For our U.K.-based reinsurance and insurance operations, on April 1, 2005, Aspen U.K. signed an agreement for underleases (following our entry in October 2004 into a heads of terms agreement) with B.L.C.T. (29038) Limited (the landlord), Tamagon Limited and Cleartest Limited in connection with leasing office space in London of approximately a total of 49,500 square feet covering three floors. The term of each lease for each floor commenced in November 2004 and runs for 15 years. Service charges of approximately £0.5 million per annum are payable from this date, and are subject to increase. In 2007, the building was sold to Tishman International. The terms of the lease remain unchanged. We began paying the yearly basic rent of approximately £2.7 million per annum in November 2007. The basic annual rent for each of the leases will each be subject to 5-yearly upwards-only rent reviews. There are no contractual provisions in any of the leases allowing us to terminate any of the leases prior to expiration of the 15-year contractual terms. We also license office space within the Lloyd’s building on the basis of a renewable twelve-month lease.
We also lease serviced office space in Paris, France, Zurich, Switzerland and Dublin, Ireland at a total annual cost of approximately $774,000. We believe that our office space is sufficient for us to conduct our operations for the foreseeable future.
The following table sets forth our selected historical financial information for the period ended and as of the dates indicated. The summary income statement data for the twelve months ended December 31, 2007, 2006, 2005, 2004 and 2003 and the balance sheet data as of December 31, 2007, 2006, 2005, 2004 and 2003 are derived from our audited consolidated financial statements. The consolidated financial statements as of December 31, 2007 and 2006, and for each of the twelve months ended December 31, 2007, 2006 and 2005, and the report thereon of KPMG Audit Plc, an independent registered public accounting firm, are included elsewhere in this report. These historical results are not necessarily indicative of results to be expected from any future period. Due to our limited operating history, the ratios presented may not be indicative of our future performance. You should read the following selected consolidated financial information along with the information contained in this report, including Item 8, ‘‘Financial Statements and Supplementary Data’’ and Item 7, ‘‘Management’s Discussion and Analysis of Financial Condition and Results of Operations’’ and the audited consolidated financial statements, condensed consolidated financial statements and related notes included elsewhere in this report.
(2) The expense ratio is calculated by dividing policy acquisition expenses and general and administrative expenses by net premiums earned.
(3) The combined ratio is the sum of the loss ratio and the expense ratio.
(5) Book value per ordinary share is based on total shareholders’ equity, excluding the aggregate value of the liquidation preferences of our preference shares (in respect of 2006 and 2007), divided by the number of shares outstanding of 69,179,303, 69,315,099, 95,209,008, 87,788,375 and 85,510,673 at December 31, 2003, 2004, 2005, 2006 and 2007, respectively. In calculating the number of shares outstanding as at December 31, 2007 for this purpose, we have deducted shares delivered to us and canceled on January 22, 2008 pursuant to our accelerated share repurchase agreement.
(6) Diluted book value per share is calculated based on total shareholders’ equity, excluding the aggregate value of the liquidation preferences of our preference shares (in respect of 2006 and 2007), at December 31, 2003, 2004, 2005, 2006 and 2007, divided by the number of dilutive equivalent shares outstanding of 71,481,906, 71,271,170, 98,126,046, 89,876,459 and 88,268,968 at December 31, 2003, 2004, 2005, 2006 and 2007, respectively. At December 31, 2003, 2004, 2005, 2006 and 2007, there were 2,302,603, 1,956,071, 2,917,038, 2,088,084 and 2,758,295 dilutive options, respectively. Potentially dilutive shares outstanding are calculated using the treasury method.
In addition to general price inflation we are exposed to a persisting long-term upwards trend in the cost of judicial awards for damages. We take this into account in our pricing and reserving of casualty business.
Capital management. During 2007, we continued to execute our strategy to optimize our capital structure. While total capital increased from $2,638.7 million to $3,067.1 million during the year, the proportion funded by our ordinary shareholders has also increased slightly from 75% to 78% due to the increase in retained income and other comprehensive income for the twelve months ended December 31, 2007. In the second half of 2007, we entered into two tranches of share repurchases totalling $100 million through accelerated share repurchases, completing the $300 million repurchase program authorized by our Board in autumn 2006.
In the fourth quarter of 2007, we announced our entry into the global excess casualty insurance line of business which will be written through the Dublin branch of Aspen U.K. This line of business is focused on construction and global risk managed programs. In addition, we entered the professional liability insurance market in 2007 which is accessed through Aspen U.K. The underwriting focus in this line is on medium to larger-sized customers targeting markets principally in the U.K. and Australia. The main business is indemnity-based coverage for professional firms. We have also entered into transportation liability insurance business and announced our entry into political risk insurance.
Net income. For 2007 we reported income after taxes of $489.0 million with positive contributions from all four operating segments and an increase of 46.3% in net investment income. This is an increase of 29.3% on our net income after taxes of $378.1 million in 2006. In 2005, we reported a net loss after taxes of $177.8 million primarily as a result of losses suffered from the 2005 Hurricanes Katrina, Rita and Wilma.
Gross written premiums. Total gross written premiums decreased by 6.5% in 2007 compared to the prior year and by 7.0% in 2006 compared to 2005. The changes in gross written premiums in each of our segments for the twelve months ended December 31, 2007 and 2006 are as follows, with reductions shown as negative percentages.
The net loss ratio for the twelve months ended December 31, 2007 of 53.1% is in line with the loss ratio for the same period in 2006.
The combination of limited catastrophe losses during the year ended December 31, 2007 and no significant reserve strengthening in the period produced a meaningful favorable variance in the property reinsurance loss ratio. The international insurance segment included some moderate sized losses in both the marine and aviation books, offset by prior year releases within the U.K. commercial liability account. Within the U.S. insurance segment, U.S. property insurance benefited from improved loss experience and U.S. casualty insurance benefited from prior year releases.
The loss ratio for casualty reinsurance was adversely impacted in 2007 by the inclusion of $35.0 million of reserves for claims related to the U.S. sub-prime and global credit crisis. This comprises $20.0 million of reserves in addition to $15.0 million of losses resulting from our normal expectations of reserving within this segment. We do not believe we are currently exposed to the credit crisis as a primary insurer on any business lines nor do we insure credit instruments that are threatened by the credit crisis. We have undertaken a ground-up review of potential exposures and have identified a casualty clash contract and a small number of Lloyd’s syndicates which have underwritten risks which include U.S. D&O and E&O covers for which we provide excess of loss reinsurance. The loss ratio for casualty reinsurance increased by 4.3 percentage points from 65.6% to 69.9% as a result of the inclusion of these additional sub-prime related reserves.
Further information relating to the release of reserves can be found below under ‘‘-Reserves for Loss and Loss Adjustment Expenses-Prior Year Loss Reserves’’.
Policy acquisition expenses have decreased from $322.8 million in 2006 to $313.9 million in 2007. The decrease is due primarily to changes in business mix in casualty reinsurance. This reduction has been offset by increases in acquisition costs for the international insurance segment which are attributable to increases in profit commissions resulting from improved profitability, particularly in the energy portfolio.
From 2006 to 2007, we had a $36.9 million increase in our operating and administrative expenses due mainly to a $14.6 million rise in personnel costs resulting from increased bonus and long-term incentive charges, a $9.9 million increase due to foreign exchange expense chiefly related to the weakening of the U.S. Dollar against the British Pound, and $7.9 million related to our entry into new business lines including global excess casualty, professional liability, non-marine and transportation liability insurance and political risk insurance.
The increases in the policy acquisition expense ratio in 2006 compared to 2005 principally reflect changes in business mix. Over the same period operating and administrative expenses increased in Bermuda, the U.S and the U.K. due to the hiring of new teams of underwriters and increased investment in support functions and infrastructure.
Investment income. In 2007, we generated net investment income of $299.0 million, up 46.3% on the prior year (2006-$204.4 million, 2005-$121.3 million), of which $44.0 million was contributed by our investment in funds of hedge funds. Our fixed income portfolio book yield increased to 5.05% from 4.52% through strategic sector rotation into high quality mortgage-backed securities and higher yielding corporate bonds during 2007. Assets under management grew from $5.2 billion at the start of 2007 to $5.9 billion at year-end.
Shareholders’ equity and financial leverage. Total shareholders’ equity increased from $2,389.3 million at the end of 2006 to $2,817.6 million as of December 31, 2007. The most significant movements were:
The amounts outstanding under our senior notes were the only material debt that we had outstanding as of December 31, 2006 and 2007. Management monitors the ratio of debt to total capital, with total capital being defined as shareholders’ equity plus outstanding debt. At December 31, 2007, this ratio was 8.1% (2006-9.4 %; 2005-10.9%).
(1) Tangible book value per ordinary share is based on total shareholders’ equity, less intangible assets and preference shares (liquidation preference less issue expenses), divided by the number of ordinary shares in issue at the end of the period. Balances as at December 31, 2007 and December 31, 2006 were:
As of December 31, 2007, we had in issue $383.6 million and £46.2 million in letters of credit to cedants, of which $367.2 million and £49.3 million were collateralized. Our reinsurance receivables decreased by 34.9% from $468.3 million at December 31, 2006 to $304.7 million at December 31, 2007, mainly as a result of amounts already received from our reinsurers in respect of 2004 and 2005 hurricane claims.
Casualty Reinsurance. Our casualty reinsurance segment is seeing rate reductions of between 2.5% and 10% depending on the type of business and loss experience. Prices have reduced but still meet our required return rates with terms and conditions remaining reasonably firm. In U.S. casualty reinsurance, rate reductions of between 10% and 15% are not uncommon in the market place; however, we were able to achieve an average reduction of only 4.5% reflecting our focus on risk selection. We are seeing increasing competition in our U.S. casualty treaty business overall with particularly aggressive pricing in workers’ compensation where a number of contracts in the market were being renewed by some of our competitors with rate reductions of around 40%. In addition, there was a significant broadening of coverage with nuclear, biological, chemical and radiological exposures increasingly being included for little or no additional premium.
International Insurance. On average we achieved single digit declines in this segment, although there was significant variation by line of business. In energy physical damage insurance, following significant rate increases in 2005 and 2006, and a benign loss experience, rate reductions are averaging approximately 16%, and we have declined to renew a number of accounts. In marine hull insurance, rates were generally flat to marginally down, however we were able to secure an average rate increase of approximately 2% on our book. On our marine liability account the experience was similar. In the marine liability market as a whole, rates were down but in spite of this we achieved an average increase of 5% on our book reflecting loss experience on certain accounts and some exceptionally strong client relationships. In our new excess casualty insurance line, we are seeing rate declines of on average 5%. Our specialty reinsurance lines experienced reductions of approximately 3% on average with bigger declines in certain classes and we declined to renew a number of programs that no longer met our hurdle rates.
Non-proportional treaties. A large number of the reinsurance contracts we write are written on a non-proportional or excess of loss treaty basis. As the ultimate level of business written by each cedant can only be estimated at the time the reinsurance is placed, the reinsurance contracts generally stipulate a minimum and deposit premium payable under the contract with an adjustable premium determined by variables such as the number of contracts covered by the reinsurance, the total premium received by the cedant and the nature of the exposures assumed. Minimum and deposit premiums generally cover the majority of premiums due under such treaty reinsurance contracts and the adjustable portion of the premium is usually a small portion of the total premium receivable. For excess of loss contracts, the minimum and deposit premium, as defined in the contract, is generally considered to be the best estimate of the contract’s written premium at inception. Accordingly, this is the amount we generally record as written premium in the period the underlying risks incept. During the life of a contract, notifications from cedants and brokers may affect the estimate of ultimate premium and result in either increases or reductions in reported revenue. Changes in estimated adjustable premiums do not generally have a significant impact on short term liquidity as the payment of adjustment premiums generally occurs after the expiration of a contract.
Many non-proportional treaties also include provision for the payment to us by the cedant of reinstatement premiums based on loss experience under such contracts. Reinstatement premiums are the premiums charged for the restoration of the reinsurance limit of an excess of loss contract to its full amount after payment by the reinsurer of losses as a result of an occurrence. These premiums relate to the future coverage obtained during the remainder of the initial policy term and are included in revenue in the same period as the corresponding losses.
The reported gross written premiums for treaty pro rata business includes estimates of premiums due to the Company but not yet reported by the cedant because of time delays between contracts being written by our cedants and the submission of treaty statements to the Company. This additional premium is normally described as pipeline premium. Treaty statements disclose information on the underlying contracts of insurance written by our cedants and are generally submitted on a monthly or quarterly basis, from 30 to 90 days in arrears. In order to report all risks incepting prior to a period end, we estimate the premiums written between the last submitted treaty statement and the period end.
• changes in the renewal rate or rate of new business acceptances by the cedant insurance companies leading to lower or greater volumes of ceded premiums than our estimate, which could result from changes in the relevant primary market that could affect more than one of our cedants or could be a consequence of changes in marketing strategy or risk appetite by a particular cedant;
This cat swap falls within the scope of SFAS 133 and is therefore measured in the balance sheet at fair value with any changes in the fair value shown on the consolidated statement of operations.
As we provided in full for these future payments when the contract commenced, any actual or projected change in this liability is also reflected as a gain or loss in the consolidated statement of operations. The impact of this contract on net income at December 31, 2007 is a net charge of $2.4 million (2006-$13.1 million).
Credit insurance contract. On November 28, 2006, the Company entered into a credit insurance contract which, subject to its terms, insures the Company against losses due to the inability of one or more of our reinsurance counterparties to meet their financial obligations to the Company. The Company considers that under SFAS 133 this contract is a financial guarantee insurance contract that does not qualify for exemption from treatment for accounting purposes as a derivative. This is because it provides for the final settlement, expected to take place two years after expiry of cover, to include an amount attributable to outstanding and IBNR claims which may not at that point of time be due and payable to the Company.
Reserving approach. We take all reasonable steps to ensure that we have appropriate information regarding our claims exposures. However, given the uncertainty in establishing claims liabilities, it is likely that the final outcome will prove to be different from the original provision established. Prior to the selection by management of our best estimate of our reserves, our actuarial team employs a number of techniques to establish a range of estimates in which the best estimate is likely to fall (the ‘‘actuarial range’’).
Reported claims. For reported claims, reserves are established on a case by case basis within the parameters of coverage provided in the insurance policy or reinsurance agreement. In estimating the cost of these claims, we consider circumstances related to the claims as reported, any information available from cedants and loss adjustors and information on the cost of settling claims with similar characteristics in previous periods. In addition, for significant events such as the 2005 hurricanes, for example, the detailed analysis of our potential exposures includes information obtained directly from cedants which has yet to be processed through market systems enabling us to reduce the time lag between a significant event occurring and establishing case reserves. This additional information is also incorporated into the analysis used to determine the actuarial IBNR. Reinsurance intermediaries are used to assist in obtaining and validating information from cedants but we establish all reserves. In addition, we may engage loss adjusters and perform on site cedant audits to validate the information provided. Disputes do occur with cedants, but the number and frequency are generally low. In the
Actuarial range of gross reserves. The following table sets out the actuarial range of gross reserves for each of our segments and compares it to management’s selected best estimate as at December 31, 2007.
Actuarial range of net reserves. In determining the range of net reserves, we estimate recoveries due under our proportional and excess of loss reinsurance programs. For proportional reinsurance we apply the appropriate cession percentages to estimate how much of the gross reserves will be collectable. For excess of loss recoveries, individual large losses are modeled through our reinsurance programme. An assessment is also made of the collectability of reinsurance recoveries taking into account market data on the financial strength of each of the reinsurance companies.
These factors are incorporated in the recommended reserve range from which management selects its best point estimate. As at December 31, 2007, a 5% change in the gross reserve for IBNR losses would have equated to a change of approximately $80.6 million in loss reserves which would represent 14.0% of net income before income tax for the twelve months ended December 31, 2007. As at December 31, 2006, a 5% change in the gross reserves for IBNR losses would equate to a change of
Gross written premiums. The following table analyzes the overall change in gross written premiums in the twelve months ended December 31, 2007, 2006 and 2005. The amounts shown as ‘underlying premiums’ exclude reinstatement premiums and other premiums receivable directly related to losses arising from Hurricanes Katrina, Rita and Wilma (‘‘KRW’’) in 2005.
Gross written premiums reduced by 6.5% to $1,818.5 million when compared to the twelve months ended December 31, 2006 as a result of a number of factors including a less favorable pricing environment in many lines of business, in particular property catastrophe reinsurance, casualty treaty reinsurance and U.K. commercial liability insurance; and the re-positioning of our U.S. excess and surplus lines property insurance business. Gross written premiums in our casualty reinsurance segment were also reduced due to the closure of our Marlton, New Jersey office and relocation of our facultative business to Rocky Hill, Connecticut, and a change in our underwriting approach.
Net premiums written. Although gross written premiums reduced by 6.5%, net premiums written decreased by only 3.7% in 2007 compared to 2006. Ceded written premium also decreased by $64.8 million reflecting our reduced reliance on outwards reinsurance relative to 2006.
The increase in net premiums earned is attributable mainly to our property reinsurance segment where ceded earned premiums have reduced from $174.6 million in 2006 to $68.7 million in 2007. The reduction in ceded earned premium is a result of our decision to reduce reliance on property retrocessional cover.
Losses and loss adjustment expenses. In 2007, we suffered a $30.1 million loss from windstorm Kyrill, $35.0 million loss from sub-prime related exposures, a $28.7 million loss from the June and July U.K. floods, an $18.1 million loss from the California Wildfires, a $14.0 million marine loss resulting from a shipping collision and a $10.1 million loss from an air crash in Brazil. In comparison, in the twelve months ended December 31, 2006, we suffered a property loss of $11.4 million, net of reinsurance. Further information relating to movements in prior year reserves can be found below under ‘‘Reserves for Loss and Loss Adjustment Expenses.’’ Our losses and loss adjustment expenses were impacted significantly in 2005 from Hurricanes Katrina, Rita and Wilma. Our insurance losses and loss adjustment expenses included paid claims of $695.6 million in 2007, $469.7 million in 2006 and $551.9 million in 2005.
The underlying changes in accident year loss ratios by segment for the twelve months ended December 31, 2007, 2006 and 2005 are shown in the following table:
The prior year adjustment for our international insurance segment is attributable mainly to reserve releases in the U.K. liability line of business. Prior year adjustments are discussed further in the ‘‘Reserves for Losses and Loss Adjustment Expenses’’ below.
Total expenses increased by $81.6 million to $490.7 million in 2006 compared to $409.1 million in 2005. The increase in the net expense ratio reflected the increase in policy acquisition ratio due to changes in business mix incurring higher policy acquisition costs and a $42.0 million increase in operating and administrative expenses. The 33.4% increase in operating and administrative expenses was mainly attributable to increased staff and premises costs.
Changes in the acquisition and operating expense ratios to gross earned premiums, and the impact of reinsurance on net earned premiums by segment for each of the twelve months ended December 31, 2007, 2006 and 2005 are shown in the following tables:
Net investment income increased by 46.3% in 2007 compared to 2006 and by 77.6% in 2006 compared to 2005. The increases have been driven by rising interest rates, fixed income sector and asset allocation changes translating into higher book yields and increases in our total cash and investment balances by 13.6% in 2007 and 16.7% in 2006 when compared to 2005.
Change in fair value of derivatives. In the twelve months ended December 31, 2007, we recorded a reduction of $2.4 million (2006-$12.3 million) in the estimated fair value of our catastrophe swap and a reduction of $9.0 million (2006-$Nil) for our credit insurance contract resulting from the change in the fair value and interest charges. Hurricane Katrina triggered the catastrophe swap for the
Income tax expense. Income tax expense decreased to $85.0 million in 2007 from $92.3 million in 2006 and $17.4 million in 2005. The tax charge in each year relates to our U.K. operations which remained profitable throughout the period. Our tax rate in 2007 was 14.8% compared to 19.6% in 2006. In 2005, our tax charge for the year was $17.4 million, notwithstanding our losses from the 2005 hurricanes. Our effective tax rate has decreased since 2006 due to a greater proportion of the Company’s profit being derived from our Bermudian operations.
Net income/(loss). In 2007, we had net income of $489.0 million, equivalent to diluted earnings per ordinary share of $5.11 based on the weighted average number of shares in issue during the period. In 2006, we had net income of $378.1 million, equivalent to diluted earnings per ordinary share of $3.75 based on the weighted average number of shares in issue during the period. In 2005, our net loss of $177.8 million loss was equivalent to a loss per ordinary share of $2.40. Preference share dividends are deducted from net income for the purpose of calculating earnings per ordinary share.
The following tables summarize gross and net premiums written and earned, underwriting results, and combined ratios and reserves for each of our four business segments for the twelve months ended December 31, 2007, 2006 and 2005.
Our property reinsurance segment is mainly written on a treaty basis and includes catastrophe, risk excess and proportional treaty risks. We also write U.S. and international property facultative risks. Aspen U.K.’s Paris branch writes property facultative business in continental Europe and the Zurich branch writes property and casualty reinsurance in Europe. We also write some structured risks out of Aspen Bermuda.
Gross written premiums. Gross written premiums in this segment decreased by 3.5% compared to 2006 and by 23.4% in 2006 when compared to 2005. The table below shows our gross written premiums for each line of business for each of 2007, 2006 and 2005, and the percentage increase/decrease in gross written premiums for each line:
Reinsurance ceded. Reinsurance costs in 2007 decreased by $40.1 million compared to 2006 as we have continued to reduce our reliance on outwards reinsurance. We were able to take advantage of favorable pricing conditions and purchased a number of outwards contracts covering us for a period
of greater than 12 months, effectively covering the 2008 windstorm season. Reinsurance costs in 2006 decreased by $146.7 million compared to 2005 primarily as a result of the $116.5 million of additional ceded premiums to reinstate reinsurance protections following the 2005 hurricanes.
There were no material property reinsurance losses reported in the 2006 year and the most significant loss reported in the year was the deterioration in the 2005 hurricane loss estimates in the period of $35.6 million. As a result of the 2005 hurricanes, the 2005 loss ratio was 140.9% as net premiums earned in the year were substantially less than the losses incurred. In 2005, we also incurred losses of $16.8 million and $11.5 million from a refinery fire and print works fire, respectively.
Policy acquisition, operating and administrative expenses. Total expenses increased by 2.4% to $182.7 million from $178.4 million in 2006 mainly as a result of the increase in operating and administrative expenses associated with personnel costs related to increased bonuses and long-term incentive charges and the weakening of the U.S. Dollar against the British Pound. The reduction in the acquisition ratio for property reinsurance from 25.0% in 2006 to 21.1% in 2007 is mainly due to a $105.9 million reduction in the earned reinsurance cost for the year compared to the same period in 2006.
Total expenses in 2006 increased by 13.8% over 2005, reflecting changes in business mix increasing average commissions. It was also impacted by an increase in the proportion of administrative expenses allocated to the property reinsurance segment to better reflect operating costs.
relocation to our Rocky Hill, Connecticut office has impacted our casualty facultative premiums in the short-term. The reduction in premium for the non-U.S. treaty business line was due to a slight reduction in premium rates in 2007 and the loss of a small number of large contracts.
Gross premiums written decreased by 7.8% in 2006 compared to 2005. The reduction in U.S. treaty business in 2006 was due to a $3.0 million reduction in premiums written by our structured risk team (2006-$52.4 million; 2005-$55.4 million) and a slight reduction in premiums written by our U.K.-based U.S. Casualty team. The reduction in premium for the non-U.S. treaty business line was due to a slight reduction in premium rates in 2006 and the loss of a small number of large contracts.
Losses and loss adjustment expenses. Losses and loss adjustment expenses increased by $46.5 million between 2007 and 2006 due mainly to the recognition of $35.0 million of losses from U.S. sub-prime exposures. This comprises of $20.0 million of reserves in addition to $15.0 million of losses resulting from our normal expectations of reserving within this segment. The loss ratio for casualty reinsurance was increased by 4.3 percentage points to 69.9% in 2007 from 58.3% in 2006, as a result of these sub-prime related losses. The loss ratio was also impacted by a reduction in prior year reserve releases from $60.3 million in 2006 to $31.8 million in 2007.
Policy acquisition, operating and administrative expenses. Policy acquisition expenses have decreased by 2.0 percentage points between 2007 and 2006 due primarily to changes in business mix and other adjustments related to certain contracts with higher commission rates. The increase in the operating and administrative expense ratio of 1.6 percentage points is mainly due to the increase in personnel costs associated with increased bonus accruals and long-term incentive charges, and the weakening of the U.S. Dollar against the British Pound.
* Not Meaningful-2007 was the first year of operations for these lines of business.
This segment suffered in 2006 $19.0 million of deterioration in 2005 hurricane losses which reduced significantly the impact of a $28.4 million favorable development on the balance of the account.
Losses and loss adjustment expenses increased by $103.0 million in 2005 compared to 2004. The increase in loss expenses was attributable to the growth of the specialty insurance lines in this segment as well as $22.8 million of 2005 hurricane losses, $18.8 million U.K. refinery fire loss and three aviation losses totaling $16.2 million.
In 2006, we increased our U.S. surplus lines in both property (2005-$67.0 million) and casualty (2005-$74.8 million).
Losses and loss adjustment expenses. The loss ratio for our U.S. insurance segment decreased to 55.1% in 2007, from 75.0% is 2006. The decrease is attributable to a combination of reserve releases of $6.3 million during 2007 compared to a reserve strengthening of $0.8 million in 2006 and favorable loss experience in the current accident year in our U.S. casualty business.
Policy acquisition, operating and administrative expenses. Although the policy acquisition expense ratio of 20.1% in 2007 is relatively consistent with 19.8% in 2006, the underlying net earned premiums from U.S. property business and U.S casualty business has changed. The change in business mix towards casualty insurance results in lower commission levels, however this has been offset by an increase in profit commission accruals in 2007 associated with increased profitability in the account. Operating and administrative expenses have increased to $24.4 million in 2007 from $17.2 million in 2006 due primarily to $3.7 million of reorganization costs associated with our U.S. operations, in addition to the increase in operating and administrative expenses associated with personnel costs connected with increased bonuses and long-term incentive charges and the weakening of the U.S. Dollar against the British Pound.
The gross reserves may be further analyzed between outstanding or reported claims and IBNR as at December 31, 2007 and 2006, as follows:
Prior year loss reserves. In the twelve months ended December 31, 2007, 2006 and 2005, there was a reduction of our estimate of the ultimate claims to be paid. An analysis of this reduction by segment is as follows:
Property Reinsurance. Property reinsurance deteriorated by $11.5 million in 2007 of which approximately $10.0 million is attributable to Hurricanes Katrina, Rita and Wilma. The methodology we use to determine the hurricanes’ ultimate losses is to review each cedant’s position with respect to its reported claims and establish an expected IBNR utilizing information from that client. In setting our loss estimates for Hurricane Katrina, we have taken account of evolving litigation relating to coverage and quantum issues and included additional provisions where appropriate. Because of ongoing litigation, there remains significant uncertainty as to our ultimate costs of Hurricane Katrina.
Casualty Reinsurance. The lines contributing to the casualty reinsurance reserves release of $31.8 million, are $12.1 million attributed to international casualty, $31.4 million to U.S. casualty less $11.7 million of reserve strengthening for casualty facultative and structured business. Although claims in these lines may take several years to emerge, the experience to date compared with our starting loss ratios and expected patterns have generally been better than expected at the aggregate level.
International Insurance. The international insurance reserves release is $80.8 million. This is spread across several lines of which the largest contributor is U.K. commercial liability which accounted for $58.3 million of releases. This reduction is attributable mainly to a reduction in the uncertainty surrounding the initial case reserving methodology and continued favorable loss experience. Most other classes exhibited releases of between $3 million and $8 million with the exception of marine and specialty liability which deteriorated by $4.9 million.
Property Reinsurance. Property reinsurance deteriorated by $40.9 million in 2006 of which $35.6 million was attributable to Hurricanes Katrina, Rita and Wilma. At year-end we held a total IBNR for Hurricane Katrina for property reinsurance of $41.5 million.
Casualty Reinsurance. As at December 31, 2006, the most significant contributions to the casualty reinsurance reserves release of $60.3 million, were $27.8 million attributed to international casualty and $28.6 million to U.S. casualty. Claims in these lines may take several years to emerge. Nonetheless, the experience through December 31, 2006 compared with our starting loss ratios and expected patterns have been better than expected.
U.S. Insurance. As at December 31, 2006, the U.S. insurance reserves were increased by $0.8 million in the year due to deterioration on the property account offsetting favorable development on the casualty account.
Property Reinsurance. The net reserves of the property reinsurance segment as at December 31, 2004 were $222.9 million which included specific case reserves in relation to Hurricanes Charley, Frances, Ivan and Jeanne and Typhoon Songda. Further claims information received in relation to Hurricane Ivan and Typhoon Songda windstorms gave rise to a $7.8 million increase in reserves in the period. In addition, further claims notifications in respect of certain treaty risk excess contracts received during the twelve months to December 31, 2005 highlighted deterioration in claims development resulting in additional strengthening in claims reserves of $6.1 million.
Casualty Reinsurance. As at December 31, 2004 the casualty reinsurance segment held net claims reserves of $373.2 million. Favorable trends in claims development in the non-U.S. casualty and U.S. casualty lines have seen claims develop at a slower than expected rate, and led to a release of prior year net reserves of $10.9 million. Most of the release in respect of the U.S. casualty lines relates to workers’ compensation catastrophe excess of loss contracts which have a shorter reporting period than other long-tail classes.
U.S. Insurance. The net reserves of the U.S. insurance segment as at December 31, 2004 were $10.4 million. Development in the shorter-tail property insurance lines has seen a lower claim development than had been expected and the liability insurance class has to date seen a lower level of incurred claims than projected giving rise to a release in net reserves of $1.2 million across these two classes.
During 2007, we continued to execute our capital management strategy to optimize our capital structure. While total capital increased during the year, the proportion funded by our ordinary shareholders also has increased from 75% to 78%.
The following table shows our capital structure at December 31, 2007 compared to December 31, 2006.
Our Preference Shares are classified in our balance sheet as equity but may receive a different treatment in some cases under the capital adequacy assessments made by certain rating agencies. Such securities are often referred to as ‘hybrids’ as they have certain attributes of both debt and equity. We also monitor the ratio of the total of debt and hybrids to total capital and this stands at 21.8% as of December 31, 2007 (2006-25.3% 2005-19.4%).
Access to capital. Our business operations are in part dependent on our financial strength and the market’s perception thereof, as measured by shareholders’ equity, which was $2,817.6 million at December 31, 2007 ($2,389.3 million at December 31, 2006). We believe our financial strength provides us with the flexibility and capacity to obtain funds through debt or equity financing. Our continuing ability to access the capital markets is dependent on, among other things, our operating results, market conditions and our perceived financial strength. We continuously monitor our capital and financial position, as well as investment and security market conditions, both in general and with respect to Aspen Holdings’ securities. Our ordinary shares and all our preference shares are listed on the New York Stock Exchange.
On December 21, 2007, we filed an unlimited shelf registration statement for the sale of securities from time to time. Under a shelf registration statement filed on October 24, 2005 we have the facility to issue and sell up to approximately $370 million of securities subject to the issuance of one or more supplementary prospectuses and market conditions.
Holding company. We monitor the ability of Aspen Holdings to service debt, to finance dividend payments to ordinary and preference shareholders and to provide financial support to the Insurance Subsidiaries.
of $35.0 million. No other dividends were paid to Aspen Holdings in 2007 or 2006. Aspen Holdings also received interest of $28.6 million (2006-$26.0 million) from Aspen U.K. Holdings in respect of an intercompany loan.
The ability of our Insurance Subsidiaries to pay Aspen Holdings a dividend or other distribution is subject to the laws and regulations applicable to each jurisdiction, as well as the Insurance Subsidiaries’ need to maintain capital requirements adequate to maintain their insurance and reinsurance operations and their financial strength ratings issued by independent rating agencies. For a discussion of the various restrictions on our ability and our Insurance Subsidiaries’ ability to pay dividends, see ‘‘Business-Regulatory Matters’’ in Part I, Item 1 in this report.
In addition to its dividend capacity as at December 31, 2007, Aspen Bermuda could also make capital repayments to Aspen Holdings in excess of $140 million without prior approval from the BMA. Aspen U.K. has $150 million available for capital repayments to Aspen U.K. Holdings which could in turn be used to fund repayments of loans made by Aspen Holdings to Aspen U.K. Holdings. Aspen U.K. would typically seek FSA approval prior to making such a capital repayment.
Insurance subsidiaries. As of December 31, 2007, the Insurance Subsidiaries held approximately $633.5 million (2006-$1,144.5 million) in cash and short-term investments that are readily realizable securities. Management monitors the value, currency and duration of cash and investments held by its Insurance Subsidiaries to ensure that they are able to meet their insurance and other liabilities as they become due and was satisfied that there was a comfortable margin of liquidity as at December 31, 2007 and for the foreseeable future.
Liquidity risks are managed by making regular forecasts of the timing and amount of expected cash outflows and ensuring that the Company maintains sufficient balances in cash and short-term investments to meet these estimates. Notwithstanding this policy, if these cash flow forecasts are incorrect, the Company could be forced to liquidate investments prior to maturity, potentially at a significant loss.
The liquidity of the Insurance Subsidiaries is also affected by the terms of contractual obligations to U.S. policyholders and by undertakings to certain regulatory authorities to facilitate the issue of letters of credit or maintain certain balances in trust funds for the benefit of policyholders. The following table shows the forms of collateral or other security provided to policyholders as at December 31, 2007 and 2006:
Consolidated cash flows for the twelve months ended December 31, 2007. Total net cash flow from operating activities in 2007 was $774.0 million (2006-$723.2 million), an increase of $51.0 million from 2006. For the twelve months ended December 31, 2007, our cash flows from operations provided us with sufficient liquidity to meet our operating requirements. We paid net claims of $695.6 million in 2007 and made net investments in the amount of $426.1 million in market securities during the period. We paid ordinary and preference share dividends of $80.7 million, and $101.2 million was used to repurchase ordinary shares. At December 31, 2007, we had a cash balance of $651.4 million.
Consolidated cash flows for the twelve months ended December 31, 2006. Total net cash flow from operating activities in 2006 was $723.2 million, a reduction of $65.9 million from 2005. Net paid claims were $469.7 million in 2006 with $934.5 million of net investment in market securities during the period. The Company paid ordinary and preference share dividends of $71.8 million, and raised
$225.4 million from preference share offerings, $200.8 million of which was used to repurchase ordinary shares. At December 31, 2006, we had a cash balance of $495.0 million.
Credit Facility. On August 2, 2005, we entered into a five-year $400 million revolving credit facility pursuant to a credit agreement dated as of August 2, 2005 (the ‘‘credit facilities’’) by and among the Company, certain of our direct and indirect subsidiaries (collectively, the ‘‘Borrowers’’) the lenders party thereto, Barclays Bank plc, as administrative agent and letter of credit issuer, Bank of America, N.A. and Calyon, New York Branch, as co-syndication agents, Credit Suisse, Cayman Islands Branch and Deutsche Bank AG, New York Branch, as co-documentation agents and The Bank of New York, as collateral agent. On September 1, 2006 the aggregate limit available under the credit facility was increased to $450 million.
The facility can be used by any of the Borrowers to provide funding for the Insurance Subsidiaries of the Company, to finance the working capital needs of the Company and our subsidiaries and for general corporate purposes of the Company and our subsidiaries. The revolving credit facility provides for a $250 million sub-facility for collateralized letters of credit. The facility will expire on August 2, 2010. As of December 31, 2007, no borrowings were outstanding under the credit facilities, though we had $204.5 million and $133.3 million of outstanding collateralized and uncollateralized letters of credit, respectively. The fees and interest rates on the loans and the fees on the letters of credit payable by the Borrowers increase based on the consolidated leverage ratio of the Company.
The Company has entered into a lease for three floors comprising a total of approximately 15,000 square feet in Hamilton, Bermuda for the holding company and Bermuda operations. The term of the rental lease agreement is for six years, and we have agreed to pay approximately a total of $1 million per year in rent for the three floors for the first three years and annual service charges of $180,000 per year. These premises were occupied by the Company on January 30, 2006.
In 2006, we moved offices in Boston and entered into a new lease for office space totaling approximately 28,715 square feet covering two floors of the Federal Reserve Bank Building in Boston, Massachusetts. The commencement date of the lease was September 1, 2006. The lease term is for ten years, with the annual rent for the first five years being approximately $1.0 million and for the remainder of the term being approximately $1.1 million.
In addition, we lease office space in Rocky Hill, Connecticut as well as other states in the United States in connection with our U.S. operations. Office space is also leased in Paris, France, Dublin, Ireland and Zurich, Switzerland. We believe that our office space is sufficient for us to conduct our operations for the foreseeable future.
Ajax Re is a variable interest entity under the provisions of FASB interpretation No.46 (R). We have a variable interest in the entity, however we are not the primary beneficiary of the entity and therefore we are not required to consolidate its results into our consolidated financial statements. For further details on the Ajax Re transactions please see Note 8 to the audited financial statements for the twelve months ended December 31, 2007 included elsewhere in this report.
We are not party to any transaction, agreement or other contractual arrangement to which an affiliated entity unconsolidated with us is a party, other than that noted above with Ajax Re, that management believes is reasonably likely to have a current or future effect on our financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.