Our corporate headquarters are located in offices we lease in Switzerland. We also lease space in Bermuda, England, Hong Kong, Ireland, Singapore and the United States for the operation of our U.S. insurance, international insurance and reinsurance segments. Our leases have remaining terms ranging from six months to approximately ten years in length. We renew and enter into new leases in the ordinary course of business as needed. While we believe that the office space from these leased properties is sufficient for us to conduct our operations for the foreseeable future, we may need to expand into additional facilities to accommodate future growth. For more information on our leasing arrangements, please see Note 15 of the notes to the consolidated financial statements in this Form 10-K.
The following table sets forth our summary historical statement of operations data and summary balance sheet data as of and for the years ended December 31, 2011, 2010, 2009, 2008 and 2007. Statement of operations data and balance sheet data are derived from our audited consolidated financial statements, which have been prepared in accordance with U.S. GAAP. These historical results are not necessarily indicative of results to be expected from any future period. For further discussion of this risk see Item 1A. “Risk Factors” in this Form 10-K. You should read the following selected financial data in conjunction with the other information contained in this Form 10-K, including
We derive our revenues primarily from premiums on our insurance policies and reinsurance contracts, net of any reinsurance or retrocessional coverage purchased. Insurance and reinsurance premiums are a function of the amounts and types of policies and contracts we write, as well as prevailing market prices. Our prices are determined before our ultimate costs, which may extend far into the future, are known. In addition, our revenues include income generated from our investment portfolio, consisting of net investment income and net realized investment gains or losses. Investment income is principally derived from interest and dividends earned on investments, partially offset by investment management and custodial expenses and fees paid to our custodian bank. Net realized investment gains or losses include gains or losses from the sale of investments, as well as the change in the fair value of investments that we mark-to-market through net income.
Due to changes in the recognition and presentation of other-than-temporary impairments (“OTTI”) of our available for sale debt securities based on guidance issued by the FASB in April 2009, OTTI, which was previously included in “net realized investment gains or losses”, has been presented separately in the consolidated income statements as “net impairment charges recognized in earnings”. See “-Critical Accounting Policies-Other-Than-Temporary Impairments of Investments” for further discussion of the recognition and presentation of OTTI.
Management measures results for each segment on the basis of the “loss and loss expense ratio,” “acquisition cost ratio,” “general and administrative expense ratio,” “expense ratio” and the “combined ratio.” Because we do not manage our assets by segment, investment income, interest expense and total assets are not allocated to individual reportable segments. General and administrative expenses are allocated to segments based on various factors, including staff count and each segment’s proportional share of gross premiums written. The loss and loss expense ratio is derived by dividing net losses and loss expenses by net premiums earned. The acquisition cost ratio is derived by dividing acquisition costs by net premiums earned. The general and administrative expense ratio is derived by dividing general and administrative expenses by net premiums earned. The expense ratio is the sum of the acquisition cost ratio and the general and administrative expense ratio. The combined ratio is the sum of the loss and loss expense ratio, the acquisition cost ratio and the general and administrative expense ratio.
Reserves for losses and loss expenses by segment as of December 31, 2011, 2010 and 2009 were comprised of the following:
Bornhuetter-Ferguson Paid Loss Method. The Bornhuetter-Ferguson paid loss method is a combination of the paid loss development method and the expected loss ratio method. The amount of losses yet to be paid is based upon the expected loss ratios and the expected percentage of losses unpaid. These
expected loss ratios are modified to the extent paid losses to date differ from what would have been expected to have been paid based upon the selected paid loss development pattern. This method avoids some of the distortions that could result from a large development factor being applied to a small base of paid losses to calculate ultimate losses. This method will react slowly if actual loss ratios develop differently because of major changes in rate levels, retentions or deductibles, the forms and conditions of reinsurance coverage, the types of risks covered or a variety of other changes.
We expect that the trend of placing greater reliance on more responsive actuarial methods, for example from the expected loss ratio method to the Bornhuetter-Ferguson reported loss method, to continue as both (1) our loss years mature and become more statistically reliable and (2) as we build databases of our internal loss development patterns. The expected loss ratio remains a key assumption as the Bornhuetter-Ferguson methods rely upon an expected loss ratio selection and a loss development pattern selection.
The selection of the expected loss ratios for the longer tail lines is our most significant assumption. Due to the lengthy reporting pattern of longer tail lines, we supplement our own experience with industry benchmarks of expected loss ratios and reporting patterns in addition to our own experience. For our longer tail lines, the primary assumption that changed during both 2011 as compared to 2010 and 2010 as compared to 2009 as it relates to prior year losses was using the Bornhuetter-Ferguson loss development method for certain casualty lines of business and loss years as discussed above. This method calculated a lower projected loss ratio based on loss emergence patterns to date. As a result of the change in the expected loss ratio, we recognized net favorable prior year reserve development in 2011, 2010 and 2009. We believe that recognition of the reserve changes in the period they were recorded was appropriate since a pattern of reported losses had not emerged and the loss years were previously too immature to deviate from the expected loss ratio method in prior periods.
There is potential for significant variation in the development of loss reserves, particularly for the casualty lines of business due to their long tail nature and high attachment points. The maturing of our casualty insurance and reinsurance loss reserves have caused us to reduce what we believe is a reasonably likely variance in the expected loss ratios for older loss years. As of December 31, 2011 and 2010, we believe reasonably likely variances in our expected loss ratio in percentage points for our loss years are as follows:
The change in the reasonably likely variance for the 2004 through 2007 loss years in 2011 compared to 2010 is due to giving greater weight to the Bornhuetter-Ferguson loss development method for additional lines of business during 2011 and additional development of losses. The reasonably likely variance of our expected loss ratio for all loss years for our casualty insurance and casualty reinsurance lines of business was seven percentage points as of December 31, 2011 and 2010. If our final casualty insurance and reinsurance loss ratios vary by seven percentage points from the expected loss ratios in aggregate, our required net reserves after reinsurance recoverable would increase or decrease by approximately $598.1 million. Because we expect a small volume of large claims, it is more difficult to estimate the ultimate loss ratios, so we believe the variance of our loss ratio selection could be relatively wide. This would result in either an increase or decrease to income, before income taxes, and total shareholders’ equity of approximately $598.1 million. As of December 31, 2011, this represented approximately 19% of total shareholders’ equity. In terms of liquidity, our contractual obligations for reserves for losses and loss expenses would also increase or decrease by approximately $598.1 million after reinsurance recoverable. If our obligations were to increase by $598.1 million, we believe we currently have sufficient cash
The following table illustrates our gross premiums written and ceded for the years ended December 31, 2011, 2010 and 2009:
The examples below illustrate the types of treaty reinsurance arrangements in force at December 31, 2011:
share reinsured with cession percentages dependent upon location. Additionally, the professional liability policies written in the United States, as well as those originating within our Asian branch offices were reinsured on an excess-of-loss basis.
As noted above, we remain obligated for amounts ceded in the event our reinsurers do not meet their obligations. Accordingly, we have evaluated the reinsurers that are providing reinsurance protection to us and will continue to monitor their credit ratings and financial stability. We generally have the right to terminate our treaty reinsurance contracts at any time, upon prior written notice to the reinsurer, under specified circumstances, including the assignment to the reinsurer by A.M. Best of a financial strength rating of less than “A-.” As of December 31, 2011, approximately 98% of ceded case reserves and 99% of our ceded IBNR were recoverable from reinsurers who had an A.M. Best rating of “A-” or higher.
Premiums are recognized as written on the inception date of a policy. For certain types of business written by us, notably reinsurance, premium income may not be known at the contract inception date. In the case of quota share reinsurance assumed by us, the underwriter makes an estimate of premium income at inception as the premium income is typically derived as a percentage of the underlying policies written by the cedents. The underwriter’s estimate is based on statistical data provided by reinsureds and the underwriter’s judgment and experience. Such estimations are refined over the reporting period of each treaty as actual written premium information is reported by ceding companies and intermediaries. Management reviews estimated premiums at least quarterly and any adjustments are recorded in the period in which they become known. As of December 31, 2011, our changes in premium estimates have been adjustments ranging from approximately negative 6% for the 2009 treaty year to approximately 22% for the 2005 treaty year. Applying this range to our 2011 quota share reinsurance treaties, our gross premiums written in the reinsurance segment could decrease by approximately $13.9 million or increase by approximately $47.7 million over the next three years. Given the recent trend of downward adjustments on premium estimates, we believe a reasonably likely change in our premium estimate would be the midpoint of the 6% and 22%, or 8%, for a change of $16.9 million. There would also be a related increase in loss and loss expenses and acquisition costs due to the increase in gross premiums written. It is reasonably likely as our historical experience develops that we may have fewer or smaller adjustments to our estimated premiums, and therefore could have changes in premium estimates lower than the range historically experienced. Total premiums estimated on quota share reinsurance contracts for the years ended December 31, 2011, 2010 and 2009 represented approximately 11%, 13% and 12%, respectively, of total gross premiums written.
At each measurement date, we estimate the fair value of the financial instruments using various valuation techniques. We utilize, to the extent available, quoted market prices in active markets or observable market inputs in estimating the fair value of our financial instruments. When quoted market prices or observable market inputs are not available, we utilize valuation techniques that rely on unobservable inputs to estimate the fair value of financial instruments. The following describes the valuation techniques we used to determine the fair value of financial instruments held as of December 31, 2011 and what level within the U.S. GAAP fair value hierarchy the valuation technique resides.
Mortgage-backed: Principally comprised of residential and commercial mortgages originated by both U.S. government agencies (such as the Federal National Mortgage Association) and non-U.S. government agency originators. The fair values of mortgage-backed securities originated by U.S. government agencies and non-U.S. government agencies are based on a pricing model that incorporates prepayment speeds and spreads to determine the appropriate average life of mortgage-backed securities. The spreads are sourced from broker-dealers, trade prices and the new issue market. As the significant inputs used to price the mortgage-backed securities are observable market inputs, the fair values of these securities are included in the Level 2 fair value hierarchy, unless the significant inputs used to price the mortgage-backed securities are broker-dealer quotes and we are not able to determine if those quotes are based on observable market inputs, in which case the fair value is included in the Level 3 fair value hierarchy.
The following table shows the pricing sources of our fixed maturity investments held as of December 31, 2011:
Interactive Data Pricing: We use Interactive Data Pricing to price our U.S. government agencies, municipalities, non-agency mortgage-backed and asset-backed securities. There are several observable inputs that Interactive Data Pricing uses in determining its prices which include among others, benchmark yields, reported trades and issuer spreads.
Broker-dealer quotes: We also utilize broker-dealers to price our agency and non-agency mortgage-backed and asset-backed securities. The pricing sources include JP Morgan Securities Inc., Bank of America
Effective April 1, 2009, we are required to recognize OTTI in the consolidated income statements if we intend to sell the debt security or if it is more likely than not we will be required to sell a debt security before the recovery of its amortized cost basis. In addition, we are required to recognize OTTI if the present value of the expected cash flows of a debt security is less than the amortized cost basis of the debt security (“credit loss”).
For our debt securities that are within the scope of the new guidance we have applied the following policy to determine if OTTI exists at each reporting period:
Our debt securities are managed by external investment portfolio managers. We require them to provide us with a list of debt securities they intend to sell at the end of the reporting period. Any impairment in these securities is recognized as OTTI, as the difference between the amortized cost and fair value and is recognized in the income statement.
Following the Company’s review of the securities in the investment portfolio during the year ended December 31, 2011, no securities were considered to be other-than-temporarily impaired due to the present value of the expected cash flows being lower than the amortized cost. During the year ended December 31, 2010, we had one mortgage-backed security that was considered to be other-than-temporarily impaired due to the present value of the expected cash flows being lower than the amortized cost. The $0.2 million of OTTI was recognized through earnings due to credit related losses.
For the mortgage-backed security for which OTTI was recognized due to credit loss, the significant inputs utilized to determine a credit loss were the estimated frequency and severity of losses of the underlying mortgages that comprise the mortgage-backed security. The frequency of losses was measured as the credit default rate, which includes such factors as loan-to-value ratios and credit scores of borrowers. The severity of losses includes such factors as trends in overall housing prices and house prices that are obtained at foreclosure. The frequency and severity inputs were used in projecting the future cash flows of the mortgage backed security. For the security in which we recognized an OTTI due to credit loss, the credit default rate was 10.3% and the severity rate was 49.0%.
We classify intangible assets into three categories: (1) intangible assets with finite lives subject to amortization; (2) intangible assets with indefinite lives not subject to amortization and (3) goodwill. Intangible assets, other than goodwill, consist of renewal rights, internally generated software, non-compete covenants and insurance licenses held by subsidiaries domiciled in the United States. The following is a summary of our goodwill and other intangible assets as of December 31, 2011 and 2010:
(1) Related to the acquisition of Allied World National Assurance Company and Allied World Assurance Company (U.S.) Inc.
book value and earnings. Our non-market based valuations are based on the present value of estimated future cash flows. Our overall point estimate is a weighted average of these valuations. Based on our analysis, the point estimate fair value of the U.S. insurance segment reporting unit was in excess of its carrying value by approximately 14%. As a result, we concluded there was no implied goodwill impairment, and therefore, no step two goodwill impairment testing was required.
non-renewal of business that did not meet our underwriting requirements (which included inadequate pricing and/or terms and conditions) and increased competition.
The difference between gross and net premiums written is the cost to us of purchasing reinsurance coverage, including the cost of property catastrophe reinsurance coverage. We ceded 20.9% of gross premiums written for the year ended December 31, 2011 compared to 20.8% for the year ended December 31, 2010.
Net investment income decreased by $48.2 million, or 19.7%, for the year ended December 31, 2011 compared to the year ended December 31, 2010. The decrease was due to lower yields on our fixed maturity investments as well as an increased allocation to equity securities and other invested assets which contribute to our total return but carry little or no current yield. We increased our equity and other invested assets by $385.3 million between December 31, 2011 and December 31, 2010. The annualized period book yield of the investment portfolio for the years ended December 31, 2011 and 2010 was 2.5% and 3.3%, respectively. Since we believe that there could be a rise in interest rates in 2012, there remains a risk of loss in the value of the company’s fixed income portfolio. We have reduced our investment duration in 2011 to mitigate this risk. Investment management expenses of $14.2 million and $11.7 million were incurred during the years ended December 31, 2011 and 2010, respectively. The increase in investment management expenses was due to the increase in the size of our investment portfolio as well as expenses from higher expense asset classes (equities).
During the year ended December 31, 2011, we recognized $10.1 million in net realized investment gains compared to net realized investment gains of $285.6 million during the year ended December 31, 2010. During the year ended December 31, 2011, we did not recognize any net impairment charges compared to $0.2 million in net impairment charges recognized in earnings during the year ended December 31, 2010. Net realized investment gains of $10.1 million for the year ended December 31, 2011 were comprised of the following:
Net realized investment gains of $32.7 million primarily from the sale of fixed maturity securities due to the rebalancing of our portfolio.
We recorded net favorable reserve development related to prior years of $253.5 million and $313.3 million during the years ended December 31, 2011 and 2010, respectively. The following table shows the net favorable reserve development of $253.5 million by loss year for each of our segments for the year ended December 31, 2011. In the table, a negative number represents net favorable reserve development and a positive number represents net unfavorable reserve development.
The following table shows the favorable reserve development of $313.3 million by loss year for each of our segments for the year ended December 31, 2010. In the table, a negative number represents net favorable reserve development and a positive number represents net unfavorable reserve development.
The loss and loss expense ratio for the year ended December 31, 2011 was 65.8% compared to 52.1% for the year ended December 31, 2010. Net favorable reserve development recognized in the year ended December 31, 2011 and the impact of the commutation adjustment to ceded IBNR decreased the loss and loss expense ratio by 17.5 percentage points. Thus, the loss and loss expense ratio related to the current loss year was 83.3%. Net favorable reserve development recognized in the year ended December 31, 2010 and the impact of the commutation adjustment to ceded IBNR reduced the loss and loss expense ratio by 23.1 percentage points. Thus, the loss and loss expense ratio related to that loss year was 75.2%. The increase in the loss and loss expense ratio for the current loss year was primarily due to $292.2 million of losses from global catastrophes during the year ended December 31, 2011, which contributed 20.1 points to the current loss year’s loss and loss expense ratio. In comparison, $164.6 million of large individual losses, including catastrophes, contributed 12.1 points to the loss and loss expense ratio for the twelve months ended December 31, 2010.
The following table shows the components of the increase in net losses and loss expenses for the year ended December 31, 2011 compared to the year ended December 31, 2010.
The increase in net losses paid for the year ended December 31, 2011 was due to higher paid losses in our U.S. insurance and reinsurance segments as a result of continued growth in these segments, combined with higher current period property catastrophe paid losses. The increase in reported case reserves was primarily due to higher case reserves in each of our operating segments. The increase in IBNR was due to higher IBNR in our international insurance segment as a result of lower net favorable reserve development.
Acquisition costs increased by $7.8 million, or 4.9%, for the year ended December 31, 2011 compared to the year ended December 31, 2010. The increase in acquisition costs was primarily due to the increase in net premiums earned in our U.S. insurance segment and reinsurance segment. Acquisition costs as a percentage of net premiums earned were 11.5% for the year ended December 31, 2011 compared to 11.7% for the same period in 2010.
General and administrative expenses decreased by $14.9 million, or 5.2%, for the year ended December 31, 2011 compared to the same period in 2010. The decrease in general and administrative expenses was primarily due to the following:
A decrease of $7.0 million in stock related compensation due to a decrease in overall awards granted during the year ended December 31, 2011, in addition to a one-time increase of $4.3 million during the year ended December 31, 2010 to recognize expected performance above the target level for our performance-based awards granted in 2009.
Our general and administrative expense ratio was 18.6% for the year ended December 31, 2011, which was lower than the 21.1% for the year ended December 31, 2010. The decrease was primarily due to the factors discussed above in addition to the increase in net premiums earned.
Gross premiums written in our international insurance segment decreased by $51.1 million, or 9.2%, due to the continued trend of the non-renewal of business that did not meet our underwriting requirements (which included inadequate pricing and/or terms and conditions) and increased competition.
Net premiums written increased by $71.3 million, or 5.4%, for the year ended December 31, 2010 compared to the year ended December 31, 2009. The increase in net premiums written was primarily due to a reduction in premiums ceded. The difference between gross and net premiums written is the cost to us of purchasing reinsurance coverage, including the cost of property catastrophe reinsurance coverage. We ceded 20.8% of gross premiums written for the year ended December 31, 2010 compared to 22.1% for the year ended December 31, 2009. The reduction in premiums ceded was due to lower premiums ceded under our property catastrophe reinsurance coverage, as well as the commutation and adjustment of $9.3 million of certain variable-rated reinsurance contracts that have swing-rated provisions. In commuting these swing-rated reinsurance contracts, we reduced certain premiums previously ceded and also reduced ceded losses by $8.9 million in accordance with the terms of the contracts.
Net premiums earned increased by $42.6 million, or 3.2%, for the year ended December 31, 2010 compared to the year ended December 31, 2009 as a result of higher net premiums earned for the U.S. insurance and reinsurance segments. This is driven by increased net premiums written in the current and prior periods, as well as the impact of the commutation of the swing-rated reinsurance contracts which are fully earned.
lower future accretions. Please see Note 2(e) of the notes to the consolidated financial statements regarding the change in OTTI policy. The annualized period book yield of the investment portfolio for the year ended December 31, 2010 and 2009 was 3.3% and 4.2%, respectively. The decrease in book yield was due to the overall market interest rate environment being at historically low levels during most of 2010. The decrease in the book yield was also due to increased investment turnover as a result of more active management of the investment portfolio given interest rate and spread volatility. The higher sales and purchases of investment securities resulted in us recognizing $217.7 million of net realized investment gains for the year ended December 31, 2010 and the proceeds being re-invested at lower yield levels. Investment management expenses of $11.7 million and $9.0 million were incurred during the year ended December 31, 2010 and 2009, respectively. The increase in investment management expenses was due to the increase in the size of our investment portfolio, the addition of a new portfolio manager and additional fees paid to investment advisors for higher cost investment strategies.
During the year ended December 31, 2010, we recognized $285.6 million in net realized investment gains compared to net realized investment gains of $126.4 million during the year ended December 31, 2009. During the year ended December 31, 2010, we recognized $0.2 million in net impairment charges recognized in earnings compared to $49.6 million during the year ended December 31, 2009. Net realized investment gains of $285.6 million for the year ended December 31, 2010 were comprised of the following:
Net realized investment gains of $71.9 million primarily related to the mark-to-market adjustments for our other invested assets, equity securities and fixed maturity investments that are accounted for as trading securities. We expect the mark-to-market adjustments on our fixed maturity investments that are accounted for as trading securities to increase as we continue to increase the balance of these securities. From December 31, 2009 to December 31, 2010, we have increased the balance of fixed maturity investments accounted for as trading by $3.3 billion, or 126.7%, from $2.5 billion as of December 31, 2009 to $5.8 billion as of December 31, 2010. Contributing to the increase was the reclassification of all of our mortgage-backed and asset-backed securities from available for sale to trading on July 1, 2010 as part of the adoption of ASU 2010-11.
Net realized investment gains of $31.9 million related to the mark-to-market adjustments of our other invested assets and fixed maturity investments that are accounted for as trading securities.
Net losses and loss expenses increased by $103.8 million, or 17.2%, for the year ended December 31, 2010 compared to the year ended December 31, 2009. The increase in net losses and loss expenses was due to a number of individual losses totaling $164.6 million in the current year, with no comparable events having occurred during the year ended December 31, 2009. We incurred $98.4 million of catastrophe related losses, of which $66.8 million was from the Chilean earthquake, $17.0 million from the New Zealand Earthquake and $14.6 million from the Australian floods. The increase due to higher loss activity was partially offset by higher net favorable prior year reserve development.
General and administrative expenses increased by $37.9 million, or 15.2%, for the year ended December 31, 2010 compared to the same period in 2009. The increase in general and administrative expenses was primarily due to the following:
An overall increase in global headcount from 652 at December 31, 2009 to 689 at December 31, 2010 resulting in an overall increase in salary and related costs of $18.0 million, excluding stock-related compensation.
Our expense ratio was 32.8% for the year ended December 31, 2010 compared to 30.2% for the year ended December 31, 2009 due to an increase in both acquisition cost ratio and general and administrative expense ratio.
The amortization and impairment of intangible assets decreased $7.6 million, or 68.5%, for the year ended December 31, 2010 compared to the year ended December 31, 2009. The decrease is primarily the result of no longer amortizing the trademark intangible asset that was fully impaired for $6.9 million during the year ended December 31, 2009. No impairments were recognized during the year ended December 31, 2010.
Tax expense decreased $9.7 million, or 26.5%, for the year ended December 31, 2010 compared to the year ended December 31, 2009. Overall our tax expense is driven by our U.S. operations, which represents the largest taxable operation of the company. The decrease in tax expense is primarily due to lower taxable income for our U.S. operations of approximately $19.5 million, which resulted in approximately $6.9 million lower tax expense during the year ended December 31, 2010 compared to the year ended December 31, 2009. The lower tax expense was also caused by a $5.0 million loss for tax purposes on the sale of our program administrator and wholesale brokerage operation during 2010 which caused a reduction of tax expense in 2010 of $1.7 million. Our consolidated effective tax rates for the years ended December 31, 2010 and 2009 were 3.9% and 5.7%, respectively. The decrease in the effective tax rate was due to the factors discussed above.
Reinsurance Segment. Our reinsurance segment has operations in Bermuda, Europe, Singapore and the United States. This segment includes the reinsurance of property, general casualty, professional liability, specialty lines and property catastrophe coverages written by insurance companies. We presently write reinsurance on both a treaty and a facultative basis, targeting several niche reinsurance markets.
Net losses and loss expenses. Net losses and loss expenses increased by $89.6 million, or 30.1%, for the year ended December 31, 2011 compared to the year ended December 31, 2010. The increase in net losses and loss expenses was primarily due to the growth of the U.S. insurance operations, lower prior year net favorable reserve development and unfavorable prior year reserve development in the 2006 loss year related to directors and officers claims within our professional liability line of business concerning a class action suit filed against a number of private equity firms alleging collusion. We recognized estimated losses from catastrophes of $8.3 million, which included $3.8 million developing from the Midwestern U.S. storms earlier in the year and $4.5 million from Hurricane Irene during the year ended December 31, 2011.
Overall, our U.S. insurance segment recorded net favorable reserve development of $23.2 million during the year ended December 31, 2011 compared to net favorable reserve development of $68.5 million for the year ended December 31, 2010 as shown in the tables below. The $23.2 million of net favorable reserve development excludes the impact of the commutation of the swing-rated reinsurance contracts of $11.5 million discussed above and the $68.5 million of net favorable reserve development for the year ended December 31, 2010 excludes the impact of the commutation of the swing-rated reinsurance contracts of $8.9 million. In the tables, a negative number represents net favorable reserve development and a positive number represents net unfavorable reserve development.
Acquisition costs. Acquisition costs increased by $7.2 million or 10.6% for the year ended December 31, 2011 compared to the year ended December 31, 2010. The increase was primarily caused by increased net premiums earned. The acquisition cost ratio decreased slightly to 12.8% for the year ended December 31, 2011 from 13.1% for the same period in 2010.
General and administrative expenses. General and administrative expenses decreased by $4.1 million, or 3.2%, for the year ended December 31, 2011 compared to the year ended December 31, 2010. The decrease in general and administrative expenses was primarily due to a decrease in performance based incentive compensation expenses. The decrease in the general and administrative expense ratio from 24.8% for the year ended December 31, 2010 to 21.3% for the same period in 2011 was primarily caused by increased net premiums earned and the decrease in expenses as discussed above.
Premiums. Gross premiums written increased by $54.5 million, or 8.1%, for the year ended December 31, 2010 compared to the same period in 2009. The increase in gross premiums written was primarily due to increases to our underwriting staff and a higher volume of gross premiums written from new products in our general casualty and other lines of business where we believe attractive underwriting opportunities exist. In addition, we experienced rate increases within our general casualty and general property lines of business. These increases were partially offset by the non-renewal of business that did not meet our underwriting requirements (which included inadequate pricing and/or terms and conditions) and increased competition, particularly for public directors and officers liability products in our professional liability line of business.
The loss and loss expense ratio for the year ended December 31, 2010 was 57.4% compared to 47.2% for the year ended December 31, 2009. Net favorable reserve development recognized and the impact of the commutation adjustment to ceded IBNR in the year ended December 31, 2010 decreased the loss and loss expense ratio by 13.2 percentage points. Thus, the loss and loss expense ratio for the current loss year was 70.6%. In comparison, net favorable reserve development recognized in the year ended December 31, 2009 decreased the loss and loss expense ratio by 15.7 percentage points. In addition, the $3.0 million decrease in premiums ceded for variable-rated reinsurance contracts of Darwin that have swing-rated provisions increased the loss and loss expense ratio by 0.4 percentage points. Thus, the loss and loss expense ratio for that loss year was 63.3%. The increase in the loss and loss expense ratio for the current loss year was primarily due to losses of $25.8 million noted above. These losses contributed 5.0 percentage points to the current loss year’s loss and loss expense ratio, after adjusting for the $9.3 million impact to ceded earned premium of the commuted swing-rated reinsurance contracts previously discussed.
The following table summarizes the underwriting results and associated ratios for the international insurance segment for the years ended December 31, 2011, 2010 and 2009.
The table below illustrates our gross premiums written by line of business for the periods indicated.
Net losses and loss expenses. Net losses and loss expenses increased by $46.4 million, or 29.0%, for the year ended December 31, 2011 compared to the year ended December 31, 2010. The increase in net losses and loss expenses was primarily due to higher loss activity in the current period and lower net favorable reserve development recognized. Catastrophe loss activity recognized during the year ended December 31, 2011 included net losses and loss expenses of $45.0 million related to the Tohoku earthquake and tsunami, $17.7 million related to the storms in the Midwestern United States, $12.7 million related to the New Zealand earthquake, $22.8 million related to the Thailand floods, $8.0 million related to Hurricane Irene and $1.4 million related to the Australian storms.
General and administrative expenses. General and administrative expenses decreased $9.9 million, or 10.5%, for the year ended December 31, 2011 compared to the year ended December 31, 2010. The decrease in general and administrative expenses was primarily due to a decrease in incentive-based compensation due to higher loss activity as well as a decrease in staffing and related salaries and benefits. The year ended December 31, 2010 included one-time expenses in professional fees related to the establishment of Syndicate 2232 and our efforts to effect our redomestication to Switzerland. These decreases were offset by an increase in fees for a full year of operating our Lloyd’s Syndicate 2232 of $4.4 million in 2011 versus six months of operation in 2010. The general and administrative expense ratios for the years ended December 31, 2011 and 2010 were 26.6% and 27.8%, respectively, due to lower general and administrative expenses.
Premiums. Gross premiums written decreased by $51.0 million, or 9.2%, for the year ended December 31, 2010 compared to the same period in 2009. The decrease in gross premiums written was due to the continued trend of the non-renewal of business that did not meet our underwriting requirements (which included inadequate pricing and/or terms and conditions) and increased competition in our international insurance segment.
Acquisition costs. Acquisition costs decreased $3.2 million for the year ended December 31, 2010 compared to the year ended December 31, 2009. The decrease in acquisition costs was due to lower net premiums earned. The acquisition cost ratio decreased from 0.7% for the year ended December 31, 2009 to a negative 0.1% for the year ended December 31, 2010.
The following table summarizes the underwriting results and associated ratios for the reinsurance segment for the years ended December 31, 2011, 2010 and 2009.
Premiums. Gross premiums written increased by $46.3 million, or 8.8%, for the year ended December 31, 2011 compared to the same period in 2010. The increase in gross premiums written was primarily due to increased writings in our international reinsurance lines of business with the continuing build out of our London and Singapore offices, including business written through Syndicate 2232, as well as $25.4 million of new business from our new global marine and specialty division. This growth was partially offset by the non-renewal of business that did not meet our underwriting requirements (which included inadequate pricing and/or terms and conditions). In addition, the increase in gross premiums written was partially offset by a two year treaty we wrote in our general casualty reinsurance line of business for $31.4 million in the year ended December 31, 2010.
The table below illustrates our gross premiums written by geographic location for our reinsurance operations.
Net losses and loss expenses. Net losses and loss expenses increased by $115.3 million, or 46.1%, for the year ended December 31, 2011 compared to the year ended December 31, 2010. The increase in net losses and loss expenses was due to loss activity incurred from the Tohoku earthquake and tsunami of $51.5 million, $45.9 million from the New Zealand earthquake, $32.2 million related to the Midwestern U.S. storms, $20.2 million related to the Thailand floods, $11.2 million related to Hurricane Irene and $15.3 million related to the Australian storms compared to $26.6 million from a number of earthquakes and other weather related events during the year ended December 31, 2010. The increase in losses and loss expenses from catastrophe losses was partially offset by greater net favorable reserve development during the year ended December 31, 2011.
Overall, our reinsurance segment recorded net favorable reserve development of $111.8 million and $64.2 million during the years ended December 31, 2011 and 2010, respectively, as shown in the tables below. In the tables, a negative number represents net favorable reserve development and a positive number represents net unfavorable reserve development.
Acquisition costs. Acquisition costs increased by $3.0 million, or 3.3%, for the year ended December 31, 2011 compared to the year ended December 31, 2010. The increase was primarily a result of higher net premiums earned partially offset by a decrease in profit commissions due to loss activity. The acquisition cost
General and administrative expenses. General and administrative expenses decreased $0.9 million, or 1.4%, for the year ended December 31, 2011 compared to the year ended December 31, 2010. The decrease in general and administrative expenses was primarily due to a decrease in performance based incentive compensation expenses partially offset by additional professional fees related to the operation of the Lloyd’s Syndicate which was operational for only six months in the prior year. The general and administrative expense ratios for the years ended December 31, 2011 and 2010 were 11.3% and 12.7%, respectively, due to lower general and administrative expenses and higher net premiums earned.
The specialty reinsurance line of business includes the workers compensation catastrophe reinsurance and accident and health reinsurance.
The loss and loss expense ratio for the year ended December 31, 2010 was 49.8%, compared to 51.4% for the year ended December 31, 2009. Net favorable reserve development recognized during the year ended December 31, 2010 reduced the loss and loss expense ratio by 12.8 percentage points. Thus, the loss and loss expense ratio related to the current loss year was 62.6%. In comparison, net favorable reserve development recognized in the year ended December 31, 2009 reduced the loss and loss expense ratio by 8.4 percentage points. Thus, the loss and loss expense ratio related to that loss year was 59.8%. The increase in the loss and loss expense ratio for the current loss year was primarily due to net incurred losses of $26.6 million noted above, which contributed 5.3 percentage points to the current loss year’s loss and loss expense ratio.
Acquisition costs. Acquisition costs increased by $4.1 million, or 4.7%, for the year ended December 31, 2010 compared to the year ended December 31, 2009 primarily as a result of higher net premiums earned. The acquisition cost ratio was 18.3% for the year ended December 31, 2010, slightly lower than the 19.3% for the year ended December 31, 2009. The decrease in the acquisition cost ratio is due to more business written on an excess-of-loss basis, which typically carries a lower acquisition cost ratio than quota share business.
Our operating subsidiaries depend upon cash inflows from premium receipts, net of commissions, investment income, and proceeds from sales and redemptions of investments. Cash outflows are in the form of claims payments, reinsurance premium payments, purchase of investments, operating expenses, income tax payments, intercompany payments as well as dividend payments to the holding company.
Historically, our operating subsidiaries have generated sufficient cash flows to meet all of their obligations. Because of the inherent volatility of our business, the seasonality in the timing of payments by insureds and cedents, the irregular timing of loss payments, the impact of a change in interest rates and credit spreads on the investment income as well as seasonality in coupon payment dates for fixed income securities, cash flows from operating activities may vary between periods. We expect that annual positive cash flows from operating activities will be sufficient to cover claims payments. In the unlikely event that paid losses exceed operating cash flows in any given period, we would use our cash balances available, or liquidate a portion of our high quality
In May 2010, the company established a share repurchase program in order to repurchase Holdings’ common shares. Repurchases under the authorization may be effected from time to time through open market purchases, privately negotiated transactions, and tender offers or otherwise. The timing, form and amount of the share repurchases under the program will depend on a variety of factors, including market conditions, the company’s capital position, legal requirements and other factors. During the year ended December 31, 2011, we repurchased through open market purchases 1,419,163 shares at a total cost of $86.7 million, for an average price of $61.09 per share. We have classified the repurchased shares as “treasury shares, at cost” on the consolidated balance sheets.
In November 2010, Allied World Bermuda issued $300 million senior notes due in 2020. The senior notes bear interest at an annual rate of 5.50% per year and were priced to yield 5.56%. Interest on the senior notes is payable semi-annually on May 15 and November 15 of each year commencing on May 15, 2011. The net proceeds from the offering of the senior notes were and will be used for general corporate purposes, including the repurchase of the company’s outstanding common shares. The senior notes are the company’s unsecured and unsubordinated obligations and rank equally in right of payment with all existing and future unsecured and unsubordinated indebtedness. We may redeem the senior notes at any time or from time to time in whole or in part at a redemption price equal to the greater of the principal amount of the senior notes to be redeemed or a make-whole price, plus accrued and unpaid interest. The senior notes include covenants and events of default that are usual and customary, but do not contain any financial covenants. In addition, these senior notes as well as the 7.50% senior notes issued in 2006 have been unconditionally and irrevocably guaranteed for the payment of the principal and interest by Holdings.
In February 2011, we repurchased a warrant owned by American International Group, Inc. (“AIG”) in a privately negotiated transaction. The warrant entitled AIG to purchase 2,000,000 of our common shares for $34.20 per share. We repurchased the warrant for an aggregate purchase price of $53.6 million. The repurchase of the warrant was recognized as a reduction in “additional paid-in capital” in the consolidated balance sheets. The repurchase was executed separately from the company’s share repurchase program.
We believe our company’s capital position continues to remain well within the range needed for our business requirements and we have sufficient liquidity to fund our ongoing operations.
We entered into an $800 million five-year senior credit facility (the “Credit Facility”) with a syndication of lenders that will terminate on November 27, 2012. The Credit Facility consists of a $400 million secured letter of credit facility for the issuance of standby letters of credit (the “Secured Facility”) and a $400 million unsecured facility for the making of revolving loans and for the issuance of standby letters of credit (the “Unsecured Facility”). Both the Secured Facility and the Unsecured Facility have options to increase the aggregate commitments by up to $200 million, subject to approval of the lenders. The Credit Facility will be used for
In May 2010, Allied World Capital (Europe) Limited established an irrevocable standby letter of credit in order to satisfy funding requirements of our Lloyd’s Syndicate 2232. As of December 31, 2011, the amount of the letter of credit was £59.0 million ($90.9 million).
(1) Net of any borrowing or repayments under the Unsecured Facility.
As of December 31, 2011, we had a combined unused letters of credit capacity of $883.0 million from the Credit Facility and Citibank Europe plc. We believe that this remaining capacity is sufficient to meet our future letter of credit needs.
Cash flows from operations for the year ended December 31, 2011 were $548.1 million compared to $451.3 million for the year ended December 31, 2010 and $668.2 million for the year ended December 31, 2009. The increase in cash flows from operations was impacted by increased premium writings in the year ended December 31, 2011 compared to the year ended December 31, 2010. The decrease in cash flows from operations for the year ended December 31, 2010 compared to the year ended December 31, 2009 was primarily due to an increase in net paid losses of $138.5 million and an increase in insurance balances receivable primarily related to a funds held balance of $73.9 million for a property catastrophe reinsurance treaty entered into in 2010. The funds held balance can be used by the cedent to pay claims, if any. Any balance remaining after the expiry of the reinsurance treaty is returned to us.
In addition to our quarterly dividends declared and paid during 2010, the Board of Directors declared a special dividend of $0.25 per common share related to the redomestication. Under Swiss law, we were not able to pay a dividend until two months after our annual meeting. This special dividend provided a dividend to shareholders for the interim period. This special dividend was paid on November 26, 2010 to shareholders of record on November 15, 2010.
Our funds are primarily invested in liquid, high-grade fixed income securities. As of December 31, 2011 and 2010, 92.6% and 96.2%, respectively, of our fixed income portfolio consisted of investment grade securities. As of December 31, 2011 and December 31, 2010, net accumulated unrealized gains on our available for sale fixed
* Our unpaid losses and loss expenses represent our best estimate of the cost to settle the ultimate liabilities based on information available as of December 31, 2011, and are not fixed amounts payable pursuant to contractual commitments. The timing and amounts of actual loss payments related to these reserves might vary significantly from our current estimate of the expected timing and amounts of loss payments based on many factors, including large individual losses as well as general market conditions.
As of December 31, 2011, we did not have any off-balance sheet arrangements.