Our headquarters are located at 1 Beacon Lane, Canton, Massachusetts 02021 and our principal executive office is located at 601 Carlson Parkway, Minnetonka, Minnesota 55305. We also maintain branch offices in various cities throughout the United States. Our headquarters is owned by us. Our principal executive office and branch offices are leased. Management considers our office facilities suitable and adequate for our current level of operations.
The following discussion also includes two non-GAAP financial measures, loss and loss adjustment expenses ratio prior to reserve reallocation and total combined ratio prior to reserve reallocation that have been reconciled to the most comparable GAAP financial measures (see pages 41 and 51). OB Holdings believes these measures to be useful supplements to the comparable GAAP measures in evaluating OB Holdings’ financial performance.
We provide a range of insurance products and services. We have historically offered a range of specialty, commercial and personal products and services sold primarily through independent agents and brokers. However, we have recently entered into two transactions that will transform us into a specialty lines company. On December 3, 2009, we sold the renewal rights to our non-specialty commercial lines business and on February 2, 2010, we entered into a definitive agreement to sell our personal lines business. With roots dating back to 1831, we have been operating for more than 175 years and have relationships with many independent agencies and brokers. We consist of a group of operating companies which are U.S.-based property and casualty insurance writers, most of which operate in a multi-company pool. Pooling arrangements permit the participating companies to rely on the capacity of the entire pool’s capital and surplus rather than just on its own capital and surplus. Under such arrangements, the members share substantially all insurance business that is written, and allocate the combined premiums, losses and expenses. In the year ended December 31, 2009, our net written premiums totaled $1.9 billion and we had total assets of $7.5 billion and total OB Holdings’ shareholder’s equity of $1.4 billion at December 31, 2009.
Other Operations. Our Other Operations segment consists of the activities of our holding company, OBH.
shareholder value. Through this compensation program, we seek to maximize shareholder value by aligning closely the financial interests of management with those of our shareholder and ultimately OBIG’s shareholders. The cost of all incentive compensation is fully accrued and expensed.
Compensation of our senior management team, including our named executive officers, consists primarily of three components: base salary, annual bonus and long-term incentive awards. Base salaries have been capped at $500,000. Annual bonus targets for all senior executives are 50%, with the exception of the Chief Executive Officer at 75%, of base salary. Long-term incentives for senior executives have in the past been comprised of performance shares and/or performance units. Under these instruments, payouts are explicitly tied to White Mountains’, OBIG’s or OneBeacon’s performance over a three-year period and are highly variable (the actual number of shares/units paid out at the end of the cycle will range from 0% to 200% of target depending on performance against established goals). See Note 9-“Employee Share-Based Incentive Compensation Plans” of the accompanying consolidated financial statements. Additionally, in recognition that the 2007-2009 and 2008-2010 performance share cycles, as described below, were projected to payout at or close to zero, creating a significant retention risk over the next years, the Compensation Committee of OBIG’s Board of Directors (the Compensation Committee) in February 2009 approved cash retention awards for the executive officers and certain members of senior management. The Compensation Committee also approved a pool of money for senior management to make retention awards to certain other key personnel.
In February 2008, the Compensation Committee defined GIBVPS for the 2008-2010 performance to be a weighted measure comprised of growth in OBIG’s adjusted book value per share and underwriting return on equity. As of December 31, 2009, 1,220,187 performance shares were outstanding with respect to the 2008-2010 performance cycle.
Our share-based compensation plans consist of performance shares which are typically settled in cash. We account for these share-based compensation plans in accordance with SFAS No. 123R, “Share-Based Payment”, subsequently codified within ASC 718. Compensation cost is measured and recognized based on the current market price of the underlying common shares and on the number of shares that are expected to vest.
In connection with purchase accounting for the OneBeacon Acquisition, we were required to adjust to fair value our loss and LAE reserves and the related reinsurance recoverables by $646.9 million and $346.9 million, respectively, on our balance sheet as of June 1, 2001. This net change to loss and LAE reserves of $300.0 million is being accreted through an income statement charge ratably with and over the period the claims are settled. Accordingly, we recognized $5.4 million, $12.0 million and $16.0 million of such charges, recorded as accretion of fair value adjustment to loss and LAE reserves, in the years ended December 31, 2009, 2008 and 2007, respectively. As of December 31, 2009, the outstanding pre-tax unaccreted adjustment was $0.
On December 3, 2009, we sold the renewal rights to approximately $490 million in premiums from our non-specialty commercial lines business to The Hanover. The transaction includes small commercial accounts and the non-specialty portion of the middle-market business, beginning with January 1, 2010 effective dates. As consideration, we received $23.2 million and will receive an additional 10% of premiums renewed in excess of $200 million for the first renewal period. We will continue to manage claims from business written prior to the Commercial Lines Transaction and for business written by The Hanover through June 30, 2010. The Hanover will reimburse us for our expenses incurred to provide the claims administration services.
During the third quarter of 2008, we acquired EBI, an insurance agency specializing in the entertainment, sports and leisure industries, for $8.0 million in cash. In connection with the purchase of EBI, which was accounted for as an acquisition under the purchase method of accounting in accordance with GAAP at the time of the acquisition, we recorded the identifiable assets and liabilities of EBI at their fair value at acquisition date. Significant assets and liabilities acquired include premiums and commissions receivable of $16.6 million and premiums and commissions payable of $16.1 million. After allocating the purchase price to identifiable tangible assets and liabilities, we also recorded an adjustment to allocate the remaining acquisition cost to an intangible asset of $9.5 million which represents the value of business in force at the acquisition date. The amortization associated with the intangible asset will be amortized over a 10-year period in proportion to the timing of the discounted cash flows used to value the business. During the year ended December 31, 2009, no amortization was recognized.
During the third quarter of 2007, we sold one of our inactive licensed subsidiaries, American Employers’ Insurance Company (AEIC) to Sparta Insurance Holdings, Inc. (Sparta) for $47.7 million in cash and recorded a pre-tax gain of $11.3 million through net other revenues.
Our comprehensive net income attributable to OB Holdings’ shareholder was $326.2 million in the year ended December 31, 2009, compared to a comprehensive net loss attributable to OneBeacon’s shareholder of $429.9 million in the year ended December 31, 2008. Other comprehensive income (loss) in the year ended December 31, 2009 included the impact of a $12.1 million after tax increase in our pension plans primarily related to an increase in the over-funded status of our qualified pension plan driven by investment results. Other comprehensive income (loss) in the year ended December 31, 2009 also included a $7.4 million pre-tax ($4.8 million after tax) increase resulting from the settlement of our interest rate swap relating to the mortgage note. Other comprehensive income (loss) in the year ended December 31, 2008 included the impact of a $19.5 million after tax decrease in our pension plans primarily related to a decrease in the over-funded status of our qualified pension plan driven by investment results and a $5.7 million after tax decrease in our interest rate swap related to the mortgage note. Net income attributable to OB Holdings’ shareholder was $307.4 million in the year ended December 31, 2009, compared to a net loss attributable to OB Holdings’ shareholder of $404.3 million in the year ended December 31, 2008.
Our income tax expense (benefit) related to pre-tax income or loss for the years ended December 31, 2009 and 2008 represented effective tax rates of 33.4% and (32.7)%, respectively. The effective tax rate for the year ended December 31, 2009 was lower than the U.S. statutory rate of 35% due to the receipt of nontaxable interest and dividend income, tax reserve adjustments and a decrease in the valuation allowance. Our effective tax rate for the year ended December 31, 2008 was lower than the U.S. statutory rate of 35% due to a pre-tax loss from operations and non-deductible dividends and accretion on the Berkshire Preferred Stock, partially offset by tax exempt interest and dividend income.
During the year ended December 31, 2007, we reallocated reserves of our insurance operations from ongoing lines of business to legacy run-off claims, particularly reserves for construction defect and workers compensation related to accident years 2001 and prior. The reallocation shifted $116.7 million of our reserves from specialty lines ($87.4 million) and personal lines ($23.3 million) to run-off claims (net $110.7 million). The reallocation included reserves from commercial lines ($6.0 million) that are now presented within run-off. This adjustment had no impact on our total combined ratio for the year ended December 31, 2007. The ratio discussions by line of business that follow are based on the ratios as computed prior to the reallocation of reserves. We believe that a presentation excluding the effect of the reserve reallocation on specialty lines, personal lines and run-off loss and LAE ratios and GAAP combined ratios is meaningful for investors to understand the performance of our underwriting units during 2007.
Our investments are managed by our affiliate, WM Advisors, and by Prospector. A discussion of our consolidated investment operations is included after the discussion of operations by segment. Our segment information is presented in Note 13-“Segment Information” of the accompanying consolidated financial statements.
Financial results for our Insurance Operations segment for the years ended December 31, 2009, 2008 and 2007 were as follows:
(1) Specialty lines now includes Technology, Financial Services, OBSP and PIM which were formerly reported in commercial lines. Prior periods have been reclassified to conform to the current presentation.
(3) Includes our long-term incentive compensation expense. For the years ended December 31, 2009, 2008 and 2007, long-term incentive compensation expense increased our total GAAP combined ratio by 2.1 points, 0.7 points and 1.6 points, respectively.
The specialty lines combined ratio for the year ended December 31, 2009 decreased to 83.5% from 85.1% for the year ended December 31, 2008. The loss and LAE ratio decreased 4.4 points to 43.9% while the expense ratio increased 2.8 points to 39.6%. The decrease in the loss and LAE ratio was mainly due to a 3.7 point decrease in current accident year non-catastrophe and catastrophe losses in the year ended December 31, 2009, compared with the year ended December 31, 2008 which included the impact of large losses at IMU, as well as higher catastrophe losses primarily related to hurricanes Ike and Gustav. Further, the year ended December 31, 2009 included 9.2 points of favorable loss reserve development primarily related to lower than expected severity in professional liability, compared with 8.5 points in the year ended December 31, 2008 primarily related to professional liability. The increase in the expense ratio was mainly due to changes in mix of business within the specialty lines businesses and the mix of products offered within those businesses and the related costs incurred to acquire those businesses. Our collector cars and boats business and some of our other newer specialty lines businesses receive higher compensation than the previous mix of business.
On February 2, 2010, we announced that we had entered into a definitive agreement to sell our personal lines business to Tower Group, Inc. The transaction includes two insurance companies containing the personal lines business, and two attorneys-in-fact managing the reciprocals which write the personal lines business in New York and New Jersey. Net written premiums for the affected books total approximately $420 million for the year ended December 31, 2009. As consideration, we will receive an amount equal to the statutory surplus in the reciprocals (approximately $103 million at
The run-off combined ratio for the year ended December 31, 2009 decreased to 100.7% from 108.3% for the year ended December 31, 2008. The loss and LAE ratio decreased 10.6 points to 61.1%, while the expense ratio increased 3.0 points to 39.6%. The decrease in the loss and LAE ratio was primarily due to 9.0 points of favorable loss reserve development in the year ended December 31, 2009, mainly due to lower than expected severity in package business and commercial multi-peril, compared with 1.4 points of favorable loss reserve development related to lower than expected severity in package business and commercial multi-peril in the year ended December 31, 2008. Further, the year ended December 31, 2009 included 1.8 points of current accident year catastrophe losses primarily related to severe wind and thunderstorm events, compared with 6.3 points of current accident year catastrophe losses in the year ended December 31, 2008 primarily related to hurricane Ike in our non-specialty middle market commercial businesses and small business division and losses from tornados in the southeastern United States in our non-specialty middle market commercial businesses in the first quarter. These favorable variances were partially offset by a 1.5 point increase in non-catastrophe losses in the year ended December 31, 2009 as compared to the prior year period. The increase in the expense ratio was primarily due to a 2.7 point increase in other underwriting expenses which included 3.5 points of higher incentive compensation costs, severance and other costs associated with the renewal rights transaction, partially offset by a 0.3 point decrease in policy acquisition costs.
Results from run-off include underwriting losses from legacy run-off operations, including national accounts, certain specialty programs and regional agency business transferred to Liberty Mutual. Legacy run-off business generated an underwriting loss of $3.2 million in the year ended December 31, 2009, compared to an underwriting loss of $21.9 million in the year ended December 31, 2008. The decrease was primarily due to lower incurred loss and LAE in the year ended December 31, 2009 which included $4.5 million of loss and LAE, compared with $20.5 million of loss and LAE in the year ended December 31, 2008 due in part to $9.2 million of incurred unallocated loss adjustment expenses (ULAE) related to the Liberty Mutual settlement.
The specialty lines combined ratio for the year ended December 31, 2008 increased to 85.1% from 81.2% for the year ended December 31, 2007. The loss and LAE ratio decreased 0.9 point to 48.3% while the expense ratio increased 4.8 points to 36.8%. The decrease in the loss and LAE ratio was mainly due to 8.5 points of favorable loss reserve development in the year ended December 31, 2008 primarily related to lower than expected severity in professional liability, compared with 3.9 points in the year ended December 31, 2007 primarily related to professional liability. Partially offsetting this decrease was a 2.0 point increase in current accident year non-catastrophe losses in the year ended December 31, 2008 mainly due to large losses at IMU, compared with the year ended December 31, 2007. Additionally, the year ended December 31, 2008 included 2.6 points of current accident year catastrophe losses primarily related to hurricane Ike, compared to 0.9 points of current accident year catastrophe losses in the year ended December 31, 2007. The increase in the expense ratio was mainly due to changes in mix of business within the specialty lines businesses and the mix of products offered within those businesses and the related costs incurred to acquire those businesses. Our collector cars and boats business and some of our other newer specialty lines businesses receive higher compensation than the previous mix of business. Also, at OBPI, increased writings of our long-term care product and decreased writings of our provider excess insurance product carry a higher and lower commission ratio, respectively, and shifted the expense ratio upward. In addition, during the year ended December 31, 2008, we incurred additional transition costs associated with the new management team at OBPI. The expense ratio for the year ended December 31, 2007 included a 0.7 point favorable impact from the partial settlement of our qualified pension plan liabilities, partially offset by 0.5 points of office consolidation costs.
benefit from the partial settlement of our qualified pension plan liabilities, which was partially offset by 1.0 point of office consolidation costs.
Other Operations Results-Year ended December 31, 2009 versus year ended December 31,
(1) Gross investment returns exclude investment expenses of $10.8 million, $14.0 million and $16.0 million for the years ended December 31, 2009, 2008 and 2007, respectively.
(2) Includes $6.2 million and $15.4 million of net investment income for assets held in trust for the years ended December 31, 2008 and 2007, respectively.
During the third and fourth quarters of 2008, there were significant declines and high volatility in the equity markets, a lack of liquidity in the credit markets and a widening of credit spreads on debt securities. These factors had a significant adverse effect on the performance of our investment portfolio in 2008. In the second half of 2008, we shifted our investment philosophy from a total return focus to a capital preservation focus in response to the significant declines and high volatility in equity markets, the lack of liquidity in the credit markets and the widening of credit spreads on fixed income securities experienced. In particular, we significantly reduced the size of our equity portfolio and now have a larger percentage of our invested assets in cash and short-term investments than we have in the past under a total return approach. As overall financial markets and our investment results continue to stabilize, we are gradually shifting back from a focus on capital preservation to our traditional total return investment philosophy.
The breakdown of our fixed maturity portfolio, including convertible bonds, at December 31, 2009 by credit class, based upon issue credit ratings provided by Standard & Poor’s, or if unrated by Standard & Poor’s, long-term obligation ratings provided by Moody’s, is as follows:
(2) Approximately 98% and 97% of our mortgage-backed securities as of December 31, 2009 and 2008, respectively, have the highest ratings ascribed by Moody’s (“Aaa”) or Standard & Poor’s (“AAA”).
Prior to February 2009, the collateral was controlled by the lending agent. The lending agent managed the investment of the cash collateral, however, other than in the event of default by the borrower, this collateral was not available to us and was remitted to the borrower by the lending agent upon the return of the loaned securities. Because of these restrictions, we considered our securities lending activities to be non-cash transactions. The fair value of the securities lending collateral was recorded as both an asset and liability on the balance sheet.
This report includes two non-GAAP financial measures that have been reconciled to the most comparable GAAP financial measures. OB Holdings believes these measures to be a useful supplement to the comparable GAAP measures in evaluating OB Holdings’ financial performance.
Loss and loss adjustment expense ratio prior to reserve reallocation and total combined ratio prior to reserve reallocation are non-GAAP financial measures which are derived by excluding the impact of the reallocation of loss and loss adjustment expense reserves from the loss and loss adjustment expense ratio and the GAAP combined ratio. During 2007, OB Holdings reallocated loss and loss adjustment expense reserves from ongoing lines of business to run-off which reduced the loss and loss adjustment expense ratios and the GAAP combined ratios for OB Holdings’ specialty and personal lines of business but had no impact on the ratios for OB Holdings’ total insurance operations. OB Holdings believes that a presentation excluding the effect of the reserve reallocation on the loss and loss adjustment expense ratios and combined ratios is a meaningful supplement for investors to understand the performance of its underwriting units. The reconciliation of these non-GAAP financial measures to the loss and loss adjustment expense ratio and GAAP combined ratio, the most closely comparable GAAP measures, is included on page 41.
Generally, our regulated insurance operating subsidiaries have the ability to pay dividends during any 12-month period in an amount equal to the greater of prior year statutory net income or 10% of prior year end statutory surplus, subject to the availability of unassigned funds. Based on 2009 statutory surplus of $1.6 billion, our top tier regulated insurance operating subsidiaries have the ability to pay approximately $157 million of dividends during 2010, subject to the availability of unassigned funds. As of December 31, 2009, OB Holdings’ top tier regulated insurance operating subsidiaries had $1.1 billion of unassigned funds. As of December 31, 2009, we had approximately $64 million of unrestricted net cash and fixed maturity investments outside of our regulated insurance operating subsidiaries.
OBH’s ability to declare or pay dividends was limited by the terms of the Series A Preferred Stock issued to Berkshire. OBH could not, in certain circumstances, declare or pay any dividend or distribution to any other class or series of stock without the consent of the holders of a majority of outstanding shares of the Berkshire Preferred Stock. Under the terms of a Keep-Well Agreement dated November 30, 2004 between White Mountains and OBH (the Keep-Well), White Mountains had agreed to return to OBH up to approximately $1.1 billion if some or all of that amount was required by OBH to meet its obligations under the terms of the Berkshire Preferred Stock. As described below, the Keep-Well has expired. Under the Keep-Well, White Mountains had to make any required contributions to OBH prior to making any distributions to its shareholders. The aggregate amount of distributions that White Mountains could make to its shareholders was limited; the limit increased or decreased by an amount equal to White Mountains’ consolidated net income or loss over the remaining life of the Keep-Well. The Keep-Well expired when all obligations of the Berkshire Preferred Stock were satisfied upon its redemption in May 2008. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Economic Defeasance” for a discussion of the creation and funding of an irrevocable grantor trust to economically defease the Berkshire Preferred Stock.
We calculate our insurance float by taking our net invested assets and subtracting our total capital. The following table illustrates our consolidated insurance float position as of the years ended December 31, 2009 and 2008.
The 5.875% Senior Notes due 2013 of OBH are currently rated are currently rated “Baa2” (“Medium Grade”, the ninth highest of twenty-one creditworthiness ratings) with a negative outlook by Moody’s, “BBB” (“Adequate”, the ninth highest of twenty-two creditworthiness ratings) on watch negative by Standard & Poor’s, “bbb” (“Good”, the ninth highest of twenty-two creditworthiness ratings) with a stable outlook by A.M. Best and “BBB” (“Good”, the ninth highest of twenty-three creditworthiness ratings) with a negative outlook by Fitch. During 2009, OBH repurchased $10.6 million of outstanding Senior Notes for $8.1 million, which resulted in a $2.5 million gain. During 2009, OBIC purchased $58.3 million of
The Senior Notes were issued under an indenture which contains restrictive covenants that, among other things, limit the ability of White Mountains, OBH and their respective subsidiaries, which includes us, as a subsidiary of White Mountains, to create liens and enter into sale and leaseback transactions and substantially limits the ability of OBH and its respective subsidiaries to consolidate, merge or transfer their properties and assets. The indenture does not contain any financial ratios or specified levels of net worth or liquidity to which White Mountains or OBH must adhere. At December 31, 2009, OBH was in compliance with all of the covenants under the Senior Notes.
The indenture also contains a cross default provision which provides that if White Mountains as guarantor has a payment default in excess of $25 million under a credit agreement, mortgage or similar debt agreement, the default provisions under the indenture to the Senior Notes will be triggered. White Mountains has two revolving credit facilities which provide for borrowing up to a maximum of $450.8 million and which contains restrictive financial covenants. As of December 31, 2009, the facilities were undrawn. See Note 16-“Related Party Disclosures” of the accompanying consolidated financial statements.
In connection with our December 2005 purchase of land and an office building in Canton, Massachusetts, which is now our headquarters, we entered into a $40.8 million, 18-year mortgage note to fund renovations. As of December 31, 2009, we had fully drawn on the facility. Repayment on the mortgage note commenced in January 2009. During the three months ended March 31, 2009, we repaid $0.2 million of principal in accordance with the terms of the mortgage note. On May 7, 2009, we repaid $40.6 million, representing the outstanding principal on the mortgage note.
(1) Represents expected future cash outflows resulting from loss and LAE payments. The amounts presented are gross of reinsurance recoverables on unpaid losses of $2,383.4 million and include the discount on our workers compensation loss and LAE reserves of $127.0 million as of December 31, 2009. These balances add back the remaining purchase accounting fair value adjustment of $190.5 million related to the OneBeacon Acquisition as it is a non-cash item.
(2) Includes expected future cash outflows under our non-qualified, non-contributory, defined benefit pension plan and our 401 (k) savings and employee stock ownership plan. Our pension plans were curtailed during the fourth
The balances included in the table above regarding our long-term incentive compensation plans include amounts payable for performance shares and units, as well as deferred compensation balances. Exact amounts to be paid cannot be predicted with certainty, as the ultimate amounts of these liabilities are based on future performance. The estimated payments reflected in the table are based on current accrual factors (common share price and pay-out percentage) and assume that all outstanding balances were 100% vested as of December 31, 2009.
There are no provisions within our lease agreements that would trigger acceleration of future lease payments. We have accrued $1.7 million, $1.3 million and $5.4 million, respectively, for the years ended December 31, 2009, 2008 and 2007 net of anticipated sub-lease income for leased space which we have ceased using. We do not finance our operations through the securitization of trade receivables, special purpose entities or synthetic leases. Further, we have not entered into any material arrangement requiring us to guarantee payment of third party debt, lease payments or to fund losses of an unconsolidated special purpose entity.
We also have future binding commitments to fund certain hedge funds and private equity funds. These commitments, which total $46.5 million as of December 31, 2009, do not have fixed funding dates and are therefore excluded from the table above.
During 2009, we declared and paid $68.1 million in cash dividends to OBEH.
During the first quarter of 2009, we repurchased a portion of the Senior Notes for $8.1 million.
During 2008, we reported net decreases in our loss and LAE reserves and reinsurance recoverables on paid and unpaid losses, primarily due to the decline of our business exposures related to legacy run-off.
During 2007, we declared and paid $93.4 million in cash dividends to OBEH.
During the first quarter of 2007, we made payments primarily with respect to our long-term incentive compensation plans totaling $39.8 million, in cash or by deferral into certain of our non-qualified compensation plans. These payments were made with respect to 4,400 performance shares and 160,470 performance units.
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 as of the date of the historical consolidated financial statements and the reported amounts of revenues and expenses during the reporting period.
Effective January 1, 2008, we adopted ASC 825 for our available-for-sale securities and our investments in hedge funds and private equity funds. Consistent with the guidance in ASC 825, in conjunction with the adoption, these securities are now reported as trading securities. Upon adoption, we recorded an adjustment of $182.4 million to reclassify net unrealized gains, after tax, and net unrealized foreign currency translation gains, after tax, related to investments from accumulated other comprehensive income to opening retained earnings. Subsequent to adoption, we report changes in fair value in revenues before the effect of tax.
Other investments, which are comprised of hedge funds and private equity funds for which the fair value option has been elected, are carried at fair value based upon our proportionate interest in the underlying fund’s net asset value, which is deemed to approximate fair value. The fair value of our investments in hedge funds and private equity funds has been estimated using net asset value because it reflects the fair value of the funds’ underlying investments in accordance with ASC 820. We employ a number of procedures to assess the reasonableness of the fair value measurements, including obtaining and reviewing each fund’s audited financial statements and discussing each fund’s pricing with the fund’s manager. However, since the fund managers do not provide sufficient information to independently evaluate the pricing inputs and methods for each underlying investment, the inputs are considered to be unobservable. Accordingly, the fair values of our investment in hedge funds and private equity funds have been classified as Level 3 under the fair value hierarchy.
At December 31, 2009 and 2008, we held one private preferred stock that represented approximately 98% and 97%, respectively, of our preferred stock portfolio. We used quoted market prices for similar securities that were adjusted to reflect management’s best estimate of fair value; this security is classified as a Level 3 measurement.
ended December 31, 2009 comprise 18 securities which had been previously classified as Level 3 measurements and were recategorized as Level 2 measurements when quoted market prices for similar securities that were considered reliable and could be validated against an alternative source became available during the year ended December 31, 2009.
others, recent entry into new markets or new products, improvements in the claims department that are expected to lessen future ultimate loss costs and legal and regulatory developments. At December 31, 2009 and 2008, total carried reserves were 10.2% and 7.3% above the actuarial point estimate, respectively.
As noted above, we have ceded estimated incurred losses of approximately $2.2 billion to the NICO Cover at December 31, 2009. Since entering into the NICO Cover, approximately 4% of the $2.2 billion of utilized coverage relates to uncollectible Third Party Recoverables and settlements on Third Party Recoverables through December 31, 2009. Net losses paid totaled $1.2 billion as of December 31, 2009, with $118.0 million paid in 2009. Asbestos payments during 2009 reflect payments resulting from intensified efforts by claimants to resolve asbestos claims prior to the potential enactment of U.S.
federal asbestos legislation. To the extent that actual experience differs from our estimate of incurred A&E losses and Third Party Recoverables, future losses could exceed the $320.2 million of protection remaining under the NICO Cover.
Our reserves for A&E losses at December 31, 2009 represent management’s best estimate of its ultimate liability based on information currently available. However, significant uncertainties, including but not limited to case law developments, medical and clean-up cost increases and industry settlement practices, limit our ability to accurately estimate ultimate liability and we may be subject to A&E losses beyond currently estimated amounts. In addition, we remain liable for risks reinsured in the event that a reinsurer does not honor its obligations under reinsurance contracts. See Note 3-“Reserves for Unpaid Loss and LAE-Asbestos and environmental loss and LAE reserve activity” of the accompanying consolidated financial statements for more information regarding our A&E reserves.
The process of establishing loss reserves is complex and imprecise as it must consider many variables that are subject to the outcome of future events. As a result, informed subjective estimates and judgments as to our ultimate exposure to losses are an integral component of our loss reserving process. We, like other insurance companies, categorize and track our insurance reserves by “line of business”, such as automobile liability, multiple peril package business, and workers compensation. Furthermore, we regularly review the appropriateness of reserve levels at the line of business level,
considering the variety of trends that impact the ultimate settlement of claims for the subsets of claims in each particular line of business.
Automobile covers both physical damage and liability coverage. Automobile physical damage insurance covers loss or damage to vehicles from collision, vandalism, fire, theft or other causes. Automobile liability insurance covers bodily injury of others, damage to their property and costs of legal defense resulting from a collision caused by the insured. The personal automobile product line is a mix of property and liability coverages and, therefore, includes both short- and long-tail coverages. The payments that are made quickly typically pertain to automobile physical damage (property) claims and property damage (liability) claims. The payments that take longer to finalize and are more difficult to estimate relate to bodily injury claims. Personal automobile reserves are typically analyzed in three components: bodily injury liability, property damage liability, and collision/comprehensive claims. This last component has minimum reserve risk and fast payouts and, accordingly, separate factors are not presented. Reporting lags are relatively short and the claim settlement process for
Multiple peril liability is generally considered a long-tail line, as it takes a relatively long period of time to finalize and settle claims from a given accident year. The speed of claim reporting and claim settlement is a function of the specific coverage provided and the jurisdiction, among other factors. There are numerous components underlying the multiple peril liability product line. Some of these have relatively moderate payment patterns (with most of the claims for a given accident
Specifically, at December 31, 2008, management had revised its expectations downward with respect to future loss emergence in the professional liability business, which is included in the general liability line of business, which had initially been based on market analysis when this business was initiated in 2002 and 2003. However, during 2009, losses continued to be significantly lower than these revised expectations. As a result, management lowered its selected reserves on the earliest years which affected more recent years as total loss expectations for those years are based in part on prior years’ results. The impact of this revised estimate was a decrease to professional liability reserves of $60.0 million.
At December 31, 2008, management had estimated that future payments from personal injury protection (PIP) litigation from our AutoOne business would be approximately $7.8 million. During 2009, the legal expenses related to this litigation were higher than expected. As a result, management increased estimates of all accident years for AutoOne. The total increase in estimate was $33.3 million.
At December 31, 2007, based on actuarial techniques described above, management estimated that IBNR related to multiple peril liability was $137.0 million, or approximately 64% of case reserves of $212.8 million for 2002 and subsequent accident years. During 2008, case incurred loss and ALAE was $16.2 million, which was less than expected for this line of business. As a result of the lower than expected case incurred loss and ALAE during 2008, the actuarial methods based on case incurred losses produced lower estimated ultimate losses for these accident years. As a result, at December 31, 2008, the IBNR was determined to be $86.9 million, or approximately 64% of the remaining case reserves. The impact of this revised estimate was a decrease to multiple peril liability reserves of $33.8 million.
At December 31, 2007, based on actuarial techniques described above, management estimated that IBNR related to workers compensation was $41.1 million, or approximately 96% of case reserves of $43.0 million for 2005 and subsequent accident years. During 2008, case incurred loss and ALAE was $20.2 million, which was greater than expected for this line of business. As a result of the higher than expected case incurred loss and ALAE during 2008, the actuarial methods based on case incurred losses produced higher estimated ultimate losses for these accident years. As a result, at December 31, 2008, the IBNR was determined to be $34.8 million, or approximately 81% of the remaining case reserves. The impact of this revised estimate was an increase to workers compensation reserves of $13.9 million.
Specifically, at December 31, 2006, management continued to expect losses to emerge in the professional liability business, which is included in our general liability line of business, in line with initial expectations based on market analysis when this business was initiated in 2002 and 2003. During 2007, losses continued to be significantly lower than initial expectations. As a result, management lowered its selected reserves on the earliest years which affected more recent years as total loss expectations for those years are based in part on prior years’ results. The impact of this revised estimate was a decrease to professional liability reserves of $79.6 million.
subsequent accident years. During 2007, case incurred loss and ALAE was $38.4 million, which was less than expected for this relatively short-tail line of business. At December 31, 2007, based on actuarial techniques described above, management estimated that IBNR was $66.1 million, or approximately 49% of the remaining case reserves. The actuarial methods that management relied upon to estimate IBNR at December 31, 2007 were similar to those used at December 31, 2006. The impact of this revised estimate was a decrease to personal automobile liability reserves of $33.0 million.
Overall, management is concerned about the impact of future increases in inflation, including adverse changes in tort liability. These types of changes would result in deterioration in the loss reserves, therefore, management has selected loss reserves somewhat higher relative to actuarial indications than in previous years.
· Workers compensation: Recorded reserves for workers compensation were $261.4 million at December 31, 2009. The two most important assumptions for workers compensation reserves are loss development factors and loss cost trends, particularly medical cost inflation. Loss development patterns are dependent on medical cost inflation. Approximately half of the workers compensation net reserves are related to future medical costs. Across the entire reserve base, a 0.5 point change in calendar year medical inflation would have changed the estimated net reserve by approximately $48 million at December 31, 2009, in either direction.
· Multiple peril liability: Recorded reserves for multiple peril were $191.7 million at December 31, 2009. Reported loss development patterns are a key assumption for these lines of business, particularly for more mature accident years. Historically, assumptions on reported loss development patterns have been impacted by, among other things, emergence of new types of claims (e.g. construction defect claims) or a shift in the mixture between smaller, more routine claims and larger, more complex claims. If case reserve adequacy for non-construction defect claims changed by 10.0 points this would have changed the estimated net reserve by approximately $19 million at December 31, 2009, in either direction.
These statements are based on certain assumptions and analyses made by us in light of our experience and perception of historical trends, current conditions and expected future developments, as well as other factors believed to be appropriate in the circumstances. However, whether actual results and developments will conform with our expectations and predictions is subject to a number of risks and uncertainties that could cause actual results to differ materially from expectations, including:
· recorded loss and loss adjustment expense reserves subsequently proving to have been inadequate;
· changes in domestic or foreign laws or regulations, or their interpretation, applicable to us, our competitors, our agents or our customers;
· an economic downturn or other economic conditions adversely affecting our financial position, including stock market volatility;