The following is a discussion and analysis of our results of operations for the years ended December 31, 2010, 2009 and 2008 and financial condition as of December 31, 2010 and 2009. The following discussion should be read in conjunction with the consolidated financial statements and accompanying notes, which appear elsewhere in this filing.
Our consolidated financial statements contain certain amounts that are inherently subjective in nature and have required management to make assumptions and best estimates to determine reported values. If certain factors, including those described in ‘‘Risk Factors’’, cause actual events or results to differ materially from our underlying assumptions or estimates, there could be a material adverse effect on our results of operations, financial condition or liquidity. We believe that the following accounting policies affect the more significant estimates used in the preparation of our consolidated financial statements. The descriptions below are summarized and have been simplified for clarity. A more detailed description of our significant accounting policies as well as recently issued accounting standards is included in Note 2 to the consolidated financial statements.
Premium Revenues and Risk Transfer. Our property and casualty reinsurance premiums are recorded as premiums written based upon contract terms and information received from ceding companies and their brokers. For excess of loss reinsurance contracts, premiums are typically stated as a percentage of the subject premiums written by the client, subject to a minimum and deposit premium. The minimum and deposit premium is typically based on an estimate of subject premiums expected to be written by the client during the contract term. Generally, the minimum and deposit premium is reported initially as premiums written and adjusted, if necessary, in subsequent periods once the actual subject premium is known.
For each quota share or proportional property and casualty reinsurance contract we underwrite, our client estimates gross premiums written at inception of the contract. We generally account for such premiums using our best estimates and then adjust our estimates based on actual reports provided by our client and based on our expectations of the industry developments. As the contract progresses, we monitor actual premiums received in conjunction with correspondence from the client in order to refine our estimate. Variances from initial gross premiums written estimates can be greater for quota share contracts than for excess of loss contracts. All premiums are earned on a pro rata basis over the coverage period. Unearned premiums consist of the unexpired portion of reinsurance provided.
We are able to confirm the accuracy and completeness of premiums reported by our clients by either reviewing the client’s statutory filings and/or performing an audit of the client, as per the terms of the contract. Discrepancies between premiums being ceded and reported under a contract are, in our experience, rare. To date, we have not had any material discrepancy in premium being reported by a client that required a dispute resolution process.
Investments. Our investments in debt and equity securities that are classified as “trading securities” are carried at fair value in accordance with U.S. GAAP. The fair values of the listed equity and debt investments are derived based on the last reported price on the balance sheet date as reported by a recognized exchange. The fair values of private debt instruments are generally derived based on the average of multiple market maker or broker quotes which are considered to be binding. Where quotes are not available, debt instruments are valued using cash flow models using assumptions and estimates that may be subjective and non-observable.
The fair values of our investments in commodities are based on the commodity’s last reported price on the balance sheet date as reported by a recognized commodities exchange. Our other investments in private and unlisted equity securities, limited partnerships and futures, are all carried at fair value, based on broker or market maker quotes, or based on management’s assumptions developed from available information, using the services of our investment advisor. Our exchange traded option contracts are recorded at fair value based on quoted prices in active markets. For OTC options and exchange traded options where a quoted price in an active market is not available, we obtain multiple market maker quotes to determine the fair values.
Case reserves are provided by our clients, and IBNR losses are estimated each reporting period based on a contract by contract review of all data available to us for each individual contract. Each of our reinsurance contracts is unique and the methods and estimates we use vary depending on the facts and circumstances of each contract. The resulting total loss reserves, including IBNR, are the sum of each loss reserve estimated on a contract by contract basis.
For all non-natural peril business, we initially reserve every individual contract to the expected loss and loss expense ratio that we calculated when we originally priced the business. In our pricing analysis, we typically utilize a significant amount of information both from the individual client and from industry data. Where practical, we compare historic reserving data that we receive from our client, if any, to publicly available financial statements of the client in an effort to identify, confirm and monitor the accuracy and completeness of the received data. We require each of our clients to provide loss information for each reporting period, which, depending on the contract, could be monthly or quarterly. The loss information required depends on the terms and conditions of each contract and may include many years of history. Depending on the type of business underwritten, we are entitled to receive client and industry information on historical paid losses, incurred losses, number of open claims, number of closed claims, number of total claims, listings of individual large losses, earned premiums, policy count, policy limits underwritten, exposure information and rate change information. We may also receive information by class or subclass of business. If we do not receive reserving data from a client, we rely on industry data, as well as the judgment and experience of our underwriters and actuaries.
Paid Loss Development Method. We estimate ultimate losses by calculating past paid loss development factors and applying them to exposure periods with further expected paid loss development. The paid loss development method assumes that losses are paid in a consistent pattern. It provides an objective test of reported loss projections because paid losses contain no reserve estimates. For many coverages, claim payments are made very slowly and it may take years for claims to be fully reported and settled.
In addition, we supplement our analysis with other reserving methodologies that we deem to be relevant to specific contracts.
Additionally, we contract with a third-party actuarial firm to perform a quarterly reserve review and to annually opine on the reasonableness and adequacy of our loss reserves. We provide our external actuary with our pricing models, reserving analysis and any other data they may request. Additionally, the actuarial firm may inquire as to the various assumptions and estimates that we may use in our reserving analysis. The external actuarial firm independently creates its own reserving models based on industry loss information, augmented by specific client loss information that we may be asked to provide as well as its own independent assumptions and estimates. Based on various reserving methodologies that the actuarial firm considers appropriate, it creates a reserve estimate for each contract in our portfolio and provides us with an aggregate recommended loss reserve, including IBNR. If there are material differences between our booked reserves and the actuarial firm’s recommended reserves we review the differences and agree upon and make any necessary adjustments to the booked reserves. To date there have been no material differences resulting from the external actuary's reviews.
Because of the uncertainties that surround our estimates of loss and loss adjustment expense reserves, we cannot be certain that ultimate loss and loss adjustment expense payments will not exceed our estimates, or be less than our estimates. If our estimated reserves are deficient, we would be required to increase loss reserves in the period in which such deficiencies are identified which would cause a charge to our earnings and a reduction of our capital. Similarly, if our estimated reserves are excessive, we would decrease loss reserves in such period in which the excesses are identified. By way of illustration, since we started underwriting operations in 2006, the reserve re-estimation process has resulted in the following effect on the prior year reserves and net income during each of the years ended December 31:
Given the uncertainties involved in estimating ultimate reserves and since we reserve to a point estimate on an individual contract basis, our estimated reserves may be deficient or excessive. Historical development of estimated reserves is not an accurate reflection of future loss development. Additionally, external factors can influence prior year loss development. For example, changes in specific tort law which may cause ultimate loss awards to increase or decrease could have a material effect on our loss reserve development. We are unable to predict with accuracy the magnitude or direction that such external factors may have on our estimated loss reserves.
Bonus Accruals. Under the Company's bonus program, each employee’s target bonus consists of two components: a discretionary component based on a qualitative assessment of each employee’s performance and a quantitative component based on the return on deployed equity (‘‘RODE”) for each underwriting year relating to reinsurance operations. The qualitative portion of an employee’s annual bonus is accrued at each employee's target amount, which may differ significantly from the actual amount approved and awarded annually by the Compensation Committee. The quantitative portion of each employee’s annual bonus is accrued based on the expected RODE for each underwriting year and adjusted for changes in the expected RODE and actual investment return each quarter until the final quantitative bonus is calculated and paid two years from the end of the fiscal year in which the business was underwritten. The expected RODE calculation utilizes proprietary models which requires significant estimation and judgment. Actual RODE may vary significantly from the expected RODE and any adjustments to the quantitative bonus estimates, which may be material, are recorded in the period in which they are determined.
Share-Based Payments. We have established a Stock Incentive Plan for directors, employees and consultants. U.S. GAAP requires us to recognize share-based compensation transactions using the fair value at the grant date of the award. We calculate the compensation for restricted stock awards based on the price of the Company’s common shares at the grant date and recognize the expense over the vesting period. Determining the fair value of share option awards at the grant date requires significant estimation and judgment. We use an option-pricing model (Black-Scholes pricing model) to assist in the calculation of fair value. Our shares have not been publicly traded for a sufficient length of time to reasonably estimate the expected volatility. Therefore we have based our expected volatility on the historical volatility of similar entities. We typically considered factors such as an entity's industry, stage of life cycle, size and financial leverage when selecting similar entities. Additionally, we used the full life of the option, ten years, as the estimated term of the option, and we have assumed that dividends will not be paid. If actual results differ significantly from these estimates and assumptions, particularly in relation to our estimation of volatility which requires significant judgment due to our limited operating history, share-based compensation expense, primarily with respect to future share-based awards, could be materially impacted.
Despite an overall less attractive marketplace, we believe that we are well positioned to compete for frequency business due to our increasing market recognition and the development of certain strategic relationships. In addition, there are a number of insurers and reinsurers that continue to suffer from capacity issues even after the rebound of the financial markets during 2009 and 2010. We have seen a number of large, frequency-oriented opportunities that we believe fit well within our business strategy. These opportunities could increase for us if financial and credit markets report large losses while we maintain our financial strength. We have seen some additional consolidation in the industry in 2010. We believe if merger and acquisition activity in the reinsurance industry increases and the number of industry participants decreases we could benefit from increased opportunities since insurers may prefer to diversify their reinsurance placements.
We believe our investment portfolio was conservatively positioned in 2010, with a net long position of 20.2% as of December 31, 2010, as the market appears to have priced in a sustained economic recovery, which may or may not hold. 2010 was a challenging environment for our core long-short strategy, particularly considering our defensive posture. For the first time in several years, momentum-driven speculation drove the market. Nonetheless, we generated a satisfactory result as our longs signifcantly outperformed the market, our shorts modestly underperformed the market, and our macro hedges, most notably gold, generated additional profits. We believe that 2011 will be challenging, with continued uncertainty and geopolitical and economic headwinds globally. Fiscal and monetary government stimulus continue to drive the U.S. equity markets' upward ascent, with further quantitative easing and accomodative tax policies. However, we believe the stimulus is causing inflationary pressures as seen by increases in commodity prices, particularly oil and food, which may have adverse consequences to the economic recovery and the value of the U.S. dollar. Given the challenging macroeconomic environment and higher government deficits, we continue to hold a significant position in gold and have other macro hedges in place in the form of options on higher interest rates, foreign exchange rates, and corporate and sovereign credit default swaps.
For the year ended December 31, 2009, we reported net income of $209.5 million compared to a net loss of $120.9 million for the year ended December 31, 2008. The net income reported in 2009 principally related to a net investment income of $199.9 million. Our investment portfolio reported a gain of 32.1% for the year ended December 31, 2009 compared to a loss of 17.6% for the year ended December 31, 2008. The underwriting income before general and administrative expenses for the year ended December 31, 2009 increased 48.3% to $26.4 million compared to $17.8 million for the year ended December 31, 2008. In addition, we generated other income of $4.5 million for the year ended December 31, 2009 (2008: $0) relating to penalty fees upon early termination of a reinsurance contract, net gains on deposit accounted contracts and advisory fees earned by Verdant.
For the year ended December 31, 2010, the premiums written relating to severity contracts decreased by $9.0 million, or 28.1%, from the year ended December 31, 2009. The decrease was principally due to our decision to reduce our participation in a property catastrophe contract which accounted for $8.3 million of the decrease. In addition, we did not renew a professional liability stop-loss contract during 2010, and also returned premiums upon commutation of a medical malpractice contract, which together contributed $6.2 million to the decrease in premiums written for the year ended December 31, 2010. The decrease was offset partially by $6.0 million of new severity premiums generated from opportunities we found during 2010, including a multi-line excess of loss catastrophe contract and a financial surety contract.
We entered into retrocessional contracts with ceded premiums of $12.0 million, $13.3 million and $16.4 million for the years ended December 31, 2010, 2009 and 2008, respectively. The decrease in ceded premiums for the year ended December 31, 2010, is the combined result of our decision to reduce the percentage retroceded on a casualty contract upon renewal, as well as one of our ceding insurer’s decision to directly retrocede an excess layer of coverage upon renewal in 2010, whereas we had purchased retrocession for this layer during 2009. The decrease was partially offset by higher premiums on a multi-line frequency casualty contract which in turn resulted in higher premiums ceded on the corresponding quota share retroceded contract.
The decrease in ceded premiums for the year ended December 31, 2009, is the net result of a health contract and its corresponding retroceded contract expiring in 2009, offset by a new general liability retroceded contract entered into during the year ended December 31, 2009.
Losses incurred include losses paid and changes in loss reserves, including reserves for IBNR, net of actual and estimated loss recoverables. Details of losses incurred for the years ended December 31, are provided in the following table:
Total losses incurred on frequency contracts continued to increase as a result of increases in premiums earned as well as unfavorable loss development relating to our commercial motor liability contracts that were placed into run-off in 2010. Losses incurred as a percentage of premiums earned (i.e. loss ratio) fluctuate based on the mix of business, and the favorable or adverse development of our larger contracts. The loss ratios of our frequency business were 68.9%, 56.6% and 44.4% for the years ended December 31, 2010, 2009 and 2008, respectively. For the year ended December 31, 2010, the increase in frequency loss ratio was principally due to adverse losses on motor liability contracts.
We expect losses incurred on our severity business to be volatile from period to period. The loss ratios for our severity business were (4.3)%, 51.2%, and 57.7% for the years ended December 31, 2010, 2009 and 2008, respectively. The negative severity loss ratio for the year ended December 31, 2010 was primarily due to the absence of any major catastrophe losses and to a lesser extent due to net favorable loss development on prior year severity contracts amounting to $6.0 million. Prior year contracts with favorable development included a multi-year excess of loss professional liability contract, an excess of loss catastrophe contract, and a medical malpractice contract that was commuted during 2010 resulting in the reversal of severity loss reserves. Meanwhile, the largest severity losses incurred during 2010 related to adverse development of the 2008 California wildfires on a 2007 casualty clash contract, which increased our severity loss reserves by $3.4 million.
The decrease in the severity loss ratio for the year ended December 31, 2009 was due to a medical malpractice contract that was terminated early with no losses. Offsetting this were losses reported during 2009 on an aggregate catastrophe excess of loss contract and an additional loss reported to us during 2009 on a 2007 casualty clash contract.
Favorable loss development of $4.1 million on a multi-year professional liability excess of loss contract, based on data received from the client and our quarterly reserve analysis;
Favorable loss development of $1.8 million in aggregate, on two catastrophe contracts based on data received from the clients and our quarterly reserve analysis;
Favorable loss development of $1.4 million in aggregate, on two 2007 professional liability excess of loss contracts, based on data received from the client and our quarterly reserve analysis;
· Favorable loss development of $1.5 million on a 2008 motor liability contract. The reserves on this contract were adjusted in the fourth quarter of 2009 based on data received from the client as well as our own quarterly reserve analysis;
· Favorable loss development of $0.7 million on a 2008 workers' compensation contract. The reserves on this contract were adjusted in the fourth quarter of 2009 based on data received from the client as well our own quarterly reserve analysis;
· Adverse loss development of $1.1 million on a 2007 health contract based on our quarterly reserve analysis.
For the year ended December 31, 2010, the increase in ceded reserves of $4.7 million was partially related to a retroceded 2010 multi-line stop-loss contract, which had a larger ceded reserve recorded due to the underlying contract’s loss ratio breaching the loss corridor limit. The increase in ceded reserves was also partially related to a 2009 retroceded multi-line frequency casualty contract, which was impacted by an increase in earned premiums (and as a result, loss reserves) on a corresponding quota share inward contract. For the year ended December 31, 2009, the decrease in ceded reserves of $4.4 million was primarily due to favorable loss development on an inward contract and the reduction in reserves recoverable on the corresponding retroceded contract.
Increased acquisition costs for the year ended December 31, 2010 compared to the same period for 2009 are consistent with the increases in premiums written and earned. For the years ended December 31, 2010, 2009 and 2008 the acquisition cost ratios for frequency business were 36.7%, 38.6% and 46.8%, respectively. We expect that acquisition costs will be higher for frequency business than for severity business. The acquisition cost ratios for severity business were 26.3%, 8.3% and 10.8% for the years ended December 31, 2010, 2009 and 2008, respectively.
For the year ended December 31, 2010, the increase in severity acquisition cost and the severity acquisition cost ratio was primarily due to profit commissions recorded on a multi-year professional liability excess of loss contract due to favorable loss development during 2010. To a lesser extent, the increase was attributed to profit commissions on our new financial line and on a catastrophe contract which had favorable loss development during 2010.
General and administrative expenses for the years ended December 31, 2010, 2009 and 2008 include $4.1 million, $3.4 million and $3.0 million, respectively, for the expensing of the fair value of stock options and restricted stock granted to employees and directors.
Investment income, net of all fees and expenses, resulted in a gain of 11.0% on our investment portfolio for the year ended December 31, 2010. This compares to a gain of 32.1% and a loss of 17.6% reported for the years ended December 31, 2009 and 2008, respectively. Investment returns are calculated monthly and compounded to calculate the annual returns. The resulting actual investment income may vary depending on cash flows into or out of the investment account.
For the year ended December 31, 2010, included in investment advisor compensation was $13.4 million (2009: $10.8 million) relating to management fees paid to DME Advisors and $12.9 million (2009: $21.9 million) relating to performance allocation in accordance with the loss carry forward provision of the advisory agreement with DME Advisors. Given the net investment loss for the year ended December 31, 2008, no performance allocation was made to DME Advisors in 2008. In addition, based on the advisory agreement, the performance allocation for the subsequent years was reduced to 10% until all the investment losses from 2008 had been recouped and an additional amount equal to 150% of the investment loss was earned. As of December 31, 2010, the loss carry forward balance was nil and the performance allocation rate reverted to 20% during December 2010.
GRIL is incorporated in Ireland and, therefore, is subject to the Irish corporation tax. GRIL is expected to be taxed at a rate of 12.5% on its taxable trading income.
For the year ended December 31, 2010, a deferred tax asset of $79,018 (2009: $68,719) resulting solely from the temporary differences in recognition of expenses for tax purposes was included in other assets on the consolidated balance sheets. At December 31, 2010, an accrual for current taxes payable of $333,865 (2009: $19,529) was recorded in other liabilities on the consolidated balance sheets. Based on the timing of the reversal of the temporary differences and likelihood of generating sufficient taxable income to realize the future tax benefit, management believes it is more likely than not that the deferred tax asset will be fully realized in the future and therefore no valuation allowance has been recorded. Neither Verdant nor GRIL have taken any tax positions that are subject to uncertainty or that are reasonably likely to have a material impact to Verdant, GRIL or the Company.
The following table sets forth our current and deferred income tax benefit (expense) on a consolidated basis for the years ended December 31, 2010, 2009 and 2008:
Our investment portfolio, including any derivatives, is valued at fair value and any unrealized gains or losses are reflected in net investment income in the consolidated statements of income. As of December 31, 2010, 92.7% of our investment portfolio (excluding restricted and unrestricted cash and cash equivalents) was comprised of investments valued based on quoted prices in actively traded markets (Level 1), 4.8% comprised of securities valued based on observable inputs other than quoted prices (Level 2) and 2.5% was comprised of securities valued based on non-observable inputs (Level 3).
At December 31, 2010, reinsurance balances receivable were $109.6 million compared to $82.7 million as of December 31, 2009, an increase of $26.9 million, or 32.5%. The increase in the reinsurance balances receivable relates primarily to increases in premiums written on several quota share frequency contracts. The entire reinsurance balance receivable is considered current and collectible and therefore no provision for uncollectible balances was recorded at December 31, 2010.
The increase in loss reserves is principally due to the frequency underwriting portfolio continuing to mature, resulting in an increase in case reserves as losses are reported by our clients, and to a lesser extent due to unfavorable loss development on certain contracts as discussed above (see Losses Incurred). For most of the contracts written as of December 31, 2010, our risk exposure is limited by defined limits of liability on these contracts. Once the loss limit for a contract has been reached, we have no further exposure to additional losses from that contract. However, certain contracts, particularly quota share contracts which relate to first dollar exposure, may not contain aggregate limits.
Our severity business includes contracts that contain or may contain natural peril loss exposure. As of February 1, 2011, our maximum aggregate loss exposure to any series of natural peril events was $93.8 million. For purposes of the preceding sentence, aggregate loss exposure is equal to the difference between the aggregate limits available in the contracts that contain natural peril exposure minus reinstatement premiums for the same contracts. We categorize peak zones as: United States, Europe, Japan and the rest of the world. The following table provides single event loss exposure and aggregate loss exposure information for the peak zones of our natural peril coverage as of the date of this filing:
Our natural peril loss exposure presented above excludes the impact of any potential recoveries from retrocessionaires or swap counter parties relating to natural peril events. We have currently entered into a weather derivative swap contract whereby upon the occurrence of certain specified earthquake events in the United States we would recover a maximum amount of $10.0 million.
Our shareholders’ equity increased to $839.2 million as of December 31, 2010 from $729.2 million as of December 31, 2009, an increase of 15.1%. The increase is principally attributable to the increase in retained earnings from net income of $90.6 million for the year ended December 31, 2010. In addition, the non-controlling interest in joint venture increased by $15.2 million primarily as a result of DME Advisors retaining its performance allocation of $12.9 million for the year ended December 31, 2010 in its joint venture account.
As of December 31, 2010, the financial strength of both Greenlight Re and GRIL was rated “A- (Excellent)” with a stable outlook by A.M. Best. This rating reflects A.M. Best’s opinion of our reinsurance subsidiaries’ financial strength, operating performance and ability to meet obligations, and it is not an evaluation directed toward the protection of investors or a recommendation to buy, sell or hold our Class A ordinary shares.
Our sources of funds primarily consist of premium receipts (net of brokerage and ceding commissions) and investment income (net of advisory compensation and investment expenses), including realized gains, and other income. We use cash from our operations to pay losses and loss adjustment expenses, profit commissions and general and administrative expenses. Substantially all of our funds, including shareholders’ capital, net of funds required for cash liquidity purposes, are invested by our investment advisor in accordance with our investment guidelines. As of December 31, 2010, approximately 93.4% of our investments were comprised of publicly traded equity securities, actively traded debt instruments and gold bullion, which can all be readily liquidated to meet current and future liabilities. As of December 31, 2010, the majority of our investments were valued based on quoted prices in active markets for identical assets (Level 1). Given our value-oriented long and short investment strategy, if markets are distressed we would expect the liability of the short portfolio to decline. Any reduction in the liability would cause our need for restricted cash to decrease and thereby free cash to be used for any purpose. Additionally, since the majority of our invested assets are liquid, even in distressed markets, we believe securities can be sold or covered to generate cash to pay claims. Since we classify our investments as “trading”, we book all gains and losses (including unrealized gains and losses) on all our investments (including derivatives) in our consolidated statements of income for each reporting period.
For the year ended December 31, 2010, we generated $38.5 million in cash from operations principally as a result of increased underwriting activities including several new Florida homeowners’ insurance contracts, which generated significant cash in the form of incoming unearned premiums. Incoming unearned premiums represent premiums for future risks on the unexpired portion of the cedant’s in-force underlying insurance policies. We do not anticipate significant incoming unearned premiums to be recurring; however we may periodically enter into contracts that include coverage of future risks on in-force underlying policies which provide incoming unearned premiums. Incoming unearned premiums are recorded at inception of a contract and are earned over the remaining future risk coverage period. We used $24.7 million of cash for investing activities which is net of $54.4 million of margin borrowing from prime brokers for investing purposes. We generated no significant cash from financing activities during the year ended December 31, 2010. For the year ended December 31, 2009, we generated $50.0 million in cash from operations mainly as a result of increased underwriting activities, used $111.3 million for purchase of investments, and generated $0.3 million from financing activities mainly relating to exercised stock options.
Greenlight Re and GRIL are currently not licensed or admitted as reinsurers in any jurisdiction other than the Cayman Islands and the European Economic Area, respectively. Because many jurisdictions do not permit domestic insurance companies to take credit on their statutory financial statements unless appropriate measures are in place for reinsurance obtained from unlicensed or non-admitted insurers we anticipate that all of our U.S. clients and some of our non-U.S. clients will require us to provide collateral through funds withheld, trust arrangements, letters of credit or a combination thereof.
Effective June 17, 2010 we increased our Butterfield Bank (Cayman) Limited letter of credit facility from $25.0 million to $60.0 million. In addition, effective July 1, 2010, we increased our Bank of America, N.A. letter of credit facility from $50.0 million to $100.0 million. As of December 31, 2010, we had three letter of credit facilities totaling $560.0 million with various financial institutions. See Note 15 of the accompanying condensed consolidated financial statements for details on each of these facilities. In addition, effective February 3, 2011, we entered into a letter of credit facility agreement with JPMorgan Chase Bank, N.A. for $50.0 million which increased our total letter of credit facilities to $610.0 million as of the date of this filing. As of December 31, 2010, an aggregate amount of $339.9 million (December 31, 2009: $278.4 million) in letters of credit was issued from these facilities. Under the letter of credit facilities, we provide collateral that may consist of equity securities, restricted cash, and cash equivalents. As of December 31, 2010, we had pledged an aggregate of $349.6 million (December 31, 2009: $315.2 million) of equity securities, restricted cash, and cash equivalents as collateral for the letters of credit issued.
The amount of collateral, currently in the form of letters of credit, posted for the benefit of our clients is based on the specific collateral requirement as stated in each reinsurance contract. For U.S. clients, the amount of letters of credit required is typically equal to the client’s reinsurance losses recoverable including IBNR plus unearned premium reserve that they book for statutory purposes on each contract. These balances need to be collateralized in order for our client to get statutory credit for their reinsurance assets which is standard practice in the reinsurance industry. Alternatively, the amount of collateral posted to a client may be a fixed negotiated amount.
Once letters of credit are issued to our clients, the minimum amount of assets that we pledge to our letter of credit providers depends upon the requirements stated in the specific letter of credit facility agreement. The amount of pledged assets required depends on the specific investment instrument that we transfer to the pledge account. The amount of credit that is given on the pledged assets depends on the type of instrument and the exchange on which that instrument is traded. For example, under the terms of the letter of credit facility with Butterfield Bank (Cayman) Limited, if we pledge an equity security that is traded on the New York Stock Exchange, we receive a fixed percentage credit for the market value of such a security. If the market value of these securities were to decline, we would be obligated to pledge additional assets. Conversely if the market value of these securities increased we would be entitled to withdraw any excess pledged assets from the account if we so choose. The ultimate amount of pledged assets posted is simply the value of securities held in a designated pledge account, which may be greater than the minimum required.
Each of the facilities contains various covenants that, in part, restrict Greenlight Re's ability to place a lien or charge on the pledged assets and further restrict Greenlight Re’s ability to issue any debt without the consent of the letter of credit provider. Additionally, if an event of default exists, as defined in the letter of credit agreements, Greenlight Re will be prohibited from paying dividends to Greenlight Capital Re. For the year ended December 31, 2010, the Company was in compliance with all of the covenants under each of these facilities.
Our capital structure currently consists entirely of equity issued in two separate classes of ordinary shares. We expect that existing capital base and internally generated funds will be sufficient to implement our business strategy. Consequently, we do not presently anticipate that we will incur any material indebtedness in the ordinary course of our business. We filed a Form S-3 registration statement for an aggregate principal amount of $200.0 million in securities, which was declared effective by the SEC on July 10, 2009, in order to provide us with additional flexibility and timely access to public capital markets should we require additional capital for working capital, capital expenditures, acquisitions and other general corporate purposes. We did not make any significant commitments for capital expenditures during the period ending December 31, 2010.
On April 28, 2010, our shareholders approved an amendment to our stock incentive plan to increase the number of Class A ordinary shares available for issuance from 2.0 million to 3.5 million. At December 31, 2010, there were 1,419,295 Class A ordinary shares available for future issuance.