The following is a discussion and analysis of our results of operations for the years ended December 31, 2010, 2009 and 2008 and our financial condition at December 31, 2010 and 2009. This should be read in conjunction with the Consolidated Financial Statements and related notes included in Item 8 of this report. Tabular dollars are in thousands, except per share amounts. Amounts in tables may not reconcile due to rounding differences.
Net income available to common shareholders of $820 million, or $6.74 per share basic and $6.02 diluted
Estimated pre-tax net losses of $118 and $138 million for the Chilean and New Zealand earthquakes, respectively
Reserve for losses and loss expenses of $7.0 billion and reinsurance recoverable of $1.6 billion
Common shareholders’ equity of $5.1 billion; diluted book value per common share of $39.37
Repurchased 21.8 million common shares under the repurchase plan authorized by our Board of Directors for total cost of $699 million; remaining authorization of $593 million at December 31, 2010
Strong liquidity, with 71% or $8.9 billion of our cash and investment portfolio invested in investment-grade, intermediate maturity fixed income holdings (excluding restricted investments) and cash expected to be available within one to three business days
We are a Bermuda-based global provider of specialty lines insurance and treaty reinsurance products with operations in Bermuda, the United States, Europe, Singapore, Canada and Australia. Our underwriting operations are organized around our two global underwriting platforms, AXIS Insurance and AXIS Re. Our strategy is to leverage our expertise, experience and relationships to expand our business globally. We are focused on organic growth, which we have supplemented with small acquisitions, while managing a portfolio of diversified and attractively priced risks. Our execution on this strategy in 2010 included:
obtained authorization from our Board of Directors for a new $750 million common share repurchase program, providing us with further capital management capabilities, and repurchased 21.8 million common shares for $699 million; and
Underwriting results in our insurance segment benefited from a substantially reduced level of claim activity in our credit and political risk lines, as well as the continued consideration of our own loss experience in establishing our
The reduction in underwriting income for our reinsurance segment was primarily the result of $246 million net losses incurred (net of related reinstatement premiums) as a result of the Chilean and New Zealand earthquakes in February and September 2010, respectively. In addition, we recognized net losses for a number of other notable 2010 weather-related events, including the first quarter Australian storms and European Windstorm Xynthia, numerous U.S. storms throughout the year, and the fourth quarter Australian floods. In contrast, catastrophe activity was notably less significant in 2009. Partially offsetting this increase in natural catastrophe losses was a lower level of claims activity in our trade credit and bond line of business in 2010.
2009 versus 2008: Total underwriting income increased $218 million, or 71%, compared to 2008. Overall, the increase was driven by lower catastrophe losses. In particular, the North Atlantic hurricane season was benign in 2009 compared to 2008, which included net losses incurred of $384 million, net of related earned reinstatement premiums, on Hurricanes Ike and Gustav. Approximately three-quarters of these hurricane losses were incurred within our reinsurance segment.
Unprecedented volatility and turmoil in the global financial markets during 2008 and 2009 led to impairment charges on our available-for-sale investments of $78 million and $337 million, respectively. The 2009 amount included a $263 million OTTI charge on a portfolio of medium-term notes (“MTNs”), where we no longer expected to fully recover amortized costs based on updated cash flow projections. The significant recovery in global financial markets since March 2009 resulted in notably improved valuations for fixed maturities and equities, a portion of which we realized in 2010.
Looking forward to 2011, we expect to see a continuation of challenging rate conditions in the insurance marketplace. As a result, gross premiums written are expected to be flat to modestly up. We expect any growth to be driven by our newer product lines and geographies, including AXIS Global Accident & Health. With respect to our reinsurance segment and based on our experience at the significant January 1 renewal date, we expect rates to be flat to marginally down. We continue to monitor market rates and conditions and may adjust our business mix based on opportunities we see.
(2) Operating ROACE is calculated by dividing operating income for the period by the average common shareholders’ equity determined by using the common shareholders’ equity balances at the beginning and end of the period. Operating ROACE is a non-GAAP financial measure, as defined in SEC Regulation G. See ‘Non-GAAP Financial Measures’ for additional information and a reconciliation to the nearest GAAP financial measure (ROACE).
In addition to the changes noted for operating ROACE above, ROACE also includes net realized gains and losses (including OTTI charges). As a result, our 2010 return improved relative to 2009 primarily due to the substantial reduction in OTTI charges.
We consider DBV per common share to be an appropriate measure of our returns to common shareholders, as we believe growth in our book value on a diluted basis will ultimately translate into growth in our stock price. Our DBV per common share increased 17% in 2010. Factors contributing to this increase include: (1) net income available to common shareholders of $820 million, (2) an overall improvement in valuations for our available-for-sale securities, as global financial markets continued to improve and (3) the execution of common share repurchases at a discount to book value. The increase in 2009 was primarily driven by the net increase in the fair value of our investment portfolio due to financial market improvements and our net income available to common shareholders of $461 million.
The following table provides our group underwriting results for the periods indicated. Underwriting income is a measure of underwriting profitability that takes into account net premiums earned and other insurance related income as revenues and net losses and loss expenses, acquisition costs and underwriting-related general and administrative costs as expenses.
2009 versus 2008: Growth in consolidated gross premium written was driven by our reinsurance segment, reflecting improved market conditions and the select expansion of our business. Market conditions in our insurance segment generally improved and the segment also benefited from certain growth opportunities, particularly within professional lines business. However, gross premiums written for the segment as a whole declined due to limited underwriting opportunities for credit and political risk business, as well as our decision to reduce peak zone catastrophe exposures in the first half of 2009, which particularly impacted property related lines.
The increase in the ceded premium ratio for our insurance segment reflected a combination of business mix changes and rate increases on our property reinsurance program.
2009 versus 2008: Consolidated net premiums earned increased, driven by the growth in our reinsurance business discussed above. Net premiums earned in our insurance segment decreased following the previously mentioned exposure reductions. This was partially offset by the accelerated recognition of certain credit and political risk policies in 2009 due to the actual and anticipated exhaustion of exposure on certain loss impacted policies.
For our medium-tail business, and in particular our professional lines insurance and reinsurance business, our historical loss experience on prior accident years has generally been lower than the loss ratios we initially established. In recognition of the increasing maturity and credibility of our own loss experience, we assigned increased weight to our own loss experience when establishing our current accident year loss ratios for this business in 2010, with a corresponding reduction in the weight assigned to industry data. We also took into account the recovery from the global financial crisis. This, therefore, led to lower current accident year loss ratios on this business for 2010.
Our estimates of net losses in relation to the Chilean and New Zealand earthquakes were derived from ground-up assessments of our individual contracts and treaties in the affected regions and are consistent with our market shares in the regions. As part of our estimation process, we also considered current industry insured loss
2009 versus 2008: The 11.5 percentage point reduction in our current accident year loss ratio was driven by lower catastrophe related losses relative to 2008. In particular, the North Atlantic hurricane season was benign in 2009, while we recognized pre-tax net losses of $408 million, or 15.2 percentage points, in relation to Hurricanes Ike and Gustav in 2008. This was partially offset by the elevated loss activity on credit and political risk insurance and trade credit and bond reinsurance business previously noted.
Our net favorable prior period development was the result of several underlying reserve developments on prior accident years, identified during our quarterly reserve review process. The following table provides a breakdown of net prior period reserve development by segment:
The following sections provide further details on prior year reserve development by segment, line of business and accident year.
available information. Partially offsetting this amount was $36 million in net favorable prior period reserve development on the 2006 through 2008 accident years, in recognition of better than anticipated loss emergence on our confiscation, expropriation, nationalization and deprivation (“CEND”) and credit business.
In 2008, we recognized $202 million of net favorable prior period reserve development, the principal components of which were:
$94 million of net favorable prior period reserve development on property business, the majority of which emanated from the 2007 and 2006 accident years and related to better than expected loss emergence.
$27 million of net favorable prior period reserve development on marine business, spanning several accident years and primarily relating to better than expected loss emergence.
$65 million of net favorable prior period reserve development on our credit and political risk business, driven by better than expected loss emergence.
$6 million of net adverse development on professional lines business. This was driven by adverse development of $37 million on the 2007 accident year, partially offset by favorable development of $32 million on the 2003 and 2004 accident years.
In 2010, we recognized $195 million of net favorable prior period reserve development, the principal components of which were:
$65 million of net favorable prior period reserve development on property business, with $54 million relating to per risk business and $11 million relating to pro-rata business. Of the total amount, $43 million emanated from the 2007 through 2009 accident years and resulted from better than expected loss emergence and a further $16 million emanated from the 2005 accident year and was largely due to a favorable court judgment associated with one particular claim.
$155 million of net favorable prior period reserve development on catastrophe and property business largely consisting of:
$65 million of net favorable prior period reserve development on property business, primarily related to the 2008 and 2007 accident years and emanating from per risk business ($42 million) and pro-rata business ($23 million). This development was largely the result of better than expected loss emergence. In addition, we accelerated the loss development profile for our per risk business, based on our review of historical data. The development on the 2008 accident year included a $6 million reduction in our estimate for Hurricanes Ike and Gustav, due to a reduction in reported losses.
$19 million of net favorable prior period reserve development on crop business, primarily relating to the 2008 accident year and reflecting better than expected loss emergence.
In 2008, we recognized $174 million of net favorable prior period reserve development, the principal components of which were:
$84 million of net favorable prior period reserve development on property business, primarily related to the 2005 through 2007 accident years and emanating from per risk business ($57 million) and pro-rata business ($27 million). The recognition of this net favorable development was driven by better than expected loss emergence.
$78 million of net favorable prior period reserve development on catastrophe business, emanating primarily from the 2007 and 2006 accident years. This development included $19 million related to workers compensation catastrophe business and was largely the result of better than expected loss emergence.
2010 versus 2009: The 8% increase in gross premiums written was led by opportunities in the U.S. property market and select new business opportunities in the onshore energy market. The increase in professional lines premiums largely reflected select new business opportunities and the continued build-out of the platform in Europe, Australia and Canada. Rate increases on offshore energy business resulting from the Deepwater Horizon event, as well as increases in our share of certain policies and select new business opportunities resulted in increased marine premiums.
2010 versus 2009: Net premiums earned on our credit and political risk line for 2010 included a $12 million reduction in connection with the settlement of prior accident year claims, while the comparative 2009 figure included the accelerated recognition of $50 million of premium due to the actual and anticipated exhaustion of exposure on certain loss impacted policies. Excluding the impact of these adjustments in both periods, net premiums earned for the segment increased 10% during 2010. This increase was primarily reflective of the second quarter 2010 reinsurance purchasing change, although the impact was somewhat muted due to the change being effective midway through the year. Increased gross premiums written also contributed to the higher net premiums earned.
2009 versus 2008: The decrease in net premiums earned primarily reflected the 10% reduction in net premiums written, although the rate of reduction was less accelerated. This was partially due to the continued earning of credit and political risk business written in prior years; these policies typically provide multi-year coverage and, therefore, earn over a number of years. Net premiums earned on credit and political risk business for 2009 was also impacted by the $50 million accelerated recognition discussed above.
The 1.8 percentage point decrease in our current accident year loss ratio was the net result of several factors. The most significant drivers for the decrease were as follows:
These factors were partially offset by increased claims activity on the credit component of credit and political risk business, emanating from the global financial crisis. The current accident year loss ratio on our credit and political risk business was 133% for 2009, compared to 38% for 2008. This contributed to an additional 14.6 points to the overall current accident year loss ratio for the insurance segment, relative to the prior year. The 2009 ratio was impacted by estimated losses for one peak credit insurance exposure, Blue City Investments 1 Limited; we concluded the related settlement and policy cancellation during 2010.
Acquisition Cost Ratio: The increase in our acquisition cost ratio during 2010 primarily reflected the impact of the previously mentioned changes in our property and professional lines reinsurance purchasing. Acquisition costs in 2008 benefited from non-recurring adjustments to sliding scale commissions arising out of net favorable prior period reserve development on our professional lines business.
2010 versus 2009: While premiums written for the segment were comparatively stable, there were variances for certain lines of business. Our motor premiums benefited from significant new business in the first quarter of 2010, as we increased our participation in select European markets including the U.K. Our trade credit and bond line of business grew as the result of new Latin American surety business. Proportional premium estimate adjustments also impacted trade credit and bond gross premiums written; we recognized net adverse estimate revisions of
The trade credit and bond reinsurance market in Continental Europe experienced significant dislocation at the January 1, 2009 renewal and we were able to strengthen our market position at improved pricing, terms and conditions. In addition, we entered the bond reinsurance market in Latin America at the July 1, 2009 renewal. The increase in catastrophe gross premiums written was driven by a combination of rate increases in the U.S. property catastrophe market together with new business opportunities and an increase in our participation on certain renewals; our 2008 balance included catastrophe reinstatement premiums of $28 million in connection with Hurricanes Ike and Gustav. The increase in property premiums in 2009 primarily reflected an improvement in rates and some new property pro rata business. Gross premiums written on our engineering and crop business (included in “Other”) decreased during 2009, primarily reflecting exposure reductions amidst less favorable market conditions.
The increase in net premiums earned in 2010 related to the aforementioned increased trade credit and bond and motor writings, while the 2009 increase reflected gross premium written growth across several lines of business, in particular professional lines, trade credit and bond and liability business.
The 19.0 ratio point decrease in our current accident year loss ratio was the net result of several factors. The most significant drivers of the decrease were:
The incorporation of more of our own historical loss experience within short-tail lines of business. Given that this experience has generally been better than we expected, this reduced our current accident year loss ratios on several lines of business relative to 2008.
Increased loss activity on trade credit and bond business emanating from the global financial crisis. The current accident year loss ratio on credit and bond business in 2009 was 17 points higher than in 2008.
Interest Expense and Financing Costs: Interest expense primarily relates to interest due on our senior notes and increased during 2010 following the issuance, on March 23, 2010, of $500 million aggregate principal amount of ten-year senior notes with a 5.875% coupon. See Item 8, Note 10(a) to the Consolidated Financial Statements for further details.
During 2010, our income tax expense included a $14 million reduction in the valuation allowance associated with our deferred tax assets arising from realized U.S. capital losses. We realized net U.S. capital gains in 2010 that will allow us to utilize a portion of those capital loss tax-carryforwards. As a result, the effective tax rate for our U.S. operations declined. Partially offsetting this was the establishment of a $6 million valuation allowance related to operating loss tax-carryforwards in other jurisdictions. The increase in our effective rate in 2009 relative to 2008 was driven by an increase in the proportion of total pre-tax income generated by our U.S. subsidiaries. The net income generated by our U.S. subsidiaries in 2008 was adversely impacted by significant losses in relation to Hurricanes Ike and Gustav.
2010 versus 2009: The 9% reduction in investment income from fixed maturities reflects lower reinvestment yields in the current year primarily due to a downward shift in U.S. Treasury rates and further tightening of credit spreads. This decline in net investment income was partially offset by growth of 7% on our average fixed maturities balances in the current year. This growth was primarily due to redeploying operating cash to fixed maturities.
2009 versus 2008: The 80% reduction in investment income in 2009 was driven by the significant decline in global short-term interest rates initiated by global government policy makers in late 2008 in response to the turmoil in the financial markets. Level of average cash and cash equivalent balances was relatively consistent in 2009 and 2008.
2009 versus 2008: The recovery in the credit markets in 2009 enabled us to rebalance our fixed maturities portfolio generating net realized gains. The realized gains in 2008 were primarily driven by the sale of certain agency MBS, in which pricing benefited from the conservatorship of Fannie Mae and Freddie Mac. However, these gains were offset by realized losses on equities, which included $60 million of losses in connection with the sale of our Fannie Mae and Freddie Mac non-redeemable preferred equities prior to their conservatorship by the U.S. Treasury.
OTTI charges recorded for fixed maturities in the first quarter of 2009 of $26 million and for the full year 2008 of $71 million are based on previous OTTI accounting guidance (i.e. the difference between the fair value and amortized cost of a debt security in an unrealized loss position). Accordingly, the OTTI recognized in earnings for the years presented the following table are not comparable.
The continued pricing improvement of credit spread sectors through 2010 significantly mitigated any further credit losses in our fixed maturities portfolio. The total 2009 OTTI charge on fixed maturities was primarily due to the $263 million impairment on our portfolio of MTNs. In response to the credit crisis, the MTNs managers reduced their leverage levels which in turn lowered the credit duration of the MTNs. As credit markets recovered and credit spreads tightened in 2009, price appreciation was not as pronounced as the depreciation during 2008 due to the lower credit duration of the MTNs. The tightening of credit spreads was more significant and much quicker than anticipated which has hindered the ability of the MTN managers to reinvest the underlying cash flows at wider credit spreads. Consequently, we revised the significant inputs in our projected cash flows for the MTNs, resulting in a significant credit impairment charge during the third quarter of 2009. Since this impairment, the MTNs have partially recovered in fair value and certain MTNs have matured or have been redeemed with total realized gains of $29 million in 2010 and an additional $14 million gain in January 2011 (see ‘Cash and Investments’ section).
The OTTI charges during 2009 also included credit losses on subordinated debt of certain U.S. and foreign banks (included in corporate debt), as well as non-agency RMBS and ABS, which were largely due to exposures to alternative-A and sub-prime collateral. Further, we made the decision to sell certain corporate debt securities, non-agency RMBS and non-agency CMBS in an unrealized loss position.
The OTTI charges in 2008 were primarily related to $32 million of impaired corporate debt securities held in Lehman Brothers following its bankruptcy and sale in 2008. Additionally, we impaired certain non-agency RMBS and ABS primarily due to higher risk of defaults driven by the credit crisis.
Due to the significant volatility in the Euro vs. U.S. dollar currencies in 2008, we implemented a fair value hedging program to hedge un-matched foreign currency exposures. Our hedging program has since been effective, generating gains/losses of less than 2% of notional balances.
The amortized cost/cost of our total investments increased by $787 million from December 31, 2009, primarily due to investing a portion of our operating cash flows generated in 2010.
rates and the tightening of credit spreads. To a lesser extent, net contributions to global equity portfolios and positive equity returns during 2010 also contributed to the increase in fair value of total investments. This combined growth was partially offset by net redemptions in certain alternative investment holdings (other investments) and negative movement in foreign exchange rates, mostly Euro against the U.S. dollar.
(2) As assigned by S&P. In the absence of an S&P rating, we used the lower rating established by either Moody’s or Fitch.
Our holdings in non-U.S. government securities consisted of fixed income obligations of non-U.S. sovereigns, including government agencies, local governments and supranationals. At December 31, 2010, the weighted average credit rating for these securities was AA+ (2009: AAA). The table below summarizes our largest country exposures by fair value at December 31, 2010 and 2009:
At December 31, 2010, our non-U.S. sovereign debt portfolio had net unrealized losses of $4 million (2009: $9 million net unrealized gains) which included net unrealized foreign exchange losses of $9 million (2009: $2 million), mainly on EUR-denominated securities, that have been effectively hedged through our hedging program.
We also had no exposure to sovereign debt related to Portugal, Ireland, Italy, and Greece at December 31, 2010.
The composition of our corporate debt securities at December 31, 2010 and 2009 was as follows:
The direct financials exposures are primarily related to U.S. banks (47%) and foreign banks (20%), with the remainder diversified across several other sub-sectors. Included in direct financials debt are $49 million (2009: $281 million) of U.S. FDIC guaranteed bonds and $262 million (2009: $205 million) of foreign government guaranteed bonds. Similar to our non-financials, the decline in the weighted average credit rating in 2010 was primarily due to the addition of the new short duration high yield portfolio.
The following table provides a breakdown of the fair value of our non-agency RMBS and CMBS portfolios by credit rating as assigned by S&P:
The following table provides a breakdown of the underlying collateral for our ABS by credit rating as assigned by S&P:
The $219 million increase in fair value during 2010 was primarily due to the purchase of new floating rate issues, all AAA rated by S&P, for deployment of operating cash. The average duration and weighted average life of our ABS portfolio at December 31, 2010 was 1.0 years (2009: 1.3 years) and 3.8 years (2009: 2.7 years), respectively. Based on fair value, our ABS securities primarily originate from years 2010 (39%) and 2009 (25%).
At December 31, 2010, the gross unrealized losses on our fixed maturities portfolio were $114 million (2009: $134 million).
The following table provides information on the severity of the unrealized loss position as a percentage of amortized cost for all investment grade fixed maturities in an unrealized loss position.
The range of greater than 50% severity of unrealized loss at December 31, 2009 consisted primarily of non-agency RMBS, non-agency CMBS and ABS where we did not anticipate credit losses. These securities had a weighted average credit rating of AA- by S&P. The decrease in this balance in 2010 was primarily due to the sale of certain securities and, to a lesser extent, pricing improvement on one AAA rated non-agency RMBS that we continue to hold.
During 2010, we increased our allocation to global equities by $110 million and recorded impairment charges of $9 million. Our equity portfolios consist of well diversified publicly traded common stocks and a foreign bond mutual fund. At December 31, 2010, no single common stock accounted for more than 2% of total equities, excluding the foreign bond mutual fund.
The $5 million decrease in the fair value of the CLO - Equities since December 31, 2009, was primarily due to $27 million of cash distributions received in 2010, offset partially by an improved valuation of $22 million primarily due to lower default rates than previously expected.
As a holding company, AXIS Capital has no operations of its own and its assets consist primarily of investments in its subsidiaries. Accordingly, AXIS Capital’s future cash flows depend on the availability of dividends or other statutorily permissible payments from its subsidiaries, such as a return of capital. The ability to pay such dividends is limited by the applicable laws and regulations of the various countries and states in which AXIS Capital’s subsidiaries operate (refer to Item 8, Note 18, to the Consolidated Financial Statements for further information), as well as the need to maintain capital levels to adequately support insurance/reinsurance operations and preserve financial strength ratings issued by independent rating agencies. During 2010, AXIS Capital received $698 million (2009: $530 million; 2008: $430 million) of dividends from its subsidiaries. AXIS Capital’s primary uses of funds are dividend payments to both common and preferred shareholders, stock repurchases, interest and principal payments on debt, capital investments in subsidiaries and payment of corporate operating expenses. We believe the dividend/distribution capacity of AXIS Capital’s subsidiaries, which was over $1 billion at December 31, 2010, will provide AXIS Capital with sufficient liquidity for the foreseeable future.
The following table summarizes our consolidated cash flows from operating, investing and financing activities in the last three years:
Note: See Consolidated Statements of Cash Flows included in Item 8, ‘Financial Statements and Supplementary Data’, of this report for additional information.
Our 2009 cash flows from operating activities declined by $676 relative to 2008, primarily as the result of a $314 million increase in net paid losses, driven by claims on our credit and political risk business, as well as a non-recurring payment of $200 million to settle our insurance derivative contract. A reduction in net investment income from cash and fixed maturities also contributed to the decrease. Our 2010 cash flows from operating activities increased $338 million compared to 2009. The primary drivers of this increase were higher premium-related cash receipts, driven by gross premiums written increases, and lower reinsurance protection costs for our insurance segment largely driven by the previously mentioned changes in our reinsurance purchasing. Partially offsetting these increases were increased cash outflows for general and administrative expenses, previously noted, and an increase in our net paid losses as we continued to fund claim payments for lines of business impacted by the global financial crisis.
Our 2010 cash outflows from investing activities relates principally to the net purchase of fixed maturities of $0.6 billion (2009: $1.6 billion; 2008: $0.1 billion). During the latter part of 2008, in response to deteriorating financial market conditions, we increased our asset-allocation to cash and cash equivalents, while reducing our net purchasing of fixed maturities. As markets stabilized during 2009, we utilized our excess cash and cash equivalents to fund fixed maturity purchases and we continued to purchase fixed maturities in 2010. Refer to the ‘Cash and Investments’ section above.
Our diversified underwriting portfolio has demonstrated an ability to withstand catastrophic losses; we have generated significant positive operating cash flows since our inception, despite the occurrence of multiple large hurricanes during this period. We anticipate that cash flows from operations will continue to be sufficient to cover cash outflows under most loss scenarios as well as our other contractual commitments through the foreseeable future. Refer to the ‘Contractual Obligations and Commitments’ section below for further information on our anticipated obligations.
In the unlikely event that paid losses accelerate beyond our ability to fund such payments from operating cash flows, we would utilize our cash and cash equivalent balances or liquidate a portion of our investment portfolio. Our investment portfolio is heavily weighted towards conservative, high quality, and highly liquid securities. We expect that, if necessary, approximately $8.9 billion of our December 31, 2010 cash and investments balance could be available in one to three business days. To provide some context, our modeled single occurrence 1-in-250 year period U.S. hurricane probable maximum loss, net of reinsurance, is approximately $1.5 billion. Refer to the ‘Risk and Capital Management’ section of Item 1 for further information. We regularly evaluate, through stress and scenario testing, our expected liquidity adequacy in extreme market and business conditions.
Long-term Debt: Long-term debt represents the senior notes we issued during 2004 and 2010. For further information, refer to Item 8, Note 10(a) of the Consolidated Financial Statements. We used the net proceeds from our 2010 senior notes offering for general corporate purposes. The issuance of this debt was the principal driver of the increase in our ratios of debt to total capital and debt and preferred equity to total capital in 2010.
Common Equity: The value of our common equity increased by $0.1 billion and $1.0 billion during 2010 and 2009, respectively, as outlined in the following table:
(i) Maintenance of a minimum consolidated net worth, with the minimum being equal to the sum of $3.689 billion plus 25% of consolidated net income (if positive) for each semi-annual fiscal period ending on or after December 31, 2010 plus 25% of the net cash proceeds received by AXIS Capital from the issuance of its capital stock during each such semi-annual fiscal period. For the purposes of this covenant, consolidated net worth excludes unrealized appreciation (depreciation) on our available for sale investments.
(iii) Maintenance of an A.M. Best Company, Inc. (“A.M. Best”) financial strength rating of at least B++ for each of AXIS Capital’s material insurance/reinsurance subsidiaries that are party to the Syndicated Credit Facility.
During 2010, we entered into a secured $750 million letter of credit facility (the “LOC Facility” and, together with the Syndicated Credit Facility, the “Credit Facilities”). This facility may be terminated by the lender on December 31, 2013 upon thirty days prior notice. This facility is subject to certain covenants, including the requirement to maintain sufficient collateral to cover all of our obligations under the facility. Such obligations include contingent reimbursement obligations for outstanding letters of credit and fees payable to the lender. In the event of default, the lender may exercise certain remedies, including the exercise of control over pledged collateral and the termination of the availability of the facility to any or all of the participating operating subsidiaries.
The following are the most recent financial strength ratings from internationally recognized agencies in relation to our principal insurance and reinsurance subsidiaries:
The following table provides a breakdown of our contractual obligations and commitments at December 31, 2010 by period due:
(1) We are obligated to pay claims for specified loss events covered by the insurance and reinsurance contracts we write. Such loss payments represent our most significant future payment obligation. In contrast to our other contractual obligations, our cash payments are not determinable from the terms specified within the underlying contracts. The total amount in the table above reflects our best estimate of our reserve for losses and loss expenses. However, the actual amounts and timing may differ materially; refer to the ‘Critical Accounting Estimates - Reserve for Losses and Loss Expenses’ for further information. We have not taken into account corresponding reinsurance recoverable amounts that would be due to us. Given the limited loss development pattern information specific to our experience, we have estimated the timing of payment by applying industry benchmark payout patterns to each underlying reserving class.
(4) We have Supplemental Executive Retirement Plans (“SERPs”) for two senior executives. For further information, refer to Item 8, Note 14(b) to the Consolidated Financial Statements.
Loss reserves are not an exact calculation of liability but instead are complex estimates. The process of estimating loss reserves involves a number of variables (see ‘Selection of Reported Reserves (Management’s Best Estimate)’ section below for further details). We review our estimate of loss reserves each reporting period and consider all significant facts and circumstances then known. As additional experience and other data become available and/or laws and legal interpretations change, we may adjust our previous estimates of loss reserves; these adjustments are recognized in the period they are determined and, therefore, can impact that period’s underwriting results either favorably (when reserves established in prior periods prove to be redundant) or adversely (when reserves established in prior periods prove to be deficient).
With respect to our insurance operations, we are generally notified of insured losses by our insureds and/or their brokers. Based on this information, our claims personnel estimate our ultimate losses arising from the claim, including the cost of administering the claims settlement process. These estimates reflect the judgment of our claims personnel based on general reserving practices, the experience and knowledge of such personnel regarding the nature of the specific claim and, where appropriate, advice of legal counsel, loss adjusters and other relevant consultants.
For our reinsurance business, case reserves for reported claims are generally established based on reports received from ceding companies and/or their brokers. For excess of loss contracts, we are typically notified of insured losses on specific contracts and record a case reserve for the estimated ultimate liability arising from the claim. With respect to contracts written on a proportional basis, we typically receive aggregated claims information and record a case reserve based on that information. However, our proportional reinsurance contracts typically require that pre-defined large losses be separately notified so that we can adequately evaluate them. Our claims department evaluates each specific loss notification we receive and records additional case reserves when a ceding company’s reserve for a claim is not considered adequate.
As part of our quarterly loss reserve review process, our actuaries employ the estimation method(s) that they believe will produce the most reliable estimate of ultimate losses, at that particular evaluation date, for each reserving class and accident year combination. Often, this is a blend (i.e. weighted average) of the results of two or more appropriate actuarial methods. These ultimate loss estimates are generally utilized to evaluate the adequacy of our ultimate loss estimates for previous accident years, as established in the prior reporting period. For the initial estimate of the current accident year, the available claim data is typically insufficient to produce a reliable estimate of ultimate losses. As a result, our initial estimate for an accident year is generally based on the ELR Method. The initial ELR for each reserving class is established collaboratively by our actuaries, underwriters and management at the start of the accident year as part of the planning process, taking into consideration prior accident years’ experience and industry benchmarks, adjusted after considering factors such as exposure trends, rate differences, changes in contract terms and conditions, business mix changes and other known differences between the current accident year and prior accident years. The initial expected loss ratios for a given accident year may be modified over time if the underlying assumptions, such as loss development or premium rate changes, differ from the original assumptions.
There are additional risks affecting our ability to accurately estimate ultimate losses for catastrophic events. For example, the estimation of loss reserves related to hurricanes and earthquakes can be affected by factors including but not limited to: the inability to access portions of impacted areas, infrastructure disruptions, the complexity of factors contributing to losses, legal and regulatory uncertainties, complexities involved in estimating business interruption losses and additional living expenses, the impact of demand surge, fraud and the limited nature of information available. For hurricanes, additional complex coverage factors may include determining whether damage was caused by flooding versus wind, evaluating general liability and pollution exposures, and mold damage. The timing of a catastrophe, for example near the end of a reporting period, can also affect the level of information available to us to estimate reserves for that reporting period.
We began operations in late 2001. In our earlier years, we placed significant reliance on industry benchmarks in establishing our expected loss ratios. Over time, we have placed more reliance on our historical loss experience in establishing these ratios where we believe the weight of our own actual experience has become sufficiently credible for consideration. The weight given to our experience differs for each of our three claim tail classes and is discussed further in the ‘Claim Tail Analysis’ section below. In establishing expected loss ratios for our insurance segment, we give consideration to a number of other factors, including exposure trends, rate adequacy on new and renewal business, ceded reinsurance costs, changes in claims emergence and our underwriters’ view of terms and conditions in the market environment. For our reinsurance segment, expected loss ratios are based on
Our quarterly reserving process involves the collaboration of our underwriting, claims, actuarial, legal and finance departments, includes various segmental committee meetings and culminates with the approval of a single point best estimate by our Group Reserving Committee, which comprises senior management. Informed judgment is applied throughout the process to consider many qualitative factors that may not be fully captured in the actuarial estimates. Such factors include, but are not limited to: the timing of the emergence of claims, volume and complexity of claims, social and judicial trends, potential severity of individual claims and the extent of internal historical loss data versus industry information due to our relatively short operating history. While these qualitative factors are considered in arriving at the point estimate, no specific provisions for qualitative factors are established.
Our short-tail business generally includes exposures for which losses are usually known and paid within a relatively short period of time after the underlying loss event has occurred. Our short-tail business primarily relates to property coverages and includes the majority of our property, terrorism and marine classes within our insurance segment, together with the property, catastrophe and crop classes within our reinsurance segment.
The initial estimates of our ultimate losses for our short-tail business in our early accident years were developed primarily with reference to industry benchmarks for both expected loss ratios and loss development patterns. Over time, our own historical loss experience has increased and, therefore, gained credibility and became relevant for consideration in our loss reserve estimation process. As a result, commencing in 2005, we have gradually
Although our estimates of ultimate losses for our short-tail business are inherently less uncertain than for our medium and long-tail business, significant judgment is still required. For example, because much of our excess insurance and excess of loss reinsurance business has high attachment points, it is often difficult to estimate whether claims will exceed those attachment points. Also, the inherent uncertainties relating to catastrophe events previously discussed, together with our typically large line sizes, further add to the complexity of estimating our potential exposure. In addition, we use managing general agents and other producers for certain business within our insurance segment; this can delay the reporting of loss information to us.
For our professional lines business, claim payment and reporting patterns are typically medium to long tail in nature. The underlying business is predominantly written on a claims-made basis, with the majority of reinsurance treaties being written on a risks attaching basis. Generally, when we believe the percentage of incurred losses for a particular accident year has reached 70% of ultimate losses, we gradually transition to sole reliance on the BF Method over the course of the next two calendar years.
Our transition from the ELR Method for estimating professional lines ultimate losses began during 2008, when we commenced the gradual transition from the ELR Method to the BF Method for the 2004 and prior accident years. As our loss history continues to develop, additional accident years are included in the transition process; at the end of 2010, the transition had begun for the 2007 and prior accident years. This transition means that our own historical loss experience is gradually incorporated when we re-estimate our ultimate losses for these accident years. As our actual loss experience has generally been more favorable than we expected when establishing the initial expected loss ratios, this transition has generally resulted in the recognition of net favorable prior period reserve development over the last three years. However, during 2009, we strengthened our 2008 accident year reserves in response to the continuing economic downturn. (See ‘Underwriting Results - Group - Prior Period Development’ for further details). As a result of the global financial crisis, there continues to be relatively high levels of uncertainty around ultimate losses for the 2007-2009 accident years. This is mainly attributable to both the higher than average volume of reported claims on these years, as well as the higher proportion of open claims, relative to earlier accident years at the same stage of development. As a result, loss development patterns on these accident years may ultimately differ from prior years.
Our estimates of ultimate losses for more recent accident years continue to rely on the ELR Method. We are progressively giving more weight to our own experience when establishing our expected loss ratios. Our assumed loss development patterns for this business continue to be based primarily on industry benchmarks.
As previously described, the estimation of the value of our recoveries on credit and political risk business requires significant management judgment. At December 31, 2010, our total estimated recoveries on credit insurance business were $163 million, of which $135 million related to contracts where we had already paid losses, $19 million related to contracts where case reserves were recognized and $9 million related to IBNR reserves. Comparatively, at December 31, 2009, our estimated recoveries were $340 million, with $87 million, $160 million and $93 million relating to paid losses, case reserves and IBNR, respectively. The overall reduction in 2010 reflects the settlement of certain claims, the realization of recoveries for certain claims and the reduction in recovery estimates (see ‘Underwriting Results - Group - Prior Period Development’ for further details).
As part of our quarterly reserving process, we monitor actual paid and incurred loss emergence relative to expected loss emergence based on industry-benchmark loss development patterns. At this stage, we generally believe that it remains too early to recognize any potentially favorable loss emergence that may be noted through this analysis. However, the drivers of any unfavorable loss emergence are investigated and, as a result, may lead to an immediate recognition of adverse development.
While we believe that our loss reserves at December 31, 2010 are adequate, new information, events or circumstances may result in ultimate losses that are materially greater or less than provided for in our loss reserves. As previously noted, there are many factors that may cause our reserves to increase or decrease, particularly those related to catastrophe losses and long-tail lines of business.
The results show the cumulative increase (decrease) in our loss reserves across all accident years. For example, if our assumed loss development pattern for our property insurance business was three months shorter with no accompanying change in our ELR assumption, our loss reserves may decrease by approximately $19 million. Each of the impacts set forth in the tables is estimated individually, without consideration for any correlation among key assumptions or among reserving classes. Therefore, it would be inappropriate to take each of the amounts and add them together in an attempt to estimate total volatility. While we believe the variations in the expected loss ratios and loss development patterns presented could be reasonably expected, our own historical data regarding variability is generally limited and actual variations may be greater or less than these amounts. It is also important to note that the variations are not meant to be a “best-case” or “worst-case” series of scenarios and, therefore, it is possible that future variations in our loss reserves may be more or less than the amounts presented. While we believe that these are reasonably likely scenarios, we do not believe this sensitivity analysis should be considered an actual reserve range.
We apply case-specific provisions against certain recoveries that we deem unlikely to be collected in full. In addition, we use a default analysis to estimate our provision for uncollectible amounts on the remainder of the balance. The principal components of the default analysis are reinsurance recoverable by reinsurer and default factors applied to estimate uncollectible amounts based on our reinsurers’ credit ratings. The default factors are based on a model developed by a major rating agency. The provision recorded against reinsurance recoverable was $17 million and $23 million at December 31, 2010 and 2009, respectively. We have not written off any significant reinsurance recoverable balances in the last three years. At December 31, 2010, the use of different assumptions within our approach could have a material effect on our provision for uncollectible reinsurance recoverable. To the extent the creditworthiness of our reinsurers was to deteriorate due to an adverse event affecting the reinsurance industry, such as a large number of major catastrophes, actual uncollectible amounts could be significantly greater than our provision. Given the various considerations used to estimate our uncollectible provision, we cannot precisely quantify the effect a specific industry event may have on our provision.
A limited portion of our insurance business is written on a line slip or proportional basis, under which we assume a fixed percentage of the premiums and losses on a particular risk or group of risks along with numerous other unrelated insurers. Although premiums on this business are not contractually stated, we recognize gross premiums written based on an estimate provided by the client via the broker. For further details on the estimation process, see the discussion provided for the reinsurance segment below. We review these estimates on a quarterly basis and record significant adjustments in premium estimates when identified. Gross premiums written on a line slip/proportional basis comprised 3%, 4% and 5% of the segment’s total for the years ended December 31, 2010, 2009 and 2008, respectively, and therefore the associated impact of these estimates on our pre-tax net income was immaterial.
changes in renewal rates or rates of new business accepted by cedants (such changes could result from changes in the relevant insurance market that could affect more than one of our cedants or could be a consequence of changes in the marketing strategy or risk appetite of an individual cedant);
As a result of this review process, any adjustments to estimates are recognized in gross premiums written during the period they are determined. Such changes in premium estimates could be material and the resulting adjustments may directly and significantly impact net premiums earned favorably or unfavorably in the period they are determined because the estimated premium may be substantially or fully earned. Proportional contracts accounted for 45%, 40% and 33% of our reinsurance segment’s gross premiums written for the years ended December 31, 2010, 2009 and 2008, respectively.
Our estimated fair value of a financial instrument may differ from the amount that could be realized if the security was sold in an immediate sale, e.g., a forced transaction. Additionally, the valuation of fixed maturities is more subjective when markets are less liquid due to the lack of market based inputs. This may lead us to change the selection of our valuation technique (from market to income approach) or may cause us to use multiple valuation techniques to estimate the fair value of a financial instrument. This circumstance may require significant management judgment and could cause an instrument to be reclassified between levels of the fair value hierarchy.
At December 31, 2010 and 2009, we used substantially the market approach valuation techniques (e.g. use of quoted market values and other relevant observable market data provided by independent pricing sources) for estimating the fair values of fixed maturities. The pricing sources are primarily nationally recognized pricing services and broker-dealers.
At December 31, 2010, pricing for approximately 86% (2009: 84%) of our total fixed maturities was based on prices provided by nationally recognized independent pricing services (70% index providers and 16% pricing vendors). Prices are sourced from multiple pricing services, and a vendor hierarchy is maintained by asset type based on historical pricing experience and vendor expertise. Generally, prices are received from multiple pricing services for each security and the pricing service ranked highest in the vendor hierarchy is selected. This hierarchy is based on prioritizing pricing services based on availability and reliability. Generally, pricing services provide pricing for less-complex, liquid securities based on market quotations in active markets when available. For fixed maturities that do not trade on a listed exchange, the pricing service will use its proprietary “pricing matrix models” to estimate the fair value of a security. These models consider various assumptions/inputs including: reported trades, benchmark yields, broker/dealer quotes, issuer spreads, two-side markets, benchmark
securities, bids, offers, reference data, and industry and economic factors. Substantially all of these assumptions/inputs are observable in the marketplace, can be derived from observable data or are supported by observable levels at which transactions are executed in the marketplace. Additionally, pricing vendors may use an Option Adjusted Spread model commonly used to develop prepayment and interest rate scenarios for the purpose of estimating fair values of mortgage-backed and asset-backed securities.
If we conclude the quote from a broker does not reflect an orderly transaction, we will place little weight on the non-binding broker quote and a greater weight on the use of an income approach valuation technique to estimate fair value of illiquid securities. The evaluation of whether or not actual transactions in the current financial markets represent distressed sales requires significant management judgment. Our income approach valuation technique consists of an internal cash flow model whereby the underlying contractual cash flows of the security are discounted. At December 31, 2010 and 2009, the use of an internal cash flow model for fixed maturities was limited to CLO-debt tranche securities, given the lack of relevant observable trades. The significant inputs used in our cash flow model were similar as those used for CLO-Equities (see below and Item 8, Note 6 of the Consolidated Financial Statements).
At December 31, 2010, approximately 10% (2009: 9%) of fixed maturities were priced by non-binding quotes from broker-dealers. Where we have the ability to corroborate the non-binding broker quote with either a quote from a pricing vendor or another independent broker, and the price quotations do not vary significantly, we classify these securities as Level 2 within our fair value hierarchy. We classify securities priced by a single non-binding independent broker quote and/or use of internal cash flow model as Level 3 in our fair value hierarchy. At December 31, 2010, these securities consisted primarily of CLO debt tranched securities. The total estimated fair value for Level 3 fixed maturities was $64 million (2009: $71 million) or less than 1% of our total fixed maturity portfolio.
Equity securities include U.S. and foreign common stocks as well as a foreign bond mutual fund. For common stocks we classified these within Level 1 as their fair values are based on quoted market prices in active markets provided by independent pricing sources. Our investment in the foreign bond mutual fund has daily liquidity, with redemption price based on the net asset value of the fund. Accordingly, we have classified this investment as Level 2.
Of these significant inputs, the default and loss severity rates are the most judgmental unobservable market inputs to which the valuation of CLO - Equities is most sensitive. In the second half of 2009, actual defaults experienced by certain of our CLO - Equities began to stabilize after experiencing an acceleration in actual defaults earlier in 2009. This stabilization continued throughout 2010 and, at the end of 2010, many of the CLO - Equities that we continue to hold are at or near historic low default rates. These lower actual defaults have positively impacted the values of the collateral balances to the extent that many OC ratios that were previously out-of-compliance are now back in compliance, triggering additional or larger cash payments to equity tranche holders. Actual default rates at November 30, 2010 for our CLO - Equities varied from 0.0% to 2.5% (November 30, 2009: 1.1% to 7.0%) on the remaining underlying collateral. Further, at November 30, 2010, all CLO - Equities were in compliance with their respective OC ratios. In light of the above events, we have further revised our projected default rates as well as projected recovery rates for all of our CLO - Equities during the fourth quarter of 2010. In establishing the revised projected default and loss severity rates for our cash flow model, we have considered the actual experience for our CLO - Equities, credit rating agencies’ forecasts on projected default and loss severity rates for U.S. corporate speculative-grade securities, and the default rate forecast from our largest CLO manager. The changes made to our significant inputs in 2010 (as noted in the above table) did not impact significantly the fair value of the CLO - Equities at December 31, 2010. The $22 million increase in fair value of CLO - Equities in 2010 was driven primarily by lower than anticipated default rates, resulting in higher cash distributions than previously expected. Due to the use of significant unobservable input in our in internal cash flow model, we have classified the CLO - Equities as Level 3.
As a sensitivity analysis, we believe it is reasonably likely that our estimated fair value of the CLO - Equities could further deteriorate by $14 million within the next 12 months in the event default rates accelerate to 5% for all of our CLO - Equities in 2011 should the U.S. economic recovery not be sustainable. Other stress test scenarios were performed but none of the reasonably likely changes to other key inputs would result in a significant deterioration in the fair value of our CLO - Equities.
The foreign currency forward contracts and options we use to economically hedge currency risk are characterized as over-the-counter (“OTC”) due to their customized nature, and the fact that they do not trade on a major exchange. These instruments are valued using market transactions and other market evidence whenever possible, including market-based inputs to models. Forward contracts trade in a very deep and liquid market, providing substantial price transparency, while our currency options are priced using a Black-Scholes option-pricing model. This model is a widely-accepted pricing source, and requires the use of transparent market inputs to calculate values, involving minimal management judgment. Accordingly, we have classified these derivatives as Level 2.
The following provides further details regarding our OTTI recognition and processes for fixed maturities and equity securities.
In accordance with the adoption of the newly issued accounting standard in 2009, we recognize an OTTI in earnings for a fixed maturity security in an unrealized loss position when we:
2) more likely than not will be required to sell the security before its anticipated recovery, or
For impaired securities that we do not intend to sell and it is more likely that we will not be required to sell, we have established some parameters for identifying securities in an unrealized loss position with potential credit impairments. Our parameters focus primarily on the extent and duration of the decline, including but not limited to:
declines in value greater than 5% and rated less than BBB (non-investment grade).
We have also established parameters for identifying potential impaired equity securities for fundamental analysis based on the severity and the duration of the unrealized loss position. For example, we review all equities with a 50% and greater severity for three or more consecutive months.
From time to time, we may sell our available-for-sale equities subsequent to the balance sheet date that were considered temporarily impaired at the balance sheet date. This may occur due to events occurring subsequent to the balance sheet date that result in a change in our intent or ability to hold an equity security. Such subsequent events that may result in a sale include significant deterioration in the financial condition of the issuer, significant unforeseen changes in our liquidity needs, or changes in tax laws or the regulatory environment.
During 2010, we recorded a total OTTI charge in earnings of $18 million (2009: $337 million). Refer to the ‘Net Investment Income and Net Realized Investment Gains/Losses’ section above for further details.
Consolidated Statements of Comprehensive Income for the years ended December 31, 2010, 2009 and
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of AXIS Capital Holdings Limited and subsidiaries as of 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.
Net investment income includes interest and dividend income and the amortization of market premiums and discounting using the effective yield method and is net of investment expenses. Investment income is recognized when earned. Purchases and sales of investments are recorded on a trade-date basis and realized gains/losses on sales of investments are determined based on the specific identification method.
We recognize investment income from fixed maturities based on the constant effective yield method, which includes an adjustment for estimated principal repayments, if any. The effective yield used to determine the amortization for fixed maturities subject to prepayment risk (e.g. asset-backed, loan-backed and other structured securities) is recalculated and adjusted periodically based upon actual historical and/or projected future cash flows. The adjustments to the yield for highly-rated (i.e. AA or above by Standard & Poor’s (“S&P”)) prepayable fixed maturities are accounted for using the retrospective method. The adjustments to the yield for other prepayable fixed maturities are accounted for using the prospective method.
Effective April 1, 2009, we adopted new Financial Accounting Standards Board (“FASB”) guidance for the recognition and presentation of OTTI for fixed maturities. Accordingly, we recognize an OTTI charge in earnings for a fixed maturity security in an unrealized loss position when we either: (a) have the intent to sell the security or more likely than not will be required to sell the security before its anticipated recovery or (b) do not anticipate to fully recover the amortized cost based on projected cash flows to be collected. Prior to the adoption of this guidance, we recorded an OTTI charge for a fixed maturity security in an unrealized position when we could not assert that we had both the intent and ability to hold the security for a period of time sufficient to allow for a recovery in its fair value to its amortized cost.
In periods subsequent to the recognition of an OTTI charge for either a fixed maturity or equity security, the new cost basis is not adjusted for increases in estimated fair value.
Insurance and reinsurance premiums are earned over the period during which we are exposed to the underlying risk, which is generally one to two years with the exception of multi-year policies. Unearned premiums represent the portion of premiums written which is applicable to the unexpired risks under contracts in force.
Acquisition costs vary with and are directly related to the acquisition of insurance and reinsurance contracts and consist primarily of fees and commissions paid to brokers and premium taxes. Acquisition costs are shown net of commissions earned on ceded reinsurance. Our net acquisition costs are deferred and charged to expense as the related premium is earned. Anticipated losses and loss expenses, other costs and investment income related to these premiums are considered in assessing the recoverability of our deferred acquisition costs. If deferred amounts are estimated to be unrecoverable, they are expensed. Compensation expenses for personnel involved in contract acquisition, as well as advertising costs, are expensed as incurred.
Our reserve for losses and loss expenses represents an estimate of the unpaid portion of our ultimate liability for losses and loss expenses for insured and reinsured events that have occurred at or before the balance sheet date. The balance reflects both claims that have been reported to us (“case reserves”) and claims that have been incurred but not yet reported to us (“IBNR”). These amounts are reduced for estimated amounts of salvage and subrogation recoveries.
Any adjustments to our previous reserve for losses and loss expenses estimates are recognized in the period they are determined. While we believe that our reserves for losses and loss expenses are adequate, this estimate requires significant judgment and new information, events or circumstances may result in ultimate losses that are materially greater or less than provided for in the Consolidated Balance Sheets.
We amortize intangible assets with finite lives over their estimated useful lives in proportion to the estimated economic benefits of the intangible assets. We also test these assets for impairment if existing conditions indicate that the carrying value may not be fully recoverable. Such conditions may include an economic downturn in a geographic market or a change in the assessment of future operations. If, as a result of such an evaluation, we determine that the carrying value of the finite lived intangible assets is not recoverable, the value of the assets will be reduced to fair value with the difference being expensed in the Consolidated Statement of Operations.
We consolidate a variable interest entity (“VIE”) if we are the primary beneficiary of the VIE, such that we are subject to a majority of the risk of loss from the VIE’s activities or are entitled to receive a majority of the VIE’s residual returns, or both. A VIE is an entity that either: (a) does not have equity investors with voting rights or (b) has equity investors that do not provide sufficient financial resources for the entity to support its activities.
Effective July 1, 2010, we adopted amended FASB guidance that clarified the bifurcation scope exemption for embedded credit-derivative features. Embedded credit-derivative features related only to the transfer of credit risk in the form of subordination of one financial instrument to another (e.g. a mortgage-backed or asset-backed security with multiple tranches) are not subject to bifurcation and separate accounting. The adoption of this guidance did not impact our results of operations, financial condition or liquidity.
Our insurance segment provides insurance coverage on a worldwide basis. The product lines in this segment are property, marine, terrorism, aviation, credit and political risk, professional lines, liability and other (including accident & health).
We estimate that the annual amortization expense for our total intangible assets with a finite life will be approximately $3 million next year, $2 million a year from 2012 to 2014 and $1 million in 2015. The estimated remaining useful lives of these assets range from one to twenty-eight years.
Intangible assets with an indefinite life consist primarily of U.S. state licenses that provide a legal right to transact business indefinitely. Our impairment reviews for goodwill and indefinite lived intangibles did not result the recognition of impairment losses for the years ended December 31, 2010, 2009 and 2008.
In the normal course of investing activities, we actively manage allocations to non-controlling tranches of structured securities (variable interests) issued by VIEs. These structured securities include RMBS, CMBS and ABS and are included in the above table. Additionally, within our other investments portfolio, we also invest in limited partnerships (hedge and credit funds) and CLO equity tranched securities, which are all variable interests issued by VIEs (see Note 5(b)). For these variable interests, we do not have the power to direct the activities that are most significant to the economic performance of the VIEs and accordingly we are not the primary beneficiary for any of these VIEs. Our
At December 31, 2010, we held insurance enhanced bonds, in the amount of approximately $169 million (2009: $217 million), which represented approximately 1.6% (2009: 2.2%) of our total fixed maturities and a weighted average credit rating of AA- (2009: AA) by S&P. If we exclude the insurance enhancement, the weighted average credit quality of our insured bond portfolio was A- (2009: AA-) by S&P. At December 31, 2010, our largest exposures to financial guarantors were Assured Guaranty Corp. for $66 million (2009: $8 million), National Public Finance Guarantee Corporation for $57 million (2009: $69 million) and Ambac Financial Group, Inc. for $23 million (2009: $57 million). We do not have any direct investments in these companies at December 31, 2010.
We concluded that these securities as well as the remaining securities in an unrealized loss position are temporarily depressed and are expected to recover in value as the securities approach maturity or as market spreads return to more normalized levels. Further, at December 31, 2010, we did not intend to sell these securities in an unrealized loss position and it is more likely than not that we will not be required to sell these securities before the anticipated recovery of their amortized costs.
The major categories and related investment strategies for our investments in hedge and credit funds are as follows:
In aggregate, all of our hedge fund allocation is redeemable within one year, subject to prior written redemption notice varying from 45 to 95 days. This includes recognition of certain funds we hold which restrict new investor redemptions during a lock-up period. A lock-up period is the initial amount of time an investor is contractually required to hold the security before having the ability to redeem. Another common restriction is the suspension of redemptions (known as “gates”) which may be implemented by the general partner or investment manager of the fund in order to defer, in whole or in part, the redemption request in the event the aggregate amount of redemption requests exceeds a predetermined percentage of the fund’s net assets or to prevent certain adverse regulatory, or any other reasons that may render the manager unable to promptly and accurately calculate the fund’s net asset value. During 2010, and 2009, no gates were imposed on our redemption requests. Additionally, certain hedge funds may be allowed to invest a portion of their assets in illiquid securities, such as private equity or convertible debt. In such cases, a common mechanism used is a side-pocket, whereby the illiquid security is assigned to a designated account. Generally, the investor loses its redemption rights in the designated account. Only when the illiquid security is sold, or otherwise deemed liquid by the fund, may investors redeem their interest. At December 31, 2010, the fair value of our hedge funds held in side-pockets was $4 million (2009: $4 million). At December 31, 2010, redemptions receivable was insignificant (2009: $34 million).
At December 31, 2010, we had $46 million (2009: $54 million) of a long/short credit fund that we do not have the ability to liquidate at our own discretion as the fund is beyond its investment period and is currently distributing capital to its investors. Of the remaining credit fund holdings, 32% of the carrying value has annual or semi-annual liquidity and 68% has quarterly liquidity, subject to prior written redemption notice varying from 65 to 95 days. At December 31, 2010 and 2009, none of our credit funds had established side-pockets.
To estimate credit losses for corporate debt securities excluding MTNs, our projected cash flows are primarily driven by our assumptions regarding the probability of default and the severity associated with those defaults. Our default and loss severity rates are based on credit rating, credit analysis, industry analyst reports and forecasts, Moody’s historical default data and any other data relevant to the recoverability of the security. At December 31, 2010, the weighted average default rate and loss severity rate were 35% and 100% (2009: 34% and 100%), respectively, for determining the credit losses on our impaired corporate debt securities, excluding MTNs.
We do not record credit impairments on agency MBS in an unrealized loss position as they represent AAA rated holdings backed by either the explicit or implicit guarantee of the U.S. government. We believe the risk of loss in this asset class is remote and linked to the overall credit-worthiness of the U.S. government. At December 31, 2010, the fair value of our agency MBS was $2.6 billion (2009: $1.6 billion), which included $21 million (2009: $4 million) of gross unrealized losses.
Our investments in CMBS are diversified and rated highly with approximately 84% (2009: 89%) rated AA or better by S&P, with a weighted average estimated subordination percentage of 27% at December 31, 2010 (2009: 27%). Based on discounted cash flows, the current level of subordination is sufficient to cover the estimated loan losses on the underlying collateral of the CMBS.
For non-agency RMBS, our expected cash flows incorporated underlying data from widely accepted third-party data sources along with certain internal assumptions and judgments regarding the future performance of the security. These assumptions included the following: default, delinquency, loss severity and prepayment rates. During 2010, we have recorded additional credit losses of $1 million on non-agency RMBS. The assumptions used to calculate the credit losses in 2010 have not changed significantly since December 31, 2009. At December 31, 2010, the fair value of our non-agency RMBS was $244 million (2009: $223 million), consisting primarily of $174 million (2009: $136 million) of Prime and $52 million (2009: $70 million) of Alt-A MBS. At December 31, 2010, we had gross unrealized losses of $12 million on these securities.
These inputs require significant management judgment and vary for each structured security based on the underlying property type, vintage, loan to collateral value ratio, geographic concentration, and current level of subordination. We also corroborate our credit loss estimate with the independent investment manager’s credit loss estimate for each structured debt security with a significant unrealized loss position.
The majority of the unrealized losses on ABS at December 31, 2010, and 2009, were related to CLO debt tranched securities. We used the following significant inputs to estimate the credit loss for these securities:
The OTTI losses on equities in 2010 and 2009 are primarily due to the severity and duration of their unrealized loss positions, for which we concluded the forecasted recovery period was uncertain. The recognition of such losses does not necessarily indicate that sales will occur or that sales are imminent or planned. At December 31, 2010, the fair value of our equities was $349 million (2009: $204 million), which included $5 million (2009: $8 million) of gross unrealized losses.
To support our insurance and reinsurance operations we provide collateral (fixed maturities and short-term investments) in various forms. We primarily utilize trust arrangements for U.S. insurance obligations, and to a lesser extent issue letters of credit, for reinsurance business. The new letter of credit facility is secured with fixed maturity investments (see Note 10(b)). We are also required to maintain securities on deposit with various regulatory authorities. The fair value of our restricted investments was as follows:
At each valuation date, we use the market approach valuation technique to estimate the fair value of our fixed maturities portfolio, when possible. This market approach includes, but is not limited to, prices obtained from third party pricing services for identical or comparable securities and the use of “pricing matrix models” using observable market inputs such as yield curves, credit risks and spreads, measures of volatility, and prepayment speeds. Pricing from third party pricing services is sourced from multiple vendors, and we maintain a vendor hierarchy by asset type based on historical pricing experience and vendor expertise.
Corporate debt securities consist primarily of investment-grade debt of a wide variety of corporate issuers and industries. The fair values of these securities are generally determined using the spread above the risk-free yield curve. These spreads are generally obtained from the new issue market, secondary trading and broker-dealer quotes. As these spreads and the yields for the risk-free yield curve are observable market inputs, the fair values of our corporate debt securities are classified within Level 2. Where pricing is unavailable from pricing services, we obtain non-binding quotes from broker-
dealers. This is generally the case when there is a low volume of trading activity and current transactions are not orderly. In this event, securities are classified within Level 3 and consisted of private corporate debt securities at December 31, 2010.
ABS include mostly investment-grade bonds backed by pools of loans with a variety of underlying collateral, including automobile loan receivables, credit card receivables, and CLO debt tranched securities originated by a variety of financial institutions. Similarly to MBS, the fair values of ABS are priced through the use of a model which uses prepayment speeds and spreads sourced primarily from the new issue market. As the significant inputs used to price ABS are observable market inputs, the fair values of ABS are classified within Level 2. Where pricing is unavailable from pricing services, we obtain non-binding quotes from broker-dealers or use a discounted cash flow model to estimate fair value. This is generally the case when there is a low volume of trading activity and current transactions are not orderly. At December 31, 2010, the use of a discounted cash flow model was limited to our investment in CLO debt tranched securities and included the following significant inputs: default and loss severity rates, collateral spreads, and risk free yield curves (see Note 5(d) for quantitative inputs). As most of these inputs are unobservable, these securities are classified within Level 3.
As a practical expedient, we estimate fair values for hedge and credit funds using net asset values as advised by external fund managers or third party administrators. As our investment in hedge and credit funds have redemption restrictions (see Note 5 for further details), we have classified these investments as Level 3.
Our foreign currency forward contracts and options are customized to our hedging strategies and trade in the over-the-counter derivative market. We use the market approach valuation technique to estimate the fair value for these derivatives based on significant observable market inputs from third party pricing vendors, non-binding broker-dealer quotes and/or recent trading activity. Accordingly, we classified these derivatives within Level 2.
During 2010 and 2009, we had no transfers between Levels 1 and 2.
Following the adoption of the new Fair Value Measurements and Disclosures guidance on January 1, 2010, transfers into and out of Level 3 reflect the fair value of the securities at the end of the reporting period. This transition was applied prospectively and accordingly the transfers into and out of Level 3 from Level 2 for the year ended December 31, 2010, are not comparable with prior periods as transfers into Level 3 were previously recorded at the fair value of the security at the beginning of the reporting period.
The transfers to Level 3 from Level 2 made in 2009 and 2010 were due to a reduction in the volume of recently executed transactions or a lack of available quotes from pricing vendors and broker-dealers. None of the transfers were as a result of changes in valuation methodology that we made.
During the year ended December 31, 2010, the transfer relating to corporate debt was in relation to one issuer as a result of entering into an agreement to take delivery of a new corporate debt security, which its fair value measurement was based on observable market inputs. The remaining transfers out of Level 3 into Level 2 made in 2009 and 2010 were primarily due to the availability of observable market inputs and multiple quotes from pricing vendors and broker-dealers as a result of the return of liquidity in the credit markets.
The carrying amount of financial assets and liabilities presented on the Consolidated Balance Sheets as at December 31, 2010, and December 31, 2009 approximated their fair values with the exception of senior notes. At December 31, 2010, the senior notes are recorded at amortized cost with a carrying value of $994 million (2009: $499 million) and a fair value of $1,018 million (2009: $510 million).
The following table shows a reconciliation of our beginning and ending gross unpaid losses and loss expenses for the periods indicated:
In 2010, we recognized net loss and loss expenses of $256 million in relation to the February 2010 Chilean and September 2010 New Zealand earthquakes. Our estimates for these events were derived from ground-up assessments of our individual contracts and treaties in the affected regions and are consistent with our market share in the regions. As part of our estimation process, we also considered current industry insured loss estimates, market share analyses, catastrophe modeling analyses and the information available to date from clients, brokers and loss adjusters. Industry-wide insured loss estimates and our own loss estimates for these events are subject to change, as additional actual loss data becomes available. Actual losses in relation to these events may ultimately differ materially from current loss estimates.
Overall, a significant portion of the net favorable prior period reserve development in each of the last three years was generated from the property, marine, and aviation lines of our insurance segment and the property and catastrophe lines of our reinsurance segment. These lines of business, the majority of which have short tail exposures, contributed 58%, 65% and 86% of the total net favorable reserve development in 2010, 2009 and 2008, respectively. The favorable development on these lines of business primarily reflects the recognition of better than expected loss emergence, rather than explicit changes in our actuarial assumptions.
Approximately 37% and 34% of the net favorable reserve development in 2010 and 2009, respectively, was generated from professional lines insurance and reinsurance business. This favorable development was driven by increased incorporation of our own historical claims experience into our ultimate expected loss ratios for accident years 2007 and prior, with less weighting being given to information derived from industry benchmarks. During 2008, we concluded that a reasonable level of credible loss data had developed for the 2005 and prior accident year professional lines business and we began to give weight to our own loss experience for those accident years. However, the impact of this change during 2008 was notably muted by adverse development on the 2007 accident year insurance business, driven by losses arising from the global financial crisis.
We purchase treaty and facultative reinsurance to reduce exposure to significant losses. Facultative reinsurance provides coverage for all or a portion of the losses incurred for a single policy and we separately negotiated each facultative contract. Treaty reinsurance provides coverage for a specified type or category of risks. Our treaty reinsurance agreements provide this coverage on either an excess of loss or a proportional basis. Excess of loss covers provide a contractually set amount of coverage after a specified loss amount has been reached. This specified loss amount can be based on the size of an industry loss or on a Company-specific incurred loss amount. These covers can be purchased on a package policy basis, which provide us with coverage for a number of lines of business within one contract. In contrast, proportional covers provide a us with a specified percentage of coverage from the first dollar of loss. All of these reinsurance covers provide us the right to recover of a portion of specified losses and loss expenses from reinsurers. However, to the extent that our reinsurers do not meet their obligations under these agreements due to solvency issues, contractual disputes or other reasons, we remain liable. Under our reinsurance security policy, we predominantly cede our business to reinsurers rated A- or better by A.M. Best.
The following table provides a breakdown of our ceded premiums by type of cover:
At December 31, 2010, 5.7% (2009: 6.4%) of the total reinsurance recoverable balance was collateralized.
(1) Asset and liability derivatives are classified within other assets and other liabilities on the consolidated balance sheets.
The following table provides the net earnings impact of the fair value hedges:
On March 23, 2010, AXIS Specialty Finance LLC (“AXIS Specialty Finance”), a 100% owned finance subsidiary, issued $500 million aggregate principal amount of 5.875% senior unsecured debt (the “5.875% Senior Notes” and, together with the 5.75% Senior notes, the “Senior Notes”) at an issue price of 99.624%. The net proceeds of the issuance, after consideration of the offering discount and underwriting expenses and commissions, totaled approximately $495 million. Interest on the 5.875% Senior Notes is payable semi-annually in arrears on June 1 and December 1 of each year, beginning on June 1, 2010. Unless previously redeemed, the 5.875% Senior Notes will mature on June 1, 2020. The 5.875% Senior Notes are ranked as unsecured senior obligations of AXIS Specialty Finance. AXIS Capital has fully and unconditionally guaranteed all obligations of AXIS Specialty Finance under the 5.875% Senior Notes. AXIS Capital’s obligations under this guarantee are unsecured and senior and rank equally with all other senior obligations of AXIS Capital.
Our syndicated $1.5 billion credit facility (the “Expired Facility”) was terminated on August 24, 2010. Letters of credit outstanding under the Expired Facility at the time of termination remain valid until their expiry. As a condition of the execution of the new Syndicated Credit Facility (discussed below), we agreed to provide collateral to secure our remaining letter of credit obligations under the Expired Facility.
On May 14, 2010, certain of AXIS Capital’s operating subsidiaries entered into a secured $750 million letter of credit facility (the “LOC Facility”) with Citibank Europe plc (“Citibank”) pursuant to a Master Reimbursement Agreement and other ancillary documents (together, the “Facility Documents”). The LOC Facility may be terminated by Citibank on December 31, 2013 upon thirty days prior notice. Under the terms of the LOC Facility, letters of credit to a maximum aggregate amount of $750 million are available for issuance on behalf of the operating subsidiaries. These letters of credit will principally be used to support the reinsurance obligations of the operating subsidiaries. The LOC Facility is subject to certain covenants, including the requirement to maintain sufficient collateral, as defined in the Facility Documents, to cover all of the obligations under the LOC Facility. Such obligations include contingent reimbursement obligations for outstanding letters of credit and fees payable to Citibank. In the event of default, Citibank may exercise certain remedies, including the exercise of control over pledged collateral and the termination of the availability of the LOC Facility to any or all of the operating subsidiaries party to the Facility Documents.
On August 24, 2010, AXIS Capital and certain of its operating subsidiaries entered into a three-year revolving $500 million credit facility (the “Syndicated Credit Facility”) with a syndication of lenders pursuant to a Credit Agreement and other ancillary documents (together, the “Facility Documents”). Subject to certain conditions and at the request of AXIS Capital, the aggregate commitment under the Syndicated Credit Facility may be increased by up to $250 million. Under the terms of the Syndicated Credit Facility, loans are available for general corporate purposes and letters of credit may be issued in the ordinary course of business, with total usage not to exceed the aggregate amount of the Syndicated Credit Facility. Interest on loans issued under the Syndicated Credit Facility is payable based on underlying market rates at the time of loan issuance. While loans under the Syndicated Credit Facility are unsecured, we have the option to issue letters of credit on a secured basis in order to reduce associated fees. The letters of credit will principally be used to support the reinsurance obligations of the operating subsidiaries. Under the Syndicated Credit Facility, AXIS Capital guarantees the obligations of the operating subsidiaries and AXIS Specialty Finance guarantees the obligations of AXIS Capital and the operating subsidiaries. The Syndicated Credit Facility is subject to certain covenants, including limitations on fundamental changes, the incurrence of additional indebtedness and liens, certain transactions with affiliates and investments, as defined in the Syndicated Facility Documents. The Syndicated Credit Facility also requires compliance with certain financial covenants, including a maximum debt to capital ratio and a minimum consolidated net worth requirement. In addition, each of AXIS Capital’s material insurance/reinsurance subsidiaries party to the Syndicated Credit Facility must maintain a minimum A.M. Best Company, Inc. financial strength rating. In the event of default, including a breach of these covenants, the lenders may exercise certain remedies including the termination of the Syndicated Credit Facility, the declaration of all principal and interest amounts related to Syndicated Credit Facility loans to be immediately due and the requirement that all outstanding letters of credit be collateralized.
maturities portfolio for securities rated A- or above and 1% or less of our fixed maturities portfolio for securities rated below A-. At December 31, 2010, we were in compliance with these limits.
We produce our business through brokers and direct relationships with insurance companies. During 2010, three brokers accounted for 62% (2009: 62%; 2008: 58%) of our total gross premiums written. Aon Corporation accounted for 25% (2009: 26%; 2008: 23%), Marsh, Inc. (including its subsidiary Guy Carpenter and Company) for 24% (2009: 23%; 2008: 23%), and Willis Group Holdings Ltd. for 13% (2009: 13%; 2008: 12%). No other broker and no one insured or reinsured accounted for more than 10% of our gross premiums written in any of the last three years.
During 2010, we purchased reinsurance coverage for our insurance lines of business. The minimum reinsurance premiums are contractually due on a quarterly basis in advance. Accordingly at December 31, 2010, we have an outstanding reinsurance purchase commitment of $51 million.
In 2005, a putative class action lawsuit was filed against our U.S. insurance subsidiaries. In re Insurance Brokerage Antitrust Litigation was filed on August 15, 2005 in the United States District Court for the District of New Jersey and includes as defendants numerous insurance brokers and insurance companies. The lawsuit alleges antitrust and Racketeer Influenced and Corrupt Organizations Act (“RICO”) violations in connection with the payment of contingent commissions and manipulation of insurance bids and seeks damages in an unspecified amount. On October 3, 2006, the District Court granted, in part, motions to dismiss filed by the defendants, and ordered plaintiffs to file supplemental pleadings setting forth sufficient facts to allege their antitrust and RICO claims. After plaintiffs filed their supplemental pleadings, defendants renewed their motions to dismiss. On April 15, 2007, the District Court dismissed without prejudice plaintiffs’ complaint, as amended, and granted plaintiffs thirty (30) days to file another amended complaint and/or revised RICO Statement and Statements of Particularity. In May 2007, plaintiffs filed (i) a Second Consolidated Amended Commercial Class Action complaint, (ii) a Revised Particularized Statement Describing the Horizontal Conspiracies Alleged in the Second Consolidated Amended Commercial Class Action Complaint, and (iii) a Third Amended Commercial Insurance Plaintiffs’ RICO Case Statement Pursuant to Local Rule 16.1(B)(4). On June 21, 2007, the defendants filed renewed motions to dismiss. On September 28, 2007, the District Court dismissed with prejudice plaintiffs’ antitrust and RICO claims and declined to exercise supplemental jurisdiction over plaintiffs’ remaining state law claims. On October 10, 2007, plaintiffs filed a notice of appeal of all adverse orders and decisions to the United States Court of Appeals for the Third Circuit, and a hearing was held in April 2009. On August 16, 2010, the Third Circuit Court of Appeals affirmed the District Court’s dismissal of the antitrust and RICO claims arising from the contingent commission arrangements and remanded the case to the District Court with respect to the manipulation of insurance bids allegations. We believe that the lawsuit is completely without merit and we continue to vigorously defend the filed action.
For the year ended December 31, 2010, there were 186,792 (2009: 1,915,574) shares for stock compensation plans which were excluded in the computation of diluted earnings per share because the effect would be anti-dilutive.
The following table presents our common shares issued and outstanding, excluding restricted shares under our stock compensation plans (see Note 15 - Stock Compensation Plans):
On October 5, 2005, we issued $250 million of 7.25% series A Preferred shares, par value $0.0125 per share, with a liquidation preference of $25.00 per share. We may redeem the shares at a redemption price of $25.00 per share. Dividends on the series A Preferred shares are non-cumulative. Consequently, if the board of directors does not authorize and declare a dividend for any dividend period, holders of the series A Preferred shares will not be entitled to receive a dividend for such period, and such undeclared dividend will not accumulate and be payable. Holders of series A Preferred shares will be entitled to receive, only when, as and if declared by the board of directors, non-cumulative cash dividends from the original issue date, quarterly in arrears on the fifteenth day of January, April, July and October of each year, commencing on January 15, 2006, without accumulation of any undeclared dividends. To the extent declared, these dividends will accumulate, with respect to each dividend period, in an amount per share equal to 7.25% of the liquidation preference per annum. For 2010 and 2009, the total dividends declared on series A Preferred share was $1.8125 per share.
Commencing on March 1, 2016, the dividend rate on the series B Preferred shares will be payable at a floating rate. During a floating rate period, the floating rate per annum will be reset quarterly at a rate equal to 3.4525% plus the 3-month LIBOR Rate. Dividends on the series B Preferred shares are non-cumulative. Consequently, if the board of directors does not declare a dividend for any dividend period, holders of the series B Preferred shares will not be entitled to receive a dividend for such period, and such undeclared dividend will not accumulate and will not be payable. For 2010 and 2009, the total dividends declared on series B Preferred share was $7.50 per share.
aggregate amount equivalent to six full quarterly dividends (whether or not consecutive) on all of the series A and B Preferred shares or any class or series of parity stock then outstanding, the holders of the series A and B Preferred shares, together with the holders of each such class or series of parity stock, will have the right, voting together as a single class regardless of class or series, to elect two directors to our board of directors. We will use our best efforts to effectuate the election or appointment of these two directors. Whenever dividends on the series A and B Preferred shares and the parity stock then outstanding have been paid in full, or declared and sufficient funds have been set aside, for at least four dividend periods, the right of holders of the series A and B Preferred shares and the parity stock to be represented by directors will cease (but subject always to the same provision for the vesting of such rights in the case of any future suspension of payments in an amount equivalent to dividends for six full dividend periods whether or not consecutive), and the terms of office of the additional directors elected or appointed to the Board of Directors will terminate.
on December 6, 2007, our Board of Directors approved a share repurchase plan with the authorization to repurchase up to $400 million of our common shares until December 31, 2009;
At December 31, 2010, we had $593 million of capacity remaining under the share repurchase plans. Share repurchases may be effected from time to time in the open market or private negotiated transactions, depending on market conditions.
The following table presents our share repurchases, which are held in treasury:
(1) To satisfy withholding tax liabilities upon vesting of restricted stock awards and exercise of stock options. Share repurchases from employees are excluded from the authorized share repurchase plans noted above.
(3) The rate is fixed at 3% for the duration of the SERPs.
At December 31, 2010, the fair value of the SERPs assets was $18 million (2009: $18 million). Our investment strategy is to maintain a conservative and diversified asset allocation strategy to yield a 5.75% annualized return over the life of the SERPs. At December 31, 2010, the SERPs were over-funded by $2 million (2009: $1 million) and accordingly we do not anticipate making any contributions to these SERPs in 2011, assuming normal market conditions.
In May 2009, our shareholders approved an amendment to the 2007 Plan, resulting in an increase in the total number of common shares authorized for issuance by 4,000,000 for a total of 9,000,000 common shares.
The above restricted stocks are subject to a vesting period of four years with 25% of the award to be vested on an annual basis.
The total intrinsic value of stock options exercised during 2010 was $4 million (2009: $3 million) and we received proceeds of $8 million (2009: $3 million). For exercised stock options, we issued new shares from the authorized share capital pool rather than from our treasury pool. At December 31, 2009 and 2008, there was no remaining unrecognized compensation cost related to stock options and accordingly we incurred no related compensation costs during December 31, 2010 and 2009.
During 2010, we incurred an expense of $37 million (2009: $48 million; 2008: $67 million) in respect of restricted stock, and recorded tax benefits thereon of $6 million (2009: $6 million; 2008: $7 million). The total fair value of shares vested
During 2010, realized additional tax benefits for certain vested restricted stocks and exercised stock options was negligible (2009: negligible; 2008: $1 million). These excess tax benefits are included in our cash flows from financing activities in the Consolidated Statements of Cash Flows.
Our non-management directors may also elect to receive their meeting and other fees in common shares or phantom stock units rather than cash, based on the fair value of our common shares at the time of the grant. At December 31, 2010, we had 35,699 (2009: 67,461) phantom stock units outstanding and we have issued a cumulative total of 161,411 (2009: 97,900) common shares in lieu of fees, including the conversion of phantom stock units into common shares.
Our U.S. subsidiaries are subject to federal, state and local corporate income taxes and other taxes applicable to U.S. corporations. The provision for federal income taxes has been determined under the principles of the consolidated tax provisions of the U.S. Internal Revenue Code and Regulations. Should the U.S. subsidiaries pay a dividend outside the U.S. group, withholding taxes will apply. Our U.S. subsidiaries are not under examination but remain subject to examination in the U.S. for tax years 2007-2010. One of our U.S. subsidiaries has a branch operation in Canada, which is subject to the relevant taxes in that jurisdiction. The branch is not under examination in this tax jurisdiction, but remains subject to examination for tax years 2008 through 2010.
We also have operating subsidiaries and branch operations in Ireland, the United Kingdom, Switzerland and Australia which are subject to the relevant taxes in those jurisdictions. Our European insurance operating subsidiary with branch operations in Ireland, the United Kingdom, Switzerland, and Australia are not under examination in any of these tax jurisdictions, but generally remain subject to examination for tax years 2006-2010. Our European reinsurance operating subsidiary with a branch in Switzerland was audited by the Irish and Swiss taxing authorities through 2007 with no significant audit adjustments.
At December 31, 2010 and 2009, the valuation allowance consisted of capital items in the U.S., including net unrealized capital losses, capital loss carryforwards, and impairments, as well as operating loss carryforwards in other jurisdictions. The movement in the valuation allowance is allocated first to income tax expense and the remainder to AOCI using the intraperiod tax allocation method.
Relevant to making the valuation allowance determination, we considered that the U.S. consolidated group has no capital loss carryback ability, uncertain ability to generate U.S. capital gains during the carryforward period, or other strategies to generate U.S. capital gains sufficient to utilize the deferred tax assets relating the U.S. investment portfolio. We did take into account net unrealized capital gains of $38 million at December 31, 2010 (2009: $24 million) in computing the valuation allowance based on the assumption that the company would dispose of these securities to avoid expiration of the U.S. capital loss carryforwards.
Capital loss carryforwards at December 31, 2010 by expiration date are as follows: $20 million expire in 2013, and $30 million expire in 2014.
Under the Insurance Act 1978, amendments thereto and Related Regulations of Bermuda, our Bermuda subsidiary, AXIS Specialty Bermuda is restricted as to the payment of dividends and/or distributions for amounts greater than 25% of the prior year’s statutory capital and surplus whereby a signed affidavit by at least two members of the Board of Directors attesting that a dividend and/or distribution in excess of this amount would not cause the company to fail to meet its
Our Irish subsidiaries, AXIS Specialty Europe and AXIS Re Ltd., are required to maintain minimum levels of statutory and capital surplus. At December 31, our subsidiaries were in compliance with these requirements. Our Irish subsidiaries may declare dividends out of retained earnings subject to meeting their solvency and capital requirements. At December 31, 2010, the maximum dividend our Irish subsidiaries could pay out of retained earnings, subject to regulatory approval, was approximately $80 million.