 31, 2007 and 2006.)
(f) Securities Lending Collateral: At December 31, 2006, the collateral was invested in segregated pooled accounts of the program manager containing floating rate bonds, including asset-backed and collateralized securities, and interest-bearing cash equivalents. During the latter half of 2007, TRH’s interest in such pooled accounts was exchanged for separate portfolios containing floating rate bonds (i.e., fixed maturities), including asset-backed and collateralized securities, and interest-bearing cash equivalents. Such securities are maintained in a segregated account for TRH by the program manager. The amortized cost and fair value of securities lending collateral by underlying category of security at December 31, 2007 is summarized as follows:
See Note 3(g) for additional information about gross unrealized losses as of December 31, 2007.
The amortized cost and fair value of securities lending collateral at December 31, 2007 by contractual maturity are as follows. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
(g) Additional Information on Gross Unrealized Losses on All Fixed Maturities, on Equities Available for Sale and on Securities Lending Collateral: As of December 31, 2007 and 2006, TRH’s aggregate gross unrealized losses on all fixed maturities, on equities available for sale and on securities lending collateral totaled $164.9 million and $38.8 million, respectively. As of December 31, 2007 and 2006, no single issuer accounted for more than 4% and 6%, respectively, of the aggregate gross unrealized losses.
The U.S. federal income tax rate was 35% for 2007, 2006 and 2005. Actual tax expense (benefit) on income (loss) before income taxes differs from the “expected” amount computed by applying the U.S. federal income tax rate because of the following:
The domestic current tax benefit for 2005 includes $61.2 million resulting from a tax net operating loss carryback to prior years. In addition, the 2005 domestic deferred tax benefit includes $20.9 million resulting from a minimum tax credit carryforward.
On January 1, 2007, TRH adopted FIN 48. At January 1, 2007, the total amount of TRH’s liability for unrecognized tax benefit, excluding interest and penalties, was $5.3 million. In 2007, TRH recognized this previously uncertain tax benefit. As a result, income tax expense for 2007 has been reduced by $5.3 million. TRH does not presently anticipate any material change in unrecognized tax benefits during the next twelve months.
The following table lists the tax years that remain subject to examination by major tax jurisdiction as of December 31, 2007:
The net adverse development arising from losses occurring in years 1998 through 2002, which represent the great majority of the 2002 and prior development, generally relates to the fact that for many classes within these years, ceding companies continue to experience increased loss costs relative to expectations coupled with an unexpected lengthening of the loss emergence patterns. Generally, loss activity was greater than expected from losses occurring in the D&O and E&O classes, which continued to be impacted by claims relating to corporate bankruptcies and IPO allocation/laddering claims. Also, classes such as Excess Umbrella and Architects & Engineers were impacted by construction defect and other late reported high layer excess claims to a greater extent than expected. Contributing to this increase is the fact that many policies during this period covered underlying contracts that extended over multiple years, which contributed to recent reported loss activity exceeding previous expectations.
This has led to an increase in both the frequency and severity of claims entering the reinsured excess-of-loss coverage layers at later points in time than had previously been experienced. The favorable development in accident years 2004 through 2006 results from favorable loss trends, particularly in the shorter tailed classes.
Net adverse development on losses occurring in prior years, for all periods discussed above, includes amounts relating to catastrophe events. See Note 9 for such amounts.
Common stock activity for each of the three years in the period ended December 31, 2007 was as follows:
2007 excludes the effect of 0.6 million anti-dilutive shares (from a total of 3.0 million potential shares). 2006 excludes the effect of performance-based restricted stock units whose performance period had not yet begun and 1.2 million anti-dilutive shares (from a total of 2.8 million potential shares). 2005 excludes the effect of 1.0 million anti-dilutive shares (from a total of 2.7 million potential shares).
Income before income taxes in 2007 includes estimated net catastrophe costs of $55.2 million principally relating to European Windstorm Kyrill and floods in the U.K. Such costs consist of net catastrophe losses incurred of $64.5 million (gross $68.2 million; ceded $3.7 million) partially offset by net assumed reinstatement premiums of $9.3 million (gross $9.6 million; ceded $0.3 million).
Net assumed (ceded) reinstatement premiums serve to increase (reduce) net premiums written and earned by such amounts in their respective periods. Reinstatement premiums may arise on assumed and ceded business as a result of contractual provisions found in many excess-of-loss catastrophe reinsurance contracts that require additional premium to be paid in the event of a loss to reinstate coverage for the remaining portion of the contract period.
The charges made to operations for these plans for 2007, 2006 and 2005 were $4.4 million, $5.2 million and $3.6 million, respectively.
Prior to 2003, TRH had accounted for stock-based compensation based on the intrinsic-value method prescribed in APB 25 and related Interpretations, as permitted under SFAS 123. On January 1, 2003, TRH adopted the recognition provisions of SFAS 123, using the prospective method of transition and employed that method until the beginning of 2006. That method requires application of such recognition provisions under the fair value method to all stock-based compensation awards granted, modified, or settled on or after the date of adoption of the standard. Accordingly, net income for 2005 reflects compensation expenses, primarily relating to stock options, for stock-based compensation awards granted in 2003 and thereafter and to TRH employees’ participation in Starr International Company (“SICO”) Deferred Compensation Profit Participation Plans (the “SICO Plans”).
Expenses relating to stock-based compensation arrangements totaled $14.8 million, $10.9 million and $9.6 million in 2007, 2006 and 2005, respectively. Income tax benefits recognized related to stock-based compensation arrangements totaled $4.9 million, $3.3 million and $2.8 million in 2007, 2006 and 2005, respectively.
Total cash received from exercises of stock-based compensation was $6.0 million, $3.3 million and $2.7 million during 2007, 2006 and 2005, respectively. TRH has not paid out any cash to settle share-based payment awards during the 2007, 2006 or 2005. Cash savings resulting from excess tax benefits, as defined by SFAS 123R, totaled $1.1 million and $1.9 million in 2007 and 2006, respectively.
Income tax benefits realized by TRH on stock-based compensation exercises totaled $2.7 million, $1.5 million and $2.9 million in 2007, 2006 and 2005, respectively.
For options granted under the Stock Option Plans, in general, 25% of the options become exercisable on the anniversary date of the grant in each of the four years following the grant and expire 10 years from the date of grant. At December 31, 2007, 1,385,000 shares were available for future grants under the 2000 Plan. No further options can be granted under the 1995 Plan, although options outstanding continue in force until exercise, expiration or forfeiture.
A summary of the status of the Stock Option Plans as of December 31, 2007 and the changes since January 1, 2007 is presented below:
As of December 31, 2007, there was $6.6 million of total unrecognized compensation costs relating to options granted but not yet vested under the 2000 Plan. Compensation expense for options granted under the 2000 Plan is recognized on a straight-line basis. These costs are expected to be recognized over a weighted average period of 2.3 years.
A summary of the status of the Service RSUs and Performance RSUs granted pursuant to the Stock Incentive Plan as of December 31, 2007 and the changes since January 1, 2007 are presented below:
103,450, 26,350 and 112,050 Service RSUs were granted in 2007, 2006 and 2005, respectively. The fair values of Service RSUs were estimated on the date of grant based on the closing market price of TRH shares on the date of grant.
As of December 31, 2007, there was $8.4 million of total unrecognized compensation costs relating to Service RSUs granted but not yet vested under the Stock Incentive Plan. These costs are expected to be recognized over a weighted average period of 2.4 years.
The SICO Plans provide that shares currently owned by SICO are set aside by SICO for the benefit of the participant and distributed upon retirement. The SICO Board of Directors currently may permit an early payout of units under certain circumstances. Prior to payout, the participant is not entitled to vote, dispose of or receive dividends with respect to such shares, and shares are subject to forfeiture under certain conditions, including but not limited to the participant’s voluntary termination of employment prior to normal retirement age. Under the SICO Plans, SICO’s Board of Directors may elect to pay a participant cash in lieu of shares of AIG common stock. Following notification in December 2005 from SICO to participants in the SICO Plans that it will settle specific future awards
under the SICO Plans with shares rather than cash, the accounting for the SICO Plans changed from variable to fixed measurement accounting.
As of December 31, 2007, there was $8.4 million of total unrecognized compensation costs relating to the SICO Plans. These costs are expected to be recognized over a weighted average period of 5.7 years.
TRH has service and expense agreements and certain other agreements with the AIG Group which provide for the reimbursement to the AIG Group of certain administrative and operating expenses which include, but are not limited to, investment advisory, investment recordkeeping, cash management services, office space and human resource related activities. Under the guidance of TRH’s Finance Committee of the Board of Directors and senior management, certain subsidiaries of AIG act as financial advisors and managers of TRH’s investment portfolio. In 2007, 2006 and 2005, $13.8 million, $13.1 million and $11.5 million, respectively, of operating and investment expenses relate to services and expenses provided by the AIG Group under these agreements.
AIG’s common stock outstanding as of October 31, 2007, this beneficial ownership represents approximately 14% of the voting stock of AIG. Although these reporting persons have made filings under Section 16 of the Securities Exchange Act of 1934, reporting sales of shares of AIG’s common stock, no amendment to the Schedule 13D has been filed to report a change in ownership subsequent to March 20, 2007. Throughout 2005 certain directors of TRH were also stockholders, executive officers or directors of Starr. On January 9, 2006, Starr released a press release indicating that all AIG executives and officers had tendered their shares in Starr pursuant to Starr’s tender offer. In 2007 and 2006, no TRH directors are stockholders, executive officers or directors of Starr.
In 2005, through April 3, Messrs. Greenberg, Matthews and Howard I. Smith were directors of TRH and also stockholders, executive officers or directors of Starr. On April 4, 2005, Messrs. Greenberg, Matthews and Smith resigned from the Board of Directors of TRH. For 2005, Messrs. Orlich and Tizzio were also stockholders, executive officers or directors of Starr. From May 19, 2005, when Messrs. Bensinger and Sullivan were elected to the Board of TRH, through approximately December 31, 2005, Messrs. Bensinger and Sullivan were also stockholders, executive officers or directors of Starr.
TRC and Putnam each prepare statutory financial statements in accordance with accounting practices prescribed or permitted by New York-their state of domicile. Prescribed statutory accounting practices are discussed in a variety of publications of the National Association of Insurance Commissioners (“NAIC”), as well as in state laws, regulations and general administrative rules. Permitted statutory accounting practices encompass all accounting practices not so prescribed. All material statutory accounting practices of TRC and Putnam are prescribed in the authoritative
literature described above. As required by the state of New York, TRC and Putnam use the Codification of Statutory Accounting Principles as primary guidance on statutory accounting.
Ceded premiums written and earned related to non-affiliates include $133 million of reinstatement premiums in 2005 relating to catastrophe loss events. Reinstatement premiums were not significant in 2007 and 2006.
Gross incurred losses and LAE include gross catastrophe losses incurred of $68 million, $85 million and $870 million in 2007, 2006 and 2005, respectively.
Ceded reinsurance arrangements do not relieve TRH from its obligations to the insurers and reinsurers from whom it assumes business. The failure of retrocessionnaires to honor their obligations could result in losses to TRH; consequently, an allowance has been established for estimated unrecoverable reinsurance on paid and unpaid losses totaling $12.0 million as of December 31, 2007 and 2006. TRH evaluates the financial condition of its retrocessionnaires through a security committee. With respect to reinsurance recoverable on paid and unpaid losses and prepaid reinsurance premiums, TRH holds substantial amounts of funds and letters of credit to collateralize these amounts. Such funds and letters of credit can be drawn on for amounts remaining unpaid beyond contract terms. No uncollateralized amounts recoverable from a single retrocessionnaire, other than amounts due from affiliates, are considered material to the financial position of TRH.
While the great majority of premium revenues and assets relate to the regions where particular offices are located, a significant portion of such amounts may be derived from other regions of the world.
Net premiums earned from affiliates approximate $427.9 million, $422.7 million and $467.4 million in 2007, 2006 and 2005, respectively, and are included primarily in Domestic.
Includes revenues from the London, England office of $884.6 million, $819.5 million and $862.0 million in 2007, 2006 and 2005, respectively, and revenues from TRZ of $385.2 million, $380.7 million and $388.4 million in 2007, 2006 and 2005, respectively.
As the Hong Kong branch segment data is considered significant to segment data in 2005 only, certain key Hong Kong data elements which are included in International-Other in 2005 are as follows: Revenues-$99.3 million; Income before income taxes-$20.3 million; Assets-$100.9 million.
On February 9, 2006, AIG announced that it reached a resolution of claims and matters under investigation by the DOJ, SEC, NYAG and NYS ID. AIG stated that the settlements resolved investigations conducted by the SEC, NYAG and NYS ID against AIG and conclude negotiations with these authorities and the DOJ in connection with the accounting, financial reporting and insurance brokerage practices of AIG and its subsidiaries, as well as claims relating to the underpayment of certain workers compensation premium taxes and other assessments.
The following is a summary of unaudited quarterly financial data for each of the years ended December 31, 2007 and 2006. However, in the opinion of management, all adjustments, consisting of normal recurring accruals, necessary for a fair statement of the results of operations for such periods have been made.