The following is a discussion and analysis of our results of operations for the years ended December 31, 2011, 2010 and 2009 and financial condition as of December 31, 2011 and 2010. The following discussion should be read in conjunction with the consolidated financial statements and accompanying notes, which appear elsewhere in this filing.
Loss and loss adjustment expenses are a function of the amount and type of reinsurance contracts we write and of the loss experience of the underlying coverage. As described below, loss and loss adjustment expenses are based on an actuarial analysis of the estimated losses, including losses incurred during the period and changes in estimates from prior periods. Depending on the nature of the contract, loss and loss adjustment expenses may be paid over a period of years.
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 premiums 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 equities are derived based on the last reported price on the balance sheet date as reported by a recognized exchange. The fair values of listed equities that have restrictions on sale or transfer which expire within one year, are determined by adjusting the observed market price of the equity using a liquidity discount based on observable market inputs. The fair values of 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 investments in private and unlisted equity securities and limited partnerships, 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. Investments in private equity funds are valued based on unadjusted net asset values reported by the funds’ managers.
Financial contracts which include total return swaps, credit default swaps, options, futures and other derivative instruments are recorded at their fair value with any unrealized gains and losses included in net investment income in the consolidated statements of income. Fair values on total return swaps are based on the underlying security’s fair value which is obtained from closing prices on a recognized exchange (for equity or commodity swaps), or from market makers or broker quotes. Fair values for credit default swaps trading in an active market are based on market maker or broker quotes taking into account credit spreads on identical contracts. Our exchange traded option contracts are recorded at fair value based on quoted prices in active markets. For over the counter (“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. Fair values for other derivative instruments are determined based on multiple broker or market maker quotes taking into account the liquidity and the availability of an active market for the derivative.
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 excess is 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:
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 awarded. 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 Compensation Committee approves all quantitative bonuses prior to being paid. The expected RODE calculation utilizes a proprietary model 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.
Industry capital has generally increased, in part due to the lack of large natural catastrophes in 2009 and 2010.We believe that the 2011 catastrophes, specifically the earthquakes in New Zealand and Japan and the floods in Thailand, eroded industry capital. Notwithstanding the eroded capital, we believe the reinsurance industry, in general, remains over capitalized and that the recent catastrophes likely will result only in a reduction of share buybacks rather than a hardening of reinsurance pricing. Further, we believe that the slowdown in worldwide economic activity continues to weaken the overall demand for property and casualty insurance and, accordingly, reinsurance. Although price reductions from prior years appear to have slowed and in some lines reversed, we believe that pricing of the property and casualty industry likely will be relatively flat for the near term, despite the fact that current price levels are not economically rational.
that are premium and capital intensive due to regulatory and other requirements.
We intend to continue to monitor market conditions to position ourselves to participate in future underserved or capacity-constrained markets as they arise and intend to offer products that we believe will generate favorable returns on equity over the long term. Accordingly, our underlying results and product line concentrations in any given period may not be indicative of our future results of operations.
We believe that our investment portfolio is neutrally positioned going into 2012, with a net long position of 37% as of December 31, 2011. The economic picture in the United States has shown steady improvement, with very accommodative monetary policy, an improving employment situation, and strong corporate profits. Many companies’ business results have been better than their stock performance, which makes them comparatively attractive investments. Against this backdrop, there continues to be a debt overhang in Europe and overall global uncertainty, leading to volatile equity markets. We are finding good investment opportunities, both long and short, and continue to hedge macroeconomic uncertainty with a significant position in gold and other macro hedges in the form of options on higher interest rates and foreign exchange rates, short positions in sovereign debt and sovereign credit default swaps.
For the year ended December 31, 2011, the basic adjusted book value per share increased by $0.22 per share, or 1.0%, to $21.98 per share from $21.76 per share at December 31, 2010. For the year ended December 31, 2010, the basic adjusted book value per share increased by $2.52 per share, or 13.1%, to $21.76 per share from $19.24 per share at December 31, 2009.
These increases were offset by decreases in premiums related to our specialty health, personal, general liability and financial lines during the year ended December 31, 2011. Health premiums decreased $28.0 million, or 42.0%, partly due to certain contracts not being renewed during 2011 and partly due to our clients shrinking their premium volume on underlying contracts. Premiums for our personal line decreased by $24.5 million, or 13.7%, primarily due to a Florida homeowners’ contract commuted during the fourth quarter of 2011 as the ceding insurer underwent a restructuring and both parties agreed to terminate the relationship. The decrease from the commuted contract was partially offset by an increase in premiums on our other Florida homeowners’ contracts. Premiums for our general liability lines decreased $9.2 million, or 21.7%, while lower surety and trade credit premiums decreased the financial line by $4.5 million, or 29.5%.
Premiums relating to quota share contracts are earned over the contract period in proportion to the period of protection. Similarly, incoming unearned premiums are earned in proportion to the remaining period of protection. For the year ended December 31, 2011, the frequency earned premiums increased $101.4 million, or 39.2%. The personal lines contracts accounted for $72.7 million of the increase primarily related to the new Florida homeowners’ property insurance contracts written during 2010 and 2011. Since the new 2010 contracts incepted in the middle of 2010, a large portion of the premiums was earned during 2011 as the period of protection extended into 2011. To a lesser extent, the increase in earned premiums related to professional indemnity, motor liability (including physical damage), financial, general liability and workers’ compensation contracts, which together accounted for $31.1 million of the increase. The increase in frequency earned premiums was partially offset by a $2.5 million decrease in the specialty health line.
For the year ended December 31, 2011, severity earned premiums decreased $9.3 million, or 32.2%, compared to the 2010 year. The decrease was partially due to our decision to continue reducing our participation in a number of property catastrophe contracts during 2011 due to softening market conditions; and partially due to premiums fully earned on a multi-year professional liability contract during 2010, with no new professional liability severity contract written during 2011.
For the year ended December 31, 2010, 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. For the year ended December 31, 2010, frequency loss ratio increased to 68.9% from 56.6% in 2009, 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 25.4%, (4.3)%, and 51.2% for the years ended December 31, 2011, 2010 and 2009, respectively. The increase in the severity loss ratio for the year ended December 31, 2011, was primarily due to a full limit loss of $5.0 million on a natural peril contract resulting from the 2011 New Zealand earthquake. Additionally, loss reserves relating to the 2010 New Zealand earthquake which were reported and recorded in 2011, also contributed to the increase in the severity loss ratio.
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, 2011, the losses incurred included $26.0 million related to net adverse loss development on reserves relating to prior year contracts. During the year ended December 31, 2011, the net loss development on prior year contracts primarily related to the following:
Adverse loss development of $1.0 million on a 2010 natural peril contract relating to the 2010 New Zealand earthquake. This loss development resulted from revised estimated losses expected to breach into our layer of coverage solely as a result of changes in foreign currency exchange rates for the New Zealand dollar and the Australian dollar against the U.S. dollar; and
For the year ended December 31, 2010, the net losses incurred included $8.7 million related to net adverse loss development on reserves relating to prior years. During the year ended December 31, 2010, the loss development on prior year contracts primarily related to the following:
Adverse loss development of $3.4 million based on data received from the client and a reassessment in connection with our quarterly reserve analysis, relating to California wildfires on a 2007 casualty clash contract, resulting in losses being reserved at the full contract limit;
Favorable loss development of $0.6 million on a 2008 clash contract, based on loss data received from the client and our quarterly reserve analysis; and
● Favorable loss development of $8.0 million on a 2006 Florida personal lines contract. During each quarter of 2009, the client reported favorable development of claims data resulting from lower than expected paid and incurred losses which impacted our own reserve analysis and correspondingly caused us to reduce our reserves by approximately $8.0 million during the year ended December 31, 2009;
● 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 as a reassessment in connection with our own quarterly reserve analysis;
● Eliminating $1.0 million of reserves, held on two casualty clash contracts which were commuted during the year ended December 31, 2009, without any reported losses;
● Adverse loss development of $3.4 million on a 2007 casualty clash contract resulting from claims relating to California wildfires; and
Increased acquisition costs for the year ended December 31, 2011 compared to the same period for 2010 are consistent with the increases in premiums earned. For the years ended December 31, 2011, 2010 and 2009, the acquisition cost ratios for frequency business were 37.4%, 36.7% and 38.6%, respectively. We expect that acquisition costs will be higher for frequency business than for severity business. The acquisition cost ratios for severity business were 20.9%, 26.3% and 8.3% for the years ended December 31, 2011, 2010 and 2009, respectively.
For the year ended December 31, 2010, the decrease in general and administrative expenses primarily related to a reduction in employee bonus accruals which resulted from adverse loss development negatively impacting the underwriting income, as well as due to a decrease in investment income accrued on the deferred bonus compensation relating to the 2008 and 2009 underwriting years, payable to the employees during 2011 and 2012, respectively. The decrease was partially offset by an increase in salaries and benefits expenses resulting from the addition of new staff during 2010.
General and administrative expenses for the years ended December 31, 2011, 2010 and 2009 include $2.9 million, $4.1 million and $3.4 million, respectively, for the expensing of the fair value of stock options and restricted stock granted to employees and directors, net of forfeitures.
Investment income, net of all fees and expenses, resulted in a gain of 2.1% on our investment portfolio for the year ended December 31, 2011. This compares to a gain of 11.0% and a gain of 32.1% reported for the years ended December 31, 2010 and 2009, 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, 2011, the investment portfolio generated gains of 5.4% (before investment advisor fees) on the short portfolio including sovereign debt CDS, which were partially offset by losses of 1% (before investment advisor fees) on the long portfolio.
Our investment advisor, DME Advisors, and its affiliates manage and expect to manage other client accounts besides ours, some of which have investment objectives similar to ours. To comply with regulation FD, our investment returns are posted on our website on a monthly basis. Additionally, on our website (www.greenlightre.ky) we provide the names of the largest disclosed long positions in our investment portfolio as of the last date of the month of the relevant posting. DME Advisors may choose not to disclose certain positions to its clients in order to protect its investment strategy. Therefore, we present on our website the largest positions held by us that are disclosed by DME Advisors or its affiliates to their other clients.
GRIL is incorporated in Ireland and, therefore, is subject to the Irish corporation tax. GRIL is taxed at a tax rate of 12.5% on its taxable trading income.
Verdant is incorporated in Delaware, and therefore is subject to taxes in accordance with the U.S. federal rates and regulations prescribed by the Internal Revenue Service. Verdant’s taxable income is taxed at an effective tax rate of 35%.
The following table sets forth our current and deferred income tax benefit (expense) on a consolidated basis for the years ended December 31, 2011, 2010 and 2009:
Due to the opportunistic and customized nature of our underwriting operations, we expect to report different loss and expense ratios in both our frequency and severity businesses from period to period. For the years ended December 31, 2011, 2010 and 2009, we reported the following ratios:
The loss ratio is calculated by dividing net loss and loss adjustment expenses incurred by net premiums earned. We expect that the loss ratio will be volatile for our severity business and may exceed that of our frequency business in certain periods. Given that we opportunistically underwrite a concentrated portfolio across several lines of business that have varying expected loss ratios, we can expect there to be significant annual variations in the loss ratios reported from our frequency business. In addition, the loss ratios for both frequency and severity business can vary depending on the lines of business written.
The combined ratio is calculated as the sum of the composite ratio and the internal expense ratio. The combined ratio measures the total profitability of our underwriting operations and does not take net investment income or loss into account. Given the nature of our opportunistic underwriting strategy, we expect that our combined ratio may also be volatile from period to period.
Investments, Financial Contracts Receivable, Financial Contracts Payable and Due to Prime Brokers
For the year ended December 31, 2011, our exposure to long investments decreased from 93% as of December 31, 2010, to 89% as of December 31, 2011, while our exposure to short investments decreased from 73% as of December 31, 2010 to 52% as of December 31, 2011. This exposure analysis is conducted on a notional basis and does not include gold, CDS, sovereign debt, cash, foreign currency derivatives, interest rate options and other macro positions.
From time to time, we incur indebtedness to our prime brokers to implement our investment strategy in accordance with our investment guidelines. As of December 31, 2011, we had borrowed $4.3 million from our prime brokers in order to purchase investment securities, compared to $54.4 million as of December 31, 2010. Additionally, as of December 31, 2011, included in due to prime brokers was $256.1 million relating to collateral provided to our prime brokers for our letters of credit outstanding under term margin agreements, compared to $218.7 million as of December 31, 2010. The increase in collateral for letters of credit was a result of additional letters of credit issued during the year ended December 31, 2011.
Short securities were $683.8 million as of December 31, 2011 compared to $726.0 million as of December 31, 2010, a decrease of $42.2 million. The decrease was primarily a result of exiting several short positions in equities and exchange traded funds, and was partially offset by the increase in short positions in non-U.S sovereign debt. During the year ended December 31, 2011, we reduced our CDS exposure in sovereign debt and increased our short position in non-U.S. sovereign debt.
Restricted cash totaled $957.5 million as of December 31, 2011 compared to $977.3 million as of December 31, 2010, a decrease of $19.8 million, or 2.0%. The decrease in restricted cash as of December 31, 2011, was principally due to the decrease in our short securities for which less cash and cash equivalents were pledged as collateral. The cash held by swap counterparties also decreased $14.9 million due to the decrease in our financial contracts as we disposed the CDS issued for corporate debt and reduced the CDS purchased for sovereign debt. Under some of our letters of credit facility agreements, we pledge investment securities to borrow cash from the prime brokers and place the cash in custodial accounts in our name. The cash in the custodial accounts is used to provide collateral for letters of credit issued under the agreements. As a result, restricted cash at December 31, 2011, included $256.1 million (2010: 218.7 million) of cash collateral relating to letters of credit issued.
At December 31, 2011, reinsurance balances receivable were $141.3 million compared to $109.6 million as of December 31, 2010, an increase of $31.7 million, or 28.9%. The increase in the reinsurance balances receivable relates primarily to increases in premiums 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, 2011.
Reserves for loss and loss adjustment expenses as of December 31, 2011 and 2010 were comprised of the following:
Our severity business includes contracts that contain or may contain natural peril loss exposure. As of January 31, 2012, our maximum aggregate loss exposure to any series of natural peril events was $98.6 million. For purposes of the calculation, 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 January 31, 2012:
For the year end December 31, 2011, loss and loss expenses recoverable increased by $17.8 million, or 148.5%, principally due to the increase in losses recoverable on our prior year multi-line retroceded contracts which experienced adverse loss development as a result of an increase in large losses on the corresponding assumed quota share contracts.
As of December 31, 2011, Greenlight Re was rated “A (Excellent)” with a stable outlook, while GRIL was rated "A- (Excellent)" with a stable outlook by A.M. Best. The ratings reflect 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 DME Advisors in accordance with our investment guidelines. As of December 31, 2011, approximately 86.8% 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, 2011, 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 equity markets decline, we expect the obligations for covering short positions to decline as well. Any reduction in our short portfolio would reduce the need for restricted cash and thereby would free our 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.
As of December 31, 2011, we believe that we have sufficient cash flow from operations to meet our foreseeable liquidity requirements. We expect that our operational needs for liquidity will be met by cash, funds generated from underwriting activities and investment income, including realized gains. We have no current plans to issue debt and expect to fund our operations for the next 12 months from operating cash flow. However, we cannot provide assurances that in the future we will not incur indebtedness to implement our business strategy, pay claims or make acquisitions.
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 losses plus unearned premium reserves that a client books for statutory purposes on each contract. These balances need to be collateralized in order for the client to receive statutory credit for its 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, 2011, 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. 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 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, and expires in July 2012 unless renewed. We did not make any significant commitments for capital expenditures during the period ending December 31, 2011.
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, 2011, there were 1,322,773 Class A ordinary shares available for future issuance.
The following table shows our aggregate contractual obligations by time period remaining to due date as of December 31, 2011:
As of December 31, 2011 we have made total commitments of $41.2 million in private investments, of which we have invested $22.1 million, and our remaining commitments to these investments total $19.1 million. Given the nature of the private equity investments, we are unable to determine with any degree of accuracy on when the commitments will be called. As such, for the purposes of the above table, we have assumed that all commitments with no fixed payment schedule will be made within one year. Under our investment guidelines, in effect as of the date hereof, no more than 10% of the assets in the investment portfolio may be held in private equity securities without specific approval from the Board of Directors.
GLRE has entered into a ten year lease agreement for office space in the Cayman Islands with the option to renew for an additional five year term. The lease term is effective from July 1, 2008 and ends on September 30, 2018. Under the terms of the lease agreement, our minimum annual rent payments are $253,539 for the first three years, increasing by 3% thereafter each year to reach $311,821 by the tenth year. The minimum lease payment obligations are included in the above table under operating lease obligations and in Note 14 to the accompanying consolidated financial statements.
On January 1, 2008, we entered into an agreement, as amended on February 20, 2009, wherein the Company and DME Advisors agreed to create a joint venture for the purposes of managing certain jointly held assets. This agreement was amended effective August 31, 2010 to include GRIL as a participant to the agreement. The term of the amended agreement is August 31, 2010 through December 31, 2013 with automatic three-year renewals unless 90 days prior to the end of the then current term, either DME Advisors terminates the agreement or any of the participants notifies DME Advisors of its desire to withdraw from the agreement. Pursuant to this agreement, we pay a monthly management fee of 0.125% on our share of the assets managed by DME Advisors and a performance allocation of 20% on the net investment income of the Company’s share of assets managed by DME Advisors subject to a loss carry forward provision. The loss carry forward provision allows DME Advisors to earn reduced incentive compensation of 10% on net investment income in any year subsequent to the year in which the investment account incurs a loss, until all the losses are recouped and an additional amount equal to 150% of the aggregate loss is earned. DME Advisors is not entitled to earn performance compensation in a year in which the investment portfolio incurs a loss. For the year ended December 31, 2010, $9.4 million of the performance compensation was calculated using the reduced rate of 10% and $3.5 million was calculated using the full rate of 20%. For the year ended December 31, 2011, the entire performance compensation of $5.4 million was calculated using a rate of 20%.
We consider the effects of inflation in our pricing and estimating loss and loss adjustment expense reserves. The actual effects of inflation on our results of operations cannot be accurately known until claims are ultimately settled. For the years ended December 31, 2011, 2010 and 2009, inflation had no significant impact on our revenues or net income. We do not believe that inflation has had or will have a material effect on our combined results of operations, except insofar as inflation may affect interest rates and the asset values in our investment portfolio.