This data should be read in conjunction with the Consolidated Financial Statements and the accompanying Notes to Consolidated Financial Statements in Item 8 of Part II of this report and with other information contained in this report, including Management’s Discussion and Analysis of Financial Condition and Results of Operations in
Successful risk management is the foundation of the Company’s value proposition, with diversification of risks at the core of its risk management strategy. The Company’s ability to succeed in the risk assumption and management business is dependent on its ability to accurately analyze and quantify risk, to understand volatility and how risks aggregate or correlate, and to establish the appropriate capital requirements and limits for the risks assumed. All risks, whether they are reinsurance related risks or capital market risks, are managed by the Company within an integrated framework of policies and processes to ensure the intelligent and consistent evaluation and valuation of risk, and to ultimately provide an appropriate return to shareholders. For further discussion of the Company’s risk management framework, see Risk Management in Item 1 of Part I of this report.
The Company’s economic objective is to manage a portfolio of risks that will generate growth in compound annual diluted book value per share and share equivalents outstanding over a reinsurance cycle. Management assesses this economic objective over the reinsurance cycle, rather than any particular quarterly or annual period, given the Company’s profitability is significantly affected by the level of large catastrophic losses that it incurs each period. The Company uses a number of metrics to monitor its performance in meeting its economic objective, which are discussed further below under Key Financial Measures.
The following discussion provides an overview of the Company’s business and trends and commentary regarding the outlook for 2013 in each business.
In its reinsurance portfolio, the Company writes all lines of business in virtually all markets worldwide, and differentiates itself through its risk management strategy and its financial strength. In assuming its clients’ risks, the Company removes the volatility associated with those risks from the client, and then manages those risks and the risk-related volatility. Through its broad product and geographic diversification, its execution capabilities and its local presence in most major markets, the Company is able to stabilize returns, respond quickly to market needs, and capitalize on business opportunities virtually anywhere in the world.
The Non-life reinsurance market has historically been highly cyclical in nature. The reinsurance cycle is driven by competition, the amount of capital and capacity in the industry, loss events and investment returns. The Company’s long-term strategy to generate shareholder value focuses on broad product, asset and geographic diversification of risks.
The cyclicality of the Non-life reinsurance market is characterized by cycles of growth and decline, known as hard and soft insurance cycles. Since late 2003, the Company began to see the emergence of a soft market across most lines of business with general decreases in pricing and profitability. With the exception of lines and markets impacted by specific catastrophic or large loss events, this trend continued throughout the decade. In 2011 and 2012, the Company experienced increases in pricing in certain loss affected lines of business and markets, which were primarily related to the increased catastrophic and large loss activity during 2011. In addition, the impact of Superstorm Sandy in 2012 has resulted in rate increases in the loss affected lines of business and markets at the January 1, 2013 renewals. In lines of business and markets that have not been specifically impacted by any recent large losses, during 2012 and for the January 1, 2013 renewals, the terms and conditions continued to be mainly static and soft in most markets, with price deteriorations observed in some markets.
losses incurred related to the business it has produced and ensuring an alignment of interests with the third party insurance companies. During 2013, the Company will obtain the necessary licenses and approvals to write this business directly itself and will transition these relationships from the third party insurance companies.
The Company generates revenue from its high quality investment portfolio, as well as the investments underlying the funds held - directly managed account, through net investment income, including coupon interest on fixed maturities and dividends on equities, and realized and unrealized gains and losses on investments.
For the Company’s capital markets risks, which include both public and private market investments, diversification of risk is critical to achieving the risk and return objectives of the Company. The Company’s investment policy distinguishes between liquid, high quality assets that support the Company’s liabilities, and the more diversified, higher risk asset classes that make up the Company’s capital funds. While there will be years where capital markets risks achieve less than the risk-free rate of return, or potentially even negative results, the Company believes the rewards for assuming these risks in a disciplined and measured way will produce a positive excess return to the Company over time. Additionally, since capital markets risks are not fully correlated with the Company’s reinsurance risks, this increases the overall diversification of the Company’s total risk portfolio.
Assuming constant foreign exchange rates, Management expects net investment income to continue to decrease in 2013 compared to 2012 primarily due to lower reinvestment rates with low yields expected to continue throughout 2013. Management expects this decrease to be partially offset by expected positive cash flow from operations (including net investment income).
The Company measures its performance in several ways. Among the performance measures accepted under U.S. GAAP is diluted net income or loss per share, a measure that focuses on the return provided to the Company’s common shareholders. Diluted net income or loss per share is obtained by dividing net income or loss available to common shareholders by the weighted average number of common shares and common share equivalents outstanding. Net income or loss available to common shareholders is defined as net income or loss less preferred dividends. See the discussion of the non-GAAP performance measures that the Company uses (operating earnings or loss and Operating ROE) and the reconciliation of those non-GAAP performance measures to the most directly comparable GAAP measures in Key Financial Measures below.
To the extent that these events have affected the year over year comparison of the Company’s results, their impact has been quantified and discussed in each of the relevant sections.
The increase in net income of $1,655 million in 2012 compared to 2011 resulted primarily from:
an increase of $427 million in pre-tax net realized and unrealized investment gains primarily as a result of narrowing credit spreads, improvements in worldwide equity markets and decrease in risk-free rates; partially offset by
a decrease in other corporate operating expenses of $67 million, primarily driven by the charges related to the Company’s voluntary termination plan in 2010; and
a decrease in income tax expense of $60 million, resulting from a lower pre-tax net income.
The decrease in net income available to common shareholders and diluted net income per share from income in 2010 to losses in 2011 was primarily due to the above factors and an increase in preferred dividends following the issuance of preferred shares in June 2011. For diluted net income per share specifically, the decrease was partially offset by a decrease in the diluted number of common shares outstanding as a result of share repurchases during 2011.
The following tables reflects the combined impact of the large catastrophic losses and large losses, the impact on the Company’s technical result, net realized and unrealized investment gains or losses, pre-tax net income or loss, loss ratio, technical ratio and combined ratio by segment and sub-segment, and the large catastrophic losses and large losses by event for the years ended December 31, 2012, 2011 and 2010 (in millions of U.S. dollars):
(1) Large catastrophic losses and large losses are shown net of any reinsurance, reinstatement premiums and profit commissions.
In addition to the Consolidated Balance Sheets and Consolidated Statements of Operations and Comprehensive Income (Loss), Management uses certain key measures to evaluate its financial performance and the overall growth in value generated for the Company’s common shareholders. The four key measures that Management uses, together with definitions of their calculations, are as follows at December 31, 2012 and 2011 and for the years ended December 31, 2012, 2011 and 2010:
(1) Diluted book value per common share and common share equivalents outstanding is calculated using common shareholders’ equity (shareholders’ equity less the aggregate liquidation value of preferred shares) divided by the number of fully diluted common shares and common share equivalents outstanding (assuming exercise of all stock-based awards and other dilutive securities).
(2) Operating earnings or loss available to common shareholders (operating earnings or loss) is calculated as net income or loss available to common shareholders excluding net realized and unrealized gains or losses on investments, net of tax, net foreign exchange gains or losses, net of tax, and interest in earnings or losses of equity investments, net of tax, where the investee’s operations are not insurance or reinsurance related and where the Company does not control the investee companies’ activities, and is calculated after preferred dividends. The presentation of operating earnings or loss is a non-GAAP financial measure within the meaning of Regulation G (see Comment on Non-GAAP Measures below) and is reconciled to the most directly comparable GAAP financial measure below. Effective January 1, 2011, Management redefined its operating earnings or loss calculation, as discussed below.
(3) Operating return on beginning diluted book value per common share and common share equivalents outstanding (Operating ROE) is calculated using operating earnings or loss, as defined above, per diluted common share and common share equivalents outstanding, divided by diluted book value per common share and common share equivalents outstanding as of the beginning of the year, as defined above. The presentation of Operating ROE is a non-GAAP financial measure within the meaning of Regulation G (see Comment on Non-GAAP Measures below) and is reconciled to the most directly comparable GAAP financial measure below. Effective January 1, 2011, Management redefined its Operating ROE calculation, as discussed below.
(4) The combined ratio of the Non-life segment is calculated as the sum of the technical ratio (losses and loss expenses and acquisition costs divided by net premiums earned) and the other operating expense ratio (other operating expenses divided by net premiums earned).
Over the past five years, since December 31, 2007, the Company has generated a compound annual growth rate in Diluted Book Value per Share in excess of 8% and over the past ten years, since December 31, 2002, the Company has generated a compound annual growth rate in Diluted Book Value per Share in excess of 11%.
Operating earnings or loss available to common shareholders (operating earnings or loss): Management uses operating earnings or loss to measure its financial performance as this measure focuses on the underlying fundamentals of the Company’s operations by excluding net realized and unrealized gains or losses on investments, certain interest in earnings or losses of equity investments and net foreign exchange gains or losses. Net realized and unrealized gains or losses on investments in any particular period are not indicative of the performance of, and distort trends in, the Company’s business as they predominantly result from general economic and financial market conditions, and the timing of realized gains or losses on investments is largely opportunistic. Interest in earnings or losses of equity investments are also not indicative of the performance of, or trends in, the Company’s business where the investee’s operations are not insurance or reinsurance related and where the Company does not control the investee companies’ activities. Net foreign exchange gains or losses are not indicative of the performance of, and distort trends in, the Company’s business as they predominantly result from general economic and foreign exchange market conditions. Management believes that the use of operating earnings or loss enables investors and other users of the Company’s financial information to analyze its performance in a manner similar to how Management analyzes performance. Management also believes that this measure follows industry practice and, therefore, allows the users of financial information to compare the Company’s performance with its industry peer group, and that the equity analysts and certain rating agencies which follow the Company, and the insurance industry as a whole, generally exclude these items from their analyses for the same reasons.
The other lesser factors contributing to the increases or decreases in operating earnings in 2012 compared to 2011 and in 2011 compared to 2010 are further described in Review of Net Income (Loss) below.
The presentation of operating earnings or loss available to common shareholders is a non-GAAP financial measure within the meaning of Regulation G and should be considered in addition to, and not as a substitute for, measures of financial performance prepared in accordance with GAAP (see Comment on Non-GAAP Measures). The table below provides a reconciliation of operating earnings or loss to the most directly comparable GAAP financial measure for the years ended December 31, 2012, 2011 and 2010 (in millions of U.S. dollars):
Operating ROE decreased from 7.4% in 2010 to a loss of 10.1% in 2011. The decrease in Operating ROE was primarily due to the decrease in operating earnings in 2011 compared to 2010, which was driven by the higher level of 2011 catastrophic loss activity.
The presentation of Operating ROE is a non-GAAP financial measure within the meaning of Regulation G and should be considered in addition to, and not as a substitute for, measures of financial performance prepared in accordance with GAAP (see Comment on Non-GAAP Measures). The table below provides a reconciliation of Operating ROE to the most directly comparable GAAP financial measure for the years ended December 31, 2012, 2011 and 2010:
Since 2003, the Company has had eight years of underwriting profitability reflected in combined ratios of less than 100% for its Non-life segment, with the only exceptions being 2005 and 2011. In 2005, when the industry recorded its worst year in history in terms of catastrophe losses in the U.S., with Hurricane Katrina being the largest insured event ever, the Company recorded a net underwriting loss and Non-life combined ratio of 116.3%. In 2011, when the industry incurred a high frequency of large losses related to the 2011 catastrophic events the Company recorded a net underwriting loss and Non-life combined ratio of 125.4%.
The Non-life combined ratio increased by 30.4 points, from 95.0% in 2010 to 125.4% in 2011. The increase in the combined ratio for 2011 compared to 2010 was primarily due to an increase in catastrophic loss activity of 31.3 points (from 13.9 points in 2010 to 45.2 points in 2011). The impact on the combined ratio by catastrophic event for each year is analyzed above.
The other lesser factors contributing to increases or decreases in the combined ratio for all years presented are described further in Review of Net Income (Loss) below.
The Company uses the combined ratio to measure its overall underwriting profitability for its Non-life segment as a whole. Given the Company does not allocate operating expenses to its Non-life sub-segments, Management measures the underwriting profitability of the Non-life sub-segments by using the technical result and technical ratio as described in Results by Segment below.
(ii) the tail factors used to reflect development of paid and reported losses after several years have elapsed since the inception of the underwriting year;
The validity of all parameter assumptions used in the reserving process is reaffirmed on a quarterly basis. Reaffirmation of the parameter assumptions means that the actuaries determine that the parameter assumptions continue to form a sound basis for projection of future liabilities. Parameter assumptions used in projecting future liabilities are themselves estimates based on historical information. As new information becomes available (e.g., additional losses reported), the Company’s actuaries determine whether a revised estimate of the parameter assumptions that reflects all available information is consistent with the previous parameter assumptions employed. In general, to the extent that the revised estimate of the parameter assumptions are within a close range of the original assumptions, the Company determines that the parameter assumptions employed continue to form an appropriate basis for projections and continue to use the original assumptions in its models. In this case, any differences could be attributed to the imprecise nature of the parameter estimation process. However, to the extent that the deviations between the two sets of estimates are not within a close range of the original assumptions, the Company reacts by adopting the revised assumptions as a basis for its reserve models. Notwithstanding the above, even where the Company has experienced no material deviations from its original assumptions during any quarter, the Company will generally revise the reserving parameter assumptions at least once a year to reflect all accumulated available information.
(vi) the selection of reserving cells results in homogeneous and credible future expectations for all business in the cell and any changes in underlying treaty terms are either reflected in cell selection or explicitly allowed in the selection of trends;
During 2012, 2011 and 2010, the Company reviewed its estimate for prior year losses for the Non-life segment (defined below in Results by Segment) and, in light of developing data, adjusted its ultimate loss ratios for prior accident years. The following table summarizes the net prior year favorable loss development for each sub-segment of the Company’s Non-life segment for the years ended December 31, 2012, 2011 and 2010 (in millions of U.S. dollars):
(2) Net prior year reserve development due to all other factors includes, but is not limited to, loss experience, changes in assumptions and changes in methodology.
The table below summarizes the net prior year favorable (adverse) loss development for the year ended December 31, 2012 by reserving line for the Company’s Non-life segment (in millions of U.S. dollars):
Loss information provided by cedants in 2012, 2011 and 2010 for prior accident years was lower than the Company expected for most lines of business (higher for motor-Non-U.S. proportional business and engineering) and included no individually significant losses or reductions but a series of attritional losses or reductions. Based on the Company’s assessment of this loss information, the Company decreased (increased for motor-Non-U.S. proportional business and engineering) its expected ultimate loss ratios, which had the net effect of decreasing (increasing for motor-Non-U.S. proportional business and engineering) prior year loss estimates.
The following paragraphs discuss how losses paid and reported during the year ended December 31, 2012 compared with the Company’s expectations, and how the Company modified its reserving parameter assumptions in line with the emerging development in each reserving line.
Aviation / Space: Aggregate losses reported in 2012 were significantly lower than the Company’s expectations. The Company reflected this experience by selecting lower loss ratios for underwriting years 2009 to 2011.
Credit / Surety: Aggregate losses reported in 2012 were lower than expected for North America business, giving rise to a moderate level of reserve releases. For the Company’s Global (Non-U.S.) business, loss development was significantly better than expected, primarily for the underwriting years 2009 to 2011. The Company reduced its loss ratios for the most recent underwriting years to reflect the lower than expected loss emergence.
Energy Onshore: Aggregate losses reported in 2012 were lower than expected across most underwriting years, with the exception of 2010 which was impacted by higher than expected losses on proportional treaties. The Company has reflected the favorable development by reducing its loss ratios for most underwriting years, with the exception of 2010.
Engineering: Aggregate losses reported in 2012 were higher than expected and were primarily driven by increases in prior year premium adjustments for various underwriting years on proportional business reflecting increased exposure. The Company did not materially change its reserving assumptions for this line.
Aggregate losses reported in 2012 for the Global (Non-U.S.) motor non-proportional line were lower than expected resulting in the Company reducing its loss ratios. The Company also increased its weightings to more experience-based indications resulting in further prior year releases on underwriting years 2003 to 2007.
Aggregate losses reported in 2012 for the Global (Non-U.S.) motor proportional line were in line with expectations, however, the Company has increased its loss development factor assumptions slightly during the year due to adverse development reported on certain treaties.
Aggregate losses reported in 2012 for the North America motor line were modestly favorable. This reflected lower than expected reported losses for the 2005 to 2009 underwriting years, while the 2011 underwriting year experienced adverse development driven by higher than expected reported losses.
Multiline: Aggregate reported losses in 2012 were lower than expected for North America business for underwriting years 2010 and prior and were partly offset by higher than expected losses reported for the 2011 underwriting year.
The following table shows the gross reserves reported by cedants (case reserves), those estimated by the Company (ACRs and IBNR reserves) and the total gross, ceded and net loss reserves recorded at December 31, 2012 by reserving line for the Company’s Non-life operations (in millions of U.S. dollars):
The Company’s best estimates are point estimates within a reasonable range of actuarial liability estimates. These ranges are developed using stochastic simulations and techniques and provide an indication as to the degree of variability of the loss reserves. The Company interprets the ranges produced by these techniques as confidence intervals around the point estimates for each Non-life sub-segment. However, due to the inherent volatility in the business written by the Company, there can be no assurance that the final settlement of the loss reserves will fall within these ranges.
Of the Company’s $10,418 million of net Non-life loss reserves at December 31, 2012, net loss reserves for accident years 2005 and prior of $857 million are guaranteed by Colisée Re, pursuant to the Reserve Agreement. The Company is not subject to any loss reserve variability associated with the guaranteed reserves. See Business - Reserves in Item 1 of Part I of this report.
As an example of the sensitivity of the Company’s policy benefits for life and annuity contracts to reserving parameter assumptions, the table below summarizes, by reserving line, the effect of different assumption selections.
It is not appropriate to sum the total impact for a specific reserving line or the total impact for a specific factor because the reinsurance portfolios are not perfectly correlated.
The Company provides proportional and non-proportional reinsurance coverage to cedants (insurance companies). In most cases, cedants seek protection for business that they have not yet written at the time they enter into reinsurance agreements and thus have to estimate the volume of premiums they will cede to the Company. Reporting delays are inherent in the reinsurance industry and vary in length by reinsurance market (country of cedant) and type of treaty. As delays can vary from a few weeks to a year or sometimes longer, the Company produces accounting estimates to report premiums and acquisition costs until it receives the cedants’ actual premium reported data. Approximately, 43%, 43% and 42% of the Company’s reported net premiums written for the years ended December 31, 2012, 2011 and 2010, respectively, were based upon estimates.
Under proportional treaties, which represented 72% of the Company’s total gross premiums written for the year ended December 31, 2012, the Company shares proportionally in both the premiums and losses of the cedant and pays the cedant a commission to cover the cedant’s acquisition costs. Under this type of treaty, the
Company’s ultimate premiums written and earned and acquisition costs are not known at the inception of the treaty. As such, reported premiums written and earned and acquisition costs on proportional treaties are generally based upon reports received from cedants and brokers, supplemented by the Company’s own estimates of premiums written and acquisition costs for which ceding company reports have not been received. Premium and acquisition cost estimates are determined at the individual treaty level. The determination of premium estimates requires a review of the Company’s experience with cedants, familiarity with each market, an understanding of the characteristics of each line of business and Management’s assessment of the impact of various other factors on the volume of business written and ceded to the Company. Premium and acquisition cost estimates are updated as new information is received from the cedants and differences between such estimates and actual amounts are recorded in the period in which estimates are changed or the actual amounts are determined.
Under non-proportional treaties, which represented 28% of the Company’s total gross premiums written for the year ended December 31, 2012, the Company is typically exposed to loss events in excess of a predetermined dollar amount or loss ratio and receives a fixed or minimum premium, which is subject to upward adjustment depending on the premium volume written by the cedant. In addition, many of the non-proportional treaties include reinstatement premium provisions. Reinstatement premiums are recognized as written and earned at the time a loss event occurs, where coverage limits for the remaining life of the contract are reinstated under pre-defined contract terms. The accrual of reinstatement premiums is based on Management’s estimate of losses and loss expenses associated with the loss event.
Acquisition costs, comprising only of incremental brokerage fees, commissions and excise taxes, which vary directly with, and are related to, the acquisition of reinsurance contracts, are capitalized and charged to expense as the related premium is earned. All other acquisition-related costs, including all indirect costs, are expensed as incurred. The recovery of deferred policy acquisition costs is dependent upon the future profitability of the related business. Deferred policy acquisition costs recoverability testing is performed periodically together with the reserve adequacy test, based on the latest best estimate assumptions by line of business.
Under U.S. GAAP, a deferred tax asset or liability is to be recognized for the estimated future tax effects attributable to temporary differences and carryforwards. U.S. GAAP also establishes procedures to assess whether a valuation allowance should be established for deferred tax assets. All available evidence, both positive and negative, is considered to determine whether, based on the weight of that evidence, a valuation allowance is needed for some portion or all of a deferred tax asset. Management must use its judgment in considering the relative impact of positive and negative evidence. The Company has also established tax liabilities relating to uncertain tax positions as defined under U.S. GAAP of $17 million at December 31, 2012 (see Notes 2(l) and 14 to Consolidated Financial Statements in Item 8 of Part II of this report).
As an example of the sensitivity of the Company’s unrecognized tax benefit related to uncertain tax positions, deferred tax asset and net deferred tax liability, the table below summarizes the impact of different assumption selections on the Company’s net income and the corresponding impact on net assets based on amounts recorded at December 31, 2012 (in millions of U.S. dollars):
For the Company’s fixed maturities, equities, other invested assets and investments underlying the funds held - directly managed account categorized as Level 3, a 10% decline in the fair value of these investments at December 31, 2012 would result in a $79 million pre-tax charge to net income or loss and a corresponding reduction in total assets.
In addition, included in the Company’s other invested assets are various investments which are accounted for using the cost method of accounting, equity method of accounting or investment company accounting, totaling $262 million at December 31, 2012. The Company does not measure its investments that are accounted for using any of these methods at fair value. For investments that are accounted for using the cost method of accounting, equity method of accounting or investment company accounting, a 10% decline in the carrying value of these investments at December 31, 2012 would result in a $26 million pre-tax charge to net income or loss and a corresponding reduction in investments and total assets.
The Company utilizes derivatives for a variety of purposes (see Note 6 to Consolidated Financial Statements in Item 8 of Part II of this report). The Company’s derivatives are carried at fair value, which is based on quoted market prices or internal valuation models where quoted market prices are not available. Most of the Company’s derivatives are fair valued using significant other observable inputs (fair value of $16 million net unrealized loss at December 31, 2012), referred to as Level 2 assets. The Company’s derivatives that are fair valued using quoted prices in active markets, referred to as Level 1 assets, had an insignificant fair value at December 31, 2012. In addition, the Company has certain total return swaps and insurance-linked securities that are fair valued using significant other unobservable inputs, and are included in the Level 3 other invested assets. The total return swaps and insurance-linked securities that are classified as Level 3 have a combined fair value of $4 million net unrealized gain at December 31, 2012, based on a combined notional exposure of $205 million.
The Company is exposed to changes in the expected amount of future cash flows of the reference assets in its total return swap portfolio. The Company’s total return swap portfolio references many different underlying assets with a number of risk factors. At December 31, 2012, the notional value of the total return swap portfolio categorized as Level 3 was $69 million and the fair value of the assets underlying the total return swap portfolio categorized as Level 3 was $75 million. The Company estimated that each 1% increase or decrease in the amount of all expected future cash flows related to the reference assets would result in an insignificant increase or decrease, respectively, in the fair value of its total return swap portfolio at December 31, 2012.
Intangible assets represent the fair value adjustments related to unpaid losses and loss expenses and the fair values of renewal rights, customer relationships, U.S. licenses and fronting arrangements arising from the acquisitions of Paris Re and Presidio. Definite-lived intangible assets are amortized over their useful lives, generally ranging from one to thirteen years. The Company recognizes the amortization of all intangible assets in the Consolidated Statement of Operations. Indefinite-lived intangible assets are not subject to amortization. The carrying values of intangible assets are reviewed for indicators of impairment on at least an annual basis. Impairment is recognized if the carrying values of the intangible assets are not recoverable from their undiscounted cash flows and are measured as the difference between the carrying value and the fair value. Based upon the Company’s assessment, there was no impairment of its intangible assets of $214 million at December 31, 2012.
the U.S. dollar ending exchange rate weakened against most currencies, except the Japanese yen, at December 31, 2012 compared to December 31, 2011 and strengthened against most currencies, except the Japanese yen, at December 31, 2011 compared to December 31, 2010.
Management analyzes the Company’s net income or loss in three parts: underwriting result, investment result and other components of net income or loss. Underwriting result consists of net premiums earned and other income or loss less losses and loss expenses and life policy benefits, acquisition costs and other operating expenses. Investment result consists of net investment income, net realized and unrealized investment gains or losses and interest in earnings or losses of equity investments. Net investment income includes interest and dividends, net of investment expenses, generated by the Company’s investment activities, as well as interest income generated on funds held assets. Net realized and unrealized investment gains or losses include sales of the Company’s fixed income, equity and other invested assets and investments underlying the funds held - directly managed account and changes in net unrealized gains or losses. Interest in earnings or losses of equity investments includes the Company’s strategic investments. Other components of net income or loss include technical result and other income or loss, other operating expenses, interest expense, amortization of intangible assets, net foreign exchange gains or losses and income tax expense or benefit.
The components of net income (loss) for the years ended December 31, 2012, 2011 and 2010 were as follows (in millions of U.S. dollars):
(1) Interest in earnings (losses) of equity investments represents the Company’s aggregate share of earnings related to several private placement investments and limited partnerships within the Corporate and Other segment.
(3) Amortization of intangible assets relates to intangible assets acquired in the acquisition of Paris Re in 2009. The acquisition of Presidio was effective December 31, 2012 and, accordingly, no amortization expense related to the intangible assets acquired has been recorded during the years ended December 31, 2012, 2011 and 2010.
The underwriting result for the Non-life segment increased by $1,429 million (corresponding to a decrease of 37.6 points on the combined ratio), from a loss of $973 million (125.4 points on the combined ratio) in 2011 to an income of $456 million (87.8 points on the combined ratio) in 2012. The increase in the Non-life underwriting result and the corresponding decrease in the combined ratio in 2012 compared to 2011 was primarily attributable to:
Large catastrophic losses and large losses-a decrease of $1,417 million (decrease of 36.6 points on the technical ratio) from $1,733 million (45.3 points on the technical ratio) related to the 2011 catastrophic events to $316 million (8.7 points on the technical ratio) related to Superstorm Sandy and the U.S. drought, which impacted the agriculture line of business in the North America sub-segment, in 2012.
Net favorable prior year loss development-an increase of $98 million (decrease of 3.2 points on the technical ratio) from $530 million (13.8 points on the technical ratio) in 2011 to $628 million (17.0 points on the combined ratio) in 2012. The increase was primarily driven by the Global (Non-U.S.) Specialty and North America sub-segments. The components of the net favorable prior year loss development are described in more detail in the discussion of individual sub-segments in Results by Segment below.
These factors driving the increase in the Non-life underwriting result and the corresponding decrease in the combined ratio in 2012 compared to 2011 were partially offset by:
Acquisition costs, comprising only of incremental brokerage fees, commissions and excise taxes, which vary directly with, and are related to, the acquisition of reinsurance contracts, are capitalized and charged to expense as the related premium is earned. All other acquisition related costs, including all indirect costs, are expensed as incurred.
The Company will discontinue hedge accounting prospectively if it is determined that the derivative is no longer effective in offsetting changes in the fair value of a hedged item. To the extent that the Company discontinues hedge accounting related to its net investment in non-U.S. dollar functional currency of subsidiaries and branches, because, based on Management’s assessment, the derivative no longer qualifies as an effective hedge, the derivative will continue to be carried in the Consolidated Balance Sheets at its fair value, with changes in its fair value recognized in net foreign exchange gains and losses.
The Company’s investment strategy allows for the use of derivative instruments, subject to strict limitations. The Company utilizes various derivative instruments such as foreign exchange forward contracts, foreign currency option contracts, futures contracts, to-be-announced mortgage-backed securities (TBAs) and credit default swaps, for the purpose of managing overall currency risk, market exposures and portfolio duration and hedging certain investments, or enhancing investment performance that would be allowed under the Company’s investment policy if implemented in other ways. These instruments are recorded at fair value as assets and liabilities in the Consolidated Balance Sheets. Changes in fair value are included in net realized and unrealized investment gains and losses in the Consolidated Statements of Operations, except changes in the fair value of
The Company enters from time to time into weather and longevity related transactions that are structured as derivatives, which are recorded at fair value with the changes in fair value reported in net realized and unrealized investment gains and losses in the Consolidated Statements of Operations.
The majority of the Company’s share-based compensation awards qualify for equity classification. The fair value of the compensation cost is measured at the grant date and is expensed over the period for which the employee is required to provide services in exchange for the award. Awards of PSUs provide performance-based equity awards based on pre-established targets relating to certain performance measures achieved by the Company. The compensation expense for PSUs is initially based on the target performance measure at the time of award and is subject to an annual review and adjustment taking into account actual performance of the Company. Forfeiture benefits on all awards are estimated at the time of grant and incorporated in the determination of share-based compensation costs. Awards granted to employees who are eligible for retirement and do not have to provide additional services are expensed at the date of grant.
The Company recognizes an asset or a liability in the Consolidated Balance Sheets for the funded status of its defined benefit plans that are overfunded or underfunded, respectively, measured as the difference between the fair value of plan assets and the pension obligation and recognizes changes in the funded status of defined benefit plans in the year in which the changes occur as a component of accumulated other comprehensive income or loss, net of tax.
The Company is involved in the normal course of business with variable interest entities (VIEs) as a passive investor in certain limited partnerships, fixed maturity investments and asset-backed securities, that are issued by third party VIEs. The Company performs a qualitative assessment at the date when it becomes initially involved in the VIE followed by ongoing reassessments related to its involvement in VIEs. The Company’s maximum exposure to loss with respect to these investments is limited to the carrying amount of each investment that is reported within fixed maturities and other invested assets in the Company’s Consolidated Balance Sheets and any unfunded commitments.
In December 2011 (with a clarification amendment issued in January 2013), the Financial Accounting Standards Board (FASB) issued new guidance aimed at enhancing disclosures about derivatives, repurchase agreements and reverse repurchase agreements, securities borrowing and securities lending transactions to the extent they are subject to master netting arrangements or similar agreements. The guidance is effective for interim and annual periods beginning on or after January 1, 2013. The adoption of this guidance had no impact on the Company’s consolidated shareholders’ equity or net income. The Company is currently evaluating the impact of the adoption of this guidance on its disclosures.
In February 2013, the FASB issued new guidance aimed at enhancing disclosures for items reclassified out of accumulated other comprehensive income. The guidance does not amend any existing requirements for reporting net income or other comprehensive income in the financial statements. The guidance is effective for interim and annual periods beginning on or after December 15, 2012. The adoption of this guidance had no impact on the Company’s consolidated shareholders’ equity or net income. The Company is currently evaluating the impact of the adoption of this guidance on its disclosures.
The Company’s financial instruments that it measures at fair value using Level 3 inputs generally include: inactively traded fixed maturities including U.S. state, territory and municipal bonds; privately issued corporate securities; special purpose financing asset-backed bonds; unlisted equities; real estate and certain other mutual fund investments; inactively traded weather derivatives; notes and loan receivables, notes securitizations, annuities and residuals, private equity funds and longevity and other total return swaps.
The Company’s financial instruments measured at fair value include investments classified as trading securities, certain other invested assets and the segregated investment portfolio underlying the funds held - directly managed account (see Notes 4 and 5). At December 31, 2012 and 2011, the Company’s financial instruments measured at fair value were classified between Levels 1, 2 and 3 as follows (in thousands of U.S. dollars):
During the year ended December 31, 2012, certain equities traded on foreign exchanges with a fair value of $1.1 million were transferred from Level 2 to Level 1 given they were trading in an active market at December 31, 2012. During the year ended December 31, 2011, there were no significant transfers between Level 1 and Level 2.
Disclosures about the fair value of financial instruments that the Company does not measure at fair value exclude insurance contracts and certain other financial instruments. At December 31, 2012 and 2011, the fair values of financial instrument assets recorded in the Consolidated Balance Sheets not described above, approximate their carrying values.
All of the above changes in fair value are included in the Consolidated Statements of Operations under the caption Net realized and unrealized investment gains.
U.S. states, territories and municipalities-U.S. states, territories and municipalities securities consist primarily of bonds issued by U.S. states, territories and municipalities. These securities are generally priced by independent pricing services using the techniques described for U.S. government and government sponsored enterprises above. The Company generally classifies these securities in Level 2. Certain of the bonds that are issued by municipal housing authorities are not actively traded and are priced based on internal models using unobservable inputs. Accordingly, the Company classifies these securities in Level 3. The significant unobservable input used in the fair value measurement of these U.S. states, territories and municipalities securities classified as Level 3 is credit spreads. A significant increase (decrease) in credit spreads in isolation could result in a significantly lower (higher) fair value measurement.
Asset-backed securities-Asset-backed securities primarily consist of bonds issued by U.S. and foreign corporations that are backed by student loans, automobile loans, credit card receivables, equipment leases, and special purpose financing. With the exception of special purpose financing, these asset-backed securities are generally priced by independent pricing services and brokers. The pricing provider applies dealer quotes and other available trade information, prepayment speeds, yield curves and credit spreads to the valuation. The Company generally classifies these securities in Level 2. Special purpose financing securities are generally inactively traded and are priced based on valuation models using unobservable inputs. The Company generally classifies these securities in Level 3. The significant unobservable inputs used in the fair value measurement of these asset-backed securities classified as Level 3 are prepayment speeds and credit spreads. Significant increases (decreases) in these prepayment speeds and credit spreads in isolation could result in a significantly lower (higher) fair value measurement.
The Company’s exchange traded derivatives, such as futures are generally classified as Level 1 as their fair values are quoted prices in active markets. The Company’s foreign exchange forward contracts, foreign currency option contracts, non-exchange traded futures, credit default swaps, total return swaps, interest rate swaps and TBAs are generally classified as Level 2 within the fair value hierarchy and are priced by independent pricing services.
significant unobservable inputs used in the fair value measurement of other invested assets classified as Level 3 include credit spreads, prepayment speeds, constant default rates and gross revenue to fair value ratios. Significant increases (decreases) in any of these inputs in isolation could result in a significantly lower (higher) fair value measurement. As part of the Company’s modeling to determine the fair value of an investment, the Company considers counterparty credit risk as an input to the model, however, the majority of the Company’s counterparties are investment grade rated institutions and the failure of any one counterparty would not have a significant impact on the Company’s consolidated financial statements.
the fair value of the CENts was calculated based on discounted cash flow models using observable market yields and contractual cash flows based on the aggregate principal amount outstanding from PartnerRe Finance II Inc. of $63 million at December 31, 2012 and 2011.
The carrying values and fair values of the Senior Notes and CENts at December 31, 2012 and 2011 were as follows (in thousands of U.S. dollars):
(1) Cost is amortized cost for fixed maturities and short-term investments and cost for equity securities.
The distribution of fixed maturities and short-term investments at December 31, 2012, by contractual maturity date, is shown below (in thousands of U.S. dollars). Actual maturities may differ from contractual maturities because certain borrowers have the right to call or prepay certain obligations with or without call or prepayment penalties.
The components of net investment income for the years ended December 31, 2012, 2011 and 2010 were as follows (in thousands of U.S. dollars):
(a) Fixed Maturities, Short-Term Investments, Other Invested Assets and Other Assets and Liabilities
(1) Cost is amortized cost for fixed maturities and short-term investments.
The distribution of fixed maturities underlying the funds held - directly managed account at December 31, 2012, by contractual maturity date, is shown below (in thousands of U.S. dollars). Actual maturities may differ from contractual maturities because certain borrowers have the right to call or prepay certain obligations with or without call or prepayment penalties.
The components of net investment income underlying the funds held - directly managed account for the years ended December 31, 2012, 2011 and 2010 were as follows (in thousands of U.S. dollars):
The Company’s derivative instruments are recorded in the Consolidated Balance Sheets at fair value, with changes in fair value mainly recognized in either net foreign exchange gains and losses or net realized and unrealized investment gains and losses in the Consolidated Statements of Operations or accumulated other comprehensive income or loss in the Consolidated Balance Sheets, depending on the nature of the derivative instrument. The Company’s objectives for holding or issuing these derivatives are as follows:
The Company utilizes foreign exchange forward contracts as part of its overall currency risk management and investment strategies. From time to time, the Company also utilizes foreign exchange forward contracts to
The Company enters into total return swaps referencing various project, investments and principal finance obligations. The Company enters into interest rate swaps to mitigate the interest rate risk on certain of the total return swaps. The Company also uses other interest rate derivatives to mitigate exposure to interest rate volatility.
The Company recorded pre-tax intangible assets related to renewal rights of $48.2 million, customer relationships of $63.4 million and fronting arrangements of $0.6 million, and goodwill of $0.8 million related to the Presidio acquisition. The goodwill was allocated to the Company’s Life segment. The amortization period related to the intangible assets for the renewal rights and customer relationships is thirteen years and related to the intangible asset for fronting arrangements is less than one year.
The gross carrying value and accumulated amortization of intangible assets by type at December 31, 2012 and 2011 is as follows (in thousands of U.S. dollars):
Unpaid losses and loss expenses are categorized into three types of reserves: reported outstanding loss reserves (case reserves), additional case reserves (ACRs) and incurred but not reported (IBNR) reserves. Case reserves represent unpaid losses reported by the Company’s cedants and recorded by the Company. ACRs are established for particular circumstances where, on the basis of individual loss reports, the Company estimates that the particular loss or collection of losses covered by a treaty may be greater than those advised by the cedant. IBNR reserves represent a provision for claims that have been incurred but not yet reported to the Company, as well as future loss development on losses already reported, in excess of the case reserves and ACRs. The following table shows the Company’s gross liability for unpaid losses and loss expenses reported by cedants (case reserves) and those estimated by the Company (ACRs and IBNR reserves) at December 31, 2012 and 2011 (in thousands of U.S. dollars):
The table below is a reconciliation of losses and loss expenses including life policy benefits for the years ended December 31, 2012, 2011 and 2010 (in thousands of U.S. dollars):
Within the Company’s North America sub-segment, the Company reported net favorable loss development for prior accident years in 2012, 2011 and 2010. The net favorable loss development for prior accident years in 2012 was driven by most lines of business, with the casualty line of business being the most pronounced. The net favorable loss development for prior accident years in 2011 was driven by most lines of business, predominantly the casualty line, while the credit/surety and motor lines experienced combined adverse loss development for prior accident years of $11 million. The net favorable loss development for prior accident years in 2010 was driven by most lines of business, predominantly the casualty and agriculture lines, while the motor line of
For the Global (Non-U.S.) Specialty sub-segment, the Company reported net favorable loss development for prior accident years in 2012, 2011 and 2010. The net favorable loss development for prior accident years in 2012 was driven by most lines of business, predominantly the specialty property, aviation/space and marine lines, while the engineering line experienced adverse loss development for prior accident years of $6 million. The net favorable loss development for prior accident years in 2011 was driven by most lines of business, except for the energy and engineering lines, which experienced combined adverse loss development for prior accident years of $13 million. The net favorable loss development for prior accident years in 2010 was driven by all lines of business, except for the specialty casualty line, which experienced adverse loss development for prior accident years of $37 million. The net favorable loss development in each year was primarily due to favorable loss emergence.
For the Catastrophe sub-segment, the Company reported net favorable loss development for prior accident years in 2012, 2011 and 2010. The net favorable loss development in each year was primarily due to favorable loss emergence.
Favorable or adverse development related to the guaranteed reserves is recorded as a change in unpaid losses and loss expenses in the Consolidated Balance Sheets and as a change in the Reserve Agreement payable or receivable balance to/from Colisée Re, which is included within Other reinsurance balances payable in the Consolidated Balance Sheets. Accordingly, the reconciliation of the beginning and ending gross and net liability for unpaid losses and loss expenses for the years ended December 31, 2012, 2011 and 2010 includes the change in the Reserve Agreement. At December 31, 2012 and 2011, the Company’s net liability for unpaid losses and loss expenses includes $857 million and $1,012 million, respectively, of guaranteed reserves and Other reinsurance balances payable includes $12 million and $183 million, respectively, payable to Colisée Re related to the Reserve Agreement. During the year ended December 31, 2012, pursuant to the Reserve Agreement, the Company settled the payable to Colisée Re of approximately $265 million based on the estimated cumulative balance of net favorable prior year loss development related to the guaranteed reserves (see Note 5 for additional information).
A significant amount of judgment was used to estimate the range of potential losses related to the earthquakes that occurred in New Zealand in September 2010, February 2011 and June 2011 (the 2010 and the February and June 2011 New Zealand Earthquakes) and the Japan Earthquake and there remains a considerable
The Company’s net reserves for unpaid losses and loss expenses at December 31, 2012 and 2011 included $199 million and $195 million, respectively, that represent estimates of its net ultimate liability for asbestos and environmental claims. The gross liability for such claims at December 31, 2012 and 2011 was $205 million and $203 million, respectively, which primarily relate to Paris Re’s gross liability for asbestos and environmental claims for accident years 2005 and prior of $125 million and $127 million, respectively, with any favorable or adverse development being subject to the Reserve Agreement. Of the remaining $80 million and $76 million, respectively, in gross reserves, the majority relates to casualty exposures in the United States arising from business written by PartnerRe SA and PartnerRe U.S.
The Life segment reported net favorable loss development for prior accident years of $14 million and $1 million for the years ended December 31, 2012 and 2011, respectively, and net adverse loss development for prior accident years of $12 million for the year ended December 31, 2010.
The net favorable prior year loss development of $14 million in 2012 was primarily due to the guaranteed minimum death benefit (GMDB) business, mainly driven by improvements in the capital markets, and certain short-term treaties in the mortality line of business.
The Company uses retrocessional agreements to reduce its exposure to risk of loss on reinsurance assumed. These agreements provide for recovery from retrocessionaires of a portion of losses and loss expenses. The Company remains liable to its cedants to the extent that the retrocessionaires do not meet their obligations under these agreements, and therefore the Company evaluates the financial condition of its reinsurers and monitors concentration of credit risk on an ongoing basis. The Company actively manages its reinsurance exposures by generally selecting retrocessionaires having a credit rating of A- or higher. In certain cases where an otherwise suitable retrocessionaire has a credit rating lower than A-, the Company generally requires the posting of collateral, including escrow funds and letters of credit, as a condition to its entering into a retrocession agreement. The selection of retrocessionaires follows a precise qualitative and quantitative process. The Company regularly reviews its reinsurance recoverable balances to estimate an allowance for uncollectible amounts based on quantitative and qualitative factors. The allowance for uncollectible reinsurance recoverable was $13.5 million and $12.5 million at December 31, 2012 and 2011, respectively.
Net premiums written, net premiums earned and losses and loss expenses and life policy benefits are reported net of reinsurance in the Company’s Consolidated Statements of Operations. Assumed, ceded and net amounts for the years ended December 31, 2012, 2011 and 2010 were as follows (in thousands of U.S. dollars):
In March 2010, PartnerRe Finance B LLC (PartnerRe Finance B), an indirect 100% owned subsidiary of the parent company, issued $500 million aggregate principal amount of 5.500% Senior Notes (2010 Senior Notes, or
For the years ended December 31, 2012, 2011 and 2010, the Company incurred interest expense of $27.5 million, $27.5 million and $21.8 million, respectively, and paid interest of $27.5 million, $27.5 million and $19.6 million, respectively, in relation to the 2010 Senior Notes issued by PartnerRe Finance B.
In May 2008, PartnerRe Finance A LLC (PartnerRe Finance A), an indirect 100% owned subsidiary of the parent company, issued $250 million aggregate principal amount of 6.875% Senior Notes (2008 Senior Notes, or collectively with 2010 Senior Notes referred to as Senior Notes). The 2008 Senior Notes will mature on June 1, 2018 and may be redeemed at the option of the issuer, in whole or in part, at any time. Interest on the 2008 Senior Notes is payable semi-annually and commenced on December 1, 2008 at an annual fixed rate of 6.875%, and cannot be deferred.
On March 13, 2009, PartnerRe Finance II, under the terms of a tender offer, paid holders $500 per $1,000 principal amount of CENts tendered, and purchased approximately 75% of the issue, or $186.6 million, for $93.3 million. Contemporaneously, under the terms of a cross receipt agreement, PartnerRe U.S. Holdings paid PartnerRe Finance II consideration of $93.3 million for the extinguishment of $186.6 million of the principal amount of PartnerRe U.S. Holdings’ 6.440% Fixed-to-Floating Rate promissory note due December 1, 2066. All other terms and conditions of the remaining CENts and promissory note remain unchanged. A pre-tax gain of $88.4 million, net of deferred issuance costs and fees, was realized on the foregoing transactions during the year ended December 31, 2009. At December 31, 2012 and 2011, the aggregate principal amount of the CENts and promissory note outstanding was $63.4 million and $71.0 million, respectively.
For the year ended December 31, 2010, the Company incurred interest expense of $1.2 million and paid interest of $1.6 million in relation to this loan.
At December 31, 2012 and 2011, the total authorized shares of the Company were 200 million shares, par value $1.00 per share, as follows (in millions of shares):
During 2012, the Company repurchased, under its authorized share repurchase program, 7.1 million of its common shares at a total cost of $532.9 million, representing an average cost of $75.00 per share. At December 31, 2012, the Company had approximately 3.2 million common shares remaining under its current share repurchase authorization and approximately 26.6 million common shares were held in treasury and are available for reissuance.
At December 31, 2012 and 2011, the Company has issued Series C, Series D and Series E cumulative redeemable preferred shares (Series C, D and E preferred shares) as follows (in millions of U.S. dollars or shares, except percentage amounts):
The Company may redeem each of the Series C, D and E preferred shares at $25.00 per share plus accrued and unpaid dividends without interest as follows: (i) each of the Series C and D preferred shares can be redeemed at the Company’s option at any time or in part from time to time, and (ii) the Series E preferred shares can be redeemed at the Company’s option on or after June 1, 2016 or at any time upon certain changes in tax law. Dividends on each of the Series C, D and E preferred shares are cumulative from the date of issuance and are payable quarterly in arrears.
(1) At December 31, 2012, 2011 and 2010, share based awards to purchase 554.7 thousand, 2,854.4 thousand and 489.7 thousand common shares, respectively, were excluded from the calculation of diluted weighted average number of common shares and common share equivalents outstanding because their exercise prices were greater than the average market price of the common shares. In addition, dilutive securities, in the form of share options and other, of 687.3 thousand shares were not included in the weighted average number of common shares and common share equivalents outstanding for the purpose of computing the diluted net loss per share because to do so would have been anti-dilutive for year ended December 31, 2011.
The Company’s ability to pay common and preferred shareholders’ dividends and its corporate expenses is dependent mainly on cash dividends from PartnerRe Bermuda, PartnerRe Europe and PartnerRe U.S. (collectively, the reinsurance subsidiaries), which are the Company’s most significant subsidiaries. The payment of such dividends by the reinsurance subsidiaries to the Company is limited under Bermuda and Irish laws and certain statutes of various U.S. states in which PartnerRe U.S. is licensed to transact business. The restrictions are generally based on net income and/or certain levels of policyholders’ earned surplus as determined in accordance with the relevant statutory accounting practices. At December 31, 2012, there were no restrictions on the Company’s ability to pay common and preferred shareholders’ dividends from its retained earnings, except for the reinsurance subsidiaries’ dividend restrictions described below.
PartnerRe Europe may declare dividends subject to it continuing to meet its minimum solvency and capital requirements, which are to hold statutory capital and surplus equal to or exceeding the Required Solvency Margin (RSM). The RSM is calculated with reference to Solvency I regulations. The maximum dividend is limited to “profits available for distribution”, which consist of accumulated realized profits less accumulated realized losses. At December 31, 2012, the maximum dividend that PartnerRe Europe could pay without prior regulatory approval was approximately $678 million.
The statutory financial statements and returns of the Company’s reinsurance subsidiaries as at, and for the year ended, December 31, 2012 are due to be submitted to the relevant regulatory authorities later in 2013, with different filing dates in each jurisdiction. In certain jurisdictions, the statutory financial statements and returns are subject to the review and final approval of the relevant regulatory authorities.
The required and actual statutory capital and surplus of the Company’s reinsurance subsidiaries at December 31, 2012 and 2011 was as follows (in millions of U.S. dollars):
Income tax expense for the years ended December 31, 2012, 2011 and 2010 was as follows (in thousands of U.S. dollars):
At December 31, 2012, the deferred tax assets (after valuation allowance) included foreign tax credit carryforwards of $14.6 million in Ireland, which can be carried forward for an unlimited period of time, and $9.7 million in the United States, which can be carried forward for 10 years, and tax loss carryforwards of $9.9 million in Canada, which can be carried forward for 20 years. At December 31, 2011, the deferred tax assets (after valuation allowance) related to foreign tax credit carryforwards of $9.0 million in Ireland, which can be carried forward for an unlimited period of time, and deferred foreign tax credits of $6.0 million in Ireland and the United States.
For the years ended December 31, 2012, 2011 and 2010, there were no unrecognized tax benefits that, if recognized, would create a temporary difference between the reported amount of an item in the Company’s Consolidated Balance Sheets and its tax basis. The Company recognizes interest and penalties as income tax expense in its Consolidated Statements of Operations.
At December 31, 2012, the total amount of unrecognized tax benefits for which it is reasonably possible to change within twelve months was $2.1 million, which primarily relates to the expected expiration of the statute of limitations related to certain tax positions and various intra-group transactions in Europe.
The Company’s Employee Equity Plan (EEP), which was approved by the Company’s shareholders, permits the grant of share options, RS, RSUs, SSARs or other share-based awards to employees of the Company. The EEP is administered by the Compensation and Management Development Committee of the Board (the Committee). From 2013, the Company will also grant PSUs to employees of the Company.
The EEP permits the grant of up to 8.3 million shares, of which a total of 3.4 million shares can be issued as either RS, RSUs or PSUs and 4.9 million shares can be issued as share options or SSARs. If an award under the EEP is cancelled or forfeited without the delivery of the full number of shares underlying such award, only the net number of shares actually delivered to the participant will be counted against the EEP’s authorized shares. Under the EEP, the exercise price of the award will not be less than the fair value of the award at the time of grant. The fair value is defined in the EEP as the closing price reported on the grant date. RSU and PSU awards granted under the EEP generally cliff vest after three years of continuous service. Share options and SSARs vest ratably over three years of continuous service and have a ten year contractual term. Participants in the EEP are eligible to receive dividend equivalents, which the Company records as an expense, on RSUs and PSUs that are unvested. At December 31, 2012, 4.8 million shares, of which a total of 1.8 million shares can be issued as either RS, RSUs or PSUs and 3.0 million shares can be issued as share options or SSARs, remained available for issuance under this plan.
At December 31, 2012, 0.4 million shares, of which a total of 0.1 million shares can be issued as either RS or RSUs and 0.3 million shares can be issued as share options or SSARs, remained available for issuance under this plan.
are eligible to participate in the ESPP and can contribute between 1% and 10% of their base salary toward the purchase of the Company’s shares up to the limit set by the IRC. Employees who enroll in the ESPP may purchase the Company’s shares at a 15% discount of the lower fair value on either the enrolment date or purchase date. Participants in the ESPP are eligible to receive dividends on their shares as of the purchase date. A total of 0.6 million common shares may be issued under the ESPP. At December 31, 2012, 0.3 million shares remained available for issuance under this plan.
For the years ended December 31, 2012, 2011 and 2010, the Company’s share-based compensation expense was $26.8 million, $24.2 million and $33.5 million, respectively, with a tax benefit of $3.6 million, $2.4 million and $3.4 million, respectively. Included within these tax benefits are amounts related to the exercise of share options and the conversion of RSUs and SSARs into shares by employees of the Company’s U.S. subsidiaries of $1.6 million, $3.1 million and $5.9 million for the years ended December 31, 2012, 2011 and 2010, respectively.
The following table summarizes the activity related to options granted and exercised for the years ended December 31, 2012, 2011 and 2010.
The activity related to the Company’s share options for the year ended December 31, 2012 was as follows:
The weighted average remaining contractual term and the aggregate intrinsic value of share options outstanding, exercisable, vested and expected to vest at December 31, 2012, was 3.7 years and $22.1 million, respectively.
During the years ended December 31, 2012, 2011 and 2010, the Company issued 294,184 RSUs, 314,182 RSUs and 374,366 RSUs with a weighted average grant date fair value of $65.33, $81.20 and $79.18, respectively. The Company values RSUs issued under all plans at the fair value of its common shares at the date of grant, as defined by the plan document.
The activity related to the Company’s RSUs for the year ended December 31, 2012 was as follows:
The RSUs that vested during the years ended December 31, 2012, 2011 and 2010 had a fair value of $5.5 million, $18.3 million and $30.9 million, respectively.
Total unrecognized share-based compensation expense related to unvested RSUs was approximately $23.4 million at December 31, 2012, which is expected to be recognized over a weighted-average period of 1.8 years.
Total unrecognized share-based compensation expense related to unvested SSARs was approximately $2.9 million at December 31, 2012, which is expected to be recognized over a weighted-average period of 1.8 years.
The Company values SSARs issued with a Black-Scholes valuation model and used the following assumptions for the years ended December 31, 2012, 2011 and 2010:
For employee retirement benefits, the Company maintains certain defined contributions plans and other active and frozen defined benefit plans. The majority of the defined benefit obligation at December 31, 2012 relates to the active defined benefit plan for the Company’s Zurich office employees (the Zurich Plan).
The Company incurred expenses for these defined contribution arrangements of $15.7 million, $16.0 million and $14.8 million for the years ended December 31, 2012, 2011 and 2010, respectively.
The fair value of the Zurich Plan’s assets at December 31, 2012 and 2011 were insured funds and cash (Level 2) of $102.4 million and $96.0 million, respectively. The insured funds comprise the accumulated pension
The assumptions used to determine the pension obligation and net periodic benefit cost for the years ended December 31, 2012, 2011 and 2010 were as follows:
At December 31, 2012, estimated employer contributions to be paid in 2013 were $5.8 million and future benefit payments were estimated to be paid as follows (in thousands of U.S. dollars):
The Company’s investment portfolio is managed following prudent standards of diversification and a prudent investment philosophy. The Company is not exposed to any significant credit concentration risk on its investments, except for debt securities issued by the U.S. government and other highly rated non-U.S. sovereign governments’ securities. At December 31, 2012, the Company’s fixed maturity investments did not include any significant concentrations of debt securities issued by non-U.S. sovereign governments. At December 31, 2011, the Company’s fixed maturity investments included $879 million, or 13.6% of the Company’s total shareholders’ equity, issued by the Government of Germany. Other than the U.S. government at December 31, 2012 and the U.S. government and the Government of Germany at December 31, 2011, the Company’s fixed maturity portfolio did not contain exposure to any non-U.S. sovereign government that accounted for more than 10% of the Company’s total shareholders’ equity. The Company keeps cash and cash equivalents in several banks and ensures that there are no significant concentrations at any point in time, in any one bank.
The Company’s investment strategy allows for the use of derivative instruments, subject to strict limitations. Derivative instruments may be used to replicate investment positions and manage currency, market exposure and duration risk, or to enhance investment performance that would be allowed under the Company’s investment policy if implemented in other ways. The Company is exposed to credit risk in the event of non-performance by the counterparties to the Company’s derivative contracts. However, the Company diversifies the counterparties to its derivative contracts to reduce credit risk, and because the counterparties to these contracts are high credit
quality international banks, the Company does not anticipate non-performance. These contracts are generally of short duration and settle on a net basis. The difference between the contract amounts and the related market value represents the Company’s maximum credit exposure.
Rent expense for the years ended December 31, 2012, 2011 and 2010 was $36.3 million, $37.0 million, and $36.1 million, respectively.
In 2010, as part of the Company’s integration of Paris Re, the Company announced a voluntary termination plan (voluntary plan) available to certain eligible employees in France. Following their departure from the Company, employees who participated in the voluntary plan continued to receive pre-determined payments related to employment benefits, which were accrued for by the Company under the terms of the voluntary plan during the year ended December 31, 2010. During the year ended December 31, 2010 the Company recorded a pre-tax charge of $40.7 million related to the costs of the voluntary plan within other operating expenses.
During 2012, the Company committed to a $100 million participation in a 10 year structured letter of credit facility issued by a high credit quality international bank, which has a final maturity of December 29, 2020. At December 31, 2012, the letter of credit facility has not been drawn down and it can only be drawn down in the event of certain specific scenarios, which the Company considers remote. Unless cancelled by the bank, the credit facility automatically extends for one year, each year until maturity.
Additionally, the syndicated unsecured credit facility allows for an adjustment to the level of pricing should the Company experience a change in its senior unsecured debt ratings. The pricing grid provides the Company greater flexibility and simultaneously provides participants under the facility with some price protection.
The Company monitors the performance of its operations in three segments, Non-life, Life and Corporate and Other. The Non-life segment is further divided into four sub-segments: North America, Global (Non-U.S.) P&C, Global (Non-U.S.) Specialty and Catastrophe. Segments and sub-segments represent markets that are reasonably homogeneous in terms of geography, client types, buying patterns, underlying risk patterns and approach to risk management.
The North America sub-segment includes agriculture, casualty, motor, multiline, property, surety and other risks generally originating in the United States. The Global (Non-U.S.) P&C sub-segment includes casualty, motor and property business generally originating outside of the United States. The Global (Non-U.S.) Specialty sub-segment is comprised of business that is generally considered to be specialized due to the sophisticated technical underwriting required to analyze risks, and is global in nature. This sub-segment consists of several lines of business for which the Company believes it has developed specialized knowledge and underwriting capabilities. These lines of business include agriculture, aviation/space, credit/surety, energy, engineering, marine, specialty casualty, specialty property and other lines. The Catastrophe sub-segment is comprised of the Company’s catastrophe line of business. The Life segment includes mortality, longevity and accident and health lines of business. Corporate and Other is comprised of the capital markets and investment related activities of the Company, including principal finance transactions, insurance-linked securities and strategic investments, and its corporate activities, including other operating expenses.
Because the Company does not manage its assets by segment, net investment income is not allocated to the Non-life segment. However, because of the interest-sensitive nature of some of the Company’s Life products, net investment income is considered in Management’s assessment of the profitability of the Life segment. The following items are not considered in evaluating the results of the Non-life and Life segments: net realized and unrealized investment gains and losses, interest expense, amortization of intangible assets, net foreign exchange gains and losses, income tax expense or benefit and interest in earnings and losses of equity investments. Segment results are shown before consideration of intercompany transactions.
The following table provides the distribution of net premiums written by line of business for the years ended December 31, 2012, 2011 and 2010:
The following table provides the geographic distribution of gross premiums written based on the location of the underlying risk for the years ended December 31, 2012, 2011 and 2010:
The following table summarizes the percentage of gross premiums written through these two brokers by segment and sub-segment for the years ended December 31, 2012, 2011 and 2010:
On February 14, 2013, the Company issued Series F non-cumulative redeemable preferred shares (Series F preferred shares) as follows (in millions of U.S. dollars or shares, except percentage amounts):
redeem the Series F preferred shares at any time upon the occurrence of a certain “capital disqualification event” or certain changes in tax law. Dividends on the Series F preferred shares will be non-cumulative and will be payable quarterly.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of PartnerRe Ltd. and subsidiaries as of December 31, 2012 and 2011, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2012, in conformity with accounting principles generally accepted in the United States of America.