We lease office space in Bermuda, which houses our executive offices and operations for both our Reinsurance and Individual Risk segments. In addition, our Individual Risk segment leases a number of offices in the U.S.; Stonington leases office space in Addison, Texas, and our other U.S. based subsidiaries lease office space in Richmond, Virginia, Raleigh, North Carolina and Stamford, Connecticut. Our Reinsurance segment also leases office space in Dublin, Ireland. As we anticipate additional growth in our businesses, it is likely that we will need to expand into additional facilities to accommodate this growth.
The following tables set forth our selected financial data and other financial information at the end of and for each of the years in the five-year period ended December 31, 2005. This historical financial information was prepared in accordance with GAAP. The consolidated statement of operations data for the years ended December 31, 2005, 2004, 2003, 2002 and 2001 and the balance sheet data at December 31, 2005, 2004, 2003, 2002 and 2001 were derived from our consolidated financial statements. You should read the selected financial data in conjunction with our consolidated financial statements and related notes thereto and ‘‘Management's Discussion and Analysis of Financial Condition and Results of Operations’’ included in this filing and all other information appearing elsewhere or incorporated into this filing by reference.
(1) Earnings per common share - diluted was calculated by dividing net (loss) income attributable to common shareholders by the number of weighted average common shares and common share equivalents outstanding. Common share equivalents are calculated on the basis of the treasury stock method. In accordance with FAS 128, diluted EPS calculations use weighted average common shares outstanding - basic, when in a net loss position.
RenaissanceRe was established in 1993 to write property catastrophe reinsurance. By pioneering the use of sophisticated computer models to construct our portfolio, we believe we have become one of the world’s largest and most successful catastrophe reinsurers. Recently, we have leveraged our expertise and have established additional franchises in other selected areas of insurance and reinsurance.
2) Specialty reinsurance written for our own account and DaVinci covering certain targeted classes of business where we believe we have a sound basis for underwriting and pricing the risk that we assume; our portfolio in 2005 includes various classes of business, such as catastrophe exposed workers’ compensation, surety, terrorism, medical malpractice and certain casualty lines. We believe that we are seen as a market leader in certain of these classes of business, such as catastrophe-exposed workers’ compensation, surety and terrorism, and that we have a growing reputation as a ‘‘first call’’ market for these products.
3) Through Ventures, we pursue joint ventures and other strategic relationships. Our three principal business activities in this area are: 1) catastrophe-oriented joint ventures which we manage, such as Top Layer Re and DaVinci; 2) customized reinsurance transactions, such as offering participations in our catastrophe portfolio; and 3) investments in other market participants, such as our investments in Channel Re and Platinum, and other activities which are directed at non-catastrophe classes of risk. Only business activities that appear in our consolidated underwriting results, such as DaVinci and certain reinsurance transactions, are included in our Reinsurance segment results; the results of Top Layer Re, Channel Re and Platinum are included in the Other category of our segment results.
We believe that the most significant accounting judgment made by management is our estimate of claims and claim expense reserves. Claims reserves represent estimates, including actuarial and
statistical projections at a given point in time, of the ultimate settlement and administration costs of claims incurred. Our estimates are not precise in that, among other things, they are based on predictions of future developments and estimates of future trends and other variable factors such as inflation. It is likely that the ultimate liability will be greater or less than such estimates and that, at times, this variance will be material. Also, reserving for our Reinsurance and Individual Risk businesses can involve added uncertainty because of the dependence on information from ceding companies, the time lag inherent in reporting information from the primary insurer to us, and differing reserving practices among ceding companies. The information received from ceding companies is typically in the form of bordereaux, broker notifications of loss and/or discussions with ceding companies or their brokers. This information can be received on a monthly, quarterly or transactional basis and normally includes estimates of paid and incurred losses and may sometimes also include an estimate of incurred but not reported reserves (‘‘IBNR’’).
For our property catastrophe reinsurance business, which is generally characterized by loss events of low frequency and high severity, reporting of claims in general tends to be prompt (as compared to reporting of claims for ‘‘long-tail’’ products, which tends to be slower). However, the timing of claims reporting also varies depending on various factors, including: whether the claims arise under reinsurance of primary companies or reinsurance of other reinsurance companies; the nature of the events (e.g., hurricanes, earthquakes or terrorism); the geographic area involved; and the quality of each customer’s claims management and reserving practices. Management’s judgments regarding these factors are reflected in management’s reserve estimates. Because the events from which claims arise under policies written by our property catastrophe reinsurance business are typically prominent, public occurrences such as hurricanes and earthquakes, we are often able to use independent reports of such events to augment our loss reserve estimation process. However, based upon the amount and timing of the reported claims from any one or more catastrophic events, such reserve estimates may change significantly from one quarter to another. Once we receive a notice of loss under a catastrophe reinsurance contract, we are generally able to process such claims promptly.
For our property catastrophe reinsurance operations, we initially set our claims reserves based on case reserves reported by insureds and ceding companies. We then add to these case reserves our estimates for additional case reserves, and an estimate for IBNR. In addition to the loss information and estimates communicated by cedants, we also use industry information which we gather and retain in our REMS© modeling system. When property catastrophe losses do occur, the information stored in our REMS© modeling system enables us to analyze each of our policies against such loss and compare our estimate of the loss with those reported by our policyholders. The REMS© modeling system also allows us to compare and analyze individual losses reported by policyholders affected by the same loss event. Although the REMS© modeling system assists with the analysis of the underlying loss, and provides us with the information and ability to perform increased analysis, the estimation of claims resulting from catastrophic events is inherently difficult because of the variability and uncertainty associated with property catastrophe claims and the unique characteristics of each loss.
The loss estimation for the coverages we offer through our specialty reinsurance and Individual Risk operations is different than that for property catastrophe oriented coverages and these coverages are potentially subject to greater uncertainties, relating to factors such as long-term inflation and changes in the social and legal environment. Moreover, in reserving for our specialty reinsurance and Individual Risk coverages we do not have the benefit of a significant amount of our own historical experience in these lines. We estimate our IBNR for these coverages by utilizing an actuarial method known as the Bornhuetter-Ferguson technique. The utilization of the Bornhuetter-Ferguson technique requires us to estimate an expected ultimate claims and claim expense ratio and select an estimated loss reporting pattern. We select our estimates of the expected ultimate claims and claim expense ratios and estimated loss reporting patterns by reviewing industry standards and adjusting these
standards based upon the terms of the coverages we offer. The estimated claims and claim expense ratio may be modified to the extent that reported losses at a given point in time differ from what would be expected based on the selected loss reporting pattern. For the Company’s specialty and Individual Risk lines we also considered estimating reserves utilizing paid and incurred development methods. We elected to use the Bornhuetter-Ferguson technique because this method allows for weight to be applied to expected results, and hence is less susceptible to the potential pitfall of being excessively swayed by one year or one quarter of paid and/or reported loss data.
Because any reserve estimate is simply an insurer’s estimate of its ultimate liability, and because there are numerous factors which affect reserves but cannot be determined with certainty in advance, our ultimate payments will vary, perhaps materially, from our initial estimate of reserves. Therefore, because of these inherent uncertainties, we have developed a reserving philosophy which attempts to incorporate prudent assumptions and estimates. In future periods, assuming future reported and paid claims activity is consistent with that of recent quarters, and barring unforeseen circumstances, we believe that, as our reserves on older accident years continue to age, we may experience further reductions to our older accident year reserves.
During 2005 we incurred significant losses from hurricanes Katrina, Rita and Wilma. These losses are in addition to significant losses in 2004 from hurricanes Charley, Frances, Ivan and Jeanne. Our estimates of these losses are based on factors including currently available information derived from preliminary claims information from our clients and brokers, industry assessments of losses from the events, proprietary models, and the terms and conditions of our contracts. In particular, due to the size and unusual complexity of the issues relating to hurricane Katrina, meaningful uncertainty remains regarding total covered losses for the insurance industry and, accordingly, various of the key assumptions underlying our loss estimates. In addition, actual losses from these events may increase if our reinsurers or other obligors fail to meet their obligations. Our actual losses from these events will likely vary, perhaps materially, from these current estimates due to the inherent uncertainties in reserving for such losses, including the preliminary nature of the available information, the potential inaccuracies and inadequacies in the data provided by clients and brokers, the inherent uncertainty of modeling techniques and the application of such techniques, the effects of any demand surge on claims activity and complex coverage and other legal issues.
The estimate of losses recoverable can be more subjective than estimating the underlying claims and claim expense reserves as discussed under the heading ‘‘Claims and Claim Expense Reserves’’ above. In particular, losses recoverable may be affected by deemed inuring reinsurance, industry losses reported by various statistical reporting services, and other factors. Losses recoverable on dual trigger reinsurance contracts require us to estimate our ultimate losses applicable to these contracts as well as estimate the ultimate amount of insured industry losses that will be reported by the applicable statistical reporting agency, as per the contract terms. In addition, the level of our additional case reserves and IBNR reserves has a significant impact on losses recoverable. These factors can impact the amount of the losses recoverable to be recorded as well as delay the recognition of losses recoverable to reporting periods that are different from the underlying loss.
Ceded premiums are also recognized on the date the contract is bound and are deducted from gross written premium, to arrive at net premiums written. Ceded premiums are earned over the terms of the related contracts and policies, and are reflected as a reduction to gross premiums earned to arrive at net premiums earned.
The three most significant items impacting our 2005 financial performance include: 1) the $891.9 million net negative impact we incurred from hurricanes Katrina, Rita and Wilma, which occurred in the third and fourth quarters of 2005; 2) the $226.9 million net favorable impact from the reserve reviews which we completed during 2005; and 3) $53.0 million of incurred expenses related to our internal review and ongoing investigations into the Company and certain of its present and former executive officers by governmental authorities.
The net negative impact from the hurricanes described above includes the sum of net claims and claim expenses incurred, assumed and ceded reinstatement premiums earned, lost profit commissions, assessment related losses and expenses, and minority interest. Net negative impact is based on management’s estimates following a review of our potential exposures and discussions with our counterparties. Given the magnitude and recent occurrence of these events, delays in receiving claims data, uncertainty surrounding final industry losses reported by statistical reporting agencies which impact our reinsurance recoveries, the unusual legal and claim issues related to certain of the events and other uncertainties inherent in loss estimation, meaningful additional uncertainty remains regarding total covered losses for the insurance industry from these events. Accordingly, these estimates are subject to change as new or revised data is received from our counterparties, and other factors. Changes to these estimates will be recorded in the periods in which they occur.
Our Reinsurance operations are comprised of three business units: 1) property catastrophe reinsurance, primarily written through Renaissance Reinsurance and DaVinci; 2) specialty reinsurance, primarily written through Renaissance Reinsurance and DaVinci; and 3) certain activities of Ventures.
The following table summarizes the underwriting results and ratios for our Reinsurance segment for the years ended December 31, 2005, 2004 and 2003:
Property Catastrophe Gross Premiums Written - Our property catastrophe gross premiums written increased by $48.8 million to $732.0 million in 2005 compared to $683.2 million in 2004, a 7.1% increase. Much of this increase, however, consisted of premiums written which we view as loss related and attributable to the large catastrophes occurring during 2005. This loss related premium, which includes reinstatement premiums written as a result of large catastrophes, back-up reinsurance coverage provided to companies to replace reinsurance protection lost following a large catastrophe, and reinsurance coverage provided to a company to cover named hurricanes, totaled $115.0 million in 2005 and $57.5 million in 2004. Large catastrophes include hurricanes Katrina, Rita and Wilma in 2005 and hurricanes Charley, Frances, Jeanne and Ivan in 2004. Excluding this premium, which in the absence of similar large catastrophes we would not expect to recur, our property catastrophe gross premiums written declined 1.4% in 2005 and 2.8% in 2004. The decline in our property catastrophe
Specialty Reinsurance Gross Premiums Written - Our specialty reinsurance gross premiums written increased by $42.8 million to $425.7 million in 2005 compared to $382.9 million in 2004, an 11.2% increase. Much of the increase in our specialty reinsurance gross premiums written, however, was attributable to premiums written due to the large catastrophes occurring during 2005. This loss related premium, which includes reinstatement premiums written as a result of large catastrophes, back-up reinsurance coverage provided to companies to replace reinsurance protection lost following a large catastrophe, and reinsurance coverage provided to a company to cover named hurricanes, totaled $38.4 million in 2005 and $nil in 2004. Excluding this premium, which in the absence of similar large catastrophes we would not expect to recur, our specialty reinsurance gross premiums written were essentially flat in 2005 when compared to 2004. In 2004, our specialty reinsurance gross premiums written increased by 31.2% when compared to 2003. The 2004 increase in our specialty reinsurance gross premiums written was primarily due to our focus on a few targeted areas of this market in 2004 where we believed we could leverage our expertise, including catastrophe exposed workers’ compensation, surety, casualty, property and terrorism-specific classes of reinsurance. In 2005, we maintained our book of business, but did not find additional attractive opportunities.
The following is a summary of our gross reinsurance premiums written allocated to the territory of coverage exposure:
(2) The category Specialty reinsurance consists of contracts that are predominantly exposed to U.S. and worldwide risks.
Our property catastrophe gross premiums written continue to be characterized by an increasing percentage of U.S. and Caribbean premium as we have not found similarly attractive business in Europe or the rest of the world. A significant amount of this U.S. and Caribbean premium provides coverage against windstorms, mainly hurricanes, as well as earthquakes and other natural and man-made catastrophes.
Due to the potential volatility of the property catastrophe reinsurance business which we sell, we purchase reinsurance to reduce our exposure to large losses and to help manage our risk portfolio. We use our REMS© modeling system to evaluate how each purchase interacts with our portfolio of reinsurance contracts we write, and with the other ceded reinsurance contracts we purchase, to determine the appropriateness of the pricing of each contract and whether or not it helps us to balance our portfolio of risks.
In 2005, we generated a net claims and claim expense ratio of 132.2%, an expense ratio of 16.5%, and an underwriting loss of $461.5 million, compared to a net claims and claim expense ratio of 79.0%, expense ratio of 16.1% and an underwriting profit of $46.4 million, in 2004. The deterioration in underwriting performance in 2005 was principally the result of hurricanes Katrina, Rita and Wilma which increased net claims and claim expenses by $1,076.1 million and added 113.6 percentage points
Losses from our property catastrophe reinsurance and specialty reinsurance policies can be infrequent, but severe, as demonstrated by our 2005 and 2004 results as compared to 2003. During periods with benign property catastrophe loss activity, such as 2003, we have the potential to produce a low level of losses and a related increase in underwriting income.
Our underwriting expenses consist of acquisition expenses and operational expenses. Acquisition expenses consist of the costs to acquire premiums and are principally comprised of broker commissions and excise taxes. Acquisition expenses are driven by contract terms and are normally a set percentage of premiums and, accordingly, these costs will normally fluctuate in line with the fluctuation in gross premiums earned. In 2005, the acquisition expense ratio of 9.8% was lower than the 12.4% and 11.5%, recorded in 2004 and 2003, respectively, driven mainly by the significant amount of loss related premium generated in 2005 which typically has lower brokerage expenses associated with it. Operating expenses consist of salaries and other general and administrative expenses. Operating expenses increased by $28.5 million to $63.5 million in 2005 when compared to 2004,
We define our Individual Risk segment to include underwriting that involves understanding the characteristics of the original underlying insurance policy. Our principal contracts include: 1) commercial and homeowners property coverages, including catastrophe-exposed products; 2) commercial liability coverages, including general, automobile, professional and various specialty products; 3) multi-peril crop insurance; and 4) reinsurance of other insurers on a quota share basis. We operate through the Glencoe Group of companies, whose principal operating subsidiaries are Glencoe, Stonington, Stonington Lloyds and Lantana.
The following table shows our Individual Risk gross premiums written by distribution channel for the years ended December 31, 2005, 2004 and 2003:
Our Individual Risk gross premiums written increased by $173.3 million to $651.4 million in 2005 compared to 2004, an increase of 36.3%. This increase was principally a result of an increase in business produced through our program managers. In 2005, our program business increased by $168.5 million to $343.4 million. We started our program business in 2003, and generated $72.1 million of gross premiums written through this distribution channel in that year. In 2004, $174.9 million of our gross premiums written in Individual Risk were produced through program managers. Our program business in 2005 represented 52.7% of our Individual Risk gross premiums written compared to 36.6% in 2004 and 16.1% in 2003. As our program business has increased, the property component of our Individual Risk gross premiums written has decreased as a percentage of our overall Individual Risk gross premiums written. In 2005, property accounted for 57.4% of our gross premiums written compared to 60.9% in 2004 and 71.9% in 2003. This is the result of the growth in specialty risks, including commercial auto, professional liability and multi-peril crop insurance, which are produced through our program managers.
We purchase reinsurance to reduce our exposure to large losses and to help manage our portfolio of risks. With the continued growth in the gross written premiums of our Individual Risk segment, we continued to look for opportunities to purchase appropriately priced reinsurance coverage in 2005. Included in ceded premiums written in our Individual Risk segment is $34.4 million and $8.3 million of ceded reinstatement premiums written attributable to the 2005 and 2004 hurricanes, respectively. In the absence of similar large catastrophes in 2006, we would not expect these ceded premiums written to recur.
For the year, the Company’s Individual Risk segment generated a net claims and claim expense ratio of 84.1%, an expense ratio of 36.7%, and an underwriting loss of $94.8 million, compared to a net claims and claim expense ratio of 89.0%, an expense ratio of 37.9%, and an underwriting loss of $105.8 million in 2004. The 2005 Individual Risk net claims and claim expense ratio was negatively impacted by hurricanes Katrina, Rita and Wilma which added 22.7 percentage points to the Individual Risk net claims and claim expense ratio. In 2004, the Individual Risk net claims and claim expense ratio was negatively impacted by hurricanes Charley, Frances, Ivan and Jeanne, which added 36.5 percentage points to the Individual Risk net claims and claim expense ratio. In addition, the Individual Risk segment recorded an additional $34.4 million of ceded earned premium attributable to the 2005 hurricanes, which negatively impacted the Individual Risk net claims and claim expense ratio by 6.0 percentage points and the expense ratio by 2.6 percentage points. In 2004, the Individual Risk segment recorded an additional $8.3 million of ceded earned premium attributable to the 2004 hurricanes, which negatively impacted the Individual Risk net claims and claim expense ratio by 1.9 percentage points and the expense ratio by 0.8 percentage points. In 2003, there was an absence of large losses and the Individual Risk segment generated a net claims and claim expense ratio of 51.7%, expense ratio of 37.8% and an underwriting profit of $32.0 million.
During 2006, given the magnitude of the hurricane losses and due to delays in receiving claims data and the likelihood of receiving new or revised data from our counterparties, the estimates of hurricane losses and related recoveries are likely to change, perhaps materially. Changes in these estimates will be recorded in the periods in which they occur.
Net investment income increased by $54.5 million to $217.3 million in 2005 compared to 2004, an increase of 33.5%. The increase in net investment income in 2005 was a result of both higher investment returns and an increased level of invested assets in 2005 compared to 2004. The increase in invested assets is due to the positive cash flow from our operating and financing activities which we generated in 2005 and which we deployed into our invested assets, principally short term investments. Our other investments, which include hedge funds, private equity funds and other alternative investments, generated $59.3 million of net investment income in 2005 compared to $46.9 million in 2004. These investments are carried at fair value, with interest, dividend income and realized and unrealized gains (losses) included in net investment income. Our other investments performed well in 2005 and 2004 and generated a considerable amount of net investment income for us.
Given our recent decision to reduce our exposure to hedge funds and non-investment grade fixed income investments, which form a significant component of other investments and contributed to the growth of our net investment income in 2004 and 2005, we expect that we may experience a decline in net investment income associated with our other investments in 2006.
Equity in earnings of other ventures represents our pro-rata share of the net income from our investments in Top Layer Re, Channel Re and Tower Hill. The decrease in equity in earnings of other ventures in 2005 was due to a decline in the earnings attributable to our equity investment in Top Layer Re compared to 2004, offset by an increase in earnings from our investment in Channel Re, due to 2004 reflecting only a partial year of earnings as this investment was made in February of 2004 and earnings attributable to Channel Re are recorded by the Company one quarter in arrears. In addition, during the first quarter of 2005 we made a $10.0 million equity investment in Tower Hill. We recorded earnings of $0.3 million from the Tower Hill investment in 2005 compared to $nil in 2004. As with Channel Re, we record our pro-rata share of the net income of Tower Hill one quarter in arrears.
The increase in equity in earnings of other ventures in 2004 compared to 2003 was primarily due to $9.8 million of equity pickup from our investment in Channel Re, which incepted in 2004.
In 2005, fee income decreased by $0.6 million to $6.2 million from $6.8 million in 2004. In 2004 fee income decreased $0.9 million from $7.7 million in 2003. Fee income primarily consists of fees related to services provided to Platinum.
Other items, which principally includes the mark-to-market on our warrant to purchase shares of Platinum stock and the mark-to-market on our short positions in credit derivatives, generated income of $3.3 million and $12.1 million in 2005 and 2004, respectively. Other items in 2004 was driven by the recording of $27.4 million of cumulative unrealized gains on the Platinum warrant in the consolidated statement of operations in the fourth quarter of 2004 for the first time as the result of the expiration of a lockup provision, in accordance with GAAP. This was partially offset by $2.7 million in 2005 and $12.5 million in 2004 of losses recognized by us from short positions in credit derivatives generally used to hedge potential credit-related exposures of the Company. The increase in other items to $12.1 million in 2004 from ($1.8) million in 2003 was principally driven by the unrealized gain on the Platinum warrant in 2004 which was recorded in accumulated other comprehensive income in 2003, in accordance with GAAP.
The $7.0 million net realized loss on investments in 2005 includes $33.2 million in other than temporary impairment charges compared to $1.2 million in 2004 and $0.2 million in 2003. The significant increase in other than temporary impairment charges in 2005 was due to our decision to recognize impairment charges for all of our fixed maturity investments available for sale that were in an unrealized loss position as of December 31, 2005 as we do not currently have the intent to hold them until they fully recover in value. This accounting is consistent with the guidance provided by the Financial Accountings Standards Board (‘‘FASB’’) in FASB Staff Position FAS 115-1 and FAS 124-1, ‘‘The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments’’, which was issued in the fourth quarter of 2005. Rising interest rates during 2005 gave rise to a higher level of unrealized losses at December 31, 2005 compared to December 31, 2004, prior to our other than temporary impairment charge. Other than temporary impairment charges are recorded as net
The 2005 balance is also net of a $29.8 million realized gain from the sale of all of the Company’s shares of Platinum during the fourth quarter of 2005 which generated net proceeds of $114.0 million. The remaining decrease in realized gains in 2005 compared to 2004 was due to a period of rising interest rates in the year in which sales of our securities resulted in realized losses.
In October 2001, we formed DaVinciRe and DaVinci with other equity investors. The Company owns a minority economic interest in DaVinciRe; however, because the Company controls a majority of DaVinciRe’s outstanding voting rights, the consolidated financial statements of DaVinciRe are included in the consolidated financial statements of the Company. The 74.75% portion of DaVinciRe's earnings owned by third parties for the years ended December 31, 2005, 2004 and 2003 is recorded in our consolidated statements of operations as minority interest.
We are subject to income taxes in certain jurisdictions in which we operate; however, since the majority of our income is currently earned in Bermuda, a non-taxable jurisdiction, the tax impact to our operations has historically been minimal. In 2005 we generated taxable income in our U.S. tax-paying subsidiaries which was offset by utilization of a net operating loss carryforward. Due to a history of losses in our U.S. subsidiaries we continue to maintain a valuation allowance equal to 100% of our net deferred tax asset. Primarily due to utilization of our net operating loss carryforward, the net deferred tax asset decreased by $4.5 million during 2005. During 2004, our U.S. tax-paying subsidiaries did not generate taxable income and, accordingly, we recorded a valuation allowance against the remaining net deferred tax asset of $4.0 million. During 2003, we wrote a limited amount of business in our U.S. operations and therefore the related tax impact for 2003 was minimal.
Our principal U.S. insurance subsidiary Stonington is also required to maintain certain measures of solvency and liquidity. Restrictions with respect to dividends are based on state statutes. In addition, there are restrictions based on risk based capital tests which is the threshold that constitutes the authorized control level. If Stonington’s statutory capital and surplus falls below the authorized control level, the commissioner is authorized to take whatever regulatory actions considered necessary to protect policyholders and creditors. At December 31, 2005, the statutory capital and surplus of Stonington was $56.5 million (2004 - $57.5 million). Because of an accumulated deficit in earned surplus from prior operations, Stonington cannot currently pay an ordinary dividend without commissioner approval.
Cash flows from operating activities for 2005 were $335.6 million, which principally consisted of increases to net reserves for claims and claim expenses of $700.0 million and an increase in the reserve for unearned premiums of $136.4 million, offset by our net loss of $246.8 million (prior to dividends on preference shares), plus a $156.4 million increase in the minority interest in the undistributed net income of DaVinciRe and an increase in premiums receivable of $156.3 million. The 2005 cash flows from operations were primarily used to increase our short term investments.
A large portion of our coverages provide protection from natural and man-made catastrophes which are generally infrequent, but can be significant, such as losses from hurricanes and earthquakes. Our claims and claim expense reserves will generally fluctuate, sometimes materially, based upon the occurrence of a significant natural or man-made catastrophic loss for which we provide reinsurance. Our claims reserves will also fluctuate based on the payments we make for these large loss events. The timing of our payments on loss events can be affected by the event causing the loss, the location of the loss, and whether our losses are from policies with insurers or reinsurers.
During 2003, 2004 and 2005 we increased our specialty reinsurance and Individual Risk gross premiums written (see ‘‘Premiums’’). The addition of these lines of business adds complexity to our claims reserving process and therefore adds uncertainty to our claims reserve estimates as the reporting of information, the setting of initial reserves and the loss settlement process for these lines of business vary from our traditional property catastrophe line of business.
Our total capital resources at December 31, 2005 and 2004 were as follows:
Our Capital Trust has issued Capital Securities which pay cumulative cash distributions at an annual rate of 8.54%, payable semi-annually. During 2005 and 2004, RenaissanceRe did not repurchase any of the Capital Securities. RenaissanceRe has repurchased an aggregate $15.4 million of the Capital Securities since their issuance in 1997. The sole asset of the Capital Trust consists of our junior subordinated debentures. The indenture relating to these junior subordinated debentures contains certain covenants, including a covenant prohibiting us from the payment of dividends if we are in default under the indenture. We were in compliance with all of the covenants of the indenture at December 31, 2005 and 2004. The Capital Securities mature on March 1, 2027.
During May 2005, DaVinciRe amended and restated its credit agreement to extend the termination date of the revolving credit facility established thereunder from May 25, 2007 to May 25, 2010. All other material terms and conditions in the credit agreement remained the same. The credit agreement provides for a $100 million committed revolving credit facility, the full amount of which was drawn in 2002 and remains outstanding. Neither RenaissanceRe nor Renaissance Reinsurance is a guarantor of this facility and the lenders have no recourse against us or our subsidiaries other than DaVinciRe and its subsidiary under the DaVinciRe facility. Pursuant to the terms of the $500 million revolving credit facility maintained by RenaissanceRe, a default by DaVinciRe on its obligations will not result in a default under the RenaissanceRe facility. Interest rates on the facility are based on a spread above LIBOR, and averaged approximately 4.08% during 2005 (2004 - 2.32%). The credit agreement contains certain covenants requiring DaVinciRe to maintain a debt to capital ratio of 30% or below and a minimum net worth of $250 million. At December 31, 2005 and 2004, DaVinciRe was in compliance with the covenants under this agreement. The term of the credit facility may be further extended and the size of the facility may be increased to $125 million if certain conditions are met. The Company is currently discussing a potential increase to the size of this facility with its bank group.
exceed $1 billion and $500 million, respectively, subject to certain adjustments under certain circumstances in the case of the Debt to Capital Ratio and certain grace periods in the case of the Net Worth Requirements, all as more fully set forth in the agreement. We have the right, subject to certain conditions, to increase the size of this facility to $600 million.
In the fourth quarter of 2005 our consolidated joint venture, DaVinciRe, raised $320.6 million of equity capital. The capital was funded by new and existing investors, including $50.0 million contributed by us. In conjunction with the transaction, we modified the DaVinciRe shareholders agreement and provided new and existing shareholders with new rights. The second amended and restated shareholders agreement provides DaVinciRe shareholders, excluding us, with certain redemption rights, which allow each shareholder to notify DaVinciRe of such shareholder’s desire for DaVinciRe to repurchase up to half of such shareholder’s aggregate number of shares held. Any share repurchases are subject to certain limitations, as described in the second amended and restated shareholders agreement, such as limiting the aggregate of all share repurchase requests to 25% of DaVinciRe's capital in any given year and subject to ensuring all applicable regulatory requirements are met. If the total shareholder requests exceed 25% of DaVinciRe's capital, the number of shares repurchased will be reduced among the requesting shareholders pro rata, based on the amounts desired to be repurchased. Shareholders must notify DaVinciRe before March 1 of each year, commencing March 1, 2007, if they desire to have DaVinciRe repurchase shares. The repurchase price will be GAAP book value as of the end of the year in which the shareholder notice is given, and the repurchase will be effective as of such date. Payment will be made as promptly as practicable in the following year, and adjusted as necessary following delivery of the audited financial statements for the year in which the repurchase was effective. The repurchase price will be subject to adjustment in future periods for development on outstanding loss reserves after settlement of all claims relating to the applicable years.
Our economic ownership interest in DaVinciRe was 19.69% at December 31, 2005, down from 25.25% prior to the capital raise. Subsequent to December 31, 2005, DaVinciRe raised an additional $53.9 million of equity capital in February 2006 and our ownership has been reduced to 18.04%. We continue to maintain majority voting control of DaVinciRe and, accordingly, will continue consolidating the results of DaVinciRe into the Company’s consolidated results of operations and financial position.
While the ratings of Renaissance Reinsurance remain among the highest in our business, these ratings actions could have an adverse effect on our ability to fully realize current or future market opportunities. Moreover, if our ratings are reduced from their current levels by A.M. Best, Moody’s or Standard & Poor’s, we believe our competitive position in the insurance industry would suffer and it would be more difficult for us to market our products. A significant downgrade could result in a substantial loss of business as ceding companies and brokers that place such business move to other reinsurers with higher ratings. We can not give any assurance regarding whether or to what extent the rating agencies may downgrade our ratings. In addition, it is increasingly common for our reinsurance contracts to contain provisions permitting our clients to cancel coverage pro-rata if our relevant operating subsidiary is downgraded below a certain rating level. Whether a client would exercise this right would depend, among other factors, on the reason for such a downgrade, the extent of the
In the future, we may return capital to our shareholders through share repurchases. In August 2003, the Board authorized a share repurchase program of $150 million. This amount includes the remaining amounts available under prior authorizations. During 2005, $0.7 million of shares were repurchased under this program. No shares were repurchased under the program in 2004. In the future, we may purchase shares under our current authorization, or increase the size of our repurchase program. Any such determination will be subject to market conditions and other factors.
At December 31, 2005, we held investments totaling $5.3 billion, compared to $4.8 billion in 2004.
provided by financing activities of $328.2 million which is net of dividends to common and preference shareholders of $57.0 million and $34.7 million, respectively, and a $74.2 million reduction in net unrealized gains on our available for sale investments.
Because our coverages include substantial protection for damages resulting from natural and man-made catastrophes, we may become liable for substantial claim payments on short notice. Accordingly, our investment portfolio is structured to preserve capital and provide a high level of liquidity. The large majority of our investment portfolio consists of highly rated fixed income securities, including U.S. Treasuries, highly-rated sovereign and supranational securities, high-grade corporate securities and mortgage-backed and asset-backed securities. We also hold a significant amount of short term investments. Short term investments are managed as part of our investment portfolio and have a maturity of one year or less when purchased. Short term investments are carried at cost which approximates fair value. As of December 31, 2005 we had $1,653.6 million of short term investments compared to $608.3 million as of December 31, 2004. At December 31, 2005, our invested asset portfolio of fixed maturity investments available for sale and short term investments had a dollar weighted average rating of AA (2004 - AA), an average duration of 1.4 years (2004 - 2.2 years) and an average yield to maturity of 4.6% (2004 - 3.3%). As noted in our discussion of our cash flows above, our future cash flows from operations will be negatively impacted by losses we will be required to pay related to the 2005 large catastrophes.
The equity investments in reinsurance company relate to our November 1, 2002 purchase of 3,960,000 common shares of Platinum in a private placement transaction. In addition, we received a 10-year warrant to purchase up to 2.5 million additional common shares of Platinum for $27.00 per share. We purchased the common shares and warrant for an aggregate price of $84.2 million. On December 6, 2005, we sold all of our common shares of Platinum for total proceeds of $114.0 million and recorded a realized gain of $29.8 million. We have recorded our investment in the warrant at fair value, and at December 31, 2005 the aggregate fair value was $26.7 million (2004 - $27.4 million). The fair value of the warrant is estimated by us using the Black-Scholes option pricing model. During the fourth quarter of 2004, a lockup provision on the warrant expired and as a result the warrant met the definition of a derivative under FAS 133 and, therefore, changes in the fair value of the warrant were recorded prospectively in other income from November 2004.
A portion of our investment assets are directly held by our subsidiary RIHL, a Bermuda company we organized for the primary purpose of holding the investments in high quality marketable securities for RenaissanceRe, our operating subsidiaries and certain of our joint venture affiliates. We believe that RIHL permits us to consolidate and substantially facilitate our investment management operations and facilitates posting of letters of credit. Each RIHL share is redeemable for cash or in marketable securities. Over time, the participants in RIHL are expected to both subscribe for additional shares and redeem outstanding shares, as our and their respective liquidity needs change. RenaissanceRe and each of our participating operating subsidiaries and affiliates have transferred to RIHL marketable securities or other assets, in return for a subscription of RIHL equity interests. Each RIHL share is redeemable by the subscribing companies for cash or in marketable securities. RIHL is currently rated AAAf/S2 by S&P.
As of December 31, 2005 our hedge funds were engaged in various investment strategies, including diversified arbitrage, distressed, U.S. long/short, sector long/short and energy trading with original capital contributed by us, generally in the range of $5 million to $15 million per fund, although we have invested up to $60 million in one hedge fund. The private equity partnerships are primarily engaged in U.S. private equity, real estate, distressed securities and secondary investment strategies with initial capital commitments ranging from $4 million to $25 million. The loan fund primarily invests in senior secured floating rate loans. The European high yield credit fund is denominated in Euros and primarily invests in unlisted and listed fixed and floating rate debt securities issued by entities that are domiciled in or have a substantial portion of their total assets or operations in a European country. The medium term note was issued by an investment company which invests predominantly in investment-grade European fixed income securities and passes through a variable U.S. dollar return on the note based on the performance of the underlying securities. The non-U.S. convertible fund is denominated in Euros and primarily invests in unlisted and listed non-U.S. convertible securities. Included in miscellaneous other investments are catastrophe bonds, that generally include variable rate notes where the return is contingent upon climatical or geological events.
We have committed capital to private equity partnerships of $323.8 million, of which $155.1 million has been contributed at December 31, 2005.
inflation are also considered in pricing and in estimating reserves for unpaid claims and claim expenses. The actual effects of this post-event inflation on our results cannot be accurately known until claims are ultimately settled.
Effective January 1, 2003, we adopted the fair value recognition provisions of FASB Statement No. 123, ‘‘Accounting for Stock-Based Compensation’’ (‘‘FAS 123’’), for all stock-based employee compensation granted, modified or settled after January 1, 2003 under the prospective method described in FASB Statement No. 148, ‘‘Accounting for Stock-Based Compensation - Transition and Disclosure’’ (‘‘FAS 148’’). Under the fair value recognition provisions of FAS 123, we estimate the fair value of employee stock options and other stock-based compensation on the date of grant and amortize this value as an expense over the service period.
For 2006 we are projecting growth in our catastrophe gross premiums written compared to our 2005 catastrophe gross premiums written, excluding loss related premium. In 2005, we generated $115.0 million of loss related premium as a result of hurricanes Katrina, Rita and Wilma. We define loss related premium as reinstatement premiums written as a result of these large catastrophes, back-up reinsurance coverage provided to companies to replace reinsurance protection lost following the large catastrophes, and reinsurance coverage provided to a company to cover a named hurricane. If there is an absence of similar large catastrophic events during 2006, we anticipate such premiums will not recur. In our specialty unit, we are projecting a significant decline in gross premiums written for 2006 compared to our 2005 specialty gross premiums written, excluding loss related premium. In 2005 we generated $38.4 million in loss related premium. Our projected decline in specialty premium is due to several factors including the non-renewal of one large contract in which the new owner fully retained the risk, clients in general retaining more risk, and our underwriters non-renewing certain programs where the pricing and terms deteriorated to a point where we no longer found the programs attractive enough for us to write. In general, our specialty premiums are attributable to a relatively small number of large contracts and the amount of specialty premium can fluctuate significantly between quarters and between years depending upon the number of, and nature of, the transactions which we complete.
We expect that our Individual Risk business will continue to grow into lines that are not catastrophe exposed, given programs that we have recently entered into as well as potential new opportunities, and are projecting growth in gross premiums written in this segment in 2006.
The SEC, the NYAG, the United States Attorney's Office for the Southern District of New York, certain state insurance regulatory authorities and others are investigating various practices within the insurance industry, including contingent commission payments to brokers, alleged ‘‘bid-rigging,’’ and ‘‘steering’’, as well as the use of non-traditional, or loss mitigation, (re)insurance products. Government authorities are also currently investigating our restatement of the Company’s financial statements. See ‘‘Legal Proceedings’’. We cannot predict the ultimate effect that these investigations, and any changes in industry practice, including future legislation or regulations that may become applicable to us, will have on the insurance industry, the regulatory framework or our business.
We announced on November 1, 2005 the resignation of Mr. Stanard as Chairman and CEO in light of the ongoing investigations resulting from our restatement of our financial results. Mr. Stanard's rights and obligations following his resignation are governed by his employment agreement and by our standard practices for senior expatriate executives (principally relating to transitional period medical insurance, transitional travel from Bermuda, and the purchase or return of Company-issued property). Upon his resignation on November 1, 2005, pursuant to the terms of his employment agreement with us, Mr. Stanard (i) vested in all options granted to him under the Company's Premium Option Plan, which options shall remain exercisable until the expiration of their stated term, subject to continued compliance with certain noncompetition obligations; and (ii) vested in all options and shares of restricted stock granted to him under the Company’s 2001 Stock Incentive Plan and Company’s Second Amended and Restated 1993 Stock Incentive Plan, with options remaining exercisable for thirty days following his termination of employment. We incurred an expense of $13.3 million in the fourth quarter of 2005 due to the accelerated vesting of these options and shares. Mr. Stanard forfeits his options under the 2004 Plan in the event that he competes with us prior to exercising such options. We did not enter into a separation agreement with Mr. Stanard, and Mr. Stanard will not receive any other severance payments in connection with his departure. This management change could have an adverse impact on our business, including on our current or prospective relationships with clients or joint venture partners.
(3) The interest on this facility is based on a spread above LIBOR. We have reflected the interest due in 2006 and 2007 based upon the current interest rate on the facility.