Properties. We currently lease office space in Bermuda (our corporate headquarters), the United States, the United Kingdom, Germany, Austria, Australia and Russia for the operation of our business. We also lease a property for employee use in Bermuda. Our leases have remaining terms ranging from 7 months to approximately 10 years in length. We renew and enter into new leases in the ordinary course of business as needed. While we believe that the office space from these leased properties is sufficient for us to conduct our operations for the foreseeable future, we may need to expand into additional facilities to accommodate future growth. For more information on our leasing arrangements, please see Note 12 of the notes to the Consolidated Financial Statements in this Form 10-K.
Since our founding in 2007, we have entered into a series of significant strategic transactions that have transformed the scope and scale of our business while keeping our low volatility, non-catastrophe risk profile intact. These transactions have increased our revenue to in excess of $1 billion while strongly positioning our capital to extend its business platform both in the U.S. and internationally and include:
• Acquiring the reinsurance operations of GMAC Insurance from GMACI Holdings, LLC in 2008 (the “GMAC Acquisition”);
• Completing a private placement of trust preferred securities of approximately $260.1 million in 2009 (the “TRUPS Offering”);
• Acquiring the majority of the reinsurance-related infrastructure, assets and liabilities of U.K.-based GMAC International Insurance Services, Ltd. in 2010 (the “IIS Acquisition”).
We currently operate our business through three segments: Diversified Reinsurance, AmTrust Quota Share and beginning in 2010, the ACAC Quota Share. As of December 31, 2010, we had approximately $3.0 billion in total assets, $750.2 million of total shareholders’ equity and $965.4 million in total capital, which includes shareholders’ equity and junior subordinated debt.
The market conditions in which we operate have historically been cyclical, experiencing cycles of price erosion followed by rate strengthening as a result of catastrophes or other significant losses that affect the overall capacity of the industry to provide coverage. During the period covered by this discussion, the reinsurance market has been characterized by significant competition in most lines of business.
In addition, the property and casualty industry invests significant portions of its premiums and retained underwriting profits in fixed income maturities, the yields on which continue to perform at historically low levels. Continued existence of these conditions, including the possibility of even lower yields in the near-term will increasingly adversely impact the results of the property and casualty industry generally, placing additional pressure on companies underwriting results at a time that market conditions are not supportive of additional pricing measures which would stabilize underwriting trends. Nonetheless, capital positions across the industry remain sufficiently strong that despite the unfavorable pricing and investment environment, competitive conditions appear unlikely to change in the immediately foreseeable future, although the ultimate impact remains unclear. As market conditions continue to develop and competition further increases, we continue to maintain our adherence to underwriting standards by declining business when pricing, terms and conditions do not meet our underwriting standards.
The substantial majority of the premiums and losses underwritten by GMAC IICL are subject to collateral requirements in the form of letters of credit and trust agreements. At the closing of the IIS Acquisition, the Company settled cash balances applicable to the subject reinsurance contracts with GMAC IICL. Actual assets in support of the liabilities assumed under the IICL Agreement will be transferred to the Company when the subject individual agreements are novated to Maiden Bermuda. Please refer to the section entitled “IIS Acquisition - Funds Withheld” in the Liquidity and Capital Resources section of “Management’s Discussion and Analysis of Financial Results and Results of Operations” in this Form 10-K for further information.
ACAC Transaction In November 2009, we announced an agreement in principal with ACAC regarding a multi-year 25% quota share agreement expected to generate over $200 million in annual revenue. The contract commenced on March 1, 2010 after final regulatory approval and the closing of ACAC’s acquisition of GMACI’s U.S. consumer property and casualty insurance business, as well as a small amount of commercial auto business. This business generated over $1.0 billion in net written premium in each of 2008 and 2009. ACAC is owned by one of our Founding Shareholders, Michael Karfunkel, and the Michael Karfunkel 2005 Grantor Retained Annuity Trust (the “Trust”), which is controlled by Michael Karfunkel. The Trust currently owns 72.4% of ACAC’s issued and outstanding common stock, Michael Karfunkel currently owns 27.6% of ACAC’s issued and outstanding common stock and AmTrust owns preferred shares convertible into 21.25% of the issued and outstanding common stock of ACAC. In addition to reinsurance support, we will provide support services focused on helping ACAC to continue its profitable expansion.
In conjunction with the acquisition of GMAC RE, on October 31, 2008, the Company and Motors entered into a Portfolio Transfer and Quota Share Reinsurance Agreement (“Agreement”) under which the Company reinsures (i) all of the existing contracts written by GMAC RE pursuant to a loss portfolio transfer and (ii) contracts written pursuant to a fronting arrangement with Motors. According to the loss portfolio transfer provisions of the Agreement, the Company assumed the loss reserves of $755.6 million associated with the GMAC RE business as of October 31, 2008. The Company also assumed unearned premium of
• Net income available to common shareholders of $69.9 million, or $0.99 basic and $0.98 diluted earnings per share
• Net premiums earned of $1.170 billion, a 27.2% increase over 2009
• Total cash and investments of $2.1 billion; fixed maturities and short-term securities comprise 90.7% of total investments, of which 63.0% have a credit rating of AAA and an overall average credit rating of AA
Certain Operating Measures Underwriting Income and Combined Ratio: The combined ratio is used in the insurance and reinsurance industry as a measure of underwriting profitability. Management measures underwriting results on an overall basis and for each segment on the basis of the combined ratio. The combined ratio is the sum of the loss and loss expense ratio and the expense ratio and the computations of each component are described below. A combined ratio under 100% indicates underwriting profitability, as the total losses and loss expenses, acquisition costs and general and administrative expenses are less than the premiums earned on that business. We have generated underwriting income in each year since our inception. Underwriting income is calculated by subtracting losses and loss adjustment expenses, commissions and other acquisition expenses and applicable general and administrative expenses from the net earned premium and is the monetized counterpart of the combined ratio.
The “loss and loss expense ratio” is derived by dividing net losses and loss expenses by net premiums earned. The “commission and acquisition cost ratio” is derived by dividing acquisition costs by net premiums earned. The “general and administrative expense ratio” is derived by dividing general and administrative expenses by net premiums earned. The “expense ratio” is the sum of the commission and acquisition cost ratio and the general and administrative expense ratio.
Relevant Factors Revenues We derive our revenues primarily from premiums on our insurance policies and reinsurance contracts, net of any reinsurance or retrocessional coverage purchased. Insurance and reinsurance premiums are a function of the amounts and types of policies and contracts we write, as well as prevailing market prices. Our prices are determined before our ultimate costs, which may extend far into the future, are known.
• change in outstanding loss or case reserves, which represent management’s best estimate of the likely settlement amount for known claims, less the portion that can be recovered from reinsurers; and
Critical Accounting Policies and Estimates It is important to understand our accounting policies in order to understand our financial position and results of operations. The Company’s Consolidated Financial Statements have been prepared in accordance with GAAP. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The following presents a discussion of those accounting policies and estimates that Management believes are the most critical to its operations and require the most difficult, subjective and complex judgment. If actual events differ significantly from the underlying assumptions and estimates used by Management, there could be material adjustments to prior estimates that could potentially adversely affect the Company’s results of operations, financial condition and liquidity. These critical accounting policies and estimates should be read in conjunction with the Company’s Notes to Consolidated Financial Statements, including Note 2, Significant Accounting Policies, for a full understanding of the Company’s accounting policies.
The reserve for IBNR is estimated by management for each account based on various factors, including underwriters’ expectations about loss experience, actuarial analysis and loss experience to date. Our actuaries employ standard actuarial methodologies to determine estimated ultimate loss reserves.
Reserves for losses and loss expenses as of December 31, 2010 and 2009 were comprised of the following:
The Reported Loss Development (“RLD”) method is a common reserving method in which ultimate losses are estimated by applying a loss development factor to actual loss experience. This method fully utilizes actual experience. Multiplication of underwriting year actual reported (or paid) losses by its respective development factor produces the estimated ultimate losses. The RLD method is based upon the assumption that the relative change in a given underwriting year’s losses from one evaluation point to the next is similar to the relative change in prior underwriting years’ losses at similar evaluation points. In addition, this method is based on the assumption that the reserving and payment patterns as well as the claim handling procedures have not changed substantially over time. When a company has a sufficiently reliable loss development history, a development pattern based on the company’s historical indications may be used to develop losses to ultimate values.
The Bornhuetter-Ferguson (“BF”) reserving technique is commonly used for long-tailed or erratic lines. It is also useful in situations where the reported loss experience is relatively immature and/or lacks sufficient credibility for the application of methods that are more heavily reliant on emerged experience. The BF method is an additive IBNR method that combines the ELR and RLD techniques by splitting the expected loss into two pieces - expected reported (or paid) losses and expected unreported (or unpaid) losses. Expected unreported (unpaid) losses are added to the current actual reported (or paid) losses to produce an estimate of
ultimate losses by underwriting year. The BF method introduces an element of stability that moderates the impact of inconsistent changes in paid and reported amounts.
With the guidance of the methods above, actuarial judgment is applied in the determination of ultimate losses. In general, the Company’s segments have varying levels of seasoning with which the Company has direct experience and as a result, differing methods are utilized to estimate loss and loss expenses reserves in each segment.
The Company has underwritten the AmTrust Quota Share segment since July 1, 2007. Certain aspects of this segment are associated with recent acquisitions by AmTrust and while the underlying experience of the book has significant seasoning, the combination of the shorter time frame with which the Company has direct experience with this business and the relative inexperience of certain aspects of this business may result in a greater range of volatility. As a result, we have tended to rely on a weighted approach which primarily employs the Reported Loss Development Method while also considering the Expected Loss Ratio Method. The Company’s actuarial analysis of this book of business is more refined in that it utilizes a combination of monthly and quarterly data instead of contract period data in totality. As a result, a range of loss development factors are utilized due to the relative lack of seasoning of the underlying business as regards the Company’s experience. Because of the refinement of the data, this allows for greater use of the loss development method earlier on in the maturity of the book than would ordinarily occur.
Significant Assumptions Employed in the Estimation of Loss and Loss Expense Reserves The most significant assumptions used as of December 31, 2010 to estimate the reserve for losses and loss expenses within the Company’s segments are as follows:
Our reporting factors and expected loss ratios are based on a blend of our own experience and industry benchmarks. The benchmarks selected were those that we believe are most similar to our underwriting business.
(iii) the diversity of loss development patterns among different types of reinsurance treaties or contracts; and
In order to verify the accuracy and completeness of the information provided to the Company by its ceding company counterparties, the Company’s underwriters, actuaries, accounting and claims personnel perform underwriting and claims reviews of the Company’s ceding companies. Any material findings are communicated to the ceding companies and utilized in the establishment or revision of the Company’s case reserves and related IBNR reserve. On occasion, these reviews reveal that the ceding company’s reported losses and loss expenses do not comport with the terms of the contract with the Company. In such events, the Company strives to resolve the outstanding differences in an amicable fashion. The large majority of such differences are resolved in this manner. In the infrequent instance where an amicable solution is not feasible, the Company’s policy is to vigorously defend its position in litigation or arbitration. As of December 31, 2010, the Company was not involved in any material claims litigation or arbitration proceedings.
Due to the large volume of potential transactions that must be recorded in the insurance and reinsurance industry, backlogs in the recording of the Company’s business activities can also impair the accuracy of its loss and loss expense reserve estimates. As of December 31, 2010, there were no significant backlogs related to the processing of policy or contract information in the Company’s segments.
• changes in the judicial and/or arbitration environment regarding the interpretation of policy and contract provisions relating to the determination of coverage and/or the amount of damages awarded for certain types of claims;
• changes in the social environment regarding the general attitude of juries in the determination of liability and damages;
In addition, the Company’s segments have varying levels of seasoning with which the Company has direct experience and as a result, the reasonably likely variance of our expected loss ratio for each segment varies commensurately with that experience. As of December 31, 2010, 86.4% of the loss reserves in the Diversified Reinsurance segment are associated with the business acquired in the GMAC Acquisition. The Company’s executive and technical management, including claims and underwriting, have significant experience with this book of business, which also has more than 25 years of loss experience associated with it. We believe the possible variance of our expected loss ratio for all applicable loss years for the Diversified Reinsurance segment was approximately one percentage point as of December 31, 2010. If our final loss ratio for the Diversified Reinsurance segment were to vary by approximately one percentage point from the expected loss ratios in the aggregate, our required reserves after reinsurance recoverable would increase or decrease by approximately $12.5 million.
The Company has underwritten the AmTrust Quota Share segment since July 1, 2007. Certain aspects of this segment are associated with recent acquisitions by AmTrust and while the underlying experience of the book has significant seasoning, the combination of the shorter time frame with which the Company has direct experience with this business and the relative inexperience of certain aspects of this business may result in a greater range of volatility in the reasonably likely variance of our expected loss ratio for all applicable loss years in the segment as compared to the Diversified Reinsurance segment. We believe a possible variance of our expected loss ratio for all applicable loss years for the AmTrust Quota Share segment was approximately four percentage points as of December 31, 2010. If our final loss ratio for the AmTrust Quota Share segment were to vary by four percentage points from the expected loss ratios in aggregate, our required reserves after reinsurance recoverable would increase or decrease by approximately $49.7 million.
Premiums and Acquisition Costs For pro-rata contracts and excess-of-loss contracts where no deposit or minimum premium is specified in the contract, written premium is recognized based on estimates of ultimate premiums provided by the ceding companies. Initial estimates of written premium are recognized in the period in which the underlying risks are incepted. Subsequent adjustments, based on reports of actual premium by the ceding companies, or revisions in estimates, are recorded in the period in which they are determined. Reinsurance premiums assumed are generally earned on a pro rata basis over the terms of the underlying policies or reinsurance contracts. Contracts and policies written on a “losses occurring” basis cover claims that may occur during the term of the contract or policy, which is typically 12 months. Accordingly, the premium is earned evenly over the term.
Contracts which are written on a “risks attaching” basis cover claims which attach to the underlying insurance policies written during the terms of such contracts. Premiums earned on such contracts usually extend beyond the original term of the reinsurance contract, typically resulting in recognition of premiums earned over a 24-month period. Reinsurance premiums on specialty risk and extended warranty are earned based on the estimated program coverage period. These estimates are based on the expected distribution of coverage periods by contract at inception, because a single contract may contain multiple coverage period options and these estimates are revised based on the actual coverage period selected by the original insured. Unearned premiums represent the portion of premiums written which is applicable to the unexpired term of the contract or policy in force. These premiums can be subject to estimates based upon information received from ceding companies and any subsequent differences arising on such estimates are recorded in the period in which they are determined.
The Company provides proportional and non-proportional reinsurance coverage to cedants (insurance companies). In most cases, cedants seek protection for business that they have not yet written at the time they enter into reinsurance agreements and thus have to estimate the volume of premiums they will cede to the Company. Reporting delays are inherent in the reinsurance industry and vary in length by type of treaty. As delays can vary from a few weeks to a year or sometimes longer, the Company produces accounting estimates to report premiums and acquisition costs until it receives the cedants’ actual results.
Acquisition costs represent the costs of writing business that vary with, and are primarily related to, the production of insurance and reinsurance business. Policy and contract acquisition costs, including assumed commissions and other direct operating expenses are deferred and recognized as expense as related premiums are earned. The Company considers anticipated investment income in determining the recoverability of these costs and believes they are fully recoverable. A premium deficiency at segment level is recognized if the sum of anticipated losses and loss adjustment expenses, unamortized acquisition costs and anticipated investment income exceed unearned premium.
For investments that have quoted market prices in active markets, the Company uses the quoted market prices as fair value and includes these prices in the amounts disclosed in the Level 1 hierarchy. To date, we have only included U.S. government fixed maturity instruments as level 1. The Company receives the quoted market prices from third party, nationally, recognized pricing services (“pricing service”). When quoted market prices are unavailable, the Company utilizes a pricing service to determine an estimate of fair value. The fair value estimates are included in the Level 2 hierarchy. The Pricing Service utilizes evaluated pricing models that vary by asset class and incorporate available trade, bid and other market information and for structured securities, cash flow and, when available, loan performance data. The Pricing Service’s evaluated pricing applications apply available information as applicable through processes such as benchmark curves, benchmarking of like securities, sector groupings and matrix pricing, to prepare evaluations. In addition, the Pricing Service uses model processes, such as the Option Adjusted Spread model, to assess interest rate
impact and develop prepayment scenarios. The market inputs that the Pricing Service normally seeks for evaluations of securities, listed in approximate order of priority, include: benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers and reference data including market research publications.
To validate prices, the Company compares the fair value estimates to its knowledge of the current market and will investigate prices that it considers not to be representative of fair value. In addition, our process to validate the market prices obtained from the Pricing Service includes, but is not limited to, periodic evaluation of model pricing methodologies and analytical reviews of certain prices. We also periodically perform testing of the market to determine trading activity, or lack of trading activity, as well as evaluating the variability of market prices. Securities sold during the quarter are also “back-tested” (i.e., the sales prices are compared to the previous month end reported market price to determine the reasonableness of the reported market price). There were no material differences between the prices from the Pricing Service and the prices obtained from our validation procedures as of December 31, 2010 and 2009.
Corporate bonds: Comprised of bonds issued by corporations that on acquisition are rated BBB-/Baa3 or higher provided that, in aggregate, corporate bonds with ratings of BBB-/Baa3 or less do not constitute more than 8% of the market value of our fixed income securities and are diversified across a wide range of issuers and industries. These securities are generally priced by pricing services. The fair values of corporate bonds that are short-term are priced, by the pricing services, using the spread above the London Interbank Offering Rate yield curve and the fair value of corporate bonds that are long-term are priced using the spread above the risk-free yield curve. The spreads are sourced from broker/dealers, trade prices and the new issue market. Where pricing is unavailable from pricing services, we obtain non-binding quotes from broker-dealers. As the significant inputs used to price corporate bonds are observable market inputs, the fair values of corporate bonds are included in the Level 2 fair value hierarchy.
Municipals: Municipal securities comprise bonds issued by U.S. domiciled state and municipality entities. The fair values of these securities are generally priced by pricing services. The pricing services typically use spreads obtained from broker-dealers, trade prices and the new issue market. As the significant inputs used to price the municipals are observable market inputs, municipals are classified within Level 2.
Junior subordinated debt: The carrying values reported in the accompanying balance sheets for these financial instruments approximate their fair value.
Other-than-Temporary Impairment of Investments (“OTTI”) Impairments of investment securities results in a charge to operations when a market decline below cost is deemed to be other than temporary. To determine the recovery period of a fixed maturity security, we consider the facts and circumstances surrounding the underlying issuer including, but not limited to, the following:
• Recoveries or additional declines in fair value subsequent to the balance sheet date.
When assessing our intent to sell a fixed maturity security or if it is more likely that we will be required to sell a fixed maturity security before recovery of its cost basis, we evaluate facts and circumstances such as, but not limited to, decisions to reposition our security portfolio, sale of securities to meet cash flow needs and sales of securities to capitalize on favorable pricing. In order to determine the amount of the credit loss for a fixed maturity security, we calculate the recovery value by performing a discounted cash flow analysis based on the current cash flows and future cash flows we expect to recover. The discount rate is the effective interest rate implicit in the underlying fixed maturity security. The effective interest rate is the original yield or the coupon if the fixed maturity security was previously impaired. If an other-than-temporary impairment (“OTTI”) exists and we have the intent to sell the security, we conclude that the entire OTTI is credit-related and the amortized cost for the security is written down to current fair value with a corresponding charge to realized loss on our Consolidated Statements of Income. If we do not intend to sell a fixed maturity security or it is not more likely than not we will be required to sell a fixed maturity security before recovery of its amortized cost basis but the present value of the cash flows expected to be collected is less than the amortized cost of the fixed maturity security (referred to as the credit loss), we conclude that an OTTI has occurred and
There were no other-than-temporary impaired securities during the years ended December 31, 2010 and 2009. During the year ended December 31, 2008, we identified three securities which were considered to be other-than-temporarily impaired. Consequently, the cost of these securities was written down to fair value and we recognized a realized loss of $43.3 million for the year ended December 31, 2008.
ASC Topic 805, Business Combinations requires that the Company make an annual assessment as to whether the value of the Company’s goodwill and intangible assets are impaired. Impairment, which can be either partial or full, is based on a fair value analysis by individual reporting unit. Based upon the Company’s assessment at the reporting unit level, there was no impairment of its goodwill and intangible assets as of December 31, 2010 of $58.4 million and $45.5 million, respectively.
Net Income for the year ended December 31, 2009 was $61.1 million compared to net income of $18.8 million for the same period in 2008. The increased net income was generally the result of an improvement in underwriting profit of $19.9 million due to the first full year of results after the GMAC Acquisition, despite a modest decline in the combined ratio. In addition, investment income increased by $25.7 million, the result of both the first full year of results after the GMAC Acquisition and the investment of the proceeds of the TRUPS issuance. Net realized investment gains were $0.3 million in 2009 as compared to net realized investment losses of $37.5 million as there was no re-occurrence in 2009 of OTTI losses that occurred in 2008. The improvement in underwriting and investment income more than offset the increase in interest expense associated with the TRUPS issuance. The Company’s expense ratio declined as a result of the
increase in revenue associated with the GMAC Acquisition although underlying general and administrative expenses increased on a year to year basis consistent with the growth in revenues. Amortization of intangible assets increased by $5.4 million as a result of the first full year of results after the GMAC Acquisition. Net income for the year ended December 31, 2009 included a net foreign exchange and other gain of $2.4 million and a deferred U.S. tax expense of $1.3 million.
Net Premiums Written Comparison of Years Ended December 31, 2010 and December 31, 2009 Net premiums written increased by $197.4 million, or 19.2%, for the year ended December 31, 2010 compared to the year ended December 31, 2009. The increase in net premiums written was primarily the result of the following:
• Continued underwriting discipline by Maiden US. Maiden US continues to maintain its underwriting discipline in the face of ongoing significant market competition. In addition, we have reduced our premiums written in the Accident & Health line of business as certain accounts no longer met the profitability standards we have established. As a result, premium associated with this business unit declined by $104.0 million or 15.8%.
Net Premiums Earned Comparison of Years Ended December 31, 2010 and December 31, 2009 Net premiums earned increased by $249.9 million, or 27.2%, for the year ended December 31, 2010 compared to the year ended December 31, 2009. The increase in net premiums earned was primarily the result of the following:
• Despite the decline in premiums written in the Diversified Reinsurance segment, earned premiums increased $33.3 million or 5.9% due to the earned premiums associated with prior years at higher production levels.
• Continuing growth in all segments of the AmTrust Quota Share, which resulted in earned premium growth of $93.2 million or 26.5%.
Comparison of Years Ended December 31, 2009 and December 31, 2008 Net premiums earned increased by $499.8 million, or 119.0%, for the year ended December 31, 2009 compared to the year ended December 31, 2008. The increase in gross premiums earned was primarily the result of the following:
The loss ratios were 64.6% and 66.2% for the years ended December 31, 2010 and 2009, respectively. The decrease was generally the result of business acquired in the GMAC Acquisition having a lower loss ratio, having completed its first full year of business in 2009 which had a higher loss ratio due to a lower earned premium base which had acquisition costs offsetting it and a modestly higher loss ratio in the AmTrust Quota Share segment.
The loss ratios were 66.2% and 62.8% for the years ended December 31, 2009 and 2008, respectively. The increase was the result of business acquired in the GMAC Acquisition having a higher loss ratio, the completion of the first full year of that business and a modestly higher loss ratio in the AmTrust Quota Share segment.
In 2009 and 2008, the Company recognized $11.4 million and $1.8 million, respectively, of favorable development on prior year’s reserves, principally due to favorable development in its Diversified Reinsurance segment in both years. The Company amortized gains as a reduction of losses incurred of $10.7 million and $1.6 million for the years ended December 31, 2009 and 2008, respectively. In 2008, the amount of this favorable development related to settlement of case reserves, primarily property claims, for amounts lower than the case reserves carried at the time of the GMAC Acquisition. These amounts are largely timing related and are not likely to recur. The total favorable development relating to the loss portfolio transfer since the closing of the GMAC Acquisition has been $17.7 million and the remaining $5.4 million is recorded as a deferred gain and is part of the Company’s loss reserves at December 31, 2009 that are included in the accompanying balance sheet.
Commissions and Other Acquisition Expenses Comparison of Years Ended December 31, 2010 and December 31, 2009 Commissions and other acquisition costs increased by $95.3 million, or 39.5%, for the year ended December 31, 2010 compared to the same period in 2009. This reflects both the growth in earned premium and the continuing shift in our mix of business to quota share business which typically has a higher acquisition cost ratio. In particular, the commencement of the ACAC Quota Share in 2010 and Diversified Reinsurance segment have contributed to the increase. For the Diversified Segment, the increases were due to: 1) 2009 reflects only a partial year of earned premiums in this segment as the first full year of operations from the GMAC Acquisition had not yet been completed; 2) the unearned premium portfolio assumed as part of the GMAC Acquisition was acquired net of acquisition costs; 3) the Diversified Reinsurance segment’s mix of business continues to shift from excess of loss to pro rata business which has a higher acquisition cost ratio;
Comparison of Years Ended December 31, 2009 and December 31, 2008 Commissions and other acquisition costs increased by $121.7 million, or 101.7%, for the year ended December 31, 2009 compared to the same period in 2008. The increase was the result of the increase in gross premiums related to the first full year of the GMAC Acquisition. Acquisition costs as a percentage of net premiums earned were 26.2% for the year ended December 31, 2009 as compared to 28.5% for the year ended December 31, 2008. This decrease was due to the acquisition cost on the business associated with the GMAC Acquisition being lower than the acquisition costs associated with the AmTrust Quota Share segment.
Other Operating Expenses Other operating expenses include general and administrative expenses which are segregated for analytical purposes as a component of underwriting income. Other operating expenses consist of:
The following is a breakdown of the major factors contributing to this increase:
• Salary and employee welfare costs, including share compensation expense, increased approximately $5.0 million due to an additional 63 full time employees including 50 that were added at November 30, 2010 as part of the IIS Acquisition.
• Additional other expenses incurred of $1.3 million including premises related, regulatory and other filing fees, insurance and IT expenses.
Net Investment Income and Net Realized Gains (Losses) Comparison of Years Ended December 31, 2010 and December 31, 2009 Net investment income increased by $8.7 million, or 13.8%, for the year ended December 31, 2010 compared to the same period in 2009. Average invested assets were approximately $2.1 billion for the year ended December 31, 2010 compared to approximately $1.8 billion for the year ended December 31, 2009, a 16.7% increase. Continued growth in the overall book of business combined with positive cash flow from operations contributed to the growth in invested assets.
Despite the Company’s premium growth and the increase in average invested assets, investment income grew at a slower rate in 2010 compared to 2009 reflecting the significant accumulation of cash and cash equivalents which occurred during 2010; we had reduced the level of cash and cash equivalents to more customary levels by December 31, 2010. Please refer to Liquidity and Capital Resources for a more detailed discussion of the Company’s investing position relative to the continuing accumulation of cash and cash equivalents, along with the Company’s operating and investing cash flow results.
Net realized investment gains were $6.6 million for the year ended December 31, 2010 compared to $0.3 million for the same period in 2009. For additional information on the Company’s investments and realized gains and losses, please refer to Liquidity and Capital Resources.
Junior Subordinated Debt Interest Expense Interest expense related to the TRUPS Offering was $36.5 million and $34.4 million for the years ended December 31, 2010 and 2009, respectively. The TRUPS Offering was completed on January 20, 2009 and thus 2010 represents the first full year of interest expense, accounting for the increase.
Deferred Tax Expense The Company recorded a deferred tax expense of $1.3 million for the years ended December 31, 2010 and 2009, respectively. These amounts are related to the goodwill associated with the Company’s acquisition of its US subsidiaries in the GMAC Acquisition. For U.S. tax purposes, this goodwill is deductible and is amortized over a fifteen year period. For U.S. financial reporting purposes, this goodwill is recorded as an asset subject to impairment testing and is not recorded as expense, creating a temporary difference. Further, under GAAP, deferred tax liabilities associated with indefinite lived intangibles cannot be applied to valuation allowance tests for recognition of net deferred tax assets. Presently, the Company carries a full valuation allowance against its U.S. originated deferred tax assets and due to the Company’s lack of historical experience, it would be premature to recognize the associated tax asset and accordingly we have recorded a full valuation reserve for the tax benefit of our U.S. net operating losses. The effect of this expense will be reversed as: 1) we develop U.S. taxable income to permit recognition of the net deferred tax asset; and 2) the amortization period of the goodwill for tax purposes is exhausted.
Underwriting Results by Operating Segments The results of operations for our three segments, Diversified Reinsurance, AmTrust Quota Share and ACAC Quota Share are discussed below.
Diversified Reinsurance Segment The following table summarizes the underwriting results and associated ratios for the Diversified Reinsurance segment for the years ended December 31, 2010, 2009 and 2008. Comparisons for the 2008 period are not meaningful as the GMAC Acquisition, which was completed on October 31, 2008, affected only a partial period in 2008 and 2009 constitutes the first full year of operations for this business.
Comparison of Years Ended December 31, 2010 and 2009 The combined ratio increased to 95.4% for the year ended December 31, 2010 as compared to 94.9% in the same period ended 2009. The increase in the combined ratio is largely due to lower profitability from the Accident & Health line of business. This segment includes business associated with the IIS Acquisition; however, since the transaction was only completed on November 30, 2010, the transaction had limited impact on the 2010 figures and comparisons to 2009.
Premiums. Net premiums written decreased by $104.0 million, or 15.8%, for the year ended December 31, 2010 as compared to the same period in 2009. The table below illustrates net premiums written by line of business in this segment for the years ended December 31, 2010 and 2009.
The table below illustrates net premiums earned by line of business in this segment for the years ended December 31, 2010 and 2009.
Net Losses and Loss Expenses. Net losses and loss expenses increased by $0.8 million, or 0.2%, for the year ended December 31, 2010 compared to the same period in 2009. Loss ratios were 65.6% and 69.3% for the years ended December 31, 2010 and 2009, respectively.
Comparison of Years Ended December 31, 2009 and 2008 The combined ratio decreased to 94.9% for the year ended December 31, 2009 as compared to 96.3% in the same period ended 2008. Comparisons for the 2008 period are not meaningful as the GMAC Acquisition, which was completed on October 31, 2008, was only a partial period in 2008 and 2009 constitutes the first full year of operations for this business.
Net Losses and Loss Expenses. Net losses and loss expenses increased by $327.8 million, or 497.3%, for the year ended December 31, 2009 compared to the same period in 2008. Loss ratios were 69.3% and 77.5% for the years ended December 31, 2009 and 2008, respectively. Comparison of loss ratio results between 2009 and 2008 are not meaningful as the GMAC Acquisition took place on October 31, 2008 and 2009 was the first full year of operations for the business associated with the GMAC Acquisition.
AmTrust Quota Share Segment The following table summarizes the underwriting results and associated ratios for the AmTrust Quota Share segment for the years ended December 31, 2010, 2009 and 2008.
Net premiums earned increased by $93.2 million, or 26.5% for the year ended December 31, 2010, as compared to the same period in 2009. The table below details net premiums earned by line of business for the years ended December 31, 2010 and 2009.
Premiums. Net premiums written decreased by $66.3 million, or 15.1%, for the year ended December 31, 2009 as compared to the same period in 2008. The table below illustrates net premiums written by AmTrust’s segments for the years ended December 31, 2009 and 2008.
Commission and Other Acquisition Expenses. The ACAC Quota Share provides that the reinsurers pay a provisional ceding commission equal to 32.5% of ceded earned premium, net of premiums ceded by the personal lines companies for inuring reinsurance, subject to adjustment. The ceding commission is subject to adjustment to a maximum of 34.5% if the loss ratio for the reinsured business is 60.5% or less and a minimum of 30.5% if the loss ratio is 64.5% or higher. The acquisition cost ratio of 31.9% reflects the adjusted ceding commission recorded in 2010 in addition to the U.S. Federal excise tax payable on this premium.
The payment of dividends from Maiden Holdings’ Bermuda-domiciled operating subsidiary Maiden Bermuda is, under certain circumstances, limited under Bermuda law, which requires our Bermuda operating
subsidiary to maintain certain measures of solvency and liquidity. In addition, Bermuda regulations require approval from the Bermuda Monetary Authority for any reduction of capital in excess of 15% of statutory capital, as defined in the Insurance Act. At December 31, 2010, the statutory capital and surplus of Maiden Insurance was $667.3 million, and the amount of capital and surplus required to be maintained under Bermuda law, the Minimum Solvency Margin, was $158.7 million. During 2010 and 2009, Maiden Bermuda did not pay any dividends to our holding company.
Cash flows from operations for the year ended December 31, 2010 were $151.6 million compared to $45.5 million for the year ended December 31, 2009. The increase in cash flows from operations for the year ended December 31, 2010 compared to December 31, 2009 was due to continued positive underwriting results and the continued growth of the Company, which in 2010 was primarily due to increased net premiums written from the AmTrust and ACAC Quota Shares. The decrease in cash flows from operations for the year ended December 31, 2009 compared to December 31, 2008 was primarily due to the one time transfer of unearned premium and loss reserves of $169.9 million and $755.6 million as part of the GMAC Acquisition in 2008, which increased operating cash flows by $628.4 million. Excluding the GMAC Acquisition, cash flow from operating activities increased by $84.0 million, primarily operating cash inflows from the first full year of results after the GMAC Acquisition compared to only two months in 2008.
Investing cash flows consist primarily of proceeds on the sale or maturity of fixed-maturity investments and payments for fixed-maturity investments acquired. We used $125.2 million in net cash for investing activities during the year ended December 31, 2010 compared to $173.4 million for the year ended December 31, 2009. The decrease in cash flows used in investing activities for the year ended December 31, 2010 compared to the year ended December 31, 2009 was primarily due to the investing of cash flows generated by operating activities and available cash on the Company’s balance sheet, in order to reduce cash levels to desired amounts. The decrease in cash flows used in investing activities for the year ended December 31, 2009 compared to the year ended period December 31, 2008 was primarily due to the GMAC Acquisition in 2008, which generated $95.0 million in investing activities. Excluding this, cash flow from investing activities increased by $448.5 million. In 2009, management utilized cash from both operating and
financing activities along with excess cash balances generated at the end of 2008 to reduce overall cash levels and increase the overall amount of fixed maturity securities in its portfolio.
Cash flows used by financing activities were $37.2 million for the year ended December 31, 2010 compared to $102.4 million for the year ended December 31, 2009. Included in cash flows provided by financing activities for the year ended December 31, 2010 were dividends paid of $18.4 million and $19.2 million of outflow relating to a reduction in the securities sold under agreements to repurchase, at contract value compared to dividends paid of $16.2 million and $137.2 million of outflow relating to a decrease in the securities sold under agreements to repurchase, at contract value, respectively, during the year ended December 31, 2009. On January 20, 2009, we completed the TRUPS Offering. The net proceeds of $255.8 million were used to capitalize Maiden US and Maiden Specialty’s business, which were the insurance subsidiaries acquired in the GMAC Acquisition. These funds were invested in fixed-maturity securities. This is discussed in more detail in the section captioned Capital Resources. During the year ended December 31, 2008 there were dividends paid of $8.9 million and $232.6 million of inflow relating to an increase in the securities sold under agreements to repurchase, at contract value.
Restrictions, Collateral and Specific Requirements Maiden Bermuda is neither licensed nor admitted as an insurer, nor is it accredited as a reinsurer, in any jurisdiction in the United States. As a result, it is generally required to post collateral security with respect to any reinsurance liabilities it assumes from ceding insurers domiciled in the United States in order for U.S. ceding companies to obtain credit on their U.S. statutory financial statements with respect to insurance liabilities ceded to them. Under applicable statutory provisions, the security arrangements may be in the form of letters of credit, reinsurance trusts maintained by trustees or funds-withheld arrangements where assets are held by the ceding company.
The pre-existing funds withheld amounts (“IIS Funds Withheld”) and cash transferred to GMAC IICL are included in the consolidated balance sheet as Funds Withheld. When the underlying reinsurance contracts are novated to Maiden Bermuda per the terms of the IICL Agreement, Maiden Bermuda will provide collateral in the form of both trusts and letters of credit as required by the respective reinsurance contracts. At December 31, 2010, the IIS Funds Withheld balance consisted of the following: