In 2010, casualty lines comprised 71% of TRH's net premiums written, while property lines totaled 29%. In addition, treaty reinsurance totaled 97% of net premiums written, with the balance representing facultative accounts. Business written by international operations represented 50% of net premiums written in 2010. (See Operational Review for year to year comparisons of such measures.)
Revenues decreased in 2010 compared to 2009 due primarily to a decrease in net premiums earned, partially offset by realized net capital gains in 2010 compared to realized net capital losses in 2009. The decrease in net premiums earned occurred principally in the Domestic and International-Europe segments. The lines with the most significant decreases in net premiums earned were the auto liability, property, medical malpractice and ocean marine lines, partially offset by a significant increase in the other liability line. The increase in realized net capital gains (losses) in 2010 is due to a decrease in
other-than-temporary impairments ("OTTI") and an increase in realized net capital gains on sales and redemptions of securities, partially offset by an increase in net foreign currency transaction losses. (See Note 4(e) of Notes to Consolidated Financial Statements ("Note 4(e)") for a breakdown of realized net capital gains (losses).)
Income before income taxes and net income decreased in 2010 compared to 2009 primarily as a result of a decrease in underwriting profit and an increase in interest expense, offset in part by realized net capital gains in 2010 compared to realized net capital losses in 2009. The decrease in underwriting profit was primarily due to an increase in catastrophe costs in 2010, partially offset by an increase in favorable net loss reserve development. The net impact of increased catastrophe costs and increased favorable net loss reserve development was to decrease pre-tax underwriting profit in 2010 by $185.5 million compared to 2009. The increase in interest expense is due to the issuance of $350 million principal amount of TRH's 8.00% senior notes due in 2039 (the "2039 Notes") in November 2009. The decrease in net income between periods was mitigated by reduced tax expense in 2010 primarily related to the lower pre-tax income in 2010.
Income before income taxes and net income increased in 2009 compared to 2008 primarily as a result of a decrease in realized net capital losses and increased underwriting profit. The increase in underwriting profit was primarily due to decreased catastrophe costs and an increase in favorable net loss reserve development in 2009. The increase in net income between periods was reduced by the significant tax expense in 2009 caused by the improved results in 2009. The net impact of decreased catastrophe costs and increased favorable net loss reserve development was to increase pre-tax underwriting profit in 2009 by $216.2 million compared to 2008.
The market conditions in which TRH operates have historically been cyclical, experiencing periods of price erosion followed by rate strengthening as a result of catastrophes or other significant losses or events
Trends in reinsurance rates at the beginning of 2009 were inconsistent, with rates increasing, staying level or deteriorating depending on the line of business or region. However, as 2009 progressed, improvements in general economic conditions, the strengthening of insurers' and reinsurers' balance sheets and the low level of catastrophe losses in 2009 put downward pressure on reinsurance rates. Insurers had greater capacity to retain risk and increased access to capital market alternatives to reinsurance compared to late 2008, while the strengthening of reinsurer balance sheets increased the amount of capacity available in the reinsurance market. Despite weakness in primary rates in several casualty lines and an increase in capacity, reinsurers generally remained disciplined during the January 1, 2010 renewal period. The January 1, 2010 renewals generally saw higher net retentions by cedants and reinsurance rates remaining within acceptable levels while exhibiting greater stability than primary rates.
In the property lines, some catastrophe-exposed regions, particularly peak zones, saw significant rate increases in the first half of 2009, which leveled off in the second half of 2009. Overall this business remained at acceptable rate levels through the January 1, 2010 renewal period, with rates in the U.S. down slightly and rates outside of the U.S. generally flat. The strengthening of insurers' balance sheets also led to higher net retentions by cedants during the January 1, 2010 renewal period.
While the catastrophe events occurring in 2010, which principally affected property lines, resulted in significant losses for the industry, they did not meaningfully impact overall catastrophe reinsurance pricing trends. In addition, some rate softening was evident, with U.S. catastrophe-exposed lines coming under greater pressure than international lines. In the casualty lines, opportunities remained in certain specialty casualty lines such as D&O, which continues to show favorable loss frequency trends, medical malpractice and accident and health ("A&H"), although these lines faced increased pressure as the year progressed. Market conditions for marine and offshore energy lines showed sustained improvement following the Deepwater Horizon explosion, while rate increases leveled off in the aviation line. Primary rates for other casualty lines generally remained under pressure, although internationally they are showing some signs of improvement.
This discussion and analysis of financial condition and results of operations is based on TRH's consolidated financial statements which have been prepared in accordance with generally accepted accounting principles in the United States ("GAAP"). The preparation of these financial statements requires the use of estimates and judgments that affect the reported amounts and related disclosures. TRH relies on historical experience and on various other assumptions that it believes to be reasonable, under the circumstances, to make judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ materially from these estimates.
preparation of TRH's consolidated financial statements and footnotes. The accounting estimates that result require the use of assumptions about certain matters that are highly uncertain at the time of estimation. To the extent actual experience differs from the assumptions used, TRH's results of operations and financial condition would be affected, possibly materially. A discussion of these most critical accounting estimates follows:
Standard actuarial methodologies employed to estimate ultimate losses incorporate the inherent "lag" from the time claims are reported to the cedant to when the cedant reports the claims to the reinsurer. Certain actuarial methodologies may be more appropriate than others in instances where this "lag" may not be consistent from period to period. Consequently, additional actuarial judgment is employed in the selection of methodologies to best incorporate the potential impact of this situation.
During the loss settlement period, which can be many years in duration, additional facts regarding individual claims and trends usually become known. As these facts and trends emerge, it usually becomes necessary to refine and adjust the loss reserves upward or downward and even then the ultimate net liability may be materially different from the revised estimates. There is potential for significant variation in the development of loss reserves when actual costs differ from those costs implied by the use of the assumptions employed in the reserve setting process. This is particularly true for assumed reinsurance of long-tail casualty classes. Among the most critical assumptions are those made for ELRs and loss development factors.
The methodologies that TRH employs to assess the reasonableness of loss reserve estimates include the paid loss development, incurred loss development, paid Bornhuetter-Ferguson ("B-F") and incurred B-F methods. The actuarial methods that TRH employs to determine the appropriate loss reserves for short-tail lines of business are the same as those employed for longer-tail lines. However, the judgments that are made with regard to factors such as loss trends, ELRs and loss development factors for shorter-tail lines generally have much less of an effect on the determination of the loss reserve amount than when those same judgments are made regarding longer-tailed lines of business. In contrast to the longer-tailed lines of business, reported losses for the shorter-tailed classes, such as the property lines of business (e.g., fire and homeowners multiple peril) and certain marine and energy classes, generally reach the ultimate level of incurred losses in a relatively short-period of time. Rather than having to rely on assumptions regarding ELRs and loss development factors for many accident years for a given line, these assumptions are generally only relevant for the most recent accident year or two. Therefore, these assumptions tend to be less critical and the reserves calculated pursuant to these assumptions are subject to less variability for the shorter-tailed lines of business.
•Other Liability: The key components of the other liability line of business are excess casualty, D&O and E&O.
the volatile nature of experience in older years. The ELRs utilized for the most recent years are based on the projected ultimate loss ratios of prior years adjusted for rate level changes, estimated loss cost trends and other quantifiable changes, as well as actuarial pricing indications.
Triangles of written premium, paid losses and incurred losses are organized by underwriting year evaluated at six month intervals. The data triangles are split by branch, contract type (i.e., treaty versus facultative), line of business and often between excess-of-loss and pro rata business. The line of business
There is potential for significant variation in the development of loss reserves when actual costs differ from those costs implied by the assumptions used to test the loss reserves. This is particularly true for assumed reinsurance of long-tail casualty classes. Among the most critical assumptions are those made for ELRs and loss development factors.
TRH's annual loss reserve review for 2010 did not include the calculation of a range of loss reserve estimates. Because management does not believe it can currently assign credible probabilistic values to a range, a better understanding of the volatility of loss reserve estimates can be gained via an analysis of the sensitivity of these estimates to changes in the critical assumptions used in the loss reserve review process as opposed to creating a range during the loss reserve review process.
As of December 31, 2010, of TRH's $11.5 billion of fixed maturities available for sale, equities available for sale and other invested assets measured at fair value on a recurring basis, $11.3 billion was based on prices received from independent pricing services and $0.2 billion was based on non-binding broker quotes or internal valuation sources. Management reviewed fair values from external sources and did not make any material adjustments to fair values.
See Note 3 for discussion of how TRH determines the fair value of its fixed maturities available for sale, equities available for sale and certain short-term investments.
The valuation of Level 3 assets requires the greatest degree of judgment, as these measurements may be made under circumstances in which there is little, if any, market activity for the asset. At December 31, 2010, TRH classified $230.0 million of assets measured at fair value on a recurring basis as Level 3. This represented 2.0% of total assets measured at fair value on a recurring basis. Level 3 fair value measurements are based on valuation techniques that use at least one significant input that is unobservable. TRH's assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment.
•Certain residential mortgage-backed securities ("RMBS") and commercial mortgage-backed securities ("CMBS"): These assets initially are valued at the transaction price. Subsequently, they may be valued by comparison to transactions in instruments with similar collateral and risk profiles, remittances received and updated cumulative loss data on underlying obligations, discounted cash flow techniques and/or option adjusted spread analyses.
Premiums written and earned, along with related costs, for which data has not been reported by the ceding companies, are estimated based on historical patterns and other relevant information. Such estimates of premiums earned are considered when establishing the IBNR portion of loss reserves. The differences between these estimates and the actual data subsequently reported, which may be material as a result of the diversity of cedants and reporting practices and the inherent difficulty in estimating premium inflows, among other factors, are recorded in the period when the actual data become available and may materially affect results of operations. In the Consolidated Statements of Operations, premiums written and earned and the change in unearned premiums are presented net of reinsurance ceded.
TRH's financial statements reflected estimates of gross premiums written, commissions and premium balances receivable, for which data had as yet to be reported by cedants as of December 31, 2010 and 2009, as follows:
Net premiums written decreased in 2010 compared to 2009 due principally to a decrease in the Domestic segment. The decrease in net premiums written reflects increased ceding company retentions and competitive market conditions which led TRH not to renew certain business that did not meet TRH's underwriting standards.
In 2010 and 2009, each as compared to the respective immediately prior year, the changes in net premiums written were primarily from treaty business. In general, premium fluctuations reflect prevailing market conditions and strategic decisions by TRH's management in recent periods as discussed earlier in MD&A.
A breakdown of total net premiums written in 2010, 2009 and 2008 is as follows:
The following table summarizes the net effect of changes in foreign currency exchange rates compared to the U.S. dollar on the percentage change in net premiums written in 2010 and 2009 compared to the respective immediately prior year.
Domestic net premiums written decreased in 2010 by $101.5 million, or 5.0%, from 2009 to $1.95 billion. Significant decreases in Domestic net premiums written were recorded in the A&H ($28.5 million), auto liability ($25.7 million), medical malpractice ($24.3 million) and other liability ($20.2 million) lines.
Domestic net premiums written increased in 2009 by $15.4 million, or 0.8%, from 2008 to $2.05 billion. Significant increases in Domestic net premiums written were recorded in the A&H ($38.1 million) and other liability ($21.5 million) lines. These increases were largely offset by significant decreases in the medical malpractice ($31.9 million) and auto liability ($17.5 million) lines.
International net premiums written decreased in 2009 by $137.4 million, or 6.6%, from 2008 to $1.94 billion. The significant decreases in net premiums written occurred in the London ($103.1 million), Paris ($100.0 million) and Hong Kong ($27.3 million) branches, partially offset by significant increases in TRZ ($46.2 million) and the Toronto branch ($26.9 million). Significant decreases in International net premiums written were recorded in the property ($101.2 million), auto liability ($59.0 million), boiler and machinery ($22.0 million) and ocean marine ($20.7 million) lines. These decreases were partially offset by significant increases in the A&H ($63.9 million) and other liability ($18.8 million) lines. Of the $137.4 million decrease in international net premiums written, $98.5 million was due to changes in foreign currency exchange rates. Excluding the impact of changes in foreign currency exchange rates, International net premiums written would have decreased 1.9% in 2009 compared to 2008.
Generally, reasons for changes in gross premiums written between years are similar to those for net premiums written, except for changes in ceded premiums, including premiums assumed from a subsidiary of AIG that, by prearrangement, were ceded in an equal amount to other subsidiaries of AIG. See Note 16 of Notes to Consolidated Financial Statements ("Note 16"). The majority of the increase in premiums ceded in 2010 compared to 2009 is due to an increase in premiums assumed from a subsidiary of AIG that, by prearrangement with TRH, were then ceded in an equal amount to other subsidiaries of AIG. The majority of the decrease in premiums ceded in 2009 compared to 2008 is due to a decrease in premiums assumed from a subsidiary of AIG that, by prearrangement with TRH, were then ceded in an equal amount to other subsidiaries of AIG. As further discussed in Note 14 of Notes to Consolidated Financial Statements, certain business assumed by TRH from the AIG Group were related party transactions as a result of the AIG Group's ownership interest during those periods. TRH either accepted or rejected business with such companies based on its assessment of risk selection, pricing, terms and conditions, among other factors.
Financial Statements for a breakdown of the components of net investment income and the cash flow discussion under Financial Condition and Liquidity.)
Realized net capital losses in 2010 included ($8.0) million of OTTI write-downs charged to earnings, largely related to issuer-specific credit losses on fixed maturities. OTTI decreased in 2010 compared to 2009 due in large part to improvements in the financial and credit markets. Realized net capital losses in 2009 included ($83.1) million of OTTI write-downs charged to earnings, due in large part to the depressed fair values of certain securities and issuer specific credit events in 2009. OTTI decreased in 2009 compared to 2008 as financial and credit markets stabilized and partially recovered from the turmoil at the end of 2008. Realized net capital losses in 2008 included ($99.9) million of net losses on sales and redemptions of securities and ($317.8) million of OTTI write-downs. The significant realized net capital losses from sales and redemptions of securities and OTTI write-downs in 2008 generally resulted from declines in the fair values of securities and issuer-specific credit events due to the downturn in the U.S. economy, turmoil in the financial markets and financial market illiquidity in 2008.
OTTI write-downs by balance sheet category at the time of impairment and type of impairment recorded for the years indicated are presented in the table below:
In 2010, 2009 and 2008, TRH repurchased portions of its 5.75% senior notes due in 2015 (the "2015 Notes" and together with the 2039 Notes, the "Senior Notes"). There were no repurchases of the 2039 Notes in 2010 and 2009. (See Note 7 of Notes to Consolidated Financial Statements ("Note 7") for the impact of the repurchases.)
ratio represents the sum of net commissions and the decrease (increase) in deferred policy acquisition costs expressed as a percentage of net premiums earned. The other underwriting expense ratio represents other underwriting expenses expressed as a percentage of net premiums earned.
In addition, in 2010, TRH decreased its estimates of the ultimate amounts of net losses occurring in 2009 and prior years by $57.0 million. This net favorable development was comprised of net favorable development of $216.9 million for losses occurring in 2002 to 2009, partially offset by net adverse development of $159.9 million relating to losses occurring in 2001 and prior. The detail of the $57.0 million net favorable development by line of business relating to all prior years is presented in the table below:
(1)Amount of reestimation represents the (increase) decrease in net losses and LAE incurred in 2010 relating to losses occurring in 2009 and prior years. Net favorable development was recorded for losses occurring in the fire, surety and credit and ocean marine lines, arising principally from losses occurring in 2005 to 2009. Significant net adverse development was recorded in 2010 in the other liability line, arising principally from losses occurring in 2002 and prior, partially offset by favorable development from losses occurring between 2003 and 2006. The other liability line includes certain specialty casualty classes, such as D&O and E&O, and general casualty classes. In addition, net adverse development was recorded in 2010 for losses occurring in the fidelity line, arising principally from losses occurring in 2006 to 2009. (See Note 10 for amounts included in net favorable development that relate to catastrophe losses.)
The favorable development in 2005 through 2009 results generally from favorable loss trends. The net adverse development arising from losses occurring in 2001 and prior generally relates to various excess casualty lines such as general liability and excess umbrella liability which were impacted by late reported excess claims.
Significant net favorable development was recorded for losses occurring in the fire and allied lines, arising principally from losses occurring in 2007 to 2008, and the surety and credit line, arising principally from losses occurring in 2004 to 2008. The line of business with the most significant net adverse development recorded in 2009 was the other liability line, arising principally from losses occurring in 2001
and prior, partially offset by favorable development from losses occurring between 2004 and 2006. The other liability line includes certain specialty casualty classes, such as D&O and E&O, and general casualty classes. In addition, significant net adverse development was recorded in 2009 for losses occurring in the fidelity line, arising principally from losses occurring in 2007 to 2008, related to the global credit crisis. (See Note 10 for amounts included in net favorable development that relate to catastrophe losses.)
The favorable development in 2004 through 2008 results generally from favorable loss trends. The net adverse development arising from losses occurring in 2001 and prior generally relates to various excess casualty lines such as general liability and excess umbrella liability which were impacted by late reported high layer excess claims. Ceding companies and their reinsurers continue to experience increased loss costs relative to expectations as loss emergence patterns continue to lengthen as regards the soft market years of 1997 through 2001.
For 2009 compared to 2008, the changes in gross and ceded losses and LAE incurred each include the effect of a $22 million decrease in losses and LAE incurred relating to business assumed from an AIG subsidiary which, by prearrangement with TRH, was then ceded in an equal amount to other AIG subsidiaries. (See Note 16.) In addition, the change in gross and ceded losses and LAE incurred includes the changes in gross and ceded catastrophe losses as discussed in Note 10.
In addition, in 2008, TRH decreased its estimates of the ultimate amounts of net losses occurring in 2007 and prior years by $0.5 million. This net favorable development was comprised of net favorable development of $209.7 million for losses occurring in 2003 to 2007, offset by net adverse development of $209.2 million, relating to losses occurring in 2002 and prior. The detail of the $0.5 million net favorable development by line of business relating to all prior years is presented in the table below:
The underwriting expense ratio for consolidated TRH in 2010 increased 1.5% compared to 2009 due to increases of 0.8% in the commission ratio and of 0.7% in the other underwriting expense ratio. The increase in the commission ratio occurred in International-Other and Domestic. The increase in the other underwriting expense ratio in 2010 compared to 2009 is related largely to increased employee compensation and benefits expenses, including stock compensation. The underwriting expense ratio for consolidated TRH in 2009 remained level with 2008 as an increase of 0.7% in the other underwriting expense ratio was offset by a decrease of 0.6% in the commission ratio. The increase in the other underwriting expense ratio in 2009 compared to 2008 is related largely to additional compensation costs associated with improved results in 2009 compared to 2008 and expenses incurred related to an employee retention plan (the "Retention Plan") covering a significant number of its employees, including its senior-most management. The decrease in the commission ratio occurred in the International-Europe and International-Other segments.
General corporate expenses, certain stock-based compensation costs and expenses relating to Professional Risk Management Services, Inc. ("PRMS") are the primary components of "other expenses, net" on the Consolidated Statement of Operations. PRMS, a wholly owned subsidiary of the Company, is an insurance program manager specializing in professional liability insurance services.
Income tax expense in 2010 includes $5.5 million of deferred tax benefits from minimum tax credit carryforwards. Income tax expense in 2009 includes $56.7 million of deferred tax benefits from minimum tax credit carryforwards. In 2008, TRH reversed $15.0 million of previously recorded deferred tax benefits from minimum tax credit carryforwards.
The effective tax rates, which represent the sum of current and deferred income taxes (benefits) divided by income before income taxes, were 14.9% in 2010, 19.9% in 2009 and (3,073.0%) in 2008. The decrease in effective tax rates in 2010 compared to 2009 was due in part to tax exempt income representing a larger percentage of pretax income in 2010 compared to 2009, largely as a result of significant net catastrophe costs in 2010, and a tax benefit of $8.4 million (net of interest on taxes) related to the resolution of certain prior year tax matters. The difference in effective tax rates in 2009 compared to 2008 was due to tax exempt income representing a smaller percentage of pretax income in 2009 compared to
2008. Net catastrophe costs and realized net capital losses significantly reduced pretax income in 2008. (See Note 5 of Notes to Consolidated Financial Statements.)
Assets increased by $337 million in 2010 due principally to a $356 million increase in investments. The increase in investments is due largely to an increase of $753 million in fixed maturities available for sale,
In addition, net premiums written decreased in 2010, due largely to changes in foreign currency exchange rates between the U.S. dollar and the currencies in which premiums are written, which decreased net premiums written by $34.2 million in 2010 as compared to 2009.
Assets increased by $181 million in 2010 due principally to a $145 million increase in investments. The increase in investments is due principally to a $443 million increase in fixed maturities available for sale, partially offset by a decrease of $293 million in short term-investments. The increase in fixed maturities available for sale and the decrease in short-term investments are due in part to the reallocation of some short-term investments to fixed maturities. The increase in fixed maturities is also due in part to the investment of net operating cash inflows.
2009 compared to 2008-Revenues decreased due to decreases in net premiums written, net of the change in unearned premiums, and, to a lesser extent, net investment income partially offset by a decrease in realized net capital losses. Changes in foreign currency exchange rates between the U.S. dollar and the currencies in which premiums are written in 2009 as compared to 2008 decreased net premiums written by $78.7 million. Revenues decreased in the London and Paris branches, partially offset by an increase in TRZ. Net premiums earned decreased principally in the property, auto liability and fidelity lines offset in part by a significant increase in the A&H line. Net investment income decreased in both the London and Paris branches and in TRZ and was due in part to changes in foreign currency exchange rates and lower yields on investments. Income before income taxes for 2009 decreased due primarily to decreases in underwriting profit and net investment income partially offset by a decrease in realized net capital losses. The decrease in underwriting profit reflects a higher loss ratio, excluding net catastrophe costs, partially offset by lower net catastrophe costs and a lower commission ratio.
includes net catastrophe costs of $91.5 million, principally related to the earthquake in Chile and hailstorms in Canada. Net catastrophe costs in 2009 were insignificant.
recoverable on paid and unpaid losses and LAE is due in part to increases in reinsurance recoverables relating to catastrophe events occurring in 2010.
As a holding company, the Company's assets consist primarily of the stock of its subsidiaries. The Company's liabilities consist primarily of the Senior Notes and related interest payable. The Company's cash inflows depend on the availability of dividends or other statutorily permissible payments from TRC and its wholly-owned operating subsidiaries, TRZ and Putnam. (See Note 15 of Notes to Consolidated Financial Statements for a discussion of restrictions on dividend payment and Schedule II-Condensed Financial Information of Registrant As of December 31, 2010 and 2009 and For the Years Ended December 31, 2010, 2009 and 2008 for the condensed financial statements of the Company.) In 2009, cash inflows also included the proceeds from the issuance of the 2039 Notes. TRH considers TRC's ability to pay dividends to the Company to be adequate for the Company's liquidity needs through the end of 2011 and thereafter for a period the length of which is difficult to predict, but which TRH believes will be at least one year. In 2010, 2009 and 2008, the Company received cash dividends, primarily from TRC, of $231.5 million, $121.5 million and $103.5 million, respectively. Based on statutory surplus of $4.30 billion as of December 31, 2010, TRC would be able to pay dividends of approximately $430 million without regulatory approval by December 31, 2011. The Company uses cash primarily to pay interest to the holders of the Senior Notes, dividends to its common stockholders and, to a lesser extent, operating expenses. The Company also uses cash to repurchase portions of the Senior Notes or its common shares when TRH believes it is advantageous to do so.
Sources of funds for the operating subsidiaries consisted primarily of premiums, reinsurance recoveries, investment income and proceeds from sales, redemptions and the maturing of investments. Funds are applied by the operating subsidiaries primarily to the purchase of investments and the payments of claims, commissions, ceded reinsurance premiums, operating expenses, income taxes and, in 2008 only, securities lending payables. Premiums are generally received substantially in advance of related claims payments. Cash and cash equivalents are maintained for the payment of claims and expenses as they become due. TRH does not anticipate any material capital expenditures in the foreseeable future.
While the expected payout pattern of liabilities (see the contractual obligations table later in this section) is considered in the investment management process, it is not the only factor considered as TRH
has historically funded its claims payments from current operating cash flows. As a result of such funding history, as of December 31, 2010 TRH did not maintain a credit facility. TRH's primary investment goal is to optimize after-tax income through a high quality diversified taxable fixed maturity and tax-exempt municipal fixed maturity portfolio, while maintaining an adequate level of liquidity. See discussion later in this section of the potential liquidity strain that could arise as a result of significant acceleration of paid losses beyond TRH's ability to fund such cash needs.
At December 31, 2010, total investments were $12.97 billion compared to $12.32 billion at December 31, 2009, an increase of $657.3 million. The increase in investments reflects $685 million of net purchases of investments and a $43 million increase in net unrealized appreciation of investments excluding the impact of a correction. (See Note 2 of Notes to Consolidated Financial Statements ("Note 2").) In addition, the impact on the carrying value of investments of foreign currency exchange rate changes between the U.S. dollar and certain currencies in which investments are denominated decreased total investments as of 2010 compared to 2009 by approximately $55 million.
Short-term investments decreased significantly in 2010 compared to 2009. The decrease in short-term investments is due in part to a reallocation to fixed maturities as well as the use of some proceeds from the sales or redemptions of short-term investments to repurchase 4.3 million shares of the Company's common stock at an aggregate cost of $219.7 million pursuant to the Company's share repurchase program in 2010.
TRH's fixed maturities classified as held to maturity and available for sale are predominantly investment grade, liquid securities. Approximately 56.4% and 45.3% of the non-asset-backed fixed
The decrease in the percentage of TRH's investment portfolio in state, municipality and political subdivision fixed maturities available for sale as of December 31, 2010 compared to December 31, 2009 is due to multiple factors including: opportunistic sales of certain securities to manage exposures as well as the investment of new cash inflows into taxable investments to manage the asset allocation of the investment portfolio.
(1)Principally Standard & Poor's ratings. (2)Consists of $4 million of BB rated securities, $32 million of CCC rated securities, $14 million of CC rated securities and $11 million of not-rated securities.
Gross unrealized gains and losses and net unrealized gains (losses) on all fixed maturities and equities at December 31, 2010 and 2009 were as follows:
At December 31, 2010, gross loss reserves totaled $9.02 billion, an increase of $411.5 million, or 4.8% over 2009. The increase in gross loss reserves includes the impact of changes in foreign currency exchange rates since the end of 2009 and gross loss reserve development.
At December 31, 2010, reinsurance recoverable on gross loss reserves totaled $793.8 million (a component of reinsurance recoverable on paid and unpaid losses on the Consolidated Balance Sheet, which is net of an allowance for uncollectible reinsurance recoverable of $12 million), an increase of $68.6 million, or 9.5%, from the prior year-end. The increase in reinsurance recoverable is due largely to an increase in reinsurance recoverables relating to catastrophe events occurring in 2010. Of the amount of reinsurance recoverable on paid and unpaid losses and LAE, which totaled $819.7 million as of December 31, 2010, $467.6 million represented balances that were unsecured. Of such unsecured balances, 97% was due from companies rated A- or better. (See Note 16.)
In all such matters, TRH believes that its positions are legally and commercially reasonable. TRH also regularly evaluates those positions, and where appropriate, establishes or adjusts loss reserves to reflect its evaluation. TRH's aggregate loss reserves take into account the possibility that TRH may not ultimately prevail in each and every disputed matter. TRH takes into consideration changes in judicial interpretation of legal liability and policy coverages, changes in claims handling practices and inflation. TRH considers not only monetary increases in the cost of what it reinsures, but also changes in societal factors that influence jury verdicts and case law, TRH's approach to claim resolution, and, in turn, claim costs. TRH believes its aggregate loss reserves reduce the potential that an adverse resolution of one or more of these matters, at any point in time, would have a material impact on TRH's financial condition or results of operations. However, there can be no assurance that adverse resolutions of such matters in any one period or in the aggregate will not result in a material adverse effect on TRH's results of operations or financial condition.
For 2010, TRH's net operating cash inflows were $1.06 billion, an increase of $109.5 million from 2009. The increase results, in large part, from net recoveries of income taxes in 2010 compared to net payments of income taxes in 2009 and increased cash received from underwriting activities, partially offset by an increase in interest paid on the Senior Notes. The total income taxes recovered in 2010 of $131.1 million consist of a $109.0 million refund of federal income taxes related to amended tax returns for
prior tax years and $22.1 million of refund claims related to capital loss carrybacks to certain other prior tax years. (See Note 5 of Notes to Consolidated Financial Statements.)
Based on its history of consistently strong operating cash flows, the present composition of its investment portfolio (including present levels of cash, cash equivalents, short-term investments and other liquid investment classes) and consideration of its cash needs, TRH considers its liquidity to be adequate through the end of 2011 and thereafter for a period the length of which is difficult to predict, but which TRH believes will be at least one year.
TRH's stockholders' equity totaled $4.28 billion at December 31, 2010, an increase of $250.1 million from year-end 2010. The net increase consisted primarily of net income of $402.2 million and other comprehensive income ("OCI") of $84.9 million, partially offset by $219.7 million of repurchases of the Company's common stock and cash dividends declared of $52.5 million.
The abovementioned OCI principally consisted of, net unrealized foreign currency translation gain from functional currencies, net of income taxes, ("UTA, net of tax") of $120.6 million partially offset by net unrealized depreciation of investments, net of income taxes, ("URA, net of tax") of ($36.1) million. The URA, net of tax, is composed principally of a decrease of $50.8 million in net unrealized appreciation of fixed maturities available for sale (principally due to net unrealized depreciation on states, municipalities and political subdivision and corporate fixed maturities, partially offset by net unrealized appreciation on RMBS fixed maturities), partially offset by an increase of $14.5 million in net unrealized appreciation of equities available for sale. Each of the preceding UTA, net of tax, and URA, net of tax, amounts includes the impact of a correction of the treatment of foreign currency exchange rates on the costs of investments denominated in functional currencies. The correction increased the reduction of URA, net of tax, in total by $63.7 million and increased UTA, net of tax, by the same amount with no net impact on other comprehensive income for 2010. (See Note 2 for a discussion of the correction and Note 4 for details of gross unrealized gains and losses by security type.)
In December 2009, the Company's Board of Directors (the "Board") authorized the repurchase of up to $200 million of the Company's outstanding common shares from time to time in the open market or via privately negotiated transactions through December 31, 2011 (the "December 2009 Authorization"). In October 2010, the Board approved a new share repurchase program, which authorizes the Company to repurchase up to $200 million of the Company's outstanding common shares from time to time in the open market or via negotiated transactions through December 31, 2012 (the "October 2010 Authorization"). The October 2010 Authorization superceded the December 2009 Authorization. In 2010, the Company repurchased 4.3 million shares of its common stock at an aggregate cost of $219.7 million. Of the shares
purchased in 2010, two million shares were repurchased from AHAC at an aggregate cost of $105 million pursuant to a stock offering agreement in connection with the March 2010 Offering. As of December 31, 2010 there was $145.4 million remaining under the October 2010 Authorization. (See Item 5. Market for the Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.)
As of December 31, 2010, the amounts due and the estimated period between year-end 2010 and the dates of payment, under specified contractual obligations of TRH are as follows:
The nature of TRH's business exposes it to losses from various catastrophe events. In a catastrophe event, losses from many insureds across multiple lines of business may result directly or indirectly from such single occurrence. In order to control such exposures, TRH employs a combination of measures, including setting targets for the amount of its exposure in key geographic zones and product lines that are prone to catastrophic events, monitoring and modeling accumulated exposures and purchasing catastrophe reinsurance when deemed cost effective.
Projections of potential catastrophe losses are typically expressed in terms of the probable maximum loss ("PML"). TRH defines PML as its anticipated maximum loss (taking into account contract limits) caused by a single catastrophic event affecting a broad contiguous area. These modeled losses are estimated based upon contracts in force at January 1, 2011.
The following is an overview of such modeled PMLs from property, engineering, marine and energy exposures and the associated natural perils that TRH deems most significant. The estimated amount of these modeled losses are presented in three ways: (a) gross losses; (b) pre-tax net catastrophe costs (i.e., gross losses, net of reinsurance and the impact of net reinstatement premiums); and (c) after-tax net catastrophe costs (i.e., the net cost to TRH). The reduction for reinsurance assumes that all reinsurers fulfill their obligations to TRH in accordance with contract terms. The values provided have a likelihood of being exceeded in any single year of 1.0% or 0.4%.
There is much uncertainty and imprecision in the compilation of these estimates at many stages in the process. Moreover, the makeup of TRH's in-force business is constantly changing as new business is added
and existing contracts terminate or expire, including contracts for reinsurance coverage purchased by TRH. In addition, these estimates take into account what TRH believes to be the most likely accumulation of territories and/or lines of business in a catastrophic natural peril event, but there can be no assurance that TRH has captured every possible scenario in its analysis. As a result of these factors, among others, there can be no assurance that TRH will not experience after-tax net catastrophe costs from individual events that will exceed these estimates by a material amount. There also can be no assurance that TRH will not experience catastrophe events more frequently than the modeled probabilities would suggest. In any given year, catastrophe events could have a material adverse effect on TRH's financial condition, results of operations, cash flows and liquidity.
In mid-2007, the U.S. residential mortgage market began to experience serious disruption due to credit quality deterioration in a significant portion of loans originated, particularly to non-prime and sub-prime borrowers; evolving changes in the regulatory environment; a residential housing market characterized by a slowing pace of transactions and declining prices; increased cost of borrowings for mortgage participants; a rising unemployment rate; increased delinquencies in non-mortgage consumer credit; and illiquid credit markets. In addition, the financial strength of certain bond insurers has been compromised to varying degrees by losses these entities experienced due in part to the coverage they provide for domestic RMBS. These conditions continued through 2008 and into 2009, expanding into the broader global credit markets and resulting in greater volatility, a steep decline in equity markets, less liquidity, widening of credit spreads, a lack of price transparency, increased credit losses in certain markets and the collapse of several prominent financial institutions. By the end of 2009 and through 2010, the disruptions to the global credit and financial markets had moderated as the markets started to stabilize or, in some cases, recover. TRH cannot predict whether current trends will continue, deteriorate or improve.
Consolidated Statements of Cash Flows For the Years Ended December 31, 2010, 2009 and 2008
I-Summary of Investments-Other than Investments in Related Parties As of December 31, 2010
II-Condensed Financial Information of Registrant As of December 31, 2010 and 2009 and For the Years Ended December 31, 2010, 2009 and 2008
III-Supplementary Insurance Information As of December 31, 2010, 2009 and 2008 and For the Years Then Ended
IV-Reinsurance For the Years Ended December 31, 2010, 2009 and 2008
VI-Supplementary Information Concerning Property/Casualty Insurance Operations As of December 31, 2010, 2009 and 2008 and For the Years Then Ended
In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Transatlantic Holdings, Inc. and its subsidiaries (the "Company") at December 31, 2010 and 2009, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2010 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedules listed in the accompanying index present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for these financial statements and financial statement schedules, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Report on Internal Control over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on these financial statements, on the financial statement schedules, and on the Company's internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
Transatlantic Holdings, Inc. (the "Company", and collectively with its subsidiaries, "TRH") is a holding company, incorporated in the state of Delaware, which owns all of the common stock of Transatlantic Reinsurance Company® ("TRC"). TRC owns all of the common stock of Trans Re Zurich Reinsurance Company Ltd. ("TRZ") and Putnam Reinsurance Company ("Putnam").
Prior to June 10, 2009 and as of December 31, 2008, American International Group, Inc. ("AIG", and collectively with its subsidiaries, the "AIG Group") beneficially owned approximately 59% of the Company's outstanding shares. On June 10, 2009, AIG and American Home Assurance Company ("AHAC"), a wholly owned subsidiary of AIG, consummated a secondary public offering (the "June 2009 Offering") of 29.9 million issued and outstanding shares of the common stock of the Company owned by AIG and AHAC. On March 15, 2010, AHAC consummated another secondary public offering (the "March 2010 Offering", and collectively with the June 2009 Offering, the "Secondary Offerings") of 8.5 million issued and outstanding shares of the Company's common stock owned by AHAC. The Company repurchased two million shares of its common stock from AHAC in the March 2010 Offering pursuant to a stock offering agreement for an aggregate purchase price of approximately $105 million. TRH did not receive any proceeds from the Secondary Offerings. Immediately following the March 2010 Offering, the AIG Group, including AHAC, beneficially owned 0.7 million shares of the Company's common stock (excluding shares held by certain mutual funds that are advised or managed by subsidiaries of AIG), representing approximately 1.1% of the Company's then outstanding shares. As a result of its reduced ownership percentage, the AIG Group was no longer considered a related party after March 15, 2010. (See Note 14 for additional discussion regarding AIG's beneficial ownership of the Company.)
The accompanying consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles ("GAAP"). All material intercompany accounts and transactions have been eliminated. Certain reclassifications and format changes have been made to prior years' amounts to conform to the 2010 presentation.
This error and its related corrections did not have a material effect on 2010 or any prior period and thus prior period financial statements have not been restated.
Fixed maturities are classified as held to maturity and carried at amortized cost if TRH has the positive intent and ability to hold each of these securities to maturity. When TRH does not have the positive intent to hold fixed maturities to maturity, such fixed maturities are classified as available for sale and carried at fair value. Premiums and discounts arising from the purchase of fixed maturities are treated
Each quarter, TRH evaluates its investments for OTTI. See Note 4(g) for the criteria TRH uses to evaluate if an investment is a candidate for OTTI.
Deferred tax assets and liabilities are recorded for the effects of temporary differences between the tax basis of an asset or liability and its reported amount in the consolidated financial statements. TRH assesses its ability to realize deferred tax assets considering all available evidence including earnings history, the timing, character and amount of future earnings potential, the reversal of taxable temporary differences and the tax planning strategies available to legal entities when recognizing deferred tax assets. See Note 5 for further discussion of income taxes.
In recent years, premiums from treaty contracts have approximated 97% of net premiums written, while facultative contracts have approximated 3%. For pro rata treaty contracts, premiums written and earned are based on reports received from ceding companies. For excess-of-loss treaty contracts, premiums are generally recorded as written based on contract terms. Premiums are earned ratably over the term of the related coverages. Unearned premiums and prepaid reinsurance premiums represent the portion of gross premiums written and ceded premiums written, respectively, relating to the unexpired terms of such coverages. Premiums written and earned, along with related costs, for which data has not been reported by the ceding companies, are estimated based on historical patterns and other relevant information. These estimates can be subject to change when actual data for such estimated items becomes available. In the Consolidated Statements of Operations, premiums written and earned and the change in unearned premiums are presented net of reinsurance ceded.
•Sales and redemptions of fixed maturities, equities, securities lending invested collateral and alternative investments •Reductions to the cost basis of fixed maturities, equity securities, securities lending invested collateral and other invested assets (except for where the fair value option has been elected) for OTTI which are recognized through earnings •Exchange gains and losses resulting from foreign currency transactions
Unpaid losses and LAE ("gross loss reserves") are principally based on reports and individual case estimates received from ceding companies. The incurred but not reported ("IBNR") portion of gross loss reserves is based on past experience and other factors. The methods used to determine such estimates and to establish the resulting reserves are continually reviewed and updated. Any adjustments are reflected in income currently. Net losses and LAE incurred consists of the estimated ultimate cost of settling claims incurred within the reporting period (net of related reinsurance recoverable), including IBNR claims, plus changes in estimates of prior period losses.
While the reserving process is difficult for ceding companies, the inherent uncertainties of estimating loss reserves are even greater for reinsurers, due primarily to the longer-term nature of much reinsurance business, the diversity of development patterns among different types of reinsurance treaties or facultative contracts, the necessary reliance on the ceding companies for information regarding reported claims and differing reserving practices among ceding companies, which can be subject to change without notice. TRH writes a significant amount of non-proportional assumed casualty reinsurance as well as proportional assumed reinsurance of excess liability business for classes such as medical malpractice, D&O, E&O and general casualty. Claims from such classes can exhibit greater volatility over time than most other classes due to their low frequency, high severity nature and loss cost trends that are more difficult to predict.
(2)Adoption of new accounting guidance on subsequent events (Accounting Standards Update ("ASU") 2010-09)
In February 2010, the FASB issued an amendment to certain recognition and disclosure requirements on subsequent events. An entity that is a Securities and Exchange Commission filer is required to evaluate subsequent events through the date that the financial statements are issued. The entity is not required to disclose the date through which subsequent events have been evaluated.
TRH adopted this guidance in the first quarter of 2010. The adoption of this guidance had no effect on TRH's consolidated financial condition, results of operations or cash flows.
(3)Adoption of new accounting guidance on disclosures about fair value measurements (ASU 2010-06)
(5)Adoption of new accounting guidance on accounting for transfers of financial assets (ASU 2009-16)
In June 2009, the FASB issued new accounting guidance on accounting for transfers of financial assets. This guidance changes financial reporting for transfers of financial assets by eliminating the exceptions for qualifying special purpose entities from the consolidation guidance and the exception that permitted sale accounting for certain mortgage securitizations when a transferor has not surrendered control over the transferred financial assets. In addition, comparability and consistency in accounting for transferred financial assets will be improved through clarifications of the requirements for isolation and limitations on portions of financial assets that are eligible for sale accounting. This guidance requires enhanced disclosures about the risks that a transferor continues to be exposed to because of its continuing involvement in transferred financial assets. Also, this guidance clarifies and improves certain prior accounting provisions that have resulted in inconsistencies in application.
TRH adopted this guidance in the first quarter of 2010 with its provisions applied prospectively. The adoption of this guidance did not have a material effect on TRH's consolidated financial condition, results of operations or cash flows.
In October 2010, the FASB issued new accounting guidance on accounting for costs associated with acquiring or renewing insurance contracts (ASU 2010-26). This guidance specifies that incremental direct costs of contract acquisition and certain costs directly related to certain acquisition activities performed by the insurer for the contract should be capitalized. All other acquisition-related costs should be charged to expense as incurred.
For TRH, this guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2011 and shall be applied prospectively. TRH does not currently expect the implementation of this guidance to be material to TRH's consolidated financial condition, results of operations or cash flows.
TRH measures at fair value on a recurring basis financial instruments included principally in its available for sale securities portfolios and certain short-term investments. The fair value of a financial instrument is the amount that would be received to sell an asset or settle a liability in an orderly transaction between willing, able and knowledgeable market participants at the measurement date.
TRH management is responsible for the determination of the value of the financial assets and the supporting methodologies and assumptions. With respect to securities, TRH employs independent third party valuation service providers to gather, analyze and interpret market information and derive fair values based upon relevant methodologies and assumptions for individual instruments. When TRH's valuation service providers are unable to obtain sufficient market observable information upon which to estimate the fair value for a particular security, fair value is determined either by requesting from brokers who are
knowledgeable about these securities to provide a quote, which is generally non-binding, or by employing widely accepted internal valuation models.
A further discussion of the most significant categories of investments carried at fair value on a recurring basis follows:
discount rates that take into consideration cash issuance spreads for similar instruments or other observable information.
TRH also measures the fair value of certain assets on a non-recurring basis, generally quarterly, annually, or when events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. These assets primarily include held-to-maturity fixed maturities, which are carried on the balance sheet at amortized cost, and equity method investments. When TRH determines that the carrying value of these assets may not be recoverable, TRH records the assets at fair value with the loss recognized in income as a realized capital loss. In such cases, TRH measures the fair value of these assets using the techniques discussed above for fixed maturity and equity securities.
•Level 3: Fair value measurements based on valuation techniques that use significant inputs that are unobservable. These measurements may be made under circumstances in which there is little, if any, market activity for the asset. TRH's assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment. In making the assessment, TRH considers factors specific to the asset. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls is determined based on the lowest level input that is significant to the fair value measurement in its entirety. Assets measured at fair value on a
At December 31, 2010 and 2009, Level 3 assets totaled $230.0 million and $150.0 million, respectively, representing 2.0% and 1.4%, respectively, of total assets measured at fair value on a recurring basis.
The following tables present analyses of the changes during 2010 and 2009 in Level 3 assets measured at fair value on a recurring basis:
(1)There were $1.7 million of OTTI related to RMBS fixed maturities available for sale that was recorded in realized net capital losses in 2009 on instruments still held at December 31, 2009. (2)Primarily private equities.
The amortized cost and fair value of fixed maturities at December 31, 2010 and 2009 are summarized as follows:
The amortized cost and fair value of fixed maturities at December 31, 2010 by contractual maturity are as follows. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Investments in fixed maturities exclude short-term investments.
(1)See Note 2(a) of Notes to Consolidated Financial Statements. (2)See Note 2(k)(1) of Notes to Consolidated Financial Statements. (3)Includes net unrealized appreciation from securities lending invested collateral of $41.2 million in 2008.
In 2010, sales of fixed maturity available for sale securities produced pre-tax gross realized losses of $6.8 million. Sales of fixed maturities available for sale were generally the result of (a) TRH's desire to manage the duration, credit risk and concentration risk of the investment portfolio as part of its overall view of prudent management of an available for sale fixed maturity investment portfolio; and (b) the disposition of certain securities that, based on TRH's judgment, were unlikely to provide on a relative basis as attractive a return as alternative securities entailing comparable risks.
In 2009, sales of fixed maturity available for sale securities, which produced pre-tax gross realized losses of $49.4 million, related primarily to corporate, municipalities and asset-backed securities. Gross realized losses on sales of fixed maturity available for sale securities were generally the result of (a) TRH's desire to manage the duration of the investment portfolio as part of its overall view of prudent management of an available for sale fixed maturity investment portfolio; (b) the disposition of certain securities that, based on TRH's judgment, were unlikely to provide on a relative basis as attractive a return as alternative securities entailing comparable risks; and (c) repositioning of the investment portfolio in light of the transition to a new investment manager in the third quarter of 2009.
In 2009, securities in the equities available for sale portfolio were sold for a number of reasons, including the repositioning of TRH's equity portfolio with respect to the continuing changes in the investment and credit markets during 2009 and the desire over time to take advantage of tax-basis capital loss carry-backs to prior years that had capital gains. TRH's equity security investment strategy includes the intent to optimize total investment return through active management, which can lead to selling securities at a gain or loss due to changing market conditions and as market opportunities arise.
As discussed in Note 4(g), the OTTI amounts on certain fixed maturities are separated into credit loss and non-credit loss components. The credit loss impairments are recognized in earnings as realized capital losses, while the non-credit loss impairments are recorded in OCI. The following table sets forth the amount of credit loss impairments on fixed maturities held by TRH as of December 31, 2010 and 2009, for which a portion of the OTTI amount was recorded in OCI.
At December 31, 2010, the carrying value of TRH's fixed maturity and equity securities aggregated $12.58 billion with aggregate pre-tax gross unrealized losses of $150 million. Additional information about these securities is as follows:
At December 31, 2010 and 2009, the gross unrealized losses for all fixed maturities, including both held to maturity and available for sale, and equities available for sale included the following concentrations:
The fair value of fixed maturities in an unrealized loss position at December 31, 2010 and 2009, by contractual maturity, is shown below:
Each quarter, TRH evaluates its investments for OTTI such that a security is considered a candidate for OTTI if it meets any of the following criteria:
The determination that a security has incurred OTTI requires the judgment of management and consideration of the fundamental condition of the issuer, its near-term prospects and all the relevant facts and circumstances. The above criteria also consider circumstances of a rapid and severe market valuation decline, such as that experienced in credit markets in recent years, in which TRH could not reasonably assert that the impairment period would be temporary (i.e., severity losses). The analysis of any individual security for OTTI is performed based on its functional currency. Additional criteria considered includes a security's business prospects, the investment's credit ratings and whether there have been any recent downgrades, whether the issuer is current on all payments in accordance with the contractual terms of the investment and is expected to meet all of its obligations under the terms of the investment, market values, issuer specific financial information and available information from asset managers and rating agencies for individual securities.
At December 31, 2010, TRH determined that there was no OTTI on its equity securities as no equities met TRH's equity security OTTI criteria and TRH has the intent and ability to hold all equities to recovery. In addition, no equities were in an unrealized loss position for over 12 months.
The domestic tax expense for 2010 includes a tax benefit of $8.9 million (excluding interest), recorded in the fourth quarter, resulting from the resolution of prior year tax audits primarily attributable to foreign tax credits that became available as a result of the carryback of tax-basis net operating losses incurred in 2001 and 2005. The domestic deferred tax expense for 2010 is net of $5.5 million resulting from minimum tax credit carryforwards. By law, minimum tax credits may be carried forward indefinitely. The domestic current tax expense for 2009 includes the impact of a tax capital loss of $209.2 million. The actual capital loss included in the 2009 U.S. consolidated tax return was $145.1 million. The 2010 tax expense includes an adjustment to align the amounts reflected in the 2009 tax expense with the amounts in the 2009 tax return. $21.3 million of tax capital loss was carried back to prior years and the remainder can be carried forward five years to offset future capital gains. The domestic deferred tax expense for 2009 is net of $56.7 million resulting from minimum tax credit carryforwards. The domestic current tax benefit for 2008 includes the
No valuation allowance has been recorded as TRH has concluded that it is more likely than not that TRH will fully realize the deferred tax assets. The most significant deferred tax assets arise from the discounting of loss reserves, minimum tax credit carryforwards, realized and unrealized losses on investments and unearned premiums. TRH's strong history of operating earnings supports its conclusion that it has the ability to realize the full benefits associated with all deferred tax assets, particularly the assets associated with the discounting of loss reserves and minimum tax credits, which may be carried forward indefinitely. In addition to TRH's strong history of operating earnings, TRH also has a strong history of generating capital gains to offset capital losses. During 2007 and 2006, TRH generated $135 million of capital gains on a tax basis that were utilized for carryback of losses generated in 2008 and 2009. In addition, while the OTTI write-downs on its fixed maturity securities are reflected as realized losses for GAAP purposes, the securities continue to be held in its available for sale portfolio and, as such, the carryforward period for capital losses on a tax basis has not begun to run. Finally, TRH's strong history of positive operating cash flow, having generated $3.11 billion over the last three years, supports the conclusion that TRH has the ability to hold until maturity, or until the values recover, those fixed income securities that have been written down, as well as those securities that are in an unrealized loss position.
The following table lists the tax years that remain subject to examination by major tax jurisdiction as of December 31, 2010:
There were no significant net catastrophe losses for events occurring in 2009. In addition, in 2009, TRH decreased its estimates of the ultimate amounts of net losses occurring in 2008 and prior years by $38.9 million. This net favorable development was comprised of net favorable development of $219.1 million for losses occurring in 2002 to 2008, offset by net adverse development of $180.2 million relating to losses occurring in 2001 and prior.
Significant net favorable development was recorded for losses occurring in the fire ($104.1 million) and allied lines ($42.4 million) lines, each arising principally from losses occurring in 2007 to 2008, and the surety and credit line ($25.3 million), arising principally from losses occurring in 2004 to 2008. The line of business with the most significant net adverse development recorded in 2009 was the other liability line ($120.4 million), arising principally from losses occurring in 2001 and prior, partially offset by favorable development from losses occurring between 2004 and 2006. The other liability line includes certain specialty casualty classes, such as D&O and E&O, and general casualty classes. In addition, significant net adverse development was recorded in 2009 for losses occurring in the fidelity ($30.0 million) line, arising principally from losses occurring in 2007 to 2008.
The favorable development in 2004 through 2008 results generally from favorable loss trends. The net adverse development arising from losses occurring in 2001 and prior, generally relates to various excess
Net development on losses occurring in prior years, for all periods discussed above, includes amounts relating to catastrophe events. See Note 10 for such amounts.
Net income per common share has been computed in the following table based upon weighted average common shares outstanding.
(1)2010 excludes the effect of 2.1 million anti-dilutive shares (from a total of 3.8 million potential shares). 2009 excludes the effect of 2.2 million anti-dilutive shares (from a total of 3.2 million potential shares). 2008 excludes the effect of 1.3 million anti-dilutive shares (from a total of 3.1 million potential shares). 10. Impact of Catastrophe Costs
Net catastrophe costs represent TRH's best estimates of the aggregate ultimate costs to be incurred relating to significant catastrophe events based upon information available at the time the estimate was made. These catastrophe cost estimates reflect significant judgment relating to many factors, including the ultimate resolution of certain legal and other issues.
Gross and ceded reinstatement premiums serve to increase or decrease, respectively, net premiums written and earned by such amounts in their respective periods. Reinstatement premiums may arise on both assumed and ceded business as a result of contractual provisions found in certain catastrophe excess-of-loss reinsurance contracts that require additional premium to be paid in the event of a loss to reinstate coverage for the remaining portion of the contract period.
Summaries of the components of pre-tax net catastrophe costs for 2010, 2009 and 2008 are presented below:
A summary of pre-tax net catastrophe costs by segment for 2010, 2009 and 2008 is presented below:
As of January 1, 2010, TRH employees no longer participate in benefit plans sponsored by the AIG Group. TRH employees now participate in DB pension, DC pension and other post retirement benefit plans sponsored and maintained by TRH. In general, vested and unvested benefits accrued through the end of 2009 by TRH employees participating in U.S. AIG Group sponsored plans, along with the associated plan assets, have been assumed by a new TRH DB pension plan established in 2010. Benefits on U.S. DB pension plans were frozen as of December 31, 2009.
These plans are not material to TRH's results of operations, financial condition or cash flows for 2010, 2009 and 2008.
In 2008, the Board adopted, and the stockholders approved, the Transatlantic Holdings, Inc. 2008 Non-Employee Directors' Stock Plan (the "Non-Employee Directors' Plan"). The Non-Employee Directors' Plan provides that equity-based or equity-related awards can be granted to non-employee directors as determined by the Compensation Committee of the Board (the "Compensation Committee"). The maximum number of shares available for grant under the Non-Employee Directors' Plan is 100,000. As of December 31, 2010, there were 53,733 shares of common stock available for issuance in connection with future grants of awards under the Non-Employee Directors' Plan.
At December 31, 2010, TRH had awards outstanding from six stock-based compensation plans: (a) the 2009 Plan; (b) the 2000 Plan; (c) the 2003 Plan; (d) the Non-Employee Directors' Plan; (e) the Transatlantic Holdings, Inc. 1990 Employee Stock Purchase Plan, as amended (the "Stock Purchase Plan"); and (f) the 2010 U.K. Sharesave Plan (the "Sharesave Plan").
Expenses relating to stock-based compensation arrangements totaled $35.3 million, $13.2 million and $18.7 million in 2010, 2009 and 2008, respectively. Income tax benefits recognized related to stock-based compensation arrangements totaled $12.3 million, $4.5 million and $6.4 million in 2010, 2009 and 2008, respectively.
Net cash received (paid) from exercises of stock-based compensation was insignificant in 2010 and $1.6 million and ($0.9) million during 2009 and 2008, respectively. The net cash paid from exercises of stock-based compensation in 2008 is due to the payment of the employee portion of withholding taxes to governmental tax authorities on vested restricted stock units. TRH has not paid out any cash to settle share-based payment awards in 2010, 2009 or 2008. Cash savings resulting from excess tax benefits totaled $0.3 million, $0.2 million and $1.8 million in 2010, 2009 and 2008, respectively.
Income tax benefits realized by TRH on stock-based compensation exercises totaled $2.6 million, $0.8 million and $2.5 million in 2010, 2009 and 2008, respectively.
(1)As of December 31, 2010, all options outstanding and exercisable have aggregate intrinsic values of zero as the exercise price of the options exceeded the closing price of TRH shares on the NYSE on December 31, 2010. The aggregate intrinsic value of options exercised (the aggregate amount by which the market price of TRH shares at the time of exercise exceeded the exercise price of options exercised) was $0.2 million, $1.6 million and $1.0 million in 2010, 2009 and 2008, respectively. A total of approximately 102,000, 167,000 and 190,000 options vested in 2010, 2009 and 2008, respectively, with aggregate grant-date fair values of $2.2 million, $3.6 million and $3.8 million in 2010, 2009 and 2008, respectively.
As of December 31, 2010, there was $1.1 million of total unrecognized compensation costs relating to options granted but not yet vested. Compensation expense for options granted is recognized on a straight-line basis. These costs are expected to be recognized over a weighted average period of 1.0 years.
Service RSUs and Performance RSUs have been granted under the 2009 Plan, the Non-Employee Directors' Plan and the 2003 Plan to officers, employees and directors of TRH. A summary of the status of the Service RSUs and Performance RSUs granted as of December 31, 2010 and the changes since January 1, 2010 are presented below:
Service RSUs have vesting dates ranging from one to four years from the date of grant. As of December 31, 2010, the great majority of Service RSUs will vest on the third anniversary of the date of grant for those grantees with continued employment through such date. The Company reserves the right to make payment for the Service RSUs in TRH shares or the cash equivalent of the fair value of such shares on the date of vesting. The fair values of Service RSUs were estimated on the date of grant based on the closing market price of TRH shares on the date of grant.
A summary of unvested Three-Year Performance RSUs grants as of December 31, 2010 follows:
(1)Amount undeterminable as of December 31, 2010 as the performance period has not yet ended. The fair values of Performance RSUs are estimated based on the NYSE closing price of TRH shares on the date of grant.
42,960 performance RSUs vested in 2010. No performance RSUs vested in 2009 or 2008.
(a) Secondary Public Offerings of the Company's Common Stock by the AIG Group
After March 15, 2010, the AIG Group ceased to be a related party of TRH, as discussed above. TRH had service and expense agreements and certain other agreements with the AIG Group which provide for the reimbursement to the AIG Group of certain administrative and operating expenses which include, but are not limited to, investment advisory, investment recordkeeping, cash management services, office space and human resource related activities. Most of these service and expense agreements have ceased on various dates in 2009. Under the guidance of TRH's Finance and Investment Committee of the Board and senior management, the AIG Group acted as financial advisors and managers of TRH's investment portfolio through June 30, 2009. Effective July 1, 2009, TRH employs a third party not affiliated with AIG to provide these services. In 2009 and 2008, $8.9 million and $13.8 million, respectively, of operating and investment expenses relate to services provided by the AIG Group under these agreements. There were no material operating or investment expenses related to services provided by the AIG Group in 2010.
The payment of dividends and interest on the Senior Notes by the Company is generally dependent on the ability of its subsidiaries to pay dividends. The payment of dividends by TRC and its wholly-owned subsidiaries, TRZ and Putnam, is restricted by insurance regulations. Under New York insurance law, TRC and Putnam may pay dividends only out of their statutory earned surplus. Such dividends are limited by statutory formula unless otherwise approved by the New York State Insurance Department (the "NYS ID"). The statutory surplus of TRC includes the statutory surplus of Putnam since all the capital stock of Putnam is owned by TRC. Based on statutory surplus of $4.30 billion as of December 31, 2010, TRC would be able to pay dividends of approximately $430 million without regulatory approval by December 31, 2011.
TRC and Putnam each prepare statutory financial statements in accordance with accounting practices prescribed or permitted by New York-their state of domicile. Prescribed statutory accounting practices are discussed in a variety of publications of the National Association of Insurance Commissioners ("NAIC"), as well as in state laws, regulations and general administrative rules. Permitted statutory accounting practices encompass all accounting practices not so prescribed. As required by the State of New York, TRC and Putnam use the Codification of Statutory Accounting Principles as primary guidance on statutory accounting. All material statutory accounting practices of TRC and Putnam are prescribed in the authoritative literature described above.
Ceded reinsurance arrangements do not relieve TRH from its obligations to the insurers and reinsurers from whom it assumes business. The failure of retrocessionnaires to honor their obligations could result in losses to TRH; consequently, an allowance has been established for estimated unrecoverable reinsurance on paid and unpaid losses totaling $12.0 million as of December 31, 2010 and 2009. During 2010, $0.1 million of reinsurance recoverable on paid and unpaid losses and LAE were
To estimate the allowance for unrecoverable reinsurance on paid and unpaid losses, TRH uses a default analysis. The primary components of the default analysis are reinsurance recoverable balances by reinsurer, net of collateral, and default factors used to determine the portion of a reinsurer's balance deemed uncollectible. Default factors require considerable judgment and are determined using the current rating, or rating equivalent, of each reinsurer as well as other key considerations and assumptions. At December 31, 2010, the use of different assumptions within our approach could have a material effect on the provision for unrecoverable reinsurance reflected in our Consolidated Financial Statements. To the extent the creditworthiness of our reinsurers was to deteriorate due to an adverse event, such as a large number of major catastrophes, actual uncollectible amounts could be significantly greater than our provision for uncollectible reinsurance. Such an event could have a material adverse effect on TRH's financial condition, results of operations, and cash flows.
Under its reinsurance security policy, TRH seeks to cede business to reinsurers generally rated "A-" or better. TRH considers reinsurers that are not rated or do not fall within the above rating categories and may grant exceptions to TRH's general policy on a case-by-case basis. At December 31, 2010, approximately 89% of total reinsurance recoverable on paid and unpaid losses and LAE balances were due from reinsurers rated "A-" or better, 1% were due from reinsurers rated between "BBB+" and "B" while 10% were due from reinsurers which were not rated.
In addition, three large international brokers, respectively, accounted for assumed premiums equal to 25%, 18% and 9% in 2010, 26%, 16% and 8% in 2009 and 28%, 16% and 10% in 2008, of consolidated revenues, with a significant portion in each segment. In each year, premiums brokered by companies acquired are included in the calculated percentages of the acquiror starting in the year of acquisition as if such acquisition had occurred on January 1 of that year.
(1)Net premiums earned from the AIG Group from contracts with effective dates of March 15, 2010 or prior were approximately $244.6 million, $334.0 million and $386.5 million in 2010, 2009 and 2008, respectively, and are included mainly in Domestic. (See Note 14 of Notes to Consolidated Financial Statements.) (footnotes continued on next page)
(6)As of December 31. Net premiums earned by major product line are as follows:
On May 21, 2010, the Company and its subsidiaries, TRC and TRZ (collectively, the "TRH Parties"), filed a demand for arbitration, with the American Arbitration Association, against AIG, AIG Securities Lending Corp. and AIG Securities Lending (Ireland) Ltd. (collectively, "AIG Securities Lending") for losses in excess of $350 million suffered by TRH arising from its participation in a securities lending program administered and managed by AIG Securities Lending during the period that TRH was controlled by AIG. The TRH Parties' participations in such securities lending program ended in the fourth quarter of 2008. While the final outcome cannot be predicted with certainty, TRH believes this arbitration, when resolved, will not have a material adverse effect on TRH's results of operations, financial position or cash flows.
In the normal course of business, TRH has letters of credit outstanding as of December 31, 2010 totaling $67.9 million. These letters of credit are provided to secure certain loss reserves and other balances due to ceding companies. Where TRH provides a letter of credit, it is generally contractually obligated to continue to provide a letter of credit to the ceding company in the future to secure certain reserves and other balances.
Rent expense approximated $12.5 million, $12.9 million and $12.0 million in 2010, 2009 and 2008, respectively.