We lease our corporate offices in Stamford, Connecticut, under a lease expiring in October 2022. Upon signing the lease in September 2004, we received a construction allowance of $3.1 million. We have three renewal options on the current premises that could extend the lease through September 2032, if all renewal options are exercised.
The following selected financial data is derived from our audited consolidated financial statements and should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of
Odyssey Re Holdings Corp. is a holding company, incorporated in the state of Delaware, which owns all of the common shares of Odyssey America Reinsurance Corporation (“Odyssey America”), its principal operating subsidiary. Odyssey America directly or indirectly owns all of the capital stock of the following companies: Clearwater Insurance Company (“Clearwater”); Clearwater Select Insurance Company; Newline Holdings U.K. Limited; Newline Underwriting Management Ltd., which owns and manages Newline Syndicate 1218, a member of Lloyd’s of London (collectively “Newline”); Newline Insurance Company Limited (“NICL”); Hudson Insurance Company (“Hudson”); Hudson Specialty Insurance Company (“Hudson Specialty”); and Napa River Insurance Services, Inc.
On June 9, 2008, Hudson Specialty purchased the remaining 60% of the outstanding shares of Hooghuis Group LLC (“Hooghuis”), an underwriting agency specializing in U.S. directors’ and officers’ liability insurance. Previously, Hudson Specialty had purchased 40% of Hooghuis in 2004. On August 29, 2008, Hudson purchased certain assets and liabilities associated with the crop insurance business previously produced by CropUSA Insurance Agency, Inc. (“CropUSA”). Since 2006, CropUSA had acted as managing general underwriter for Hudson in the crop insurance sector. These acquisitions were entered into to reduce operating costs and to gain better access to the producer agents who maintain direct access to the policyholders.
We are a leading underwriter of reinsurance, providing a full range of property and casualty products on a worldwide basis. We offer a broad range of both treaty and facultative reinsurance to property and casualty insurers and reinsurers. We also write insurance in the United States and through the Lloyd’s and London marketplaces.
We review our critical accounting estimates and assumptions quarterly. These reviews include the estimate of reinsurance premiums and premium related amounts, establishing deferred acquisition costs, an evaluation of the adequacy of reserves for unpaid losses and LAE, review of our reinsurance and retrocession agreements, an analysis of the recoverability of deferred income tax assets and an evaluation of the fair value of our investment portfolio, including a review for other-than-temporary declines in estimated fair value. Actual results may differ materially from the estimates and assumptions used in preparing the consolidated financial statements.
The following table displays, by division, the estimates included in our consolidated financial statements as of and for the years ended December 31, 2008, 2007 and 2006 related to gross premiums written, acquisition costs, premiums receivable and unearned premium reserves (in millions):
and, in some cases, movements in foreign exchange rates over the period. However, historically, the final reported premium compared to the original estimated premium has deviated by smaller amounts.
Our estimates are based on contract and policy terms. Estimates are based on information typically received in the form of a bordereau, broker notifications and/or discussions with ceding companies. These estimates, by necessity, are based on assumptions regarding numerous factors. These can include premium or loss trends, which can be influenced by local conditions in a particular region, or other economic factors and legal or legislative developments which can develop over time. The risk associated with estimating the performance under our contracts with our ceding companies is the impact of events or trends that could not have been reasonably anticipated at the time the estimates were performed. Our business is diversified across ceding companies and there is no individual ceding company which represents more than 2.0% of our gross premiums written in 2008. As a result, we believe the risks of material changes over time are mitigated.
Acquisition costs consist of commissions and brokerage expenses incurred on insurance and reinsurance business written. These costs are deferred and amortized over the period in which the related premiums are earned, which is generally one year. Deferred acquisition costs are limited to their estimated realizable value based on the related unearned premiums, which considers anticipated losses and LAE and estimated remaining costs of servicing the business, all based on our historical experience. The realizable value of our deferred acquisition costs is determined without consideration of investment income. The estimates are continually reviewed by us and any adjustments are made in the accounting period in which an adjustment is considered necessary.
Our losses and LAE reserves, for both reported and unreported claims obligations, are maintained to cover the estimated ultimate liability for all of our reinsurance and insurance obligations. Losses and LAE reserves are categorized in one of three ways: (i) case reserves, which represent unpaid losses and LAE as reported by cedants and insureds to us, (ii) additional case reserves (“ACRs”), which are reserves we establish in excess of the case reserves reported by the cedant on individual claim events, and (iii) incurred but not reported reserves (“IBNR”), which are reserves for losses and LAE that have been incurred, but have not yet been reported to us, as well as additional amounts relating to losses already reported, that are in excess of case and ACR reserves. Incurred but not reported reserves are estimates based on all information currently available to us and are reevaluated quarterly utilizing the most recent information supplied from our cedants and claims adjusters.
loss activity as estimated by the ceding company. Reporting for excess of loss, facultative and insurance contracts includes detailed individual claim information, including a description of the loss, confirmation of liability by the cedant or claims adjuster and the cedant’s or claims adjuster’s current estimate of the ultimate liability under the claim. Upon receipt of claim notices from cedants and insureds, we review the nature of the claim against the scope of coverage provided under the contract. Questions arise from time to time regarding the interpretation of the characteristics of a particular claim measured against the scope of contract terms and conditions. Reinsurance contracts under which we assume business generally contain specific dispute resolution provisions in the event that there is a coverage dispute with the ceding company. The resolution of any individual dispute may impact estimates of ultimate claims liabilities. Reported claims are in various stages of the settlement process. Each claim is settled individually based on its merits, and certain claims may take several years to ultimately settle, particularly where legal action is involved. Based on an assessment of the circumstances supporting the claim, we may choose to establish additional case reserves over the amount reported by the ceding company. Aggregate case reserves established in addition to reserves reported by ceding companies were $19.6 million and $18.7 million as of December 31, 2008 and December 31, 2007, respectively. Due to potential differences in ceding company reserving and reporting practices, we perform periodic audits of our ceding companies to ensure the underwriting and claims procedures of the cedant are consistent with representations made by the cedant during the underwriting process and meet the terms of the reinsurance contract. Our estimates of ultimate loss liabilities make appropriate adjustment for inconsistencies uncovered in this audit process. We also monitor our internal processes to ensure that information received from ceding companies is processed in a timely manner.
The reserve methodologies employed by us are dependent on the nature and quality of the data that we collect from ceding companies for reinsurance business and claims adjusters for insurance business. This data primarily consists of loss amounts reported by the ceding companies and claims adjusters, loss payments made by ceding companies and claims adjusters, and premiums written and earned reported by the ceding companies or estimated by us. Underwriting and claim information provided by our ceding companies and claims adjusters is aggregated by the year in which each treaty or policy is written into groups of business by geographic region and type of business to facilitate analysis, generally referred to as “reserve cells.” These reserve cells are reviewed annually and change over time as our business mix changes. We supplement this information with claims and underwriting audits of specific contracts, internally developed pricing trends, as well as loss trend data developed from industry sources. This information is used to develop point estimates of carried reserves for each business segment. These individual point estimates, when aggregated, represent the total carried losses and LAE reserves carried in our consolidated financial statements. Due to the uncertainty involving estimates of ultimate loss exposures, we do not attempt to produce a range around our point estimate of loss. The actuarial techniques for projecting losses and LAE reserves by reserve cell rely on historical paid and case reserve loss emergence patterns and insurance and reinsurance pricing trends to establish the claims emergence of future periods with respect to all reported and unreported insured events that have occurred on or before the balance sheet date.
emergence trends is not practical. Generally, we rely on BF and loss ratio methods for estimating ultimate loss liabilities for more recent treaty years. These methodologies, at least in part, apply a loss ratio, determined from aggregated analysis of internally developed pricing trends across reserve cells, to premium earned on that business. Adjustments to premium estimates generate appropriate adjustments to ultimate loss estimates in the quarter in which they occur using the BF and loss ratio methods. To estimate losses for more mature treaty years, we generally rely on the incurred loss development methodology, which does not rely on premium estimates. In addition, we may use other methods to estimate liabilities for specific types of claims. For property catastrophe losses, we may utilize vendor catastrophe models to estimate ultimate loss soon after a loss occurs, where loss information is not yet reported to us from cedants. The provision for asbestos loss liabilities is established based on an annual review of internal and external trends in reported loss and claim payments. IBNR is determined by subtracting the total of paid loss and case reserves including ACRs from ultimate loss.
If a change were to occur in the frequency and severity of claims underlying our December 31, 2008 unpaid losses and LAE, the approximate change in pre-tax income would be as follows (in millions):
increase in frequency and severity of claims resulting from an increase in shareholder lawsuits against corporations and their officers and directors, corporate bankruptcies and other financial and management improprieties in the late 1990s and early 2000s.
The EuroAsia division reported net decreases in prior period loss estimates of $2.4 million, $6.9 million and $9.0 million for the years ended December 31, 2008, 2007 and 2006, respectively. The decrease in prior period loss estimates for the year ended December 31, 2008 was principally attributable to loss emergence lower than expectations in the period on credit business, partially offset by loss emergence greater than expectations in the period on miscellaneous property lines of business. The reduction in prior period loss estimates for the year ended December 31, 2007 was principally attributable to favorable loss emergence on credit and miscellaneous property lines of business, partially offset by increased loss estimates on motor and liability exposures in the period. The reduction in prior period loss estimates for the year ended December 31, 2006 was driven by favorable loss emergence on property catastrophe, marine and credit lines of business in the period.
The London Market division reported net decreases in prior period loss estimates of $40.0 million, $57.0 million and $24.8 million for the years ended December 31, 2008, 2007 and 2006, respectively. The reduction in prior period loss estimates for the year ended December 31, 2008 was principally attributable to loss emergence lower than expectations in the period on professional liability and miscellaneous property lines of business. The reduction in prior period loss estimates for the year ended December 31, 2007 was principally attributable to favorable loss emergence on liability, property catastrophe and other miscellaneous property lines of business in the period. The reduction in prior period loss estimates for the year ended December 31, 2006 was principally attributable to favorable loss emergence on satellite, accident and health, non-catastrophe property and aviation exposures, partially offset by $3.6 million of net adverse loss development on prior period catastrophe losses in the period.
The U.S. Insurance division reported net decreases in prior period loss estimates of $34.3 million, $38.7 million and $39.0 million for the years ended December 31, 2008, 2007 and 2006, respectively. For the years ended December 31, 2008, 2007 and 2006, the reductions in prior period loss estimates were principally due to loss emergence lower than expectations on professional liability business in each period.
Estimates of reserves for unpaid losses and LAE are contingent upon legislative, regulatory, social, economic and legal events and trends that may or may not occur or develop in the future, thereby affecting assumptions of claim frequency and severity. Examples of emerging claim and coverage issues and trends in recent years that could
The following table summarizes, by type of reserve, the unpaid losses and LAE reserves as of December 31, 2008 and 2007. Case reserves represent unpaid claim reports provided by cedants to us plus additional reserves determined by us. IBNR is the estimate of unreported loss liabilities established by us.
We seek to limit the probable maximum loss to a specific level for severe catastrophic events. Currently, we generally seek to limit the probable maximum loss, after tax, including the effect of reinsurance protection and applicable reinstatement premiums, to a maximum of approximately 15% of statutory surplus for a severe catastrophic event in any geographic zone that could be expected to occur once in every 250 years, although this can change based on market opportunities. There can be no assurances that we will not incur losses greater than 15% of our statutory surplus from one or more catastrophic events due to the inherent uncertainties in estimating the frequency and severity of such events, the margin of error in making such determinations resulting from potential inaccuracies and inadequacies in the data provided by clients and brokers, and the modeling techniques and the application of such techniques.
Reinsurance recoverables are recorded as assets, based on our evaluation of the retrocessionaires’ ability to meet their obligations under the agreements. Premiums written and earned are stated net of reinsurance ceded in the consolidated statements of operations. Direct, reinsurance assumed, reinsurance ceded and net amounts (in millions) for these items follow:
The total amount of reinsurance recoverables on paid and unpaid losses, net of allowance, as of December 31, 2008 and 2007 was $773.2 million and $726.6 million, respectively. We have established a reserve for potentially
The following table shows the amount of loss and LAE attributable to each coverage period ceded to the Whole Account Excess of Loss Agreements for the years ended December 31, 2008, 2007 and 2006 (in millions):
The following table provides a summary of the cumulative experience, including the income before income taxes, for two agreements in force at December 31, 2008, in each case since inception (in millions):
In accordance with SFAS 157, we have categorized our financial instruments, based on the priority of the inputs to the valuation technique, into a three-level fair value hierarchy. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). We use valuation techniques for our Level 3 investments, which represent approximately 0.9% of our total invested assets and cash. To verify Level 3 pricing, we assess the reasonableness of the fair values by comparison to economic pricing models, by reference to movements in credit spreads, and by comparing the fair values to recent transaction prices for similar assets where available. We will further evaluate any prices for our investments to ensure they represent fair value.
“other-than-temporary,” the cost or amortized cost of the investment will be written down to the fair value and a realized loss will be recorded in our consolidated statements of operations.
Total reinsurance gross premiums written for the year ended December 31, 2008 were $1,502.2 million, compared to $1,545.9 million for 2007, a decrease of 2.8%. Total insurance gross premiums written for the year ended December 31, 2008, which include our U.S. Insurance division, our Lloyd’s syndicate and NICL, were $792.3 million, compared to $736.8 million for 2007, an increase of 7.5% For the year ended December 31, 2008, total reinsurance gross premiums written represented 65.5% (67.7% in 2007) of our business, and insurance represented the remaining 34.5% (32.3% in 2007) of our business.
36.6% for the year ended December 31, 2007. Gross premiums written across each geographic region of the Americas were as follows:
Canada - Gross premiums written of $40.3 million for the year ended December 31, 2008 decreased $3.0 million, or 6.9%, compared to $43.3 million for the year ended December 31, 2007. The Canadian unit primarily writes property, crop hail and automobile coverage.
London Market. Gross premiums written in the London Market division for the year ended December 31, 2008 were $381.7 million, an increase of $31.8 million, or 9.1%, compared to $349.9 million for the year ended December 31, 2007. These amounts represent 16.7% of our gross premiums written for the year ended December 31, 2008 and 15.3% in 2007. Gross premiums written across each unit of the London Market division were as follows:
U.S. Insurance. Gross premiums written in the U.S. Insurance division for the year ended December 31, 2008 were $539.7 million, an increase of $7.4 million, or 1.4%, compared to $532.3 million for the year ended December 31, 2007. These amounts represent 23.5% of our gross premiums written for the year ended December 31, 2008 and 23.3% for the year ended December 31, 2007. Lines of business that experienced the greatest change in
gross premiums written or were significant to the U.S. Insurance division for the year ended December 31, 2008 were as follows:
Medical professional liability gross premiums written were $113.9 million for the year ended December 31, 2008, a decrease of $16.3 million, or 12.5%, from $130.2 million for the year ended December 31, 2007. This decrease reflects the more competitive market conditions for 2008, as well as certain client groups retaining more exposure or self-insuring their own programs.
Specialty liability remained nearly flat, with $90.9 million in gross premiums written for the year ended December 31, 2008, versus $90.3 million for the year ended December 31, 2007.
Property and package business gross premiums written increased $43.0 million, to $111.5 million, for the year ended December 31, 2008, from $68.5 million for the year ended December 31, 2007. Contributing to this increase were the crop program, which increased by $33.2 million, and the offshore energy business, which increased by $13.7 million.
Commercial automobile gross premiums written increased $15.8 million, to $68.2 million, for the year ended December 31, 2008, from $52.4 million for the year ended December 31, 2007. This increase resulted from new programs in the logging and transportation industries.
Americas. Net premiums written in the Americas division for the year ended December 31, 2008 were $760.7 million, compared to $817.8 million for the 2007 period, a decrease of $57.1 million, or 7.0%. These amounts represented 37.5% of our net premiums written for the year ended December 31, 2008 and 39.1% for the
year ended December 31, 2007. The net retention ratio, which represents net premiums written as a percent of gross premiums written, was 98.0% for both of the years ended December 31, 2008 and 2007.
The decrease in net premiums written in the Americas division is consistent with the 7.0% decrease in gross premiums written.
The loss and LAE ratio for the years ended December 31, 2008 and 2007 and the percentage point change for each of our divisions and in total are as follows:
Americas Division - Losses and LAE decreased $16.0 million, or 2.4%, to $645.5 million for the year ended December 31, 2008, from $661.5 million for the year ended December 31, 2007. This resulted in a loss and LAE ratio of 82.8% for the year ended December 31, 2008, compared to 78.6% for the year ended December 31, 2007. This decrease in losses and LAE was principally due to a decrease in prior period losses of $76.5 million, to $66.6 million for the year ended December 31, 2008, from $143.1 million for the year ended December 31, 2007, and a decrease in loss exposure associated with a decrease in net premiums earned of $61.8 million. These decreases were partially offset by an increase in current year catastrophe events of $97.3 million, to $129.3 million for the year ended December 31, 2008, from $32.0 million for the year ended December 31, 2007. For the year ended December 31, 2008, losses and LAE included $93.9 million for Hurricane Ike, $9.3 million for Hurricane Gustav, $8.2 million for Australian floods and prior period losses of $66.6 million, principally attributable to loss emergence greater than expectations in the period on asbestos. Losses and LAE for the year ended December 31, 2007 included $10.0 million for the Mexico flood in Tabasco and prior period losses of $143.1 million, which included $11.7 million for increased loss estimates on prior period catastrophe events, principally attributable to Hurricanes Katrina and Wilma, $77.4 million for increased asbestos and environmental loss estimates, principally attributable to the annual review of these exposures, and $21.2 million related to settlement of litigation in the period, with the remainder principally due to loss emergence greater than expectations in the period on U.S. casualty business.
EuroAsia Division - Losses and LAE increased $48.6 million, or 13.9%, to $397.2 million for the year ended December 31, 2008, from $348.6 million for the year ended December 31, 2007. This resulted in a loss and LAE ratio of 70.1% for the year ended December 31, 2008, compared to 64.2% for the year ended December 31, 2007. This increase in losses and LAE was principally due to an increase in current year catastrophe events of $27.9 million, to $81.3 million for the year ended December 31, 2008, from $53.4 million for the year ended December 31, 2007, and an increase in loss exposure associated with an increase in net premiums earned of $23.4 million. For the year ended December 31, 2008, losses and LAE included $45.9 million for the China winter storm, $19.1 million for Windstorm Emma, $5.1 million for the China earthquake and a decrease in prior period losses of $2.4 million, principally attributable to loss emergence lower than expectations in the period on credit
London Market Division - Losses and LAE increased $38.2 million, or 25.4%, to $188.6 million for the year ended December 31, 2008, from $150.4 million for the year ended December 31, 2007. This resulted in a loss and LAE ratio of 59.9% for the year ended December 31, 2008, compared to 49.0% for the year ended December 31, 2007. This increase in losses and LAE was principally due to an increase in prior period losses of $17.0 million, to a decrease of $40.0 million for the year ended December 31, 2008, from a decrease of $57.0 million for the year ended December 31, 2007, and an increase in current year catastrophe events. Current year catastrophe events increased $6.0 million, to $26.5 million for the year ended December 31, 2008, from $20.5 million for the year ended December 31, 2007. For the year ended December 31, 2008, losses and LAE included $23.1 million attributable to Hurricane Ike and reflected a decrease in prior period losses of $40.0 million, principally due to loss emergence lower than expectations in the period on professional liability and miscellaneous property lines of business. For the year ended December 31, 2007, losses and LAE included $11.7 million for Windstorm Kyrill, $5.1 million for floods in the United Kingdom and reflected a reduction in prior period losses of $57.0 million, principally due to favorable loss emergence on liability, property catastrophe and other miscellaneous property lines of business in the period.
Acquisition Costs. Acquisition costs for the year ended December 31, 2008 were $418.0 million, a decrease of $19.3 million or 4.4%, compared to $437.3 million for the year ended December 31, 2007. The resulting acquisition expense ratio, expressed as a percentage of net premiums earned, was 20.1% for the year ended December 31, 2008, compared to 20.6% for the year ended December 31, 2007, a decrease of 0.5 points. The Americas divisions’ acquisition ratios increased by 0.2 points, while the EuroAsia, London Market and U.S. Insurance divisions’ acquisition ratios decreased by 1.6, 0.1 and 0.5 points, respectively.
Net Investment Income. Net investment income for the year ended December 31, 2008 decreased by $74.2 million, or 22.5%, to $255.2 million, from $329.4 million for the year ended December 31, 2007. Net investment income is comprised of gross investment income of $295.5 million less investment expenses of $40.3 million for the year ended December 31, 2008, compared to gross investment income of $368.1 million less investment expenses of $38.7 million for the year ended December 31, 2007. The decrease in net investment income for the year ended December 31, 2008 is primarily attributable to the following:
a decrease of $3.3 million, or 8.8%, in net investment income from equity investments for the year ended December 31, 2008, compared to the corresponding period in 2007. Net income of common stocks, at equity, decreased by $12.8 million, partially due to the sale of Hub in June 2007, offset by an increase in dividends on common stocks of $9.5 million;
a decrease in net investment income from other invested assets of $33.5 million, or 74.7%, for the year ended December 31, 2008, compared to the corresponding period in 2007, which primarily reflects a decrease in investment income from hedge funds and private equity funds accounted for under the equity method.
Our total effective annualized yield on average invested assets, net of expense but before the impact of interest expense from funds held balance was 3.3% and 4.5% for the year ended December 31, 2008 and 2007, respectively.
Interest expense on funds held, which primarily relates to our Whole Account and Facultative Excess of Loss Agreements and is included in investment expenses, of $5.3 million for the year ended December 31, 2008, represents a decrease of $2.7 million, or 33.8%, from $8.0 million for the year ended December 31, 2007. The decrease was primarily attributable to ceded paid losses reducing the funds held balance.
higher net realized investment gains on fixed income securities of $110.1 million; offset by:
a decrease in foreign exchange realized investment gains on short-term investments of $134.4 million resulting from the strengthening of the U.S. dollar versus foreign currencies;
lower net realized investment gains on equity securities of $435.1 million, which included other-than-temporary write-downs of equity securities of $339.0 million and $42.1 million for the years ended December 31, 2008 and 2007, respectively. The year ended December 31, 2007 included gains of $119.2 million related to the sale of Hub International Limited shares;
During the year ended December 31, 2008, net realized investment gains were reduced by other-than-temporary impairment losses of $358.7 million, comprised of fixed income securities of $18.9 million, equity securities of $339.0 million and preferred stock of $0.8 million. During the year ended December 31, 2007, net realized investment gains were reduced by other-than-temporary impairment losses in the amount of $59.8 million, comprised of fixed income securities, common and preferred stock. Other-than temporary impairments reflect situations where the fair value was below the cost of the securities, and the ability of the security to recover its value could not be reasonably assured.
Preferred Dividends. We recorded preferred dividends related to our Series A and Series B non-cumulative perpetual preferred shares of $7.4 million and $8.3 million in the years ended December 31, 2008 and 2007, respectively.
United States - Gross premiums written of $650.6 million for the year ended December 31, 2007 decreased $105.8 million, or 14.0%, compared to $756.4 million for the year ended December 31, 2006. The decrease in the United States relates to all classes of business. Property business decreased by $44.2 million, or 23.0%, to $148.1 million in 2007 from $192.3 million in 2006 as we reduced our proportional catastrophe exposed business in certain peak zones. Treaty and facultative casualty business decreased by $52.0 million, or 10.3%, to $452.0 million in 2007 from $504.0 million in 2006 due to an increase in competitive market conditions and the nonrenewal of certain business that did not meet our underwriting criteria. All other classes of business accounted for the remaining decrease of $9.6 million.
Canada - Gross premiums written of $43.3 million for the year ended December 31, 2007 increased $11.3 million, or 35.3%, compared to $32.0 million for the year ended December 31, 2006, due to the nonrenewal in 2006 of certain treaties, which included the return of unearned premium to the ceding company.
EuroAsia. Gross premiums written in the EuroAsia division for the year ended December 31, 2007 were $565.6 million, an increase of $4.4 million, or 0.8%, as compared to $561.2 million for the year ended December 31, 2006. These amounts represent 24.8% of our gross premiums written for the year ended December 31, 2007 and 24.0% in 2006. Included in the overall increase in gross premiums written is the impact of movements in foreign exchange rates, which contributed approximately $19.0 million to the increase in 2007. Excluding the impact of movements in foreign exchange rates, actual premiums for the calendar year 2007 would have decreased by $14.6 million. Property, marine and liability business increases were offset by decreases in motor business, accident and health, aviation and credit and bond business. Gross premiums written from property business, which represents 61.5% of EuroAsia in 2007, increased by $7.1 million, or 2.1%, for the year ended December 31, 2007 driven by increases in the European and Middle East markets. The increase in marine business of $3.1 million, or 9.3%, and liability business of $4.5 million, or 19.2%, is related to increases in new and renewal business throughout Europe. Offsetting these increases are decreases in motor business of $5.4 million, or 6.3%, primarily related to European, Middle East and Asia business, credit and bond business of $3.9 million or $7.0% related to the European market, and accident and health and aerospace business of $0.2 million and $0.8 million, respectively.
London Market. Gross premiums written in the London Market division for the year ended December 31, 2007 were $349.9 million, an increase of $9.2 million, or 2.7%, as compared to $340.7 million for the year ended December 31, 2006. These amounts represent 15.3% of our gross premiums written for the year ended December 31, 2007 and 14.6% in 2006. Included in the overall increase in gross premiums written is the impact of movements in foreign exchange rates, which contributed approximately $20.0 million to the increase in 2007. Excluding the impact of movements in foreign exchange rates, actual premiums for the calendar year 2007 would have decreased by $10.8 million. Gross premiums written across each unit of the London Market division are as follows:
London branch - Gross premiums written of $145.3 million for the year ended December 31, 2007 increased $7.1 million, or 5.1%, compared to $138.2 million for the year ended December 31, 2006. Property business increased $19.9 million, or 41.9%, due to increased writings on both a new and renewal basis. Casualty business decreased by $5.6 million, or 19.7%, and marine and aerospace business decreased $7.2 million, or 11.6% in 2007 compared to 2006, due to share reduction and non-renewal of business not meeting our underwriting criteria.
Newline and NICL - Gross premiums written of $204.6 million for the year ended December 31, 2007 increased $2.1 million, or 1.0%, compared to $202.5 million for the year ended December 31, 2006.
Medical professional liability gross premiums written were $130.2 million for the year ended December 31, 2007, a decrease of $22.6 million, or 14.8%, from $152.8 million for the year ended December 31, 2006. The medical professional liability class of business is experiencing a softening market.
Property and package business increased $37.8 million to $68.5 million for the year ended December 31, 2007, from $30.7 million for the year ended December 31, 2006. This primarily resulted from new agriculture business and offshore energy business.
Net Premiums Written. Net premiums written for the year ended December 31, 2007 decreased by $71.5 million, or 3.3%, to $2,089.4 million from $2,160.9 million for the year ended December 31, 2006. Net premiums written represent gross premiums written less ceded premiums written. Net premiums written decreased over 2006 at a higher rate than gross premiums written, reflecting an increase in ceded premiums written during 2007.
The decrease in net premiums written in the Americas division is consistent with the 9.7% decrease in gross premiums written.
London Market. Net premiums written in the London Market division for the year ended December 31, 2007 were $305.6 million, compared to $312.5 million for 2006, a decrease of 2.2%. These amounts represented 14.6% of our net premiums written for the year ended December 31, 2007 and 14.5% for the year ended December 31, 2006. The net retention ratio was 87.3% for the year ended December 31, 2007, compared to 91.7% for the year ended December 31, 2006.
U.S. Insurance. Net premiums written in the U.S. Insurance division for the year ended December 31, 2007 were $423.9 million, compared to $408.1 million for the year ended December 31, 2006, an increase of 3.9%. These amounts represented 20.3% of our net premiums written for the year ended December 31, 2007 and 21.8% for the year ended December 31, 2006. The net retention ratio was 79.6% for the year ended December 31, 2007, compared to 80.1% for the year ended December 31, 2006.
Net Premiums Earned. Net premiums earned for the year ended December 31, 2007 decreased by $105.3 million, or 4.7%, to $2,120.5 million, from $2,225.8 million for the year ended December 31, 2006. Net premiums earned decreased in the Americas division by $133.2 million, or 13.7%, and in the London Market division by $26.7 million, or 8.0%, offset by increases in the EuroAsia division of $11.8 million, or 2.2%, and in the U.S. Insurance division of $42.8 million, or 11.1%.
Losses and Loss Adjustment Expenses. Net losses and LAE decreased $75.8 million, or 5.1%, to $1,408.4 million for the year ended December 31, 2007, from $1,484.2 million for the year ended December 31, 2006 as follows (in millions):
The decrease in net losses and LAE incurred was principally related to a decrease of $99.4 million in prior period losses, to $40.5 million for the year ended December 31, 2007, from $139.9 million for the year ended December 31, 2006, and a decrease in loss exposure associated with a decrease in net premiums earned of $105.3 million. This decrease was partially offset by an increase in current year catastrophe losses of $71.0 million, to $105.9 million for the year ended December 31, 2007, from $34.9 million for the year ended December 31, 2006. Losses and LAE for the year ended December 31, 2007 included an increase in prior period losses of $40.5 million, predominantly attributable to increased loss estimates due to loss emergence greater than expectations in the period in the Americas division, partially offset by reduced loss estimates due to loss emergence lower than expectations in the period in the EuroAsia, London Market and U.S. Insurance divisions. Losses and LAE for the year ended December 31, 2006 included an increase in prior period losses of $139.9 million, which included $42.6 million on prior period catastrophe events, principally due to an increase in loss estimates on marine business for Hurricane Rita and the triggering of industry loss warranty contracts written by us for Hurricane Wilma due to unexpected deterioration in industry-wide Wilma loss estimates as well as unexpected loss emergence on Florida proportional property accounts in the period. The remaining amount of prior period losses of $97.3 million in 2006 was predominantly attributable to increased loss estimates on non-catastrophe business in the Americas division of $169.7 million, which included $27.1 million for increased asbestos loss estimates, principally attributable to the annual review of this exposure, with the remainder principally due to loss emergence greater than expectations in the period on U.S. casualty business. This increase was partially offset by reduced loss estimates due to loss emergence lower than expectations in the period on non-catastrophe business written in the EuroAsia, London Market and U.S. Insurance divisions.
Americas Division - Losses and LAE decreased $104.3 million, or 13.6%, to $661.5 million for the year ended December 31, 2007, from $765.8 million for the year ended December 31, 2006. This resulted in a loss and LAE ratio of 78.6% for the year ended December 31, 2007, compared to 78.5% for the year ended December 31, 2006. The decrease in losses and LAE was principally due to a decrease in prior period losses of $69.6 million, to $143.1 million for the year ended December 31, 2008, from $212.7 million for the year ended December 31, 2007, and a decrease in loss exposure associated with a decrease in net premiums earned of $133.2 million. Losses and LAE for the year ended December 31, 2007 included $10.0 million for the Mexico flood in Tabasco and prior period losses of $143.1 million, which included $11.7 million for increased loss estimates on prior period catastrophe events, principally attributable to Hurricanes Katrina and Wilma, $77.4 million for increased asbestos and environmental loss estimates, principally attributable to the annual review of these exposures, and $21.2 million related to settlement of litigation during the period, with the remainder principally due to loss emergence greater than expectations in the period on U.S. casualty business. Losses and LAE for the year ended December 31, 2006 included prior period losses of $212.7 million, which included $43.0 million for increased loss estimates on prior period catastrophe events, principally attributable to Hurricanes Rita and Wilma. In addition, asbestos loss estimates were increased by $27.1 million, principally attributable to the annual review of this exposure. The remaining prior period losses of $142.6 million were principally attributable to loss emergence greater than expectations in the period on U.S. casualty business.
EuroAsia Division - Losses and LAE increased $28.2 million, or 8.8%, to $348.6 million for the year ended December 31, 2007, from $320.4 million for the year ended December 31, 2006. This resulted in a loss and LAE ratio of 64.2% for the year ended December 31, 2007, compared to 60.3% for the year ended December 31, 2006. The increase in losses and LAE was principally due to an increase in current year catastrophe losses of $34.0 million, to $53.4 million for the year ended December 31, 2007, from $19.4 million for the year ended December 31, 2006. Losses and LAE for the year ended December 31, 2007 included $26.8 million for Windstorm Kyrill, $12.3 million for Cyclone Gonu, $5.6 million for the Jakarta floods and a reduction in prior period losses of $6.9 million, principally attributable to favorable loss emergence on credit and miscellaneous property lines of business, partially offset by increased loss estimates on motor and liability exposures. Losses and LAE for the year ended December 31, 2006 included a reduction in prior period losses of $9.0 million, principally due to favorable emergence on property catastrophe, marine and credit lines of business in the period.
London Market Division - Losses and LAE decreased $32.1 million, or 17.6%, to $150.4 million for the year ended December 31, 2007, from $182.5 million for the year ended December 31, 2006. This resulted in a loss and LAE ratio of 49.0% for the year ended December 31, 2007, compared to 54.7% for the year ended December 31, 2006. The decrease in losses and LAE was principally due to a reduction in prior period losses of $32.2 million, to a decrease of $57.0 million for the year ended December 31, 2007, from a decrease of $24.8 million for the year ended December 31, 2006, and a decrease in loss exposure associated with a decrease in net premiums earned of $26.7 million. For the year ended December 31, 2007, losses and LAE included $11.7 million for Windstorm Kyrill, $5.1 million for floods in the United Kingdom and reflected a reduction in prior period losses of $57.0 million,
U.S. Insurance Division - Losses and LAE increased $32.4 million, or 15.0%, to $247.9 million for the year ended December 31, 2007, from $215.5 million for the year ended December 31, 2006. This resulted in a loss and LAE ratio of 57.8% for the year ended December 31, 2007, compared to 55.8% for the year ended December 31, 2006. The increase in losses and LAE was principally related to an increase in loss exposure associated with an increase in net premiums earned of $42.8 million. For the years ended December 31, 2007 and 2006, prior period losses decreased by $38.7 million and $39.0 million, respectively, principally due to loss emergence lower than expectations on professional liability business in each period.
Acquisition Costs. Acquisition costs for the year ended December 31, 2007 were $437.3 million, a decrease of $26.8 million or 5.8%, compared to $464.1 million for the year ended December 31, 2006. The resulting acquisition expense ratio, expressed as a percentage of net premiums earned, was 20.6% for the year ended December 31, 2007, compared to 20.9% for the year ended December 31, 2006, a decrease of 0.3 points. The Americas and London Market divisions’ acquisition ratios decreased by 1.1 and 1.4 points, respectively, while the EuroAsia and U.S. Insurance divisions’ acquisition ratios increased by 1.2 and 1.0 points, respectively.
an increase in investment expenses of $8.4 million for the year ended December 31, 2007 compared to 2006, reflecting an increase in investment advisory and administration fees and investment expenses from our consolidated subsidiaries of $9.6 million, offset by a decrease in interest expense of $1.2 million on funds held;
Interest expense on funds held primarily relates to our Whole Account and Facultative Excess of Loss Agreements, which is included in investment expenses, of $7.1 million for the year ended December 31, 2007, and represents a decrease of $1.6 million, or 18.4%, from $8.7 million for the year ended December 31, 2006. The decrease was primarily attributable to ceded paid losses reducing the funds held balance.
an increase in net realized investment gains from other investments of $18.7 million for the year ended December 31, 2007, mainly due to net realized investment gains on securities sold short; offset by
Other Expenses, Net. Other expenses, net for the year ended December 31, 2007, were $14.0 million, compared to $21.1 million for the year ended December 31, 2006. Other expenses are primarily comprised of operating expenses of our holding company and include audit related fees, corporate-related legal fees, consulting fees, and compensation expense, including the amortization of restricted share grants. The decrease of $7.1 million for the year ended December 31, 2007 compared to 2006 is primarily comprised of: (i) a decrease of $2.3 million in compensation expense, (ii) a decrease of $2.3 million relating to contracts under deposit accounting, (iii) a decrease in legal fees of $1.7 million due to litigation settled in 2006, and (iv) a decrease in audit fees of $1.8 million; offset by: (v) an increase in foreign exchange related adjustments of $1.2 million.
Preferred Dividends. We recorded preferred dividends related to our Series A and Series B non-cumulative perpetual preferred shares of $8.3 million in each of the years ended December 31, 2007 and 2006.
from Odyssey America included extraordinary dividends of $150.0 million and $100.0 million, which required and received the approval of the Connecticut Insurance Department, and were paid in the second and third quarters, respectively. The dividends have been and will continue to be used for general corporate purposes, which may include the continued repurchase of our common stock pursuant to our publicly announced share repurchase plan.
Although the obligations of our reinsurers to make payments to us are based on specific contract provisions, these amounts only become recoverable when we make a payment of the associated loss amount, which may be several years, or in some cases decades, after the actual loss occurred. Reinsurance recoverables on unpaid losses, which represent 89.3% of our total reinsurance recoverables as of December 31, 2008, will not be due for collection until some time in the future, and over this period of time, economic conditions and the operational performance of a particular reinsurer may negatively impact its ability to meet its future obligations to us. We manage our exposure by entering into reinsurance transactions with companies that have a strong capital position and a favorable long term financial profile.
Approximately $49.9 million of our total reinsurance paid recoverable is current billings, and $33.1 million is over 120 days past due. The change in the economic conditions of any of our retrocessionaires may impact their ability to meet their obligations and negatively impact our liquidity.
Cash provided by operations was $112.1 million for the year ended December 31, 2008, compared to $157.4 million for the year ended December 31, 2007. This reflects a decrease in cash provided by operations of $45.3 million, or 28.8%, over the corresponding period of 2007.
$0.4 billion as of December 31, 2008, a decrease of $2.7 billion compared to December 31, 2007. Investments in fixed income securities of U.S. states, municipalities and political subdivisions were $2.3 billion at December 31, 2008, an increase of $2.1 billion over December 31, 2007. The duration of our investment portfolio, including short-term investments, cash and cash equivalents, was 6.8 years, compared to 5.1 years at December 31, 2007.
On November 28, 2006, we completed the private sale of $40.0 million aggregate principal amount of floating rate senior debentures, Series C (the “Series C Notes”), due on December 15, 2021. Interest on the Series C Notes accrues at a rate per annum equal to the three-month London Interbank Offer Rate (“LIBOR”), reset quarterly, plus 2.50%, and is payable quarterly in arrears on March 15, June 15, September 15 and December 15 of each year starting on March 15, 2007. We have the option to redeem the Series C Notes at par, plus accrued and unpaid interest, in whole or in part on any interest payment date on or after December 15, 2011. For the years ended December 31, 2008 and 2007, the average annual interest rate on the Series C Notes was 5.71% and 7.93%, respectively.
On February 22, 2006, we issued $100.0 million aggregate principal amount of floating rate senior debentures, pursuant to a private placement. The net proceeds from the offering, after fees and expenses, were $99.3 million. The debentures were sold in two tranches, $50.0 million of series A due March 15, 2021 (the “Series A Notes”), and $50.0 million of series B due March 15, 2016 (the “Series B Notes”). Interest on each series of debentures is due quarterly in arrears on March 15, June 15, September 15 and December 15 of each year. The interest rate on each series of debentures is equal to the three-month LIBOR, reset quarterly, plus 2.20%. The Series A Notes are callable by us in 2011 at their par value, plus accrued and unpaid interest, and the Series B Notes are callable by us in 2009 at their par value, plus accrued and unpaid interest. For the year ended December 31, 2008, the average annual interest rate on each series of notes was 5.41%, compared to an average annual interest rate of 7.62% for the year ended December 31, 2007.
In December 2008, we entered into five-year interest rate swap contracts, with an aggregate notional value of $140.0 million, pursuant to which we receive a floating interest rate of three-month LIBOR and pay a fixed interest rate of 2.49% on the $140.0 million notional value of the underlying contracts.
As of December 31, 2008, there was $56.5 million outstanding under the Credit Agreement, all of which was in support of letters of credit. Loans under the Credit Agreement bear interest at a fluctuating rate per annum equal to the higher of (a) the federal funds rate plus 0.5%, and (b) Wachovia’s publicly announced prime rate. Alternatively, at our option, loans bear interest at the LIBOR, which is the offered rate that appears on the page of the Telerate screen that displays an average British Bankers Association Interest Settlement Rate for deposits in dollars, plus 0.55%, which additional percentage may be adjusted if our debt rating changes.
Due to the current global financial crisis, it is difficult to determine if we would be able to refinance our credit facility at the present time at the same pricing, terms and conditions, if the need were to arise. Similarly, due to the slowdown in the capital markets, it is difficult to determine our ability to refinance and issue debt or equity securities, if the need were to arise.
We participate in Lloyd’s through our 100% ownership of Newline Syndicate 1218 (“Syndicate 1218”), through which we provide 100% of the capacity for Syndicate 1218. The results of Syndicate 1218 are consolidated in our consolidated financial statements. In support of Syndicate 1218’s capacity at Lloyd’s, Odyssey America has pledged securities and cash, with a fair value of $214.7 million as of December 31, 2008, in a deposit trust account in favor of the Society and Council of Lloyd’s. Securities held may be substituted with other securities with Lloyds’ approval. The securities are carried at fair value and are included in investments and cash in our consolidated balance sheets. Interest earned on the securities is included in investment income. The pledge of assets in support of Syndicate 1218 provides us with the ability to participate in writing business through Lloyd’s, which remains an important part of our business. The pledged assets effectively secure the contingent obligations of Syndicate 1218 should it not meet its obligations. Odyssey America’s contingent liability to the Society and Council of Lloyd’s is limited to the aggregate amount of the pledged assets. We have the ability to remove funds at Lloyd’s annually, subject to certain minimum amounts required to support its outstanding liabilities as determined under risk-based capital models and approved by Lloyd’s. The funds used to support outstanding liabilities are adjusted annually and our obligation to support these liabilities will continue until they are settled or the liabilities are reinsured by a third party approved by Lloyd’s. We expect to continue to actively operate Syndicate 1218 and support its requirements at
During the second quarter of 2004, Odyssey America pledged U.S. Treasury Notes with a par value of $162.0 million (“the pledged assets”), or approximately £110.0 million equivalent, to the Society and Council of Lloyd’s on behalf of Advent Capital (Holdings) PLC (“Advent”) to support Advent’s underwriting activities for the 2001 to 2005 underwriting years of account. Advent is 66.6% owned by Fairfax and its affiliates, which includes 14.4% held by us. nSpire Re had previously pledged assets at Lloyd’s on behalf of Advent pursuant to a November 2000 agreement with Advent. In consideration of Odyssey America pledging the assets, nSpire Re paid Odyssey America a fee equal to 2.0% per annum of the pledged assets, which we considered to be representative of commercial market terms. The securities were carried at fair value and were included in investments and cash in our consolidated balance sheets. Interest earned on the securities was included in investment income. The placement of funds at Lloyd’s was scheduled to automatically terminate effective no later than December 31, 2008 and any remaining pledged assets would have reverted to Odyssey America at that time. In January 2006, September 2006, June 2007, July 2008 and December 2008, Odyssey America received assets with par values of $48.6 million, $10.7 million, $14.6 million, $63.9 million and $24.2 million, respectively, in each case representing a permanent reduction and unconditional release of such amount, prior to the stated termination date. Following these returns of assets, and as of December 31, 2008, Lloyd’s has returned all the pledged assets related to Advent to Odyssey America, and Odyssey America has received a deed of total release with respect thereto.
During the year ended December 31, 2008, Odyssey America purchased 128,000 shares of our Series B preferred stock, with a liquidation preference of $3.1 million, for $1.7 million. As a result of the purchase of the Series B preferred shares, we recorded a gain of $1.4 million during the year ended December 31, 2008, which was recorded in net income to common shareholders’. As of December 31, 2008, 1,872,000 shares of our Series B preferred stock were outstanding.
On each of March 28, 2008 and June 27, 2008, we paid dividends of $0.0625 per common share. On July 31, 2008, we announced that our Board of Directors had approved a 20% increase in our quarterly common stock dividend, and declared a quarterly cash dividend of $0.075, which was paid on September 26, 2008. On December 2, 2008, our Board of Directors declared a quarterly cash dividend of $0.075 per common share, which was paid on December 30, 2008 to all common shareholders of record as of December 16, 2008. These common share dividends resulted in an aggregate annual dividend in 2008 of $0.275 per common share, totaling $17.4 million.
On December 2, 2008, our Board of Directors declared quarterly dividends of $0.5078125 per share on our 8.125% Series A preferred shares and $0.4845313 per share on our floating rate Series B preferred shares. The total dividends of $1.9 million were paid on January 20, 2009 to Series A and Series B preferred shareholders of record on December 31, 2008.
For determining the fair value of our Level 1 investments, (approximately 40.2% of total invested assets and cash), we utilize quoted market prices. The majority of our Level 1 investments are common stocks that are actively traded in a public market, and cash, cash equivalents and short-term investments where the cost basis approximates fair value.
Our Level 2 investments (approximately 51.4% of total invested assets and cash), the majority of which are in government, corporate and municipal securities, are priced using publicly traded over-the-counter prices and broker-dealer quotes. Observable inputs such as benchmark yields, reported trades, broker-dealer quotes, issuer spreads and bids are available for these investments. For determining the fair value of credit default swaps, which are classified as Level 2, we utilize broker-dealer quotes, which include observable credit spreads. Also included in Level 2 are inactively traded convertible corporate debentures, which are valued using a pricing model that includes observable inputs such as credit spreads and discount rates in the calculation.
The Company and its subsidiaries are assigned financial strength (insurance) and credit ratings from internationally recognized rating agencies, which include A.M. Best, Standard & Poor’s and Moody’s. Financial strength ratings represent the opinions of the rating agencies of the financial strength of a company and its capacity to meet the obligations of insurance and reinsurance contracts. The rating agencies consider many factors in determining the financial strength rating of an insurance or reinsurance company, including the relative level of statutory surplus necessary to support the business operations of the company.
These ratings are used by insurers, reinsurers and intermediaries as an important means of assessing the financial strength and quality of reinsurers. A reduction in our financial strength ratings could limit or prevent us from writing new reinsurance or insurance business. The financial strength ratings of our principal operating subsidiaries are as follows:
Our senior unsecured debt is currently rated “BBB-” by Standard & Poor’s, “Baa3” by Moody’s and “bbb” by A.M. Best. Our Series A and Series B preferred shares are currently rated “BB” by Standard & Poor’s, “Ba2” by Moody’s and “bb+” by A.M. Best. “See Part I, Item 1 - Business-Ratings” for further detail regarding the Company and its subsidiaries’ ratings.
Effective December 31, 2006, we began recognizing the funded status of our pension and postretirement plans in accordance with SFAS 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans - an amendment of SFAS 87, 88, 106, and 132(R).” SFAS 158 requires company plan sponsors to display the net funded position of a defined benefit postretirement plan as an asset or liability, with any unrecognized prior service costs, transition obligations or actuarial gains or losses reported as a component of accumulated other comprehensive income in stockholders’ equity in the year in which the change occurs. SFAS 158 also requires employers to measure plan assets and liabilities as of the date of their financial statements. Accordingly, the measurement date for two of our benefit plans has been changed from October 1 to December 31. We have elected to apply the “fifteen-month” approach for these two benefit plans, to measure plan assets and liabilities from the plans’ previous measurement date, October 1, 2007, for a fifteen-month period through December 31, 2008. On January 1, 2008, we recorded a transition adjustment of $1.2 million, net of tax, decreasing retained earnings, and $0.1 million, net of tax, increasing accumulated other comprehensive income, related to the change in the measurement date for the two benefit plans. SFAS 158 does not require retrospective application.
realized investment gains and losses. Upon adoption, we recorded a cumulative adjustment of $16.5 million to reclassify unrealized investment gains, net of tax, including foreign currency effects, to retained earnings as of January 1, 2007.
On January 1, 2007, we adopted FASB Interpretation 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109.” The interpretation clarifies the accounting for uncertainty in income taxes recognized in a company’s financial statements in accordance with SFAS 109, “Accounting for Income Taxes.” Specifically, the pronouncement prescribes a recognition threshold and a measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The interpretation also provides guidance on the classification, interest and penalties, accounting for interim periods, disclosure and transition of uncertain tax positions. The adoption of FIN 48 did not have a material impact on our results of operations or financial position.
Effective January 1, 2008, we adopted SFAS 157 and FSP FAS 157-2. Accordingly, the provisions of SFAS 157 were not applied to non-financial assets (goodwill and intangible assets) held by us and measured annually for impairment testing purposes only. The adoption of SFAS 157, for all other assets and liabilities held by us, did not have a material effect on our results of operations, financial position or liquidity. We will adopt SFAS 157 for non-financial assets and non-financial liabilities on January 1, 2009 and do not expect the provisions to have a material effect on our results of operations, financial position or liquidity.
In December 2007, the FASB issued SFAS 160, “Non-controlling Interests in Consolidated Financial Statements,” which amends Accounting Research Bulletin 51, “Consolidated Financial Statements,” to establish accounting and reporting standards for the non-controlling interest in a subsidiary and for the deconsolidation of a subsidiary. SFAS 160 clarifies the definition of a non-controlling interest and the proper accounting for that entity. SFAS 160 is effective for fiscal years beginning on or after December 15, 2008. Earlier adoption is prohibited. The adoption of SFAS 160 will not have a material impact on our consolidated financial statements.
In March 2008, the FASB issued SFAS 161, “Disclosures About Derivative Instruments and Hedging Activities,” which requires additional disclosures for derivative and hedging activities. While earlier application is encouraged, SFAS 161 is effective for fiscal years and interim periods beginning after November 15, 2008. SFAS 161 does not require, but encourages comparative application to prior periods at the initial adoption date. Upon adoption of SFAS 161, we will include additional disclosures within our future consolidated financial statements.
In May 2008, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position Accounting Principles Bulletin 14-1 (“FSP APB 14-1”), “Accounting for Convertible Debt Instruments That May Be Settled in Cash Upon Conversion (Including Partial Cash Settlement),” to clarify the guidance related to convertible debt with options to settle partially or fully in cash. This statement does not change the accounting for convertible debt that does not offer a cash settlement feature, nor does it apply if the conversion feature is accounted for as an embedded derivative or for convertible preferred stock. FSP APB 14-1 is applicable to annual and interim periods beginning after December 15, 2008, however it must be applied on a retrospective basis for comparative purposes, even if the convertible debt did not exist as of the date of application. We will apply the provisions of FSP APB 14-1, effective January 1, 2009, related to the Convertible Notes that we issued in June 2002 (see Note 13). As of May 1, 2007, all of the Convertible Notes had been converted to common stock of the Company. The adoption of FSP APB 14-1 will not have a material impact on our financial statements.
We have certain business arrangements with affiliated companies that have financial implications. A description of these arrangements is provided in Note 16 to our consolidated financial statements included in this Annual Report on Form 10-K.
The preceding table indicates an asymmetric fair value response to equivalent basis point shifts, up and down, in interest rates. This partly reflects exposure to fixed income securities containing a put feature. In total, securities with a put feature represented 3% and 4% of the fair value of the total fixed income portfolio as of the years ended December 31, 2008 and 2007, respectively. The asymmetric fair value response reflects our ability to put these bonds back to the issuer for early maturity in a rising interest rate environment (thereby limiting fair value loss) but to hold these bonds to their much longer full maturity dates in a falling interest rate environment (thereby maximizing the full benefit of higher fair values in that environment).
As of December 31, 2008, we had net unrealized gains of $115.6 million, before taxes, related to our total investments and cash. This net amount was comprised of gross unrealized appreciation of $285.1 million, offset by gross unrealized depreciation of $169.5 million, and includes gross unrealized appreciation of $258.6 million and gross unrealized depreciation of $167.0 million related to fixed income securities and common stocks carried at fair value.
During the third quarter of 2008, we entered into Eurodollar futures contracts to manage our interest rate risk with respect to certain investments. A futures contract is a variation of a forward contract, with some additional features, such as a clearinghouse guarantee against credit losses, a daily settlement of gains and losses, and trading on an organized electronic or floor trading facility. Futures contracts are entered either long or short. We have entered into the long side, which agrees to buy the underlying currency at the future date at the agreed-upon price. As of December 31, 2008, we were party to futures contracts with a notional amount of $791.0 million. As of December 31, 2008, the fair value of these contracts is reported in other liabilities at $0.1 million. Futures contracts had net realized gains of $3.4 million for the year ended December 31, 2008.
As of December 31, 2008 and December 31, 2007, 91.6% and 96.1%, respectively, of the aggregate fair value of our fixed income securities consisted of securities rated investment grade, with 8.4% and 3.9%, respectively, rated below investment grade.
In recent years, we purchased credit default swaps, referenced to various issuers in the banking, mortgage and insurance sectors of the financial services industry in the U.S. and worldwide, that provide a hedge against adverse movements in the fair value of investments and other corporate assets resulting from systemic financial and credit risk. Under a credit default swap, as the buyer, we agree to pay at specified periods fixed premium amounts based on an agreed notional principal amount in exchange for the credit default protection on a specified asset. Credit default swaps are recorded at fair value in other invested assets, with the related changes in fair value recognized as a realized gain or loss in the period in which they occur. We obtain market derived fair values for our credit default swaps from third party providers, principally broker dealers. We assess the reasonableness of the fair values obtained from these providers by comparison to models validated by qualified personnel, by reference to movements in credit spreads and by comparing the fair values to recent transaction prices for similar credit default swaps where available. The total cost of the credit default swaps was $30.8 million and $94.2 million as of December 31, 2008 and 2007, respectively, and the fair value was $82.8 million and $307.6 million, as of December 31, 2008 and 2007, respectively. The notional amount of the credit default swaps was $1.8 billion and $5.0 billion as of December 31, 2008 and 2007, respectively. The credit default swaps had net realized gains of $350.7 million and $298.3 million, and net realized losses of $22.6 million for the years ended December 31, 2008, 2007 and 2006, respectively. The fair values of credit default swaps are subject to significant volatility given potential differences in the perceived risk of default of the underlying issuers, movements in credit spreads and the length of time to the contracts’ maturities. The fair value of the credit default swaps may vary dramatically either up or down in short periods, and their ultimate value may therefore only be known upon their disposition. As a result of the appreciation in the fair value of the credit default swaps, our counterparties to these transactions have been required to place government securities as collateral, pursuant to the swap agreements. The fair value of this collateral at December 31, 2008 was $65.7 million, of which we do not have the right to sell or repledge $19.1 million. We have not exercised our right to sell or repledge the remaining $46.6 million of this collateral.
In addition, we had sold short primarily equity securities, all of which were closed out during the second quarter of 2008. As of December 31, 2007, we had short positions of $62.3 million, primarily with respect to equity securities, for which we recorded a liability equal to the underlying fair value of the securities of $60.7 million. Net realized gains of $12.8 million, $60.5 million, and $3.0 million for the years ended December 31, 2008, 2007 and 2006, respectively, were recognized in our consolidated statements of operations. As of December 31, 2007, we provided cash of $195.8 million as collateral for the borrowed securities.
On a quarterly basis, we review our investment portfolio for declines in value, and specifically consider securities with fair values that have declined to less than 80% of their cost or amortized cost at the time of review. Declines in the fair value of investments which are determined to be temporary are recorded as unrealized depreciation, net of tax, in accumulated other comprehensive income. If we determine that a decline is “other-than-temporary,” the cost or amortized cost of the investment will be written down to the fair value and a realized loss will be recorded in our consolidated statements of operations.
We believe the gross unrealized depreciation is temporary in nature and we have not recorded a realized investment loss in our consolidated statements of operations related to these securities. Given the size of our investment portfolio and capital position, we have the ability and intent to hold our fixed income securities until the fair value recovers to its original cost.
For further detail on our losses and LAE, see Note 9 to our consolidated financial statements included in this Annual Report on Form 10-K. Our reserves for losses and LAE do not have contractual maturity dates. However, based on historical payment patterns, we have included an estimate of when we expect our losses and LAE to be paid in the table above. The exact timing of the payment of claims cannot be predicted with certainty. We maintain a portfolio of investments with varying maturities and a substantial amount of short-term investments to provide adequate cash flows for the payment of claims. The reserves for unpaid losses and LAE reflected in the table above have not been reduced for reinsurance recoverables on unpaid losses which are reflected in our consolidated balance sheet as an asset of $690.2 million as of December 31, 2008. Based on historical patterns, we estimate that we will collect the recoveries as follows: $165.3 million in less than one year; $208.7 million in one to three years; $107.7 million between three and five years and $208.5 million in more than five years.
Consolidated Statements of Operations and Comprehensive Income for the years ended December 31, 2008, 2007 and 2006
IV. Reinsurance for the years ended December 31, 2008, 2007 and 2006
To the Board of Directors and Shareholders of Odyssey Re Holdings Corp.:
Odyssey Re Holdings Corp. (together with its subsidiaries, the “Company” or “OdysseyRe”) is an underwriter of reinsurance, providing a full range of property and casualty products on a worldwide basis, and an underwriter of specialty insurance, primarily in the United States and through the Lloyd’s of London marketplace. Odyssey Re Holdings Corp. was formed as a holding company and incorporated in Delaware in 2001 in conjunction with its initial public offering. Odyssey Re Holdings Corp. owns all of the common shares of Odyssey America Reinsurance Corporation (“Odyssey America”), its principal operating subsidiary, which is domiciled in the state of Connecticut. Odyssey America directly or indirectly owns all of the common shares of the following domestic and foreign subsidiaries: Clearwater Insurance Company (“Clearwater”); Clearwater Select Insurance Company; Newline Holdings U.K. Limited; Newline Underwriting Management Ltd., which owns and manages Newline Syndicate 1218, a member of Lloyd’s of London (collectively, “Newline”); Newline Insurance Company Limited (“NICL”); Hudson Insurance Company (“Hudson”); Hudson Specialty Insurance Company (“Hudson Specialty”) and Napa River Insurance Services, Inc. As of December 31, 2008, Fairfax Financial Holdings Limited (“Fairfax”), a publicly traded financial services holding company based in Canada, owned 70.4% of OdysseyRe.
(a) Basis of Presentation. The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The consolidated financial statements include the accounts of the Company and its subsidiaries. Intercompany transactions have been eliminated. The preparation of the consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions, which could differ materially from actual results, that affect the reported amounts of assets, liabilities, revenues and expenses and disclosure of contingent assets and liabilities. Certain amounts from prior periods have been reclassified to conform with the current year’s presentations.
(d) Deferred Acquisition Costs. Acquisition costs, which are reported net of acquisition costs ceded, consist of commissions and brokerage expenses incurred on insurance and reinsurance business written, and are deferred and amortized over the period in which the related premiums are earned, which is generally one year. Commission
adjustments are accrued based on changes in premiums and losses recorded by the Company in the period in which they become known. Deferred acquisition costs are limited to their estimated realizable value based on the related unearned premium, which considers anticipated losses and loss adjustment expenses and estimated remaining costs of servicing the business, all based on historical experience. The realizable value of the Company’s deferred acquisition costs is determined without consideration of investment income.
(e) Goodwill and Intangible Assets. The Company accounts for goodwill and intangible assets in accordance with Statement of Financial Accounting Standards 141 (“SFAS 141”), “Business Combinations.” A purchase price paid that is in excess of net assets arising from a business combination is recorded as an asset (“goodwill”) and is not amortized. Intangible assets with a finite life are amortized over the estimated useful life of the asset. Intangible assets with an indefinite useful life are not amortized. Goodwill and intangible assets are tested for impairment on an annual basis or more frequently if events or changes in circumstances indicate that the carrying amount may not be recoverable. If the goodwill or intangible asset is impaired, it is written down to its realizable value with a corresponding expense reflected in the consolidated statements of operations. The Company has determined that its goodwill and intangible assets are not impaired as of December 31, 2008 and 2007. Goodwill and intangible assets with an indefinite useful life are carried at $39.2 million and $30.5 million and are reflected in other assets as of December 31, 2008 and 2007, respectively. As of December 31, 2008 and 2007, intangible assets with a finite life are also reflected in other assets with a value of $11.1 million and $4.3 million, respectively. The Company amortized $1.6 million, $0.8 million, and $0.8 million for the years ended December 31, 2008, 2007 and 2006, respectively, related to its intangible assets with a finite life.
The following table provides the estimated amortization expense related to intangible assets for the succeeding five years (in millions):
(m) Stock Compensation Plans. The Company adopted SFAS 123(R), “Share-Based Payment”, on a prospective basis effective January 1, 2006. SFAS 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the consolidated financial statements based on the fair values of such payments. Prior to adopting SFAS 123(R), the Company followed the provisions of SFAS 123, “Accounting for Stock-Based Compensation” from its effective date of January 1, 2003, on a prospective basis. The prospective method requires the application of the fair value based method to compensation awards granted, modified, or settled on or after the date of adoption. For stock options granted during 2002, the year in which the shareholders approved the Company’s first stock incentive plan, the Company accounted for stock-based compensation based on the intrinsic-value method prescribed in Accounting Principles Board Opinion (“APB”) 25, “Accounting for Stock Issued to Employees” and related interpretations, as permitted under SFAS 123.
(n) Payments. Payments of claims by the Company, as reinsurer, to a broker on behalf of a reinsured company are recorded on the Company’s books as a paid loss at the time the cash is disbursed. The payment is treated as a paid claim to the reinsured. Premiums due to the Company from the reinsured are recorded as
receivables from the reinsured until the cash is received by the Company, either directly from the reinsured or from the broker.
Depreciation and amortization expense for the years ended December 31, 2008, 2007 and 2006 was $5.1 million, $9.5 million and $5.0 million, respectively.
Effective December 31, 2006, the Company began recognizing the funded status of its pension and postretirement plans in accordance with SFAS 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans - an amendment of SFAS 87, 88, 106, and 132(R).” SFAS 158 requires company plan sponsors to display the net funded position of a defined benefit postretirement plan as an asset or liability, with any unrecognized prior service costs, transition obligations or actuarial gains or losses reported as a component of accumulated other comprehensive income in stockholders’ equity in the year in which the change occurs. SFAS 158 also requires employers to measure plan assets and liabilities as of the date of their financial statements. Accordingly, the measurement date for two of the Company’s benefit plans has been changed from October 1 to December 31. The Company has elected to apply the “fifteen-month” approach for these two benefit plans, to measure plan assets and liabilities from the plans’ previous measurement date, October 1, 2007, for a fifteen-month period through December 31, 2008. On January 1, 2008, the Company recorded a transition adjustment of $1.2 million, net of tax, decreasing retained earnings, and $0.1 million, net of tax, increasing accumulated other comprehensive income, related to the change in the measurement date for the two benefit plans. SFAS 158 does not require retrospective application.
On January 1, 2007, the Company adopted SFAS 155, “Accounting for Certain Hybrid Financial Instruments - an amendment of SFAS 133 and 140.” SFAS 155 applies to certain “hybrid financial instruments,” which are instruments that contain embedded derivatives. The standard established a requirement to evaluate beneficial interests in securitized financial assets to determine if the interests represent freestanding derivatives, or are hybrid financial instruments containing embedded derivatives requiring bifurcation. SFAS 155 permits an election for fair value measurement of any hybrid financial instrument containing an embedded derivative that otherwise would have required bifurcation under SFAS 133, including financial instruments previously recorded by the Company under SFAS 133. As a result of the adoption of SFAS 155, the Company no longer bifurcates the embedded derivatives included in certain fixed income securities, and, beginning on January 1, 2007, changes in the fair value of the hybrid financial instruments, which have been categorized as trading securities, are recorded as realized investment gains and losses in the Company’s consolidated statements of operations. Prior to the adoption of SFAS 155, changes in the fair value of the host instrument were recorded as unrealized investment gains and losses, a component of shareholders’ equity, while changes in the fair value of the embedded derivative were recorded as realized investment gains and
On January 1, 2007, the Company adopted FASB Interpretation 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109.” The interpretation clarifies the accounting for uncertainty in income taxes recognized in a company’s financial statements in accordance with SFAS 109, “Accounting for Income Taxes.” Specifically, the pronouncement prescribes a recognition threshold and a measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The interpretation also provides guidance on the classification, interest and penalties, accounting for interim periods, disclosure and transition of uncertain tax positions. The adoption of FIN 48 did not have a material impact on the Company’s results of operations or financial position.
In September 2006, the FASB issued SFAS 157, “Fair Value Measurements,” to define existing fair value measurements, create a framework for measuring fair value, and expand disclosures about fair value measurements. In February 2008, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position FAS 157-2 (“FSP FAS 157-2”), “Effective Date of FASB Statement No. 157,” which permits a one-year deferral of the application of SFAS 157 for all non-financial assets and non-financial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually).
Effective January 1, 2008, the Company adopted SFAS 157 and FSP FAS 157-2. Accordingly, the provisions of SFAS 157 were not applied to non-financial assets (goodwill and intangible assets) held by the Company and measured annually for impairment testing purposes only. The adoption of SFAS 157, for all other assets and liabilities held by the Company did not have a material effect on the Company’s results of operations, financial position or liquidity. The Company will adopt SFAS 157 for non-financial assets and non-financial liabilities on January 1, 2009 and does not expect the provisions to have a material effect on its results of operations, financial position or liquidity.
due to the investment nature of the transactions. For comparative purposes, prior period cash flows have been reclassified to conform with the current year’s presentation.
In May 2008, the FASB issued SFAS 162, “The Hierarchy of Generally Accepted Accounting Principles,” which provides the framework necessary to determine the proper application of accounting principles in preparing financial statements in conformity with GAAP. SFAS 162 is effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board (“PCAOB”) amendments to AU Section 411, “The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles.” The amendments to AU Section 411 are still in deliberations. The adoption of SFAS 162 will not have a material impact on the Company’s consolidated financial statements.
In June 2008, the FASB issued FSP Emerging Issues Task Force 03-6-1 (“FSP EITF 03-6-1”), “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities.” FSP EITF 03-6-1 addresses whether instruments granted in share-based payment transactions are participating securities prior to vesting and therefore need to be included in the earnings allocation in calculating earnings per share under the two-class method
On August 29, 2008, Hudson purchased certain assets and liabilities associated with the crop insurance business previously produced by CropUSA Insurance Agency, Inc. (“CropUSA”) for cash consideration of $8.0 million. Since 2006, CropUSA had acted as managing general underwriter for Hudson in the crop insurance sector. The acquisition resulted in an increase of $34.1 million in assets (including $7.7 million in goodwill and $5.5 million in intangible assets, which will be amortized over the expected lives of such assets) and $26.1 million in liabilities. As of December 31, 2008, the unamortized balance of the intangible assets was $5.0 million.
In calculating diluted earnings per share, the Company is required to evaluate each stock option and restricted stock grant to determine if it is dilutive or anti-dilutive in nature. For the years ended December 31, 2008, 2007 and 2006, respectively, 110,537, 31,926, and 140,153 existing stock options and restricted stock awards outstanding were excluded from the computation of weighted average common shares for diluted earnings per common share, due to the anti-dilutive effect.
On May 1, 2007, the remainder of the Convertible Notes then outstanding were fully converted and 1.1 million shares of the Company’s common stock were issued related to the conversion (see Note 13) and weighted for inclusion in the calculation of basic earnings per share. As the Convertible Notes were outstanding for a portion of the year ended December 31, 2007, the effect of the conversion of the Convertible Notes has been included in the diluted weighted average common shares outstanding used in the calculation of diluted earnings per share.
Level 1: Level 1 financial instruments are financial assets and liabilities, the values of which are based on unadjusted quoted prices for identical assets or liabilities in an active market that the Company has the ability to access.
The Company’s Level 2 investments, (approximately 51.4% of total invested assets and cash), the majority of which are in government, corporate and municipal fixed income securities, are priced using publicly traded over-the-counter prices and broker-dealer quotes. Observable inputs such as benchmark yields, reported trades, broker-dealer quotes, issuer spreads and bids are available for these investments. For determining the fair value of credit default swaps, which are classified as Level 2, the Company utilizes broker-dealer quotes that include observable credit spreads. Also included in Level 2 are inactively traded convertible corporate debentures that are valued using a pricing model that includes observable inputs such as credit spreads and discount rates in the calculation.
The Company uses valuation techniques for its Level 3 investments, which represent approximately 0.9% of the Company’s total invested assets and cash. To verify Level 3 pricing, the Company assesses the reasonableness of the fair values by comparison to economic pricing models, by reference to movements in credit spreads and by comparing the fair values to recent transaction prices for similar assets where available. The Company further evaluates any prices for its investments to ensure they represent fair value. During the year ended December 31, 2008, the Company purchased $72.7 million of investments that are classified as Level 3. These Level 3 investments are valued using a discounted cash flow model, including unobservable inputs that are supported by limited market-based activity. The Company has determined that its investments in Level 3 securities are not material to its operations.
A review of fair value hierarchy classifications is conducted on a quarterly basis. Changes in the observability of valuation inputs may result in a reclassification for certain financial assets or liabilities. Reclassifications impacting Level 3 of the fair value hierarchy are reported as transfers in or out of the Level 3 category as of the beginning of the period in which the reclassifications occur. After considering the current economic conditions and the liquidity concerns in the credit markets, the Company has determined that it should not re-classify any of its investments from Level 1 or Level 2 to Level 3.
The following table presents the fair value hierarchy for those assets measured at fair value on a recurring basis as of December 31, 2008 (in thousands):
As of December 31, 2008, the Company did not hold any liabilities at fair value.
The following tables provide a summary of changes in the fair value of Level 3 financial assets for the year ended December 31, 2008 (in thousands):
The following table presents gains and losses included in net income for the year ended December 31, 2008 (in thousands):
The Company elected the FVO under SFAS 159 for its investment in Advent Capital (Holdings) PLC (“Advent”). Advent is publicly traded on a foreign stock exchange and its traded price is a better indicator of its value than its carrying value under the equity method. As of December 31, 2008, Fairfax owned 66.6% of the common stock of Advent, including 14.4% of Advent owned by the Company.
During the fourth quarter of 2007, the Company recognized an impairment adjustment to its investment in Advent and wrote-down Advent’s value to its publicly traded fair value as of December 31, 2007. Accordingly, the Company’s election of the FVO under SFAS 159 had no effect on Advent’s carrying value or the Company’s shareholders’ equity as of January 1, 2008. Upon the election of SFAS 159 for Advent, the Company recorded a cumulative adjustment of $2.4 million, or $1.5 million net of tax, to reclassify foreign currency unrealized gains from the foreign currency translation account (included in accumulated other comprehensive income) to retained earnings as of January 1, 2008.
Common stocks accounted for under the equity method of accounting were carried at $141.5 million as of December 31, 2008, reflecting gross unrealized appreciation of $26.6 million and gross unrealized depreciation of $2.1 million. Other invested assets were carried at $222.8 million as of December 31, 2008, reflecting no gross unrealized appreciation or depreciation. Fixed income securities held as trading securities were carried at fair value of $338.2 million as of December 31, 2008, with changes in fair value reflected as realized gains or losses in the consolidated statements of operations. Fixed income securities held as trading securities include corporate, foreign government and mortgage-backed securities, at fair value of $187.7 million, $84.1 million and $66.4 million, respectively, as of December 31, 2008.
A summary of the Company’s investment portfolio as of December 31, 2007, excluding common stocks at equity, other invested assets and fixed income securities held as trading securities, is as follows (in thousands):
The fair values of fixed income securities and common stocks are based on the quoted market prices of the investments as of the close of business on December 31 of the respective years.
The following table sets forth the components of net investment income for the years ended December 31, 2008, 2007, and 2006 (in thousands):
The following table sets forth the components of net realized investment gains and losses for the years ended December 31, 2008, 2007 and 2006 (in thousands):
Included in net realized investment gains for the years ended December 31, 2008, 2007 and 2006 are $358.7 million, $54.5 million and $28.1 million, respectively, related to realized investment losses on the other-than-temporary impairment of investments, as follows (in thousands):
The following table sets forth the changes in unrealized net appreciation (depreciation) of investments, and the related tax effect, reflected in accumulated other comprehensive income for the years ended December 31, 2008, 2007 and 2006 (in thousands):
In assessing the value of the Company’s debt and equity securities held as investments, and possible impairments of such securities, the Company reviews (i) the issuer’s current financial position and disclosures related thereto, (ii) general and specific market and industry developments, (iii) the timely payment by the issuer of its principal, interest and other obligations, (iv) the outlook and expected financial performance of the issuer, (v) current and historical valuation parameters for the issuer and similar companies, (vi) relevant forecasts, analyses and recommendations by research analysts, rating agencies and investment advisors, and (vii) other information the
Company may consider relevant. Generally, a change in the market or interest rate environment would not, of itself, result in an impairment of an investment. In addition, the Company considers its ability and intent to hold the security to recovery when evaluating possible impairments.
The following tables reflect the fair value and gross unrealized depreciation of the Company’s fixed income securities, preferred stocks and common stocks, at fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized depreciation position, as of December 31, 2008 and December 31, 2007 (in thousands):
The Company believes the gross unrealized depreciation is temporary in nature and has not recorded a realized investment loss in its consolidated statements of operations related to these securities. Given the size of its investment portfolio and capital position, the Company has the ability and intent to hold its fixed income securities until the fair value recovers to its original cost.
For common stocks, at equity, as of December 31, 2008, the relative ownership held by the Company is: Fairfax Asia Limited (100% owned by Fairfax, which includes a 26.2% economic interest owned by the Company) and TRG Holding Corporation (100% owned by Fairfax, which includes 13.0% owned by the Company). Common stocks, at equity, and certain other invested assets, are recorded under the equity method of accounting based on the
On March 28, 2008, the Company sold its 7.4% investment in MFXchange Holdings Inc. to Fairfax, resulting in a realized investment loss of $2.0 million.
During 2006, the Company redeemed its interest in HWIC Asia, an investment vehicle that primarily invests in public foreign equities, resulting in a pre-tax realized gain of $75.1 million. In accordance with the equity method of accounting, interest and dividend income, and realized gains and losses of HWIC Asia are included in net investment income.
The following table is a summary of HWIC Asia’s financial information, and the Company’s proportionate share of HWIC Asia as of August 16, 2006, the date of the Company’s redemption of HWIC Asia, for the period January 1, 2006 through August 16, 2006 (in thousands):
The Company has utilized, and may continue to utilize, credit default swaps, call options and warrants, total return swaps, interest rate options, forward currency contracts and short sales to manage against adverse changes in the values of assets and liabilities. These products are not linked to specific assets and liabilities on the consolidated balance sheets or to a forecasted transaction and, therefore, do not qualify for hedge accounting. The following table sets forth the Company’s derivative and short sale positions, which are included in other invested assets or other liabilities in the consolidated balance sheets as of December 31, 2008 and 2007 (in thousands):
In recent years, the Company has purchased credit default swaps, referenced to various issuers in the banking, mortgage and insurance sectors of the financial services industry in the U.S. and worldwide, that provide a hedge against adverse movements in the fair value of investments and other corporate assets resulting from systemic financial and credit risk. Under a credit default swap, as the buyer, the Company agrees to pay, at specified periods, fixed premium amounts based on an agreed notional principal amount in exchange for the credit default protection on a specified asset. Credit default swaps are recorded at fair value in other invested assets, with the related changes in fair value recognized as realized investment gains or losses in the period in which they occur. The credit default swap portfolio had an average term to expiration of 2.5 years as of December 31, 2008. The Company obtains market-derived fair values for its credit default swaps from third-party providers, principally broker-dealers. The Company assesses the reasonableness of the fair values obtained from these providers by comparison to models validated by qualified personnel, by reference to movements in credit spreads and by comparing the fair values to recent transaction prices for similar credit default swaps where available. The fair values of credit default swaps are subject to significant volatility given potential differences in the perceived risk of default of the underlying issuers, movements in credit spreads and the length of time to the contracts’ maturities. The fair value of the credit default swaps may vary dramatically either up or down in short periods, and their ultimate value may therefore only be known upon their disposition. As a result of the appreciation in the fair value of the credit default swaps, counterparties to these transactions are required to place government securities as collateral, pursuant to the swap agreements. The fair value of this collateral as of December 31, 2008 was $65.7 million, of which the Company does not have the right to sell or repledge $19.1 million. The Company has not exercised the right to sell or repledge the remaining $46.6 million of this collateral.
During the third quarter of 2008, the Company entered into Eurodollar futures contracts to manage its interest rate risk with respect to certain investments. A futures contract is a variation of a forward contract, with some additional features, such as a clearinghouse guarantee against credit losses, a daily settlement of gains and losses, and trading on an organized electronic or floor trading facility. Futures contracts are entered either long or short. The Company has entered into the long position, which agrees to buy the underlying currency at the future date at the price agreed upon. As of December 31, 2008, futures contracts are recorded at fair value in other liabilities, with the
The Company has entered into forward currency contracts to manage its foreign currency exchange rate risk on a macro basis. Under a forward currency contract, the Company and the counterparty are obligated to purchase or sell an underlying currency at a specified price and time. Forward currency contracts are recorded at fair value in other invested assets as of December 31, 2008 and other liabilities as of December 31, 2007, depending upon their position as of each balance sheet date, with the related changes in fair value recognized as realized investment gains or losses in the period in which they occur.
The Company holds options on certain securities within its fixed income portfolio, which allows the Company to extend the maturity date of fixed income securities or convert fixed income securities to equity securities. As a result of the adoption of SFAS 155 on January 1, 2007, the Company no longer bifurcates these options from the host fixed income securities, and, beginning on January 1, 2007, changes in the fair value of the hybrid financial instruments are recorded as realized investment gains and losses in the Company’s consolidated statements of operations. Prior to the adoption of SFAS 155, changes in the fair value of the host instrument were recorded as unrealized investment gains and losses, a component of shareholders’ equity, while changes in the fair value of the embedded options were recorded as realized investment gains and losses. Upon adopting SFAS 155, the Company recorded a cumulative adjustment of $16.5 million to reclassify unrealized investment gains, net of tax, including foreign currency effects, to retained earnings as of January 1, 2007. The following sets forth the components of the cumulative adjustment as of January 1, 2007 (in thousands):
The Company is required to maintain assets on deposit with various regulatory authorities to support its insurance and reinsurance operations. These requirements are generally promulgated in the statutes and regulations of the individual jurisdictions. The assets on deposit are available to settle insurance and reinsurance liabilities. The Company utilizes trust funds in certain transactions where the trust funds are set up for the benefit of the ceding companies and generally take the place of letter of credit requirements. As of December 31, 2008, restricted assets totaled $897.2 million, with $804.3 million included in fixed income securities and the remaining balance of $92.9 million included in short-term investments, cash and cash equivalents. Of the $897.2 million of assets on deposit, $490.6 million was held for foreign regulatory requirements, which included $437.8 million in fixed income securities and the remaining balance of $52.8 million held in short-term investments, cash and cash equivalents.
Losses and loss adjustment expenses incurred related to the current year, as reflected in the table above, were $1,518.8 million, $1,367.9 million and $1,344.3 million for the years ended December 31, 2008, 2007 and 2006, respectively. The increase in losses and loss adjustment expenses incurred for the year ended December 31, 2008 was primarily attributable to increased catastrophe losses. The increase in losses and loss adjustment expenses incurred for the year ended December 31, 2007 was primarily attributable to increased catastrophe losses, partially offset by reduced loss exposure associated with a decline in earned premium. For the years ended December 31, 2008, 2007 and 2006, current year catastrophe events were $264.7 million, $105.9 million and $34.9 million,
Net losses and loss adjustment expenses incurred related to prior years decreased $10.1 million for the year ended December 31, 2008, and increased $40.5 million and $139.9 million for the years ended December 31, 2007 and 2006, respectively. The decrease in prior period losses and loss adjustment expenses for the year ended December 31, 2008 was attributable to decreased loss estimates due to loss emergence lower than expectations in the period in the London Market and U.S. Insurance divisions, partially offset by increased loss estimates due to loss emergence greater than expectations in the period in the Americas division. The increase in prior period losses and loss adjustment expenses for the year ended December 31, 2007 was attributable to increased loss estimates due to loss emergence greater than expectations in the period in the Americas division and included $21.2 million related to settlement of litigation. This increase was partially offset by decreased loss estimates due to loss emergence lower than expectations in the period in the London Market, EuroAsia, and U.S. Insurance divisions. The increase in prior period losses and loss adjustment expenses for the year ended December 31, 2006 was attributable to increased loss estimates due to loss emergence greater than expectations in the period in the Americas division. This increase was partially offset by decreased loss estimates due to loss emergence lower than expectations in the period in the London Market, EuroAsia, and U.S. Insurance divisions.
Ceded unpaid losses and loss adjustment expenses were $690.2 million, $643.5 million and $739.0 million as of December 31, 2008, 2007 and 2006, respectively. The increase in ceded unpaid losses and loss adjustment expenses for the year ended December 31, 2008 was attributable to a $62.9 million increase in unpaid reinsurance recoverables related to current year property catastrophe events, principally Hurricane Ike. The decrease reflected in ceded unpaid losses and loss adjustment expenses for the year ended December 31, 2007 was principally attributable to a $49.3 million decrease in unpaid reinsurance recoverables related to the Company’s whole account aggregate excess of loss retrocessional agreements and a $27.5 million decrease in unpaid reinsurance recoverables related to miscellaneous excess of loss retrocessional agreements.
The Company has exposure to losses from asbestos, environmental pollution and other latent injury damage claims. Net unpaid asbestos and environmental losses and loss adjustment expenses as of December 31, 2008 were $260.3 million, representing 5.7% of total net unpaid losses and loss adjustment expenses. Exposure arises from reinsurance contracts written by Clearwater prior to 1986 under which the Company has assumed liabilities, on an indemnity or assumption basis, from ceding companies, primarily in connection with general liability insurance policies issued by such ceding companies. The Company’s estimate of its ultimate liability for such exposures
In addition, other issues have emerged regarding asbestos exposure that has further impacted the ability to estimate ultimate liabilities for this exposure. These issues include an increasingly aggressive plaintiffs’ bar, an increased involvement of defendants with peripheral exposure, the use of bankruptcy filings due to asbestos liabilities as an attempt to resolve these liabilities to the disadvantage of insurers, the concentration of litigation in venues favorable to plaintiffs, and the potential of asbestos litigation reform at the state or federal level.
The Company’s reserves for asbestos and environmental related liabilities displayed below are from business written prior to 1986. The Company’s asbestos and environmental reserve development, gross and net of reinsurance, for the years ended December 31, 2008, 2007 and 2006, is set forth in the table below (in thousands):
The Company utilizes reinsurance and retrocessional agreements to reduce and spread the risk of loss on its insurance and reinsurance business and to limit exposure to multiple claims arising from a single occurrence. The Company is subject to accumulation risk with respect to catastrophic events involving multiple treaties, facultative certificates and insurance policies. To protect against these risks, the Company purchases catastrophe excess of loss protection. The retention, the level of capacity purchased, the geographical scope of the coverage and the costs vary from year to year. In 2008, the Company purchased catastrophe excess of loss protection for certain non-U.S. exposures as well as various additional specific protections for its facultative property account in Latin America. Additionally, the Company purchases specific protections related to the business underwritten by its U.S. Insurance division.
There is a credit risk with respect to reinsurance, which would result in the Company recording a change to earnings in the event that such reinsuring companies are unable, at some later date, to meet their obligations under the reinsurance agreements in force. Reinsurance recoverables are recorded as assets and a reserve for uncollectible reinsurance recoverables is established, based on the Company’s evaluation of each reinsurer’s or retrocessionaire’s ability to meet its obligations under the agreements. Premiums written and earned are stated net of reinsurance ceded in the consolidated statements of operations. Direct, reinsurance assumed, reinsurance ceded and net amounts for the years ended December 31, 2008, 2007 and 2006 follow (in thousands):
The total amount of reinsurance recoverable on paid and unpaid losses as of December 31, 2008 and 2007 was $773.2 million and $726.6 million, respectively. The reserve for uncollectible recoverables as of December 31, 2008 and 2007 was $44.5 million and $44.4 million, respectively, and has been netted against reinsurance recoverables on loss payments in the consolidated balance sheets. The Company has also established a reserve for potentially uncollectible assumed reinsurance balances of $3.0 million and $1.5 million as of December 31, 2008 and 2007, respectively, which has been netted against premiums receivable.
The Whole Account Excess of Loss Agreements provide that the Company may withhold a significant portion of the premium payable to the retrocessionaires in funds held accounts, which, under certain circumstances, may be set-off against the retrocessionaires’ losses and other obligations owed to the Company. These funds are shown as a liability in the Company’s consolidated balance sheets as funds held under reinsurance contracts. Interest on the funds held account, calculated using a contractual fixed interest rate of approximately 7.0% for those agreements with amounts ceded, is credited quarterly by the Company, which results in an increase in the funds held account balance and is recorded as an expense, reducing the Company’s investment income. Loss payments are deducted from the funds held account balance, which reduces the liability as such payments are made.
During the second quarter of 2006, the Company commuted certain Whole Account Excess of Loss Agreements for total consideration of $80.6 million through the settlement of funds held under reinsurance contracts and the receipt of cash from the reinsurer, net of the settlement of outstanding commissions receivable. This commutation covered all outstanding Whole Account Excess of Loss Agreements applicable to underwriting and accident years 1999 and prior, as well as the reinsurer’s participation on underwriting years 2000 and 2001.
In addition to the Whole Account Excess of Loss Agreements, the Company entered into a three-year aggregate excess of loss reinsurance contract protecting its United States facultative casualty business for underwriting years 1998 through 2000 (“Facultative Excess of Loss Agreement”), which indemnified the Company for losses in excess of an annual retention, subject to an annual limit of liability. During December 2006, the Company entered into a commutation and release agreement related to this contract, pursuant to which all rights, obligations and liabilities were fully and finally settled. As a result of the commutation, a pre-tax loss of $1.4 million
was recognized. Additionally, reinsurance recoverables were reduced by $16.1 million for the year ended December 31, 2006.
The income before income taxes reflected in the Company’s statements of operations related to the Company’s Whole Account Excess of Loss Agreements and Facultative Excess of Loss Agreement, including the effect of commutations, for the years ended December 31, 2008, 2007 and 2006 is as follows (in thousands):
The Company’s ten largest reinsurers represent 45.8% of its total reinsurance recoverables as of December 31, 2008. Amounts due from all other reinsurers are diversified, with no other individual reinsurer representing more than $21.6 million, or 2.8%, of reinsurance recoverables as of December 31, 2008, and the average balance is less than $3.0 million. The Company held total collateral of $225.7 million as of December 31, 2008, representing 29.2% of total reinsurance recoverables. The following table shows the total amount that is recoverable from each of the Company’s ten largest reinsurers for paid and unpaid losses as of December 31, 2008, the amount of collateral held, and each reinsurer’s A.M. Best rating (in thousands):
On February 22, 2006, the Company issued $100.0 million aggregate principal amount of floating rate senior debentures, pursuant to a private placement. The net proceeds from the offering, after fees and expenses, were $99.3 million. The debentures were sold in two tranches, $50.0 million of series A, due March 15, 2021 (the
“Series A Notes”) and $50.0 million of series B, due March 15, 2016 (the “Series B Notes”). Interest on each series of debentures is due quarterly in arrears on March 15, June 15, September 15 and December 15 of each year. The interest rate on each series of debentures is equal to the three-month LIBOR, reset quarterly, plus 2.20%. The Series A Notes are callable by the Company in 2011 at their par value, plus accrued and unpaid interest, and the Series B Notes are callable by the Company in 2009 at their par value, plus accrued and unpaid interest. For the year ended December 31, 2008, the average annual interest rate on each series of notes was 5.41%, compared to an average annual interest rate of 7.62% for the year ended December 31, 2007. In December 2008, the Company entered into interest rate swaps, with an aggregate notional value of $140.0 million, to protect it from adverse movements in interest rates. Under these swap contracts, the Company receives a floating interest rate of three-month LIBOR and pays a fixed interest rate of 2.49% on the $140.0 million notional value of the contracts, for a five-year period ending in December 2013.
During the fourth quarter of 2003, the Company issued $225.0 million aggregate principal amount of senior notes due November 1, 2013. The issue was sold at a discount of $0.4 million, which is being amortized over the life of the notes. Interest accrues on the senior notes at a fixed rate of 7.65% per annum, which is due semi-annually on May 1 and November 1.
As of December 31, 2008, the aggregate maturities of the Company’s debt obligations, at face value, are as follows (in thousands):
As of December 31, 2008, there was $56.5 million outstanding under the Credit Agreement, all of which was in support of letters of credit. Loans under the Credit Agreement bear interest at a fluctuating rate per annum equal to the higher of (a) the federal funds rate plus 0.5%, and (b) Wachovia’s publicly announced prime rate. Alternatively, at the Company’s option, loans bear interest at the LIBOR, which is the offered rate that appears on the page of the Telerate screen that displays an average British Bankers Association Interest Settlement Rate for deposits in dollars, plus 0.55%, which additional percentage may be adjusted if the Company’s debt rating changes.
On June 15, 2007, the Company’s Board of Directors authorized a share repurchase program. Under the initial authorization, effective as of such date, the Company was authorized to repurchase shares of its common stock on the open market from time to time through June 15, 2009, up to an aggregate purchase price of $200.0 million. On March 18, 2008, the Company announced that its Board of Directors had increased the share repurchase program authorization by an additional $200.0 million, to a total repurchase authorization of $400.0 million. On September 3, 2008, the Company announced that its Board of Directors had increased the program by an additional $200.0 million, to a total repurchase authorization of $600.0 million, and extended the termination date of the repurchase program to December 31, 2009. Shares repurchased under the program are retired. Depending on market conditions and other factors, these repurchases may be commenced or suspended at any time, or from time to time, without prior notice. For the year ended December 31, 2008, the Company repurchased and retired 9,480,756 shares of its common stock, at a cost of $351.4 million, an average repurchase price of $37.06 per share.
From inception of the program through December 31, 2008, the Company has repurchased and retired 12,117,745 shares of its common stock at a total cost of $445.8 million.
On October 20, 2005, the Company completed the sale of $100.0 million of non-cumulative perpetual preferred shares. The Company sold 2.0 million shares of 8.125% Series A perpetual preferred stock and 2.0 million shares of floating rate Series B perpetual preferred stock, for total net proceeds of $97.5 million. The Series A preferred shares have a liquidation preference of $25.00 per share and are redeemable at $25.00 per share at the Company’s option, in whole, or in part from time to time, starting on or after October 20, 2010. Dividends on the Series B preferred shares are payable at an annual rate equal to 3.25% above the three-month LIBOR on the applicable determination date. During the year ended December 31, 2008, Odyssey America purchased 128,000 shares of the Company’s Series B preferred shares, with a liquidation preference of $3.1 million, for $1.7 million. As a result of the purchase of the Series B preferred shares, the Company recorded a gain of $1.4 million during the year ended December 31, 2008, which was reflected in the Company’s retained earnings and included in net income available to common shareholders. As of December 31, 2008, 1,872,000 shares of the Company’s Series B preferred stock were outstanding.
As of December 31, 2008, a subsidiary of Fairfax owned 253,599 shares and 70,000 shares of the Company’s Series A and Series B preferred stock, respectively.
The following table shows our gross premiums written, by distribution source, for the year ended December 31, 2008 (in millions):
The increase in the Company’s net deferred tax assets as of December 31, 2008 as compared to December 31, 2007 is primarily attributable to deferred tax liabilities on unrealized gains in 2007 that were realized for tax purposes in 2008, and 2008 impairment losses on equity losses that are deferred for tax purposes until they are sold.
The following table reconciles federal and foreign income taxes at the statutory federal income tax rate to the Company’s tax provision (benefit) for the years ended December 31, 2008, 2007 and 2006 (in thousands):
The Company files income tax returns with various federal, state, and foreign jurisdictions. The Company’s U.S. federal income tax returns for 2005 through 2007 remain open for examination. The Internal Revenue Service completed their audit of the Company’s 2003 and 2004 tax returns and commenced their audit of the Company’s 2005 and 2006 tax returns during 2008. There have been no material adjustments proposed under the current audit cycle. Income tax returns filed with various state and foreign jurisdictions remain open to examination in accordance with individual statutes.
In July 2006, Fairfax filed a lawsuit in the Superior Court, Morris County, New Jersey, seeking damages from a number of defendants who, the complaint alleges, participated in a stock market manipulation scheme involving Fairfax shares. In January 2008, two of these defendants filed a counterclaim against Fairfax and a third party complaint against, among others, OdysseyRe and certain of its directors. Those counterclaims and third-party claims were voluntarily withdrawn in March 2008. In September 2008, the same two defendants filed an amended counterclaim and third-party complaint that again named OdysseyRe and certain directors as defendants. The complaint alleges, among other things, claims of racketeering, intentional infliction of emotional distress, tortious interference with economic advantage and other torts, and seeks unspecified compensatory and punitive damages and other relief. OdysseyRe denies the allegations and intends to vigorously defend against these claims. OdysseyRe has not yet responded to the complaint, and the timing of that response has not been set. At this early stage of the proceedings, it is not possible to make any determination regarding the likely outcome of this matter.
The Company participates in Lloyd’s through its 100% ownership of Newline, through which the Company provides 100% of the capacity for Newline Syndicate 1218 (“Syndicate 1218”). The results of Syndicate 1218 are consolidated in the financial statements of the Company. In support of Syndicate 1218’s capacity at Lloyd’s, Odyssey America has pledged municipal bonds and cash, with a fair value of $214.7 million as of December 31, 2008, in a deposit trust account in favor of the Society and Council of Lloyd’s. These securities may be substituted with other securities at the discretion of the Company, subject to approval by Lloyd’s. The securities are carried at fair value and are included in investments and cash in the Company’s consolidated balance sheets. Interest earned on the securities is included in investment income. The pledge of assets in support of Syndicate 1218 provides the Company with the ability to participate in writing business through Lloyd’s, which remains an important part of the Company’s business. The pledged assets effectively secure the contingent obligations of Syndicate 1218 should it not meet its obligations. Odyssey America’s contingent liability to the Society and Council of Lloyd’s is limited to the aggregate amount of the pledged assets. The Company has the ability to remove funds at Lloyd’s annually, subject to certain minimum amounts required to support its outstanding liabilities as determined under risk-based capital models and approved by Lloyd’s. The funds used to support outstanding liabilities are adjusted annually and the obligations of the Company to support these liabilities will continue until they are settled or the liabilities are reinsured by a third party approved by Lloyd’s. The Company expects to continue to actively operate Syndicate 1218 and support its requirements at Lloyd’s. The Company believes that Syndicate 1218 maintains sufficient liquidity and financial resources to support its ultimate liabilities and the Company does not anticipate that the pledged assets will be utilized.
Clearwater agreed to allow Ranger Insurance Company, a subsidiary of Fairfax that is now known as Fairmont Specialty Insurance Company (“Fairmont”), to attach an assumption of liability endorsement of Clearwater to certain Fairmont policies issued from July 1, 1999 to April 30, 2004, the effective termination date of the agreement. Should Fairmont fail to meet its obligations, Clearwater is ultimately liable for any unpaid losses, pursuant to the terms of the endorsements. This arrangement enabled Fairmont to provide additional security to its customers as a result of Clearwater’s financial strength ratings and capital resources. The agreement to provide the endorsements was provided by Clearwater while each company was 100% owned by Fairfax. The potential exposure in connection with these endorsements is currently estimated at $0.6 million, based on the subject policies’ outstanding case loss reserves as of December 31, 2008. Fairmont has met and continues to meet all of its obligations, including those subject to this agreement, in the normal course of business, and Clearwater does not anticipate making any payments under this guarantee. The Company believes that the financial resources of Fairmont provide adequate protection to support its liabilities in the ordinary course of business. In addition, Fairfax has indemnified Clearwater for any obligations under this guarantee. The Company does not consider its potential exposure under this guarantee to be material to its consolidated financial position.
order to further expand the Company’s international reinsurance business. The guarantee was terminated effective December 31, 2001. There were no amounts received from CTR under the guarantee, and the Company did not provide any direct consideration for the renewal rights to the business of CTR. CTR was dissolved and its assets and liabilities were assumed by subsidiaries of Fairfax that have the responsibility for the run-off of its liabilities. Although CTR’s liabilities were assumed by Fairfax subsidiaries, the guarantee only pertains to those liabilities attaching to the policies written by CTR. Fairfax has agreed to indemnify Odyssey America for all its obligations incurred under its guarantee. The Company believes that the financial resources of the Fairfax subsidiaries that have assumed CTR’s liabilities provide adequate protection to satisfy the obligations that are subject to this guarantee. The Company does not expect to make payments under this guarantee and does not consider its potential exposure under this guarantee to be material to its consolidated financial position.
The Company organized O.R.E Holdings Limited (“ORE”), a corporation domiciled in Mauritius, on December 30, 2003 to act as a holding company for various investments in India. On January 29, 2004, ORE was capitalized by the Company in the amount of $16.7 million. ORE is consolidated in the Company’s consolidated financial statements. During 2004, ORE entered into a joint venture agreement relating to the purchase by ORE of 45% of the shares of Cheran Enterprises Private Limited (“CEPL”). CEPL is a corporation domiciled in India, engaged in the purchase, development and sale of commercial real estate properties. The joint venture agreement governing CEPL contains a provision whereby Odyssey America could have been called upon to provide a guarantee of a credit facility, if such a facility had been established by CEPL, in an amount up to $65.0 million for the funding of proposed developments. The credit facility was never established, and the requisite conditions for any future provision of the guarantee no longer exist. ORE’s Indian joint venture partner claimed that the guarantee should be available and pursued legal actions against the Company. The Company found this claim without merit and vigorously defended the legal actions. On August 13, 2008, the Company Law Board in Chennai, India ruled in ORE’s favor and directed CEPL to return to ORE the full amount of its investment in CEPL, plus 8% interest, within the one-year period commencing November 1, 2008. As of December 31, 2008, the Company had written down the value of its investment in ORE by $9.9 million. The carrying value of the Company’s investment in ORE as of both December 31, 2008 and 2007 was $6.7 million. Because no payment of the award has yet been received and collection may require additional legal action on the part of ORE, the Company has taken no steps to reverse the write-downs that have been taken to date. The Company continues to vigorously pursue collection of the award.
Rental expense, before sublease income under these operating leases, was $11.3 million, $8.2 million and $9.8 million for the years ended December 31, 2008, 2007 and 2006, respectively. The Company recovered pre-tax amounts of $0.1 million for each of the years ended December 31, 2008, 2007 and 2006, respectively, from subleases.
Odyssey America paid dividends to the Company of $410.0 million, $155.0 million and $60.0 million during the years ended December 31, 2008, 2007 and 2006, respectively. In addition, effective December 31, 2005, the Company received approval from the Connecticut Insurance Commissioner to make a $200.0 million capital contribution to Odyssey America, to be completed prior to February 28, 2006. In February 2006, the Company completed the $200.0 million capital contribution to Odyssey America.
The following is the consolidated statutory basis net income and policyholders’ surplus of Odyssey America and its subsidiaries, for each of the years ended and as of December 31, 2008, 2007 and 2006 (in thousands):
The Company has entered into various reinsurance arrangements with Fairfax and its affiliates. The approximate amounts included in or deducted from income, expense, assets and liabilities in the accompanying consolidated financial statements, with respect to reinsurance assumed and ceded, as of and for the years ended December 31, 2008, 2007 and 2006 follow (in thousands):
Due to expense sharing and investment management agreements with Fairfax and its affiliates, the Company has accrued, on its consolidated balance sheet, amounts receivable from affiliates of $1.0 million and $1.0 million as of December 31, 2008 and 2007, respectively, and amounts payable to affiliates of $1.6 million and $4.6 million as of December 31, 2008 and 2007, respectively.
In the ordinary course of the Company’s investment activities, the Company makes investments in investment funds, limited partnerships and other investment vehicles in which Fairfax or its affiliates may also be investors.
The following tables set forth the Plan’s funded status and amounts recognized in the Company’s consolidated financial statements as of December 31, 2008 and 2007 (in thousands):
The discount rate represents the Company’s estimate of the interest rate at which the Plan’s benefits could be effectively settled. The discount rates are used in the measurement of the expected and accumulated postretirement benefit obligations and the service and interest cost components of net periodic postretirement benefit cost.
Net periodic benefit cost included in the Company’s consolidated statements of operations for the years ended December 31, 2008, 2007 and 2006 is comprised of the following components (in thousands):
The weighted average assumptions used to calculate the net periodic benefit cost for the years ended December 31, 2008, 2007 and 2006 are as follows:
The Company estimates that it will record a $6.4 million expense related to the net periodic benefit cost during the year ended December 31, 2009. The Company does not expect any refunds of Plan assets during the year ended December 31, 2009.
The Company maintains two non-qualified excess benefit plans (“Excess Plans”) that provide more highly compensated officers and employees with defined retirement benefits in excess of qualified plan limits imposed by federal tax law. The following tables set forth the combined amounts recognized for the Excess Plans in the Company’s consolidated financial statements as of December 31, 2008 and 2007 (in thousands):
Net periodic benefit cost included in the Company’s consolidated statement of operations for the years ended December 31, 2008, 2007 and 2006 is comprised of the following components (in thousands):
The accumulated benefit obligation for the Excess Plans is $11.7 million and $12.1 million as of December 31, 2008 and 2007, respectively.
The Company expects to contribute $1.1 million to the Excess Plans during the year ended December 31, 2009, which represents the amount necessary to fund the 2009 expected benefit payments.
The Company provides certain health care and life insurance (“postretirement”) benefits for retired employees. Substantially all employees may become eligible for these benefits if they reach retirement age while working for the
The discount rate represents the Company’s estimate of the interest rate at which the Postretirement Benefit Plan benefits could be effectively settled. The discount rates are used in the measurement of the expected and accumulated post retirement benefit obligations and the service and interest cost components of net periodic post retirement benefit cost.
The annual assumed rate of increase in the per capita cost of covered benefits (i.e., health care cost trend rate) is assumed to be 9.5% in 2008 and decreasing to 5.0% in 2015 and remaining constant thereafter. The health care cost trend rate assumption has a significant effect on the amounts reported. For example, increasing the assumed health care cost trend rates by one percentage point in each year would increase the accumulated postretirement benefit obligation by $2.1 million (14.9% of the benefit obligation as of December 31, 2008) and the service and interest cost components of net periodic postretirement benefit costs by $0.5 million for 2008. Decreasing the assumed health care cost trend rates by one percentage point in each year would decrease the accumulated postretirement benefit obligation and the service and interest cost components of net periodic postretirement benefit cost for 2008 by $1.7 million and $0.4 million, respectively.
As a result of the adoption of SFAS 158, the Company recognized a $0.5 million, after-tax, reduction in accumulated other comprehensive income related to the postretirement plan as of December 31, 2006, of which, on an after tax basis, $0.8 million related to net losses, while $0.3 million related to prior service credit.
On January 1, 2006, the Company adopted Statement of Financial Accounting Standards 123(R), “Share-Based Payments,” on a prospective basis. SFAS 123(R) requires all share-based payments to employees, including
grants of employee stock options, to be recognized in the consolidated financial statements based on their fair values. Additionally, SFAS 123(R) requires that the deferred stock-based compensation on the consolidated balance sheet on the date of adoption be netted against additional paid-in capital. As of December 31, 2005, there was approximately $1.8 million of deferred stock-based compensation that was netted against additional paid-in capital on January 1, 2006.
In 2002, the Company adopted the 2002 Option Plan, which provides for the grant of non-qualified stock options to officers, key employees and directors who are employed by or provide services to the Company. Options for an aggregate of 1,500,000 of the Company’s common shares may be granted under the 2002 Option Plan. Pursuant to the 2002 Option Plan, 25% of the options granted become exercisable on each anniversary of the grant in each of the four years following the date of grant and all options expire 10 years from the date of grant. Stock options are exercisable at the grant price.
As of December 31, 2008, there was less than $0.1 million of unrecognized compensation cost related to unvested options from the 2002 Option Plan; the remaining cost is expected to be recognized over a remaining weighted-average vesting period of 1.1 years. The total intrinsic value of options exercised during the years ended December 31, 2008, 2007 and 2006 was approximately $4.4 million, $3.0 million and $1.7 million, respectively.
There were no options granted during the years ended December 31, 2008 and 2007. The fair value of options granted during the year ended December 31, 2006, estimated as of the grant date using the Black-Scholes option pricing model, was $9.21 per share. The weighted-average remaining contractual term for options outstanding as of December 31, 2008, 2007 and 2006 was 4.1 years, 4.9 years and 5.9 years, respectively. The weighted-average remaining contractual term for options vested and exercisable as of December 31, 2008 was 4.0 years. As of December 31, 2008, the aggregate intrinsic value was $5.8 million for options outstanding and $5.6 million for options vested and exercisable.
In accordance with SFAS 123(R), the fair value of restricted share awards is estimated on the date of grant based on the market price of the Company’s stock and is amortized to compensation expense on a straight-line basis over the related vesting periods. As of December 31, 2008, there was $16.8 million of unrecognized compensation cost related to unvested restricted share awards, which is expected to be recognized over a remaining weighted-average vesting period of 2.5 years. SFAS 123(R) requires that the deferred stock-based compensation on the consolidated balance sheet on the date of adoption be netted against additional paid-in capital. As of December 31, 2005, there was approximately $1.8 million of deferred stock-based compensation, which was netted against additional paid-in capital on January 1, 2006. The total fair value of the restricted share awards vested during the years ended December 31, 2008, 2007 and 2006 was $6.8 million, $7.4 million and $5.8 million, respectively. As of December 31, 2008, the aggregate fair value of restricted share awards outstanding was $43.2 million.
As of December 31, 2008, financial guaranty reinsurance in force had a remaining maturity term of one (1) to 21 years. The approximate distribution of the estimated debt service (principal and interest) of bonds, by type and unearned premiums, for the years ended December 31, 2008 and 2007 is as follows (in millions):
A summary of selected quarterly financial information follows for each of the quarters in the years ended December 31, 2008 and 2007 (in thousands, except share amounts):