The following tables set forth our selected financial data and other financial information at the end of and for each of the years in the five-year period ended December 31, 2006. This historical financial information was prepared in accordance with GAAP. The consolidated statement of operations data for the years ended December 31, 2006, 2005, 2004, 2003 and 2002 and the balance sheet data at December 31, 2006, 2005, 2004, 2003 and 2002 were derived from our consolidated financial statements. You should read the selected financial data in conjunction with our consolidated financial statements and related notes thereto and ‘‘Management’s Discussion and Analysis of Financial Condition and Results of Operations’’ included in this filing and all other information appearing elsewhere or incorporated into this filing by reference.
The following is a discussion and analysis of our results of operations for the year ended December 31, 2006 compared with the years ended December 31, 2005 and 2004. The following also includes a discussion of our liquidity and capital resources at December 31, 2006. This discussion and analysis should be read in conjunction with the audited consolidated financial statements and related notes included in this filing. This filing contains forward-looking statements that involve risks and uncertainties. Actual results may differ materially from the results described or implied by these forward-looking statements. See ‘‘Note on Forward-Looking Statements.’’
RenaissanceRe, established in Bermuda in 1993 to write principally property catastrophe reinsurance, is today a leading global provider of reinsurance and insurance. Through our operating subsidiaries, we seek to obtain a portfolio of reinsurance, insurance and financial risks in each of our businesses that are significantly better than the market average and produce an attractive return on equity. Overall, our strategy focuses on superior risk selection, active capital management, superior utilization of risk management and information systems, the development and enhancement of a high performance and ethical culture and our commitment to our clients and joint venture partners. We provide value to our clients in the form of financial security, innovative products, and responsive service. We are known as a leader in paying valid reinsurance claims promptly. We measure our financial success through long-term growth in tangible book value per common share plus accumulated dividends, which we believe is the most appropriate measure of the performance of our Company, and believe we have delivered superior performance in respect of this measure in the past.
Since a substantial portion of the reinsurance and insurance we write provides protection from damages relating to natural and man-made catastrophes, our results depend to a large extent on the frequency and severity of such catastrophic events, and the coverages we offer to clients affected by these events. We are exposed to significant losses from these catastrophic events and other exposures
that we cover. Accordingly, we expect a significant degree of volatility in our financial results and that our financial results may vary significantly from quarter-to-quarter or from year-to-year, based on the level of insured catastrophic losses occurring around the world.
Our expenses primarily consist of: 1) net claims and claim expenses incurred on the policies of reinsurance and insurance we sell; 2) acquisition costs which typically represent a percentage of the premiums we write; 3) operating expenses which primarily consist of personnel expenses, rent and other operating expenses; 4) corporate expenses which include certain executive, legal and consulting expenses, costs for research and development, and other miscellaneous costs associated with operating as a publicly traded company; 5) minority interest, which represents the interest of third parties with respect to the net income (loss) of DaVinciRe; and 6) interest and dividend costs related to our debt, preference shares and subordinated obligation to our capital trust. We are also subject to taxes in certain jurisdictions in which we operate; however, since the majority of our income is currently earned in Bermuda, a non-taxable jurisdiction, the tax impact to our operations has historically been minimal.
2) Specialty reinsurance, written for our own account and for DaVinci, covering certain targeted classes of business where we believe we have a sound basis for underwriting and pricing the risk that we assume; our portfolio in 2006 includes various classes of business, such as catastrophe exposed workers’ compensation, surety, terrorism, medical malpractice, casualty clash, certain casualty lines and other specialty lines of reinsurance that we collectively refer to as specialty reinsurance. We believe that we are seen as a market leader in certain of these classes of business, such as catastrophe-exposed workers’ compensation, surety, terrorism and casualty clash.
3) Through Ventures, we pursue joint ventures and other strategic relationships. Our three principal business activities in this area are: 1) catastrophe-oriented joint ventures which we manage, such as Top Layer Re, DaVinci, Starbound and Tim Re; 2) customized reinsurance transactions, such as offering participations in our catastrophe portfolio; and 3) investments in other market participants, such as our investments in Channel Re and Platinum, and other activities which are directed at non-catastrophe classes of risk. Only business activities that appear in our consolidated underwriting results, such as DaVinci and certain reinsurance transactions, are included in our Reinsurance segment results; our share of the results of Top Layer Re, Channel Re, Starbound, Tower Hill and Platinum are included in the Other category of our segment results.
Our Individual Risk business is written by the Glencoe Group through its principal operating subsidiaries Glencoe and Lantana, which write on an excess and surplus lines basis, and through Stonington and Stonington Lloyds, which write on an admitted basis. As noted above, in our Individual Risk business, we substantially rely on third parties for services including the generation of premium, the issuance of policies and the processing of claims. We actively oversee our third-party partners through an operations review team at Glencoe Group Services, which conducts initial due diligence as well as ongoing monitoring.
In evaluating such new ventures, we seek an attractive return on equity, the ability to develop or capitalize on a competitive advantage, and opportunities that will not detract from our core Reinsurance and Individual Risk operations. Accordingly, we regularly review strategic opportunities and periodically engage in discussions regarding possible transactions, although there can be no assurance that we will complete any such transactions or that any such transaction would contribute materially to our results of operations or financial condition.
We believe the most significant accounting judgment made by management is our estimate of claims and claim expense reserves. Claims and claim expense reserves represent estimates, including actuarial
and statistical projections at a given point in time, of the ultimate settlement and administration costs for unpaid claims and claim expenses arising from the insurance and reinsurance contracts we sell. We establish our claims and claim expense reserves by taking claims reported to us by insureds and ceding companies, but which have not yet been paid (‘‘case reserves’’), adding the costs for additional case reserves (‘‘additional case reserves’’) which represent our estimates for claims previously reported to us which we believe may not be adequately reserved as of that date, and adding estimates for the anticipated cost of claims incurred but not yet reported to us (‘‘IBNR’’).
A 10% change to our reserves at December 31, 2006 would equate to a $209.8 million adjustment to net claims and claim expenses incurred, which represents 27.5% of our net income available to common shareholders for the year ended 2006, and 6.4% of shareholders’ equity at December 31, 2006. During 2007, we intend to develop an analytical approach to quantifying reasonably likely changes to the variability of our key reserving assumptions embedded in our reserving estimation techniques. We will include the results of this analysis in our Annual Report on Form 10-K for the year ended December 31, 2007.
Because of the inherent uncertainties discussed above, we have developed a reserving philosophy which attempts to incorporate prudent assumptions and estimates, and we have generally experienced favorable development on prior year reserves in the last several years. However, there is no assurance that this will occur in future periods.
Because the events from which claims arise under policies written by our property catastrophe reinsurance business are typically prominent, public occurrences such as hurricanes and earthquakes, we are often able to use independent reports as part of our loss reserve estimation process. We also review catastrophe bulletins published by various statistical reporting agencies to assist us in determining the size of the industry loss, although these reports may not be available for some time after an event. In addition to the loss information and estimates communicated by cedants and brokers, we also use industry information which we gather and retain in our REMS© modeling system. The information stored in our REMS© modeling system enables us to analyze each of our policies against a loss and compare our estimate of the loss with those reported by our policyholders. The REMS© modeling system also allows us to compare and analyze individual losses reported by
In general, our property catastrophe reinsurance reserves for our more recent reinsured catastrophic events are subject to greater uncertainty and, therefore, greater potential variability, and are likely to experience material changes from one period to the next. This is due to the uncertainty as to the size of the industry losses from the event, uncertainty as to which contracts have been exposed to the catastrophic event, and uncertainty as to the magnitude of claims incurred by our clients. As our property catastrophe reinsurance reserves age, more information becomes available and we believe our estimates become more certain, although there is no assurance this trend will continue in the future. As seen in the Actual vs. Initial Expected Property Catastrophe Reinsurance Claims and Claim Expenses Reserve Analysis table below, 67.3% of our inception to date claims and claim expenses in our property catastrophe reinsurance unit were incurred in the 2004 and 2005 accident years, due principally to the losses from hurricanes Charley, Frances, Ivan, Jeanne, Katrina, Rita and Wilma. Due to the size and complexity of the losses in these accident years, there still remains significant uncertainty as to the ultimate settlement costs associated with these accident years.
Within our property catastrophe reinsurance business, we seek to review substantially all of our claims and claim expense reserves quarterly. Our quarterly review procedures include identifying events that have occurred up to the latest balance sheet date, determining our best estimate of the ultimate expected cost to settle all claims and administrative costs associated with those new events which have arisen during the reporting period, and reviewing the ultimate expected cost to settle claims and administrative costs associated with those events which occurred during previous periods. This process is judgmental in that it involves reviewing changes in paid and reported losses each period and adjusting our estimates of the ultimate expected losses for each event if there are developments that are different from our previous expectations. If we determine that adjustments to an earlier estimate are appropriate, such adjustments are recorded in the period in which they are identified. During the twelve months ended December 31, 2006, 2005 and 2004, changes to our prior year estimated claims reserves in our property catastrophe reinsurance unit decreased our net income by $13.9 million, reduced our net loss by $61.8 million and increased our net income by $67.2 million, respectively.
The table below summarizes our initial assumptions and changes in those assumptions for claims and claim expense reserves within our property catastrophe reinsurance unit. As discussed above, the key assumption in estimating reserves for our property catastrophe reinsurance unit is our estimate of ultimate claims and claim expenses. The table shows our initial estimates of ultimate claims and claim expenses for each accident year and how these initial estimates have developed over time. The initial estimate of accident year claims and claim expenses represents our estimate of the ultimate settlement and administration costs for claims incurred from catastrophic events occurring during a particular
Actual vs. Initial Expected Property Catastrophe Reinsurance Claims and Claim Expenses Reserve Analysis
As quantified in the table above, since the inception of the Company in 1993 we have experienced $126.6 million of cumulative favorable development on the run-off of our reserves within our property catastrophe reinsurance unit. This represents 3.5% of our inception to date gross claims and claim expenses of $3.5 billion and is calculated based on our estimates of claims and claim expense reserves as of December 31, 2006, compared to our initial estimates of ultimate claims and claim expenses. As described above, given the complexity in reserving for claims and claims expenses associated with catastrophe losses for property catastrophe excess of loss reinsurance contracts, we have experienced development, both favorable and unfavorable, in any given accident year in amounts that exceed our inception to date percentage of 3.5%. For example, our 2002 accident year developed favorably by $79.6 million, which is 51.2% better than our initial estimates of claims and claim expense for the 2002 accident year as estimated as of December 31, 2002, while our 2004 accident year developed unfavorably by $95.1 million, or 12.5%. On a net basis our cumulative favorable or unfavorable development is generally reduced by offsetting changes in our reinsurance recoverables, as well as changes to loss related premiums such as reinstatement premiums, both of which generally move in the opposite direction to changes in our ultimate claims and claim expenses.
Within our specialty reinsurance business unit we write a number of reinsurance lines such as catastrophe exposed workers’ compensation, surety, terrorism, medical malpractice, casualty clash, property per risk and other specialty lines of reinsurance, which we collectively refer to as specialty reinsurance. We offer our specialty reinsurance products principally on an excess of loss basis, as described above with respect to our property catastrophe reinsurance products, and we also provide some proportional coverage. In a proportional reinsurance arrangement (also referred to as quota share reinsurance or pro-rata reinsurance), the reinsurer shares a proportional part of the original premiums and losses of the reinsured. We offer our specialty reinsurance products to insurance companies and other reinsurance companies and provide coverage for specific geographic regions or on a worldwide basis. We expanded our specialty reinsurance business in 2002 and have significantly increased our presence in the specialty reinsurance market since that time.
When initially developing our reserving techniques for our specialty reinsurance coverages, we considered estimating reserves utilizing several actuarial techniques such as paid and incurred development methods. We elected to use the Bornhuetter-Ferguson technique because this method is appropriate for lines of business, such as our specialty reinsurance business, where there is a lack of historical claims experience. This method allows for greater weight to be applied to expected results in periods where little or no actual experience is available, and, hence, is less susceptible to the potential pitfall of being excessively swayed by one year or one quarter of actual paid and/or reported loss data. This method uses initial expected loss ratio expectations to the extent that losses are not paid or reported, and it assumes that past experience is not fully representative of the future. As the Company’s reserves for claims and claim expenses age, and actual claims experience becomes available, this method places less weight on expected experience and places more weight on actual experience. We reevaluate our actuarial reserving techniques on a periodic basis.
catastrophes. We estimate claim reserves for these losses after the event giving rise to these losses occurs, following a process that is similar to our property catastrophe reinsurance unit described above.
management has not made significant changes to its initial estimates of expected ultimate claims and claim expense ratios from one underwriting year to the next. The principal reason for the modest changes from one underwriting year to the next is that the mix of business has changed. For example, the mix of business for the 2006 underwriting year has a lower initial expected ultimate claims and claim expense ratio than in prior years as it is more heavily weighted to business that is expected to produce a lower level of losses.
As each underwriting year has developed, our re-estimated expected ultimate claims and claim expense ratios have decreased. In particular, our re-estimated expected ultimate claims and claim expense ratios decreased significantly between December 31, 2004 and December 31, 2005. This was principally due to our 2005 reserve review, discussed below. During our 2005 reserve review, we further segmented the specialty business with the aim of grouping risks into more homogeneous categories which respond to the evolution of actual exposures. This became possible as the volume of this business increased over the three preceding years. This further segmentation required the selection of loss reporting patterns to be applied to these new groups. We also updated our assumptions for our original loss reporting patterns based on a combination of new industry information and actual experience accumulated over the three preceding years. The assumptions for the new loss reporting patterns were applied to all prior underwriting years. In addition, we made explicit allowances for commuted contracts whereas previously these were considered in the overall reserving assumptions. We also reviewed substantially all of our case reserves and additional case reserves. The result of the foregoing was a decrease in our specialty reinsurance re-estimated ultimate claims and claim expense reserves in 2005. Subsequent to this reserve review, the specialty book of business has continued to perform better than expected. This includes favorable development within the 2006 underwriting year as actual paid and reported losses during 2006 have been less than expected, which has resulted in a reduction in our expected ultimate claims and claim expense ratio for this year. However, there is no assurance that this trend will continue in the future. As noted above, our specialty reinsurance business is characterized by events of low frequency and high severity which results in actual experience that can be significantly better or worse than long term trends or industry standards may imply.
Actual vs. Initial Expected Individual Risk Segment Claims and Claim Expenses Reserve Analysis - Estimated Ultimate Claims and Claim Expenses Ratio
We estimate our valuation allowance by applying specific percentages against each recovery based on our counterparty’s credit rating. The percentages applied are based on historical industry default statistics developed by major rating agencies and are then adjusted by us based on industry knowledge and our judgment and estimates. We also apply case-specific valuation allowances against certain recoveries that we deem unlikely to be collected in full. We then evaluate the overall adequacy of the valuation allowance based on other qualitative and judgmental factors. The valuation allowance recorded against losses recoverable was $21.9 million at December 31, 2006 (2005 - $46.0 million). The reinsurers with the three largest balances accounted for 24.5%, 12.7% and 6.4%, respectively, of our losses recoverable balance at December 31, 2006 (2005 - 17.9%, 14.7% and 11.8%, respectively). The three largest company-specific components of the valuation allowance represented 14.8%, 13.2% and 8.6% of our total valuation allowance at December 31, 2006 (2005 - 39.6%, 18.1% and 10.3%).
In our Individual Risk business, it is often necessary to estimate portions of premiums written from quota-share contracts and by program managers and the related commission expense. Management estimates these amounts based on discussions with ceding companies and program managers, together with historical experience and judgment. Total premiums written estimated in our Individual Risk business at December 31, 2006, 2005 and 2004 were $16.2 million, $57.9 million and $30.1 million, respectively, and total estimated premiums earned were $6.8 million, $10.9 million and $3.5 million, respectively. Total earned commissions estimated at December 31, 2006, 2005 and 2004 were $3.4 million, $4.8 million and $1.1 million, respectively. Management tracks the actual premium received and commissions incurred and compares this to the estimates previously booked. Such estimates are subject to adjustment in subsequent periods when actual figures are recorded. To date such subsequent adjustments have not been material.
Income taxes have been provided in accordance with the provisions of FASB Statement No. 109, Accounting for Income Taxes, on those operations which are subject to income tax. Deferred tax assets and liabilities result from temporary differences between the amounts recorded in the consolidated financial statements and the tax basis of the Company’s assets and liabilities. Such
temporary differences are primarily due to the tax basis discount on unpaid losses and loss expenses, foreign tax credits, deferred policy acquisition costs and net operating loss carryforwards. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance against deferred tax assets is recorded if it is more likely than not that all, or some portion, of the benefits related to deferred tax assets will not be realized.
At December 31, 2006, our net deferred tax asset and valuation allowance were $nil million and $28.9 million, respectively (see Note 13 of the consolidated financial statements for more information). At each balance sheet date, we assess the need to establish a valuation allowance that reduces deferred tax assets when it is more likely than not that all, or some portion, of the deferred tax assets will not be realized. The valuation allowance is based on all available information including projections of future taxable income from each tax-paying component in each tax jurisdiction. Projections of future taxable income incorporate several assumptions of future business and operations that are apt to differ from actual experience. At December 31, 2006, a full valuation allowance of $28.9 million was recorded which reflects management’s assessment that it is more likely than not that the deferred tax asset will not be realized. If we subsequently assess that the valuation allowance is no longer needed, a benefit would be recorded in our consolidated statements of operations in the period in which such determination is made.
(1) In accordance with FAS 128, earnings per share calculations use average common shares outstanding - basic, when in a net loss position.
We generated $761.6 million of net income available to common shareholders in 2006, compared to a $281.4 million net loss attributable to common shareholders and $133.1 million of net income available to common shareholders in 2005 and 2004, respectively. As a result of our net income available to common shareholders in 2006, we generated a 36.3% return on average common equity and our book value per common share plus accumulated dividends increased to $40.50 at December 31, 2006, an increase of 35.9% from the amount at December 31, 2005. In 2005 and 2004, we generated (losses)
Our 2005 financial performance was negatively impacted by hurricanes Katrina, Rita and Wilma, which occurred in the third and fourth quarters of 2005 and resulted in an $891.9 million net negative impact. Our 2005 financial performance was also impacted by $53.0 million of expenses related to our internal review and ongoing investigations into the Company and certain of its present and former executive officers by governmental authorities, including severance and other costs relating to the 2005 departure of our former Chairman and Chief Executive Officer. In addition, 2005 was impacted by several other large natural catastrophes including hurricanes Dennis and Emily, European windstorm Erwin as well as flooding in several European cities. Total insured losses from the 2005 catastrophes are estimated to be the most costly on record for a single year. As one of the largest writers of property catastrophe reinsurance in the world, our financial results are negatively impacted when there are large insured catastrophe losses. Finally, our 2005 financial performance benefited by the $226.9 million net favorable impact as a result of our reserve reviews completed in 2005.
The following table summarizes the net financial statement impact of the 2005 hurricanes, reserve reviews, internal review related costs and 2004 hurricanes described above by segment.
The net negative impact from the hurricanes described above includes the sum of net claims and claim expenses incurred, assumed and ceded reinstatement premiums earned, lost profit commissions, assessment related losses and expenses, and minority interest. Net negative impact is based on
We conduct our business through two reportable segments, Reinsurance and Individual Risk. Our Reinsurance segment provides reinsurance through our catastrophe reinsurance and specialty reinsurance business units and through Ventures. Our Individual Risk segment provides primary insurance and quota share reinsurance.
Below is a summary of the underwriting results and ratios for our Reinsurance segment followed by an analysis of our property catastrophe reinsurance unit and specialty reinsurance unit underwriting results and ratios for the years ended December 31, 2006, 2005 and 2004:
Gross premiums written in our Reinsurance segment increased by $118.2 million to $1,321.2 million for 2006, primarily due to the favorable pricing and terms experienced during our 2006 catastrophe reinsurance renewals. The improved pricing and terms for our 2006 catastrophe reinsurance renewals was principally driven by a hardening property catastrophe reinsurance market following the large catastrophes occurring during 2005. In 2006, we also wrote $114.0 million of gross premiums on behalf of two new fully-collateralized joint ventures which were established to take advantage of the favorable pricing and terms discussed above. The increase in our catastrophe gross premiums written more than offset a significant decline in our specialty reinsurance premium in 2006. For 2005, our gross premiums written increased by $118.1 million to $1,203.0 million. The 2005 increase consisted primarily of premiums written which we view as loss related and attributable to the large catastrophes occurring during 2005. This loss related premium, which includes reinstatement premiums written as a result of large catastrophes, back-up reinsurance coverage provided to companies to replace reinsurance protection lost following a large catastrophe, and reinsurance coverage provided to a company to cover named hurricanes, totaled $153.4 million in 2005 and $57.5 million in 2004. Large catastrophes include hurricanes Katrina, Rita and Wilma in 2005 and hurricanes Charley, Frances, Ivan and Jeanne in 2004.
Our property catastrophe reinsurance gross premiums written continue to be characterized by an increasing percentage of U.S. and Caribbean premium as we have not found similarly attractive
business in Europe or the rest of the world. A significant amount of this U.S. and Caribbean premium provides coverage against windstorms, mainly U.S. Atlantic hurricanes, as well as earthquakes and other natural and man-made catastrophes.
Given the magnitude of the hurricane losses from 2005 and 2004 and due to delays in receiving claims data and the likelihood of receiving new or revised data from our counterparties, the estimates of hurricane losses and related recoveries are likely to change, perhaps materially. Changes in these estimates will be recorded in the periods in which they occur.
Catastrophe Reinsurance Gross Premiums Written - Our catastrophe reinsurance gross premiums written increased by $323.5 million in 2006 to $1,099.1 million, primarily due to the favorable pricing and terms experienced on renewal business as a result of the large catastrophes occurring in 2005. Also in 2006, we wrote $114.0 million of gross premiums on behalf of two new fully-collateralized joint ventures which were established to provide capacity to our clients and take advantage of the favorable pricing and terms discussed above. This premium was fully ceded to these fully-collateralized joint ventures in return for a profit commission and expense override. The $73.6 million increase in catastrophe reinsurance gross premiums written for 2005 when compared to 2004, consisted primarily of premiums written which we view as loss related and attributable to the large catastrophes occurring during 2005. This loss related premium, which includes reinstatement premiums written as a result of large catastrophes, back-up reinsurance coverage provided to companies to replace reinsurance protection lost following a large catastrophe, and reinsurance coverage provided to a company to cover named hurricanes, totaled $115.0 million in 2005 and $57.5 million in 2004. Large catastrophes include hurricanes Katrina, Rita and Wilma in 2005 and hurricanes Charley, Frances, Ivan and Jeanne, in 2004. Excluding this premium, which in the absence of similar large catastrophes we would not expect to recur; our property catastrophe gross premiums written were relatively flat in 2005 compared to 2004.
Our property catastrophe gross premiums written continue to be characterized by an increasing percentage of U.S. and Caribbean premium as we have not found similarly attractive business in Europe or the rest of the world. A significant amount of this U.S. and Caribbean premium provides coverage against windstorms, principally U.S. Atlantic hurricanes, as well as earthquakes and other natural and man-made catastrophes.
Catastrophe Reinsurance Underwriting Results - In 2006, our underwriting results were significantly impacted by the low level of insured catastrophe losses experienced and we generated $472.0 million of underwriting income and recorded a net claims and claims expense ratio of 17.9%, underwriting expense ratio of 17.8% and combined ratio of 35.7%, compared to an underwriting loss of $563.4 million, net claims and claims expense ratio of 188.0%, underwriting expense ratio of 15.3% and combined ratio of 203.3%, in 2005. Our 2006 accident year net claims and claim expenses of $117.5 million were $969.6 million lower than 2005, primarily as a result of $938.9 million in net claims and claim expenses in 2005 related hurricanes Katrina, Rita and Wilma, that did not recur. In addition, 2005 was also impacted by several other large natural catastrophes including hurricanes Dennis and Emily, European windstorm Erwin, as well as flooding in several European cities. In 2004, we incurred a $60.3 million underwriting loss and recorded a net claims and claims expense ratio of 94.7%, underwriting expense ratio of 15.8% and combined ratio of 110.5%. In 2004, hurricanes Charley, Frances, Ivan and Jeanne resulted in $581.8 million of net claims and claim expenses.
(1) Includes gross premiums written ceded from the Individual Risk segment to the Specialty unit of $2.3 million, $1.7 million and $nil for the years ended December 31, 2006, 2005 and 2004, respectively.
Specialty Reinsurance Gross Premiums Written - Our specialty reinsurance gross premiums written decreased by $205.4 million to $222.0 million in 2006, due to several factors including the non-renewal of contracts due to clients in general retaining more risk, and our underwriters non-renewing certain programs where the pricing and terms deteriorated to a point where we no longer found the programs attractive enough for us to write. In addition, our 2006 specialty reinsurance gross premiums written were negatively impacted by $28.3 million of return premium on contracts that were commuted in 2006 which resulted in a corresponding decrease in gross premiums written. The increase in our specialty reinsurance gross premiums written for 2005 was primarily attributable to premiums written due to the large catastrophes occurring during that year. This loss related premium, which primarily includes reinstatement premiums written as a result of large catastrophes, totaled $38.4 million in 2005. Excluding this premium, which in the absence of similar large catastrophes we would not expect to recur, our specialty reinsurance gross premiums written were relatively flat in 2005 when compared to 2004.
Specialty Reinsurance Underwriting Results - Our specialty reinsurance unit experienced improved underwriting performance in 2006 with underwriting income of $164.2 million, a net claims and claim expense ratio of 7.0%, underwriting expense ratio of 24.1% and combined ratio of 31.1%, compared to $101.9 million of underwriting income, a net claims and claim expense ratio of 56.5%, underwriting expense ratio of 18.1% and combined ratio of 74.6%, in 2005. The improvement was due to a lower level of loss activity in the 2006 accident year compared with 2005. Our accident year specialty net
claims and claims expense ratio was 65.4%, 98.7% and 67.1% in 2006, 2005 and 2004, respectively. The increase in 2005 was driven by losses associated with the 2005 large hurricanes.
Our specialty reinsurance unit has experienced favorable development on prior year reserves of $139.2 million, $169.6 million and $46.6 million, in 2006, 2005 and 2004, respectively. The reductions in our prior year reserves in 2006 was principally driven by the application of our formulaic reserving methodology used for this book of business with the decrease being due to actual paid and reported loss activity coming in better than what we anticipated when setting the initial reserve estimates. In addition, within our specialty reinsurance unit $46.0 million of the favorable development was driven by a reduction in carried reserves due to commutations. In 2005, we completed a review of our specialty reinsurance reserves. As a result of this review, we reduced prior year reserves for our specialty reinsurance unit by $129.9 million, which reduced our 2005 net claims and claim expense ratio by 32.3 percentage points. After adjusting for the impact of minority interest, our 2005 net loss was reduced by $117.6 million as a result of the specialty reinsurance reserve review. The 2005 reserve review changes for our specialty reinsurance business were principally due to a reassessment of our estimated loss reporting patterns. Since establishing the specialty reinsurance business unit in 2002, reported claim activity has been less than expected and therefore we have adjusted our estimated loss reporting patterns to reflect this experience. We cannot provide assurance that favorable reserve releases will continue, or that we will not experience unfavorable reserve development in the future.
We define our Individual Risk segment to include underwriting that involves understanding the characteristics of the original underlying insurance policy. Our principal contracts include insurance contracts and quota share reinsurance with respect to risks including: 1) commercial multi-line, which includes commercial property and liability coverage, such as general liability, automobile liability and physical damage, building and contents, professional liability and various specialty products, and multi-peril crop insurance; 2) commercial property, which principally includes catastrophe-exposed commercial property products; and 3) personal lines property, which principally includes homeowners personal lines property coverage and catastrophe exposed personal lines property coverage. We operate through the Glencoe Group of companies, whose principal operating subsidiaries are Glencoe, Stonington, Stonington Lloyds and Lantana.
$173.3 million to $651.4 million in 2005, compared to 2004. This increase was principally a result of an increase in our commercial multi-line business and personal lines property business of $103.0 million and $66.1 million, respectively. The increases in gross premiums written in 2006 and 2005 were principally a result of an increase in business produced through our program managers. Business produced through this distribution source has increased from 36.6% of our Individual Risk gross premiums written in 2004 to 52.7% in 2005 and 63.2% in 2006.
Individual Risk Segment Underwriting Results - For the year, the Company’s Individual Risk segment generated $57.0 million of underwriting income and recorded a net claims and claim expense ratio of 53.5%, an expense ratio of 36.3% and combined ratio of 89.8%, compared to an underwriting loss of $94.8 million, a net claims and claim expense ratio of 84.1%, an expense ratio of 36.7% and combined ratio of 120.8%, in 2005. In 2006, the Individual Risk net claims and claim expense ratio was positively impacted by the absence of large losses as a result of minimal catastrophe activity. In 2005, our Individual Risk net claims and claim expense ratio was negatively impacted by hurricanes Katrina, Rita and Wilma which resulted in $103.5 million of net claims and claim expenses and added 22.7 percentage points to the Individual Risk net claims and claim expense ratio. In addition, the Individual Risk segment recorded an additional $34.4 million of ceded earned premium attributable to the 2005 hurricanes, which negatively impacted the Individual Risk net claims and claim expense ratio by 6.0 percentage points and the expense ratio by 2.6 percentage points.
In 2004, the Individual Risk segment incurred an underwriting loss of $105.8 million and recorded a net claims and claim expense ratio of 89.0%, an expense ratio of 37.9% and combined ratio of 126.9%. The 2004 Individual Risk underwriting results were impacted by the 2004 large hurricanes which resulted in $143.7 million of net claims and claim expenses which added 36.5 percentage points to the net claims and claims expense ratio. In addition, the 2004 hurricanes generated an additional $8.3 million of ceded earned premium, which negatively impacted the Individual Risk net claims and claim expense ratio by 1.9 percentage points and the expense ratio by 0.8 percentage points.
Our underwriting expenses consist of acquisition expenses and operational expenses. Acquisition expenses consist of costs to acquire premiums and are comprised of fees and expenses paid to: 1) program managers, who source primary insurance premiums for us through specialized programs; 2) primary insurers, for whom we write quota share reinsurance; and 3) broker commissions and excise taxes paid to brokers, who source insurance for us on a risk-by-risk basis. Acquisition expenses are driven by contract terms and are generally determined based on a set percentage of premiums. Acquisition expenses as a percentage of net premiums earned have remained relatively consistent at 29.6%, 31.8% and 32.5% in 2006, 2005 and 2004, respectively. Operating expenses consist of compensation and other general and administrative expenses. Our Individual Risk business operates with a limited number of employees and, accordingly, we outsource much of the administration of our Individual Risk business to program managers and third-party administrators. Operating expenses in our Individual Risk segment increased by $14.9 million to $37.2 million in 2006 compared to $22.3 million in 2005, principally due to the growth in our business over the last several years which has resulted in an increase in operating expenses such as compensation, office expenses and related costs as well as an increase in allocated operating expenses.
was a result of a rising interest rate environment during the year which resulted in unrealized losses on our fixed maturity securities, prior to the recognition of other than temporary impairment losses on such securities. Credit related impairment losses totaled $0.1 million in 2006.
The $7.0 million net realized loss on investments in 2005 includes $33.2 million in other than temporary impairment charges compared to $1.2 million in 2004. The increase in other than temporary impairment charges in 2005 was a result of a rising interest rate environment during the year which resulted in unrealized losses on our fixed maturity securities, prior to the recognition of other than temporary impairment losses on such securities. Credit related impairment charges in our fixed maturity investments available for sale were $0.5 million and $0.1 million in 2005 and 2004, respectively.
In October 2001, we formed DaVinciRe and DaVinci with other equity investors. The Company owns a minority economic interest in DaVinciRe; however, because the Company controls a majority of DaVinciRe’s outstanding voting rights, the consolidated financial statements of DaVinciRe are included in the consolidated financial statements of the Company. Minority interest represents the portion of DaVinciRe’s earnings owned by third parties for the years ended December 31, 2006, 2005 and 2004. In 2006, DaVinciRe generated net income which resulted in a minority interest expense to the Company. In 2005 and 2004, DaVinciRe suffered losses which resulted in minority interest income to the Company. Our economic ownership interest in DaVinciRe at December 31, 2006, 2005 and 2004 was approximately 20.5%, 19.7% and 25.3%.
income and therefore be able to recover all or a portion of our net deferred tax asset, we will reduce the valuation allowance in the period in which we make such determination. There will be a corresponding increase in net income at such time, which may be material to the period in which such determination is made. As of December 31, 2006, the valuation allowance against our net deferred tax asset was $28.9 million.
RenaissanceRe is a holding company, and we therefore rely on dividends from our subsidiaries and investment income to make principal and interest payments on our debt and capital securities and to make dividend payments to our preference and common shareholders.
Cash flows from operating activities for 2006 were $813.3 million, which principally consisted of our net income of $797.1 million (prior to dividends on preference shares), a $144.2 million increase in the minority interest in the undistributed net income of DaVinciRe and an increase in reinsurance balances payable of $102.8 million, offset by decreases to net reserves for claims and claim expenses of $145.1 million, an increase in ceded reinsurance balances receivable of $76.8 million, and an increase in premiums receivable of $56.0 million. Our 2006 cash flows from operations were primarily used to increase our short term investments.
We have generated cash flows from operations over the three year period 2004-2006 significantly in excess of our operating commitments. Because a large portion of the coverages we provide typically can produce losses of high severity and low frequency, it is not possible to accurately predict our future cash flows from operating activities. As a consequence, cash flows from operating activities may
fluctuate, perhaps significantly, between individual quarters and years. In addition, given the severity of losses incurred in 2005 from the large catastrophes, many of which remain unpaid at December 31, 2006, it is likely that we will experience a significant amount of paid claims in 2007 which could result in us having reduced or negative cash flows from operations.
We believe the most significant accounting judgment made by management is our estimate of claims and claim expense reserves. Claims and claim expense reserves represent estimates, including actuarial and statistical projections at a given point in time, of the ultimate settlement and administration costs for unpaid claims and claim expenses arising from the insurance and reinsurance contracts we sell. We establish our claims and claim expense reserves by taking claims reported to us by insureds and ceding companies, but which have not yet been paid (‘‘case reserves’’), adding the costs for additional case reserves (‘‘additional case reserves’’) which represent our estimates for claims previously reported to us which we believe may not be adequately reserved as of that date, and adding estimates for the anticipated cost of claims incurred but not yet reported to us (‘‘IBNR’’).
Our estimates of claims and claim expense reserves are not precise in that, among other matters, they are based on predictions of future developments and estimates of future trends and other variable factors. Some, but not all, of our reserves are further subject to the uncertainty inherent in actuarial methodologies and estimates. Because a reserve estimate is simply an insurer’s estimate at a point in time of its ultimate liability, and because there are numerous factors which affect reserves and claims payments but cannot be determined with certainty in advance, our ultimate payments will vary, perhaps materially, from our estimates of reserves. If we determine in a subsequent period that adjustments to our previously established reserves are appropriate, such adjustments are recorded in the period in which they are identified. During the twelve months ended December 31, 2006, 2005 and 2004, changes to prior year estimated claims reserves increased our net income by $136.6 million, reduced our net loss by $241.5 million and increased our net income by $140.3 million, respectively.
A 10% change to our reserves at December 31, 2006 would equate to a $209.8 million adjustment to net claims and claim expenses incurred, which represents 27.5% of our net income available to common shareholders for the year ended December 31, 2006, and 6.4% of shareholders’ equity at December 31, 2006. During 2007, we intend to develop an analytical approach to quantifying reasonably likely changes to the variability of our key reserving assumptions embedded in our
reserving estimation techniques. We will include the results of this analysis in our Annual Report on Form 10-K for the year ended December 31, 2007.
Our total capital resources at December 31, 2006 and 2005 were as follows:
(1) See below for a discussion of post December 31, 2006 redemption notices that impact our preference shares and subordinated obligation to Capital Trust.
Our Capital Trust has issued $100.0 million aggregate liquidation amount of mandatorily redeemable capital securities (‘‘Capital Securities’’) which pay cumulative cash distributions at an annual rate of 8.54%, payable semi-annually. During 2006 and 2005, RenaissanceRe did not repurchase any of the Capital Securities. RenaissanceRe has repurchased an aggregate of $15.4 million of the Capital Securities since their issuance in 1997. The sole asset of the Capital Trust consists of our junior subordinated debentures. The indenture relating to these junior subordinated debentures contains certain covenants, including a covenant prohibiting us from the payment of dividends if we are in default under the indenture. We were in compliance with all of the covenants of the indenture at December 31, 2006 and 2005. The Capital Securities mature on March 1, 2027.
Under the terms of certain reinsurance contracts, our insurance and reinsurance subsidiaries and joint ventures are required to provide letters of credit to reinsureds in respect of reported claims and/or unearned premiums. Our principal letter of credit facility is a syndicated secured facility which accepts as collateral shares issued by our subsidiary RIHL. Our participating operating subsidiaries and our managed joint ventures have pledged (and must maintain as pledged) RIHL shares issued to them with a sufficient collateral value to support their respective obligations under the facility, including reimbursement obligations for outstanding letters of credit. The participating subsidiaries and joint ventures have the option to post alternative forms of collateral. In addition, for liquidity purposes, in order to be permitted to pledge RIHL shares as collateral, each participating subsidiary and joint venture must maintain additional unpledged RIHL shares that have a net asset value at least equal to 15% of its facility usage, and RIHL shares having an aggregate net asset value equal to at least 15% of the net asset value of all outstanding RIHL shares must remain unencumbered. In the case of a default under the facility, or in other circumstances in which the rights of our lenders to collect on their collateral may be impaired, the lenders may exercise certain remedies under the facility agreement, in accordance with and subject to its terms, including redemption of pledged shares and conversion of the collateral into cash or eligible marketable securities. The redemption of shares by the collateral agent takes priority over any pending redemption of unpledged shares by us or other holders. In April 2006, the reimbursement agreement was amended to, among other things, (i) extend the term of the agreement to April 27, 2007; (ii) change the total commitment thereunder from
$1.75 billion to $1.7 billion; and (iii) provide for the potential increase of the total commitment to up to $2.0 billion if certain conditions are met. Effective June 30, 2006, the total commitment was increased to $1.725 billion with the addition of a new bank to the lending group. At February 12, 2007, we had $1.149 billion of letters of credit with effective dates on or before December 31, 2006 outstanding under the facility and total letters of credit outstanding under all facilities of $1.187 billion.
Our subsidiary, Stonington, has provided a letter of credit in the amount of $30.7 million to one counterparty which is secured by cash and eligible marketable securities. In connection with our Top Layer Re joint venture, we have committed $37.5 million of collateral to support a letter of credit and are obligated to make a mandatory capital contribution of up to $50.0 million in the event that a loss reduces Top Layer Re’s capital and surplus below a specified level.
In the fourth quarter of 2005 our consolidated joint venture, DaVinciRe, raised $320.6 million of equity capital. The capital was funded by new and existing investors, including $50.0 million contributed by us. In conjunction with the transaction, we modified the DaVinciRe shareholders agreement and provided new and existing shareholders with new rights. The second amended and restated shareholders agreement provides DaVinciRe shareholders, excluding us, with certain redemption rights, which allow each shareholder to notify DaVinciRe of such shareholder’s desire for DaVinciRe to repurchase up to half of such shareholder’s aggregate number of shares held. Any share repurchases are subject to certain limitations such as limiting the aggregate of all share repurchase requests to 25% of DaVinciRe’s capital in any given year and subject to ensuring all applicable regulatory requirements are met. If the total shareholder requests exceed 25% of DaVinciRe’s capital, the number of shares repurchased will be reduced among the requesting shareholders pro rata, based on the amounts desired to be repurchased. Shareholders must notify DaVinciRe before March 1 of each year, commencing March 1, 2007, if they desire to have DaVinciRe repurchase shares. The repurchase price will be GAAP book value as of the end of the year in which the shareholder notice is given, and the repurchase will be effective as of such date. Payment will be made by April 1 of the following year, following delivery of the audited financial statements for the year in which the repurchase was effective. The repurchase price will be subject to a true-up for development on outstanding loss reserves after settlement of all claims relating to the applicable years.
In December 2006, A.M. Best affirmed the financial strength ratings (‘‘FSR’’) of ‘‘A’’ (Excellent) and upgraded the issuer credit ratings (‘‘ICR’’) to ‘‘a+’’ from ‘‘a’’ of Renaissance Reinsurance and Renaissance Europe. Concurrently, A.M. Best upgraded the ICR to ‘‘bbb+’’ from ‘‘bbb’’, the debt ratings on senior notes to ‘‘bbb+’’ from ‘‘bbb’’ and preferred stock to ‘‘bbb−’’ from ‘‘bb+’’of RenaissanceRe. A.M. Best also upgraded the indicative debt ratings for securities available under shelf registration for RenaissanceRe for senior notes to ‘‘bbb+’’from ‘‘bbb’’, subordinated notes to ‘‘bbb’’ from ‘‘bbb−’’ and preferred stock to ‘‘bbb−’’ from ‘‘bb+’’. In addition, A.M. Best assigned an indicative debt rating of ‘‘bbb−’’ to the Series D Preference Shares issued by RenaissanceRe in December 2006. The outlook for all ratings has been revised to positive from stable.
In October 2006, A.M. Best affirmed the FSR of ‘‘A’’ (Excellent) and the ICR of ‘‘a’’ for DaVinci. They also affirmed the FSR of ‘‘A−’’ (Excellent) and ICR of ‘‘a−’’ for the operating subsidiaries of the Glencoe Group.
While the ratings of Renaissance Reinsurance remain among the highest in our business, adverse ratings actions could have a negative effect on our ability to fully realize current or future market opportunities. Moreover, if our ratings are reduced from their current levels by A.M. Best, Moody’s or Standard & Poor’s, we believe our competitive position in the insurance industry would suffer and it would be more difficult for us to market our products. A significant downgrade could result in a substantial loss of business as ceding companies and brokers that place such business move to other reinsurers with higher ratings. We can not give any assurance regarding whether or to what extent the rating agencies may downgrade our ratings. In addition, it is increasingly common for our reinsurance contracts to contain provisions permitting our clients to cancel coverage pro-rata if our relevant operating subsidiary is downgraded below a certain rating level. Whether a client would exercise this right would depend, among other factors, on the reason for such a downgrade, the extent of the downgrade, the prevailing market conditions and the pricing and availability of replacement reinsurance coverage. Therefore, in the event of a further downgrade, it is not possible to predict in advance the extent to which this cancellation right would be exercised, if at all, or what effect such cancellations would have on the financial condition or future operations, but such effect potentially could be material. To date we are not aware that we have experienced such a cancellation.
In the future, we may return capital to our shareholders through share repurchases. In August 2003, the Board authorized a share repurchase program of $150.0 million. This amount includes the remaining amounts available under prior authorizations. During 2006, $nil (2005 - $0.7 million) of shares were repurchased under this program. In the future, we may purchase shares under our current authorization, or increase the size of our repurchase program. Any such determination will be subject to market conditions and other factors.
At December 31, 2006, we held investments totaling $6.3 billion, compared to $5.3 billion at December 31, 2005, with net unrealized appreciation included in accumulated other comprehensive income of $25.2 million at December 31, 2006, compared to $4.8 million at December 31, 2005. Our investment guidelines, which are approved by our Board, stress preservation of capital, market liquidity, and diversification of risk. Notwithstanding the foregoing, our investments are subject to market-wide risks and fluctuations, as well as to risks inherent in particular securities.
The large majority of our investments consist of highly rated fixed income securities. We also have an allocation to other investments, including hedge funds, private equity partnerships and other investments. At December 31, 2006, these other investments totaled $592.8 million or 9.3% (2005 - $586.5 million or 11.1%) of our total investments.
At December 31, 2006, our fixed maturities available for sale and short term investment portfolio had a dollar-weighted average credit quality rating of AA (2005 - AA). At December 31, 2006, our average yield to maturity on our fixed maturity investments available for sale and our short term investment portfolio was 5.3% (2005 - 4.6%), before investment expenses. At December 31, 2006, our non-investment grade fixed maturity investments available for sale totaled $77.9 million or 2.5% of our fixed maturity investments available for sale, and at December 31, 2005 our non-investment grade fixed maturity investments available for sale totaled $70.1 million or 2.4% of our total fixed maturity investments available for sale. In addition, within our other investments category we have several funds that invest in non-investment grade fixed income securities. At December 31, 2006, the funds that invest in non-investment grade fixed income securities totaled $113.3 million compared to $141.3 million at December 31, 2005.
• Changes in the overall interest rate environment can expose us to ‘‘prepayment risk’’ on our mortgage-backed investments. When interest rates decline, consumers will generally make
• Our investments in debt securities of other corporations are exposed to losses from insolvencies of these corporations, and our investment portfolio can also deteriorate based on reduced credit quality of these corporations.
• Within our other investments category, we have several funds that invest in non-investment grade fixed income securities as well as securities denominated in foreign currencies. These investments expose us to losses from insolvencies and other credit related issues. We are also exposed to fluctuations in foreign exchange rates that may result in realized losses to us if our exposures are not hedged or if our hedging strategies are not effective.
The following table summarizes the composition of the fair value of our fixed maturity investments available for sale at the dates indicated by ratings as assigned by S&P, or Moody’s and/or other rating agencies when S&P ratings were not available.
The Company’s fixed maturity investments are classified as available for sale and are reported at fair value. The net unrealized appreciation or depreciation on these investments is included in accumulated other comprehensive income. Net investment income includes interest income together with amortization of market premiums and discounts and is net of investment management and custody fees. The amortization of premium and accretion of discount for fixed maturity investments is computed using the effective yield method. The fair values of our fixed maturity investments are based on quoted market prices, or when such prices are not available, by reference to broker or underwriter bid indications and/or internal pricing valuation techniques.
Realized gains or losses on the sale of fixed maturity investments are determined using the average cost method and include adjustments to the cost for declines in value that are considered to be other than temporary. The Company routinely assesses whether declines in the fair value of its fixed maturity investments below cost represent impairments that are considered other than temporary. There are several factors that are considered in the assessment of impairment of a security, which include (i) the time period during which there has been a significant decline below cost, (ii) the extent of the decline below cost, (iii) the Company’s intent and ability to hold the security, (iv) the potential for the security to recover in value, (v) an analysis of the financial condition of the issuer and (vi) an analysis of the collateral structure and credit support of the security, if applicable. Where the Company has determined that there is an other than temporary decline in the fair value of the security, the cost of the security is written down to its fair value and the unrealized loss at the time of the determination is charged to income.
The fair value of certain of our other investments is generally established on the basis of the net valuation criteria established by the managers of such investments. These net valuations are determined based upon the valuation criteria established by the governing documents of such investments. Such valuations may differ significantly from the values that would have been used had ready markets existed for the shares, partnership interests or notes. Many of the investments are subject to restrictions on redemptions and sale which are determined by the governing documents and limit our ability to liquidate these investments in the short term. Due to a lag in the valuations reported by the fund managers, the majority of our hedge fund and private equity partnership valuations are reported on a one month or one quarter lag. The fair value of catastrophe bonds are based on quoted market prices, or when such prices are not available, by reference to broker or underwriter bid indications. Interest income, income distributions and realized and unrealized gains and losses on other investments are included in net investment income and totaled $65.7 million (2005 - $59.3 million, 2004 - $46.9 million) of which $30.1 million (2005 - $28.8 million, 2004 - $24.4 million) was related to net unrealized gains.
We have committed capital to private equity partnerships of $340.2 million, of which $209.6 million has been contributed at December 31, 2006.
Investments in other ventures, under equity method includes our investment in Channel Re of $160.9 million (2005 - $142.1 million). We invested $119.7 million in 2004, representing a 32.7% ownership interest in Channel Re. Investments in other ventures, under equity method also includes an investment in Top Layer Re of $26.6 million (2005 - $26.3 million) and in Tower Hill of $11.0 million (2005 - $10.3 million). We originally invested $13.1 million and $10.0 million in Top Layer Re and Tower Hill, respectively, representing a 50.0% and 28.6% ownership, respectively. The equity in the earnings of Tower Hill and Channel Re are reported one quarter in arrears. Investments in other ventures, under equity method also includes an investment in Starbound of $28.6 million. We initially invested $7.5 million in Starbound in May 2006, and in December 2006, the Company purchased additional shares from existing shareholders of Starbound for consideration of $21.3 million, representing a 17.8% ownership interest at December 31, 2006. In addition, $2.3 million of other intangible assets generated upon the purchase of the additional shares of Starbound are included in other assets. Our investments in other ventures are considered illiquid in nature.
Our investments include an interest in RIHL. RIHL was formed to enhance administrative efficiency and take advantage of the increased benefits and reduced costs ordinarily associated with the
Under the terms of certain reinsurance contracts, certain of our subsidiaries and joint ventures are required to provide letters of credit to reinsureds in respect of reported claims and/or unearned premiums. We maintain a facility which, as of December 31, 2006, makes available to our operating subsidiaries and joint ventures letters of credit having an aggregate face amount not to exceed $1.725 billion. To support the facility, our participating operating subsidiaries and joint ventures have pledged RIHL shares and other securities owned by them as collateral. At February 12, 2007, we had $1.149 billion of letters of credit with effective dates on or before December 31, 2006 outstanding under our $1.725 billion letter of credit facility and $1.187 billion of total letters of credit outstanding under all facilities.
Prior to adopting FAS 123(R), we accounted for stock-based compensation under the fair value recognition provisions of FAS 123 with effect from January 1, 2003 for all stock-based employee compensation granted, modified or settled after January 1, 2003 under the prospective method described in FASB Statement No. 148, Accounting for Stock-Based Compensation - Transition and
In February 2007, the FASB issued FASB Statement No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (‘‘FAS 159’’). FAS 159 permits an entity to choose, at specified election dates, to measure eligible financial instruments and certain other items at fair value that are not currently required to be measured at fair value. An entity shall report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. Upfront costs and fees related to items for which the fair value option is elected shall be recognized in earnings as incurred and not deferred. FAS 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between entities that choose different measurement attributes for similar types of assets and liabilities. FAS 159 is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. An entity may adopt this standard and elect the fair value option for existing eligible items as of January 1, 2007, provided that the choice to adopt early shall be made after the issuance of this standard, but within 120 days of the beginning of the fiscal year of adoption. At the effective date, an entity may elect the fair value option for eligible items that exist at that date. The entity shall report the effect of the first remeasurement to fair value as a cumulative-effect adjustment to the opening balance of retained earnings. We are currently evaluating the potential impact of FAS 159 on the Company’s statements of operations and financial condition when adopted.
For 2007, we are currently projecting an approximate 5% decline in our property catastrophe gross premiums written, compared to our 2006 property catastrophe gross premiums written, net of premium written on behalf of our fully-collateralized joint ventures, Starbound Re and Tim Re and net of premium assumed from our Individual Risk segment. The market for our catastrophe reinsurance products is dynamic and changes in state-sponsored catastrophe funds such as the FHCF noted above, increased or decreased catastrophe loss activity, and changes in the amount of capital in the industry, can result in significant changes to the pricing, policy terms and demand for our catastrophe reinsurance contracts over a relatively short period of time. As a consequence, our estimate of catastrophe gross premiums written for 2007 is subject to material change.
We have established our Ventures unit to facilitate strategic investments. We may consider opportunities in other areas of the insurance and reinsurance markets, or in other financial markets, either through organic growth, the formation of new joint ventures, or the acquisition of other companies or books of business of other companies. We are currently in the process of reviewing certain opportunities and periodically engage in discussions regarding possible transactions, although there can be no assurance that we will complete any such transactions or that any such transaction would contribute materially to our results of operations or financial condition.
(2) On January 25, 2007, the Capital Trust called for the redemption of all our issued and outstanding Capital Securities. The redemption is expected to take place on March 1, 2007.
(3) The interest on this facility is based on a spread above LIBOR. We have reflected the interest due in 2007 through 2011 based upon the current interest rate on the facility.
(4) On January 15, 2007, we redeemed all of our outstanding Series A Preference Shares, plus accrued dividends.
(6) We caution the reader that the information provided above related to estimated future payment dates of our reserves for claims and claim expenses is not prepared or utilized for internal purposes and that we currently do not estimate the future payment dates of claims and claim expenses. Because of the nature of the coverages that we provide, the amount and timing of the cash flows associated with our policy liabilities will fluctuate, perhaps significantly, and therefore are highly uncertain. In order to estimate the payment dates of our contractual obligations for our reserve for claims and claim expense, we have used the work of an actuarial firm. This firm has based its estimate of future claim payments upon benchmark payment patterns constructed internally, drawing upon available relevant sources of loss and allocated loss adjustment expense development data. These benchmarks are revised periodically as new trends emerge. We believe that it is likely that this benchmark data will not be predictive of our future claim payments and that material fluctuations can occur due to the nature of the losses which we insure and the coverages which we provide.