We currently lease office space in Pembroke, Bermuda, where the Company and Montpelier Re are located. We also lease office space in London, U.K. where MUAL, PUAL, MCL and MUSL are located; in Zug, Switzerland, where MEAG is located; in Chicago, IL, Hartford, CT and Overland Park, KS where MUI is located; and in Woburn, MA and Hanover, NH where MTR is located.
(b) During 2009 we experienced $181.8 million in net realized and unrealized investment gains. During 2008 we experienced $244.9 million in net realized and unrealized investment losses. The magnitude of these gains and losses significantly impacted our revenues in those years.
(c) During 2011 we incurred $409.0 million in net losses associated with several catastrophic events, including earthquakes in New Zealand and Japan, and Thailand floods. During 2010 we incurred $135.9 million in net losses associated with earthquakes in Chile and New Zealand. During 2008 we incurred $177.1 million in net losses associated with Hurricanes Ike and Gustav. These catastrophic events significantly impacted our expenses in those years.
(h) See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in
We ended 2011 with a fully converted tangible book value per share of $22.71, a decrease of 5.8% for the year after taking into account dividends declared on Common Shares. The decrease in our fully converted tangible book value per share during 2011 resulted from significant natural catastrophe underwriting losses, which were partially offset by modest investment results. Our comprehensive loss for 2011 was $113.1 million and our GAAP combined ratio was 131.1%.
Our underwriting results for 2011 included $409.0 million of net catastrophe losses which included, among others, earthquakes in Japan and New Zealand, floods in Thailand, Denmark and Australia, wildfires in Texas and Hurricane Irene. These net losses were partially offset by $89.3 million of prior year favorable loss reserve development. Our investment results for 2011 included $26.2 million of net realized and unrealized investment gains which were comprised of $34.0 million in net gains from fixed maturities, $1.5 million in net losses from equity securities and $6.3 million in net losses from other investments.
We ended 2009 with a fully converted tangible book value per share of $21.08, an increase of 34.7% for the year after taking into account dividends declared on Common Shares. The increase in our fully converted tangible book value per share during 2009 resulted from strong overall underwriting and investment results. Our comprehensive income for 2009 was $463.8 million and our GAAP combined ratio was 62.2%.
(1) Represents the value of MUSIC’s excess and surplus lines licenses and authorizations we acquired in 2007. We realized the full value of this asset in 2011 in connection with the MUSIC Sale.
During the second half of 2011, we took certain strategic actions which leave us better positioned to take advantage of favorable market movements. The MUSIC Sale enables us to increase our focus on core business lines, and the acquisition of a competitor’s renewal rights and the expansion of our underwriting partnerships collectively increased our access to opportunities well suited to our areas of expertise.
Despite recent improvements in the pricing environment and our continued ability to access attractive business, given the current valuation of our Common Shares relative to our fully converted tangible book value per Common Share and absent a significant change in market conditions, our expectation for 2012 is that we will maintain our current net risk position and will consider deploying our capital through additional Common Share repurchases.
Our net impact from single event losses may vary considerably within a particular territory depending on the specific characteristics of the event. This is particularly true for the direct insurance and facultative reinsurance portfolio we underwrite. For example, our net impact from a large European windstorm may differ materially depending on whether the majority of loss comes from the U.K. & Ireland or from Continental Europe.
We view this approach as a supplement to our single event stress test as it allows for multiple losses from both natural catastrophe and other circumstances and attempts to take into account certain risks which are unrelated to our underwriting activities. Through our modeling, we endeavor to take into account many risks that we face as an enterprise. However, by the very nature of the insurance and reinsurance business, and due to limitations associated with the use of models in general, our simulated result does not cover every potential risk.
Our consolidated financial results for the years ended December 31, 2011, 2010 and 2009 follow:
Underwriting results for Montpelier Bermuda for the years ended December 31, 2011, 2010 and 2009 were as follows:
Net premiums written and earned by Montpelier Bermuda in 2011, 2010 and 2009 included reinstatement premiums (reversals) of $21.0 million, $10.8 million and $(0.7) million, respectively. The 2011 reinstatement premiums were mainly attributable to the Japan and New Zealand earthquakes and the 2010 reinstatement premiums were mainly attributable to the Chilean earthquake. The level of reinstatement premiums that we may realize in future periods will be dependent upon the occurrence of future losses.
Reinsurance premiums ceded by Montpelier Bermuda in 2011, 2010 and 2009 were $78.4 million, $41.7 million and $24.8 million, respectively. Montpelier Bermuda purchases reinsurance in the normal course of its business in order to manage its exposures. The amount and type of reinsurance that Montpelier Bermuda purchases is dependent on a variety of factors, including the cost of a particular reinsurance cover and the nature of its gross premiums written during a particular period. Various other factors will also continue to affect Montpelier Bermuda’s appetite and capacity to write and retain risk. These include the impact of changes in frequency and severity assumptions used in our models and the corresponding pricing required to meet our return targets, evolving industry-wide capital requirements, increased competition, market conditions and other considerations.
All of Montpelier Bermuda’s reinsurance purchases to date have represented prospective cover; that is, ceded reinsurance purchased to protect it against the risk of future losses as opposed to covering losses that have already occurred but have not been paid. Montpelier Bermuda’s purchased reinsurance contracts are excess-of-loss contracts covering one or more lines of business. Montpelier Bermuda also purchases: (i) quota share reinsurance with respect to specific lines of its business; and (ii) industry loss warranty policies which provide coverage for certain losses provided they are triggered by events exceeding a specified industry loss size.
The following tables summarize Montpelier Bermuda’s loss and LAE reserve activities for the years ended December 31, 2011, 2010 and 2009:
Our best estimates for Montpelier Bermuda’s ending gross loss and LAE reserves at December 31, 2011 and 2010 were $716.9 million and $583.1 million, respectively. Montpelier Bermuda’s gross IBNR reserves as a percentage of its total gross reserves amounted to 57% and 62% as of December 31, 2011 and 2010, respectively. This decrease relates primarily to the earthquakes that occurred in Japan and New Zealand during 2011. As of December 31, 2011, the case reserves associated with these large loss events represented a disproportionately large portion of Montpelier Bermuda’s total gross loss reserves.
We estimated Montpelier Bermuda’s gross and net loss and LAE reserves using the methodology outlined in our “Summary of Critical Accounting Estimates” contained in Item 7 herein. We did not make any significant changes in the assumptions or methodology used in Montpelier Bermuda’s reserving process during the year ended December 31, 2011.
The following table presents Montpelier Bermuda’s net loss and LAE ratios for the years ended December 31, 2011, 2010 and 2009:
The individually significant loss events contributing to Montpelier Bermuda’s 2009 current year net loss and LAE of $133.0 million included a $47.7 million net loss associated with European windstorm Klaus and hail storms in Europe and Canada.
During 2009 Montpelier Bermuda experienced $68.6 million in net favorable development on prior year loss and LAE reserves, which included the following loss events:
· 2007 mining accident (claim settlement resulting in a $3.8 million decrease), and
The following table summarizes Montpelier Bermuda’s underwriting expenses incurred during the years ended December 31, 2011, 2010 and 2009:
All other acquisition costs are generally driven by contract terms and are normally a set percentage of gross premiums written. Such acquisition costs consist of the net of commission expenses incurred on assumed business and commission revenue earned on purchased reinsurance covers. Commission revenue on purchased reinsurance covers is earned over the same period that the corresponding premiums are expensed.
Montpelier Bermuda’s acquisition cost ratio for 2011 increased as compared to 2010 primarily as a result of an increase in ceded premium earned. Although ceding commissions on ceded reinsurance represent revenue to Montpelier Bermuda, the ceding commission ratio on reinsurance ceded during 2011 was lower than the acquisition cost ratio of gross premium written. As a result, the increase in ceded premium earned led to an increase in the net acquisition cost ratio. Montpelier Bermuda’s acquisition cost ratio for 2010, exclusive of profit commission adjustments, was consistent with that of 2009.
The following table summarizes Montpelier Bermuda’s general and administrative expenses during the years ended December 31, 2011, 2010 and 2009:
Incentive compensation expenses recorded at Montpelier Bermuda include two broad components. The first component represents amounts that are not dependent on our consolidated underwriting results, and consist of: (i) a limited amount of RSUs granted in a given year; (ii) RSUs granted in prior years, but vest over multi-year periods; and (iii) the portion of annual employee cash bonuses that is based on individual performance goals. The second component represents amounts that are entirely dependent on our consolidated underwriting results, and consist of: (i) RSUs granted in a given year; and (ii) annual employee cash bonuses.
Underwriting results for Montpelier Syndicate 5151 for the years ended December 31, 2011, 2010 and 2009 were as follows:
Gross premiums written by Montpelier Syndicate 5151 during 2010 increased 38% over those written during 2009. The increase in Montpelier Syndicate 5151’s 2010 gross premiums written related primarily to: (i) growth in its marine writings (Property and Specialty Individual Risk); and (ii) growth in its casualty writings (Other Specialty - Treaty and Property and Specialty Individual Risk).
Net premiums written and earned by Montpelier Syndicate 5151 in 2011, 2010 and 2009 included reinstatement premiums of $6.5 million, $6.7 million and $1.8 million, respectively. The 2011 reinstatement premiums were mainly attributable to the Japan and New Zealand earthquakes and the 2010 reinstatement premiums were mainly attributable to the Chilean earthquake. The level of reinstatement premiums that we may realize in future periods will be dependent upon the occurrence of future losses.
Our best estimates for Montpelier Syndicate 5151’s ending gross loss and LAE reserves at December 31, 2011 and 2010 were $341.6 million and $166.4 million, respectively. Montpelier Syndicate 5151’s gross IBNR reserves as a percentage of its total gross reserves were 57% and 64% as of December 31, 2011 and 2010, respectively. This decrease relates primarily to the cancellation and subsequent run-off of certain casualty insurance contracts previously written at Montpelier Syndicate 5151. The losses associated with this cancelled business are long-tail in nature and, as a result, represent IBNR reserves when initially incurred. However, as this business runs off, its remaining IBNR represents an increasingly small portion of Montpelier Syndicate 5151’s gross loss reserves.
During 2009 Montpelier Syndicate 5151 incurred $72.1 million of current year net loss and LAE, nearly all of which related to claims and events that had been incurred in that year but had not yet been reported to us.
During 2011 Montpelier Syndicate 5151 experienced $38.3 million of favorable development on prior year loss and LAE reserves, which included loss reserve movements associated with: (i) 2010 non-catastrophe property losses ($15.4 million decrease); (ii) 2010 marine losses ($3.8 million decrease); and (iii) 2010 Australian flood losses ($3.6 million decrease).
During 2010 Montpelier Syndicate 5151 experienced $19.5 million of favorable development on prior year loss and LAE reserves, which included loss reserve movements associated with: (i) 2009 and prior non-marine individual risk losses ($9.0 million decrease); and (ii) 2008 Hurricane Ike ($1.0 million decrease).
Net Impact of Foreign Currency Movements on Loss and LAE Reserves
Montpelier’s Syndicate 5151’s foreign currency transaction gains (losses) related to its current and prior year loss and LAE reserves are recorded as favorable or unfavorable loss and LAE reserve development, which impacts Montpelier Syndicate 5151’s underwriting results (including its loss and combined ratios).
The following table summarizes Montpelier Syndicate 5151’s underwriting expenses for the years ended December 31, 2011, 2010 and 2009:
Montpelier Syndicate 5151 recorded premium deficiency charges (reversals) in 2011, 2010 and 2009 of $0.1 million, $(0.1) million and $(0.7) million, respectively, which also impacted the acquisition costs it incurred during those periods.
Absent profit commissions and premium deficiency charges (reversals), Montpelier Syndicate 5151’s acquisition cost ratio increased gradually from 2009 to 2011 as a result of changes in the mix of the business it writes. Montpelier Syndicate 5151’s marine, pro-rata engineering and casualty writings, which have grown significantly from 2009 to 2011, are subject to a higher acquisition cost ratio than most of the other business it writes.
The decrease in Montpelier Syndicate 5151’s operating expenses during 2011, as compared to 2010, was largely due to a change in the allocation of our centrally managed information technology costs to Montpelier Syndicate 5151 and from decreased salary expenses at MUI due to prior year staff reductions. The increase in Montpelier Syndicate 5151’s operating expenses during 2010, as compared to 2009, was largely due to an overall increase in Lloyd’s fees.
Incentive compensation expenses recorded at Montpelier Syndicate 5151 include two broad components. The first component represents amounts that are not dependent on our consolidated underwriting results, and consist of: (i) a limited amount of RSUs granted in a given year; (ii) RSUs granted in prior years, but vest over multi-year periods; and (iii) the portion of annual employee cash bonuses that is based on individual performance goals. The second component represents amounts that are entirely dependent on our consolidated underwriting results, and consist of: (i) RSUs granted in a given year; and (ii) annual employee cash bonuses.
Due to the timing of the MUSIC Sale, our 2011 consolidated statement of operations contains MUSIC’s results of operations for the entire year.
Underwriting results for MUSIC for the years ended December 31, 2011, 2010 and 2009 were as follows:
MUSIC’s gross premiums written, all of which relate to our Property and Specialty Individual Risk line of business, increased steadily from MUSIC’s inception in 2007 to the date of the MUSIC Sale. MUSIC’s ceded reinsurance premiums during 2011, 2010 and 2009 totaled $7.8 million, $1.7 million and $0.6 million, respectively. The increase in MUSIC’s ceded reinsurance premiums in 2011, as compared to 2010 and 2009, resulted from a significant purchase of additional excess-of-loss reinsurance in 2011 covering MUSIC’s property and casualty exposures. MUSIC’s ceded reinsurance premiums also include amounts ceded to Montpelier Syndicate 5151 as part of an inter-segment excess-of-loss reinsurance agreement. See “Corporate and Other” under this Item 7.
(1) MUSIC’s ending loss and LAE reserves of $38.3 million at December 31, 2011 represent MUSIC’s losses and LAE that were assumed by Montpelier Re under the MUSIC Quota Share. These loss and LAE reserves have historically been, and will continue to be, reported within our MUSIC segment as opposed to our Montpelier Bermuda segment.
We estimated MUSIC’s loss and LAE reserves using the methodology outlined in our “Summary of Critical Accounting Estimates” contained in Item 7 herein. We did not make any significant changes in the assumptions or methodology used in MUSIC’s reserving process during the year ended December 31, 2011.
As a result of MUSIC’s limited premium writings and loss experience, its loss and LAE expenses incurred to date primarily represent IBNR. Current year losses incurred by MUSIC during 2011 also reflect $3.5 million of net losses resulting from U.S. storms occurring in 2011. The favorable prior year loss reserve development experienced by MUSIC during 2011 and 2010 of $3.0 million and $0.9 million, respectively, related primarily to MUSIC’s casualty (as opposed to property) classes of business.
MUSIC’s incurred acquisition costs of $11.3 million, $8.3 million and $3.4 million for 2011, 2010 and 2009, respectively, were largely consistent with corresponding increases in MUSIC’s net earned premiums as evidenced by its consistent acquisition cost ratios during each of the years presented.
MUSIC’s operating expenses were heavily influenced by our overall information technology costs, as well as changes in the manner in which those costs were allocated to MUSIC. These factors were the primary reason for the operating expense fluctuations experienced by MUSIC during the years presented.
Incentive compensation expenses recorded at MUSIC include two broad components. The first component represents amounts that are not dependent on our consolidated underwriting results, and consist of: (i) a limited amount of RSUs granted in a given year; (ii) RSUs granted in prior years, but vest over multi-year periods; and (iii) the portion of annual employee cash bonuses that is based on individual performance goals. The second component represents amounts that are entirely dependent on our consolidated underwriting results, and consist of: (i) RSUs granted in a given year; and (ii) annual employee cash bonuses.
Corporate and Other, which collectively represents the Company, certain intermediate holding and service companies and intercompany eliminations relating to inter-segment reinsurance and service charges, is not considered to be an operating segment of our business. The underwriting losses generated by Corporate and Other principally reflect general and administrative expenses we incur in support of our various operating companies.
Our Corporate and Other results for the years ended December 31, 2011, 2010 and 2009 were as follows:
Operating expenses recorded within Corporate and Other include salaries and benefits, information technology costs, director fees, legal and consulting expenses, corporate insurance premiums, audit fees and fees associated with being a publicly traded company. The gradual increases in operating expenses experienced from 2009 to 2011 relate primarily to increased allocations of our centrally managed information technology costs to Corporate and Other.
Incentive compensation expenses recorded at Corporate and Other include two broad components. The first component represents amounts that are not dependent on our consolidated underwriting results, and consist of: (i) a limited amount of RSUs granted in a given year; (ii) RSUs granted in prior years, but vest over multi-year periods; and (iii) the portion of annual employee cash bonuses that is based on individual performance goals. The second component represents amounts that are entirely dependent on our consolidated underwriting results, and consist of: (i) RSUs granted in a given year; and (ii) annual employee cash bonuses.
The decreases in incentive compensation expenses recorded at Corporate and Other from 2009 to 2011 reflect reductions in our consolidated underwriting results over that period.
Our total return on cash and investments for 2011 was lower than that of 2010, due to lower net realized and unrealized investment gains and net investment income experienced in 2011. Our total return on cash and investments for 2010 was significantly lower than that of 2009, due to lower net realized and unrealized investment gains and net investment income experienced in 2010.
Despite a higher average investment portfolio balance, our investment income has decreased each year since 2009 mainly as a result of continual declines in short-term interest rates and reductions in dividend income earned on a smaller portfolio of equity securities.
During 2011 we recognized $34.0 million in net realized and unrealized gains from our fixed maturity portfolio, $1.5 million in net realized and unrealized losses from our equity portfolio and $6.3 million in net realized and unrealized losses from our other investments. The fixed maturity net gains we experienced during 2011 were largely the result of a declining U.S. Treasury yield curve as well as tightening credit spreads between the yield on those securities versus that of U.S. Treasuries. The equity portfolio net losses we experienced during 2011 followed a trend consistent with that of the U.S. equity market, as measured by the S&P 500 and MSCI World indices. The other investment net losses we experienced during 2011 included a $4.7 million unrealized loss associated with a private investment fund.
During 2010 we recognized $21.2 million in net realized and unrealized gains from our fixed maturity portfolio, $25.1 million in net realized and unrealized gains from our equity portfolio and $4.3 million in net realized and unrealized gains from our other investments. The fixed maturity net gains and the majority of the other investment net gains we experienced during 2010 were largely the result of a declining U.S. Treasury yield curve as well as tightening credit spreads between the yield on those securities versus that of U.S. Treasuries. In addition, we experienced a $4.3 million realized loss from a limited partnership investment carried as an other investment. The equity portfolio net gains we experienced during 2010 followed a trend consistent with that of the U.S. equity market, as measured by the S&P 500 and MSCI World indices.
As of December 31, 2011, $83.7 million, or 3.3%, of our total invested assets measured at fair value were considered to be Level 3 assets. Our investments classified as Level 3 at December 31, 2011 consisted primarily of the following: (i) with respect to fixed maturity investments, bank loans and certain asset-backed securities, many of which are not actively traded; and (ii) with respect to other investments, certain limited partnership interests and private investment funds.
As of December 31, 2010, $85.2 million, or 3.4%, of our total invested assets measured at fair value were considered to be Level 3 assets. Our investments classified as Level 3 at December 31, 2010 were of a similar composition to those at December 31, 2011.
The significant decrease in our Level 3 securities during 2010 was the result of increased levels of analysis of the valuations of residential mortgage-backed and corporate fixed maturity securities, which provided a higher reliance on observable inputs. In addition, our investment in Symetra was transferred from Level 3 to Level 1 during 2010 as a result of it becoming a publicly traded company.
The following table summarizes the components of our consolidated net foreign exchange gains (losses) for the years ended December 31, 2011, 2010 and 2009:
From time to time we, either directly or indirectly through our investment managers, enter into foreign currency exchange agreements (“Foreign Exchange Contracts”) which constitute obligations to buy or sell specified currencies at future dates at prices set at the inception of each contract. We enter into these agreements in connection with our underwriting and investing activities.
From time to time our investment managers enter into various credit derivative arrangements (“Credit Derivatives”) whose value is derived from the credit risk associated with an underlying bond, loan or other financial asset. In such transactions, we are effectively the buyer or seller of credit protection, depending on the specific instrument. When we are buying credit protection, the value of our derivative position increases (or decreases) when the associated credit risk increases (or decreases). Conversely, when we are selling credit protection, the value of our derivative position decreases (or increases) when the associated credit risk increases (or decreases).
We recorded an expense of $4.9 million associated with Credit Derivatives during 2011.
From time to time our investment managers enter into various interest rate derivative instruments (“Interest Rate Contracts”) whose value is based on the right to pay or receive a notional amount of money at a given interest rate. These instruments are either used to limit our exposure to fluctuations in specified interest rates or to address an anticipated change in interest rates.
We recorded income (expense) of $2.8 million, $(6.7) million and $8.1 million associated with Investment Options and Futures during 2011, 2010 and 2009, respectively.
In November 2010 we entered into an industry loss warranty (“ILW”) swap transaction (the “ILW Swap”) with a third-party in order to purchase protection against Montpelier Re’s U.S. earthquake and Europe windstorm exposures. In return for a fixed-rate payment of $1.0 million, we receive a floating-rate payment which is triggered on the basis of losses incurred by the insurance industry as a whole. The ILW Swap expired June 30, 2011, without any recovery to us.
In April 2010 we entered into an ILW contract (the “ILW Contract”) with a third-party under which qualifying loss payments were triggered exclusively by reference to the level of losses incurred by the insurance industry as a whole rather than by losses incurred by the insured. The ILW Contract, which expired in March 2011, provided the insured with $15.0 million of protection resulting from earthquake losses incurred in any of several U.S. states. We received consideration of $0.4 million for the ILW contract.
We recorded income of $0.1 million and $0.3 million associated with the ILW Contract during 2011 and 2010, respectively.
We recorded an expense of $0.2 million associated with the CAT Bond Protection during 2009.
On December 31, 2011, we completed the MUSIC Sale, received total proceeds of $54.9 million therefrom and recorded a gain on the sale of $11.1 million. The gain on sale is net of $1.0 million in expenses we incurred in connection with the sale.
During 2010 we repurchased and retired $1.0 million in principal amount of our Senior Notes and recognized a loss of less than $0.1 million representing the difference between the amount of consideration paid and the carrying value of the Senior Notes repurchased.
Our consolidated other revenue is comprised of: (i) services provided to third parties consisting of commissions earned by PUAL and advisory fees and royalties earned from providing catastrophe modeling services and technology to third parties; and (ii) interest on funds advanced to ceding companies to cover losses in accordance with contract terms. The following table summarizes our consolidated other revenue for the years ended December 31, 2011, 2010 and 2009:
The following table summarizes our consolidated interest and other financing expenses for the years ended December 31, 2011, 2010 and 2009:
Our consolidated income tax provision (benefit) for the years ended December 31, 2011, 2010 and 2009 consisted of the following:
As a provider of short-tail insurance and reinsurance, mainly from natural and man-made catastrophes, we could become liable for significant losses on short notice. As a result, we have structured our fixed maturity investment portfolio with high-quality securities with a short average duration in order to reduce our sensitivity to interest rate fluctuations and to provide adequate liquidity for the settlement of our expected liabilities. As of December 30, 2011, our fixed maturities had an average credit quality of “AA-” (Very Strong) from Standard & Poor’s and an average duration of 3.0 years. If our calculations with respect to the timing of the payment of our liabilities are incorrect, or if we improperly structure our investment portfolios, we could be forced to liquidate our investments prior to maturity, potentially at a significant loss.
The following table summarizes our capital structure as of December 31, 2011 and December 31, 2010:
Our total capital decreased by $79.5 million during 2011 as a result of our recording a comprehensive loss of $113.1 million, issuing $150.0 million of Preferred Shares, recognizing $4.9 million of additional paid-in capital through the amortization and issuance of share-based compensation, incurring $4.6 million in Preferred Share issuance costs, declaring $34.0 million in dividends to holders of Common Shares and Preferred Shares and repurchasing $82.7 million of Common Shares.
Our Trust Preferred Securities mature on March 30, 2036, but are redeemable at our option at par. We currently have no intention of redeeming our Trust Preferred Securities. The Trust Preferred Securities bore interest at 8.55% per annum through March 30, 2011, and thereafter at a floating rate of 3-month LIBOR plus 380 basis points, reset quarterly. On February 7, 2012, we entered into a five-year swap agreement with a third-party which will result in our future net cash flows in connection with our Trust Preferred Securities, for the five-year period beginning March 30, 2012, being the same as if these securities bore interest at a fixed rate of 4.905%, provided we hold the swap agreement to its maturity.
We issued the Preferred Shares on May 10, 2011. The net proceeds of $145.4 million associated with the offering were used to support the underwriting activities of our insurance and reinsurance subsidiaries and for general corporate purposes.
The issuance of any new debt, equity or hybrid financial instruments might contain terms and conditions that are more unfavorable to holders of our Common and Preferred Shares than those contained within our current capital structure. More specifically, any new issuances of equity or hybrid securities could include the issuance of securities with rights, preferences and privileges that are senior or otherwise superior to those of our Common and Preferred Shares and could be dilutive to our existing holders of these equity securities. Further, if we cannot obtain adequate capital on favorable terms or otherwise, our business, financial condition and operating results could be adversely affected.
The following table outlines our letter of credit facilities as of December 31, 2011:
Our letter of credit facilities were secured by collateral accounts containing cash and investments totaling $264.2 million and $376.7 million at December 31, 2011 and 2010, respectively.
The Bilateral Facility is subject to an annual commitment fee of 0.45%, which was increased from 0.40% effective August 1, 2011 and from 0.20% effective April 1, 2010. The commitment fee is charged on drawn balances only.
During 2010 we voluntarily terminated a $230.0 million letter of credit facility, which was formerly used to meet our ongoing Fund’s at Lloyd’s requirements, and entered into the Lloyd’s Capital Trust for such purposes. See “Trust Arrangements” below.
In June 2012 our Syndicated 5-Year Facility (II) and our Syndicated 364-Day Facility will expire in accordance with their terms. We are currently evaluating how much of the $465.0 million in expiring letter of credit capacity we wish to replace or renew prior to their expiry. The amount of letter of credit capacity we will ultimately replace or renew depends on how quickly our cedants release their outstanding letters of credit once they are fully migrated to the Reinsurance Trust. We believe that current market conditions would permit us to replace or renew these expiring letter of credit facilities with new facilities of comparable capacity.
In December 2011 we entered into the MUSIC Trust in connection with the MUSIC Sale. The MUSIC Trust was established as a means of providing statutory credit to MUSIC in support of the MUSIC Quota Share and the Loss Development Cover. As of December 31, 2011, the fair value of all assets held in the MUSIC Trust was $65.0 million, which exceeded the minimum value required on that date.
In September 2010 we entered into the Reinsurance Trust as a means of providing statutory credit to our cedants. As of December 31, 2011, we were granted authorized or trusteed reinsurer status in 50 states and the District of Columbia. As of December 31, 2011 and 2010, the fair value of all assets held in the Reinsurance Trust was $328.1 million and $101.4 million, respectively, which exceeded the minimum value required on both dates.
Our loss and LAE reserves do not have contractual maturity dates. Our expected loss and LAE reserve obligations are based on historical loss and LAE reserve payment patterns.
Our debt and interest and other financing obligations assume that we exercise our option to redeem the Trust Preferred Securities in March 2017 and that the interest rate thereon accrues at a fixed rate of 4.905%, the fixed rate that we have achieved through our recent five-year interest rate swap transaction. Our letter of credit facilities, each of which is cancellable within one year, are assumed to be fully cancelled on December 31, 2012.
As of December 31, 2011, we had unfunded commitments to invest $14.2 million into three separate private investment funds. For purposes of this presentation, it is assumed that all of our unfunded commitments are called during 2012.
Our Foreign Exchange Contracts, Credit Derivatives, Interest Rate Contracts, Investment Options and Futures and the Loss Development Cover each constitute off-balance sheet arrangements. Excluding these specific transactions, as of December 31, 2011, we were not subject to any off-balance sheet arrangement that we believe is material to our investors.
Our cash flows provided from operations totaled $166.8 million, which resulted primarily from premiums received, net of acquisition costs, partially offset by net paid losses.
· we received $51.2 million in connection with the MUSIC Sale,
· we paid $8.4 million in settlements of investment-related derivative instruments,
· we paid $1.0 million to repurchase and retire a portion of our Senior Notes,
· we paid $26.2 million in dividends to holders of our Common Shares.
Our cash flows provided from operations were $233.1 million, which resulted primarily from premiums received, net of acquisition costs, partially offset by net paid losses.
· we paid $15.1 million to repurchase and retire a portion of our Senior Notes,
Of our cash and cash equivalents held in the U.K. at December 31, 2011, $126.8 million represented amounts held in the Lloyd’s Premiums Trust Funds which may be used for the payment of Syndicate 5151’s claims and valid expenses but can only be distributed to its parent annually, subject to meeting Lloyd’s requirements. We do not currently have the intent or ability to repatriate such funds to the Company in Bermuda.
Our loss and LAE reserves are comprised of case reserves (which are based on claims that have been reported to us) and IBNR reserves (which are based on losses that we believe to have occurred but for which claims have not yet been reported to us and may include a provision for expected future development on our case reserves).
Our primary focus is on short-tail property treaty reinsurance, written on both an excess-of-loss and proportional basis. We also underwrite direct insurance and facultative reinsurance, as well as casualty specialty risks. The nature and extent of management judgment involved in the reserving process depends upon the type of business.
As a predominantly broker-market reinsurer for both excess-of-loss and proportional contracts, we must rely on loss information reported to brokers by primary insurers who, in turn, must estimate their own losses at the policy level, often based on incomplete and changing information. The information we receive varies by cedant and may include paid losses, estimated case reserves and an estimated provision for IBNR reserves. Reserving practices and the quality of data reporting varies among ceding companies, which adds further uncertainty to the estimation of our ultimate losses. The nature and extent of information received from ceding companies also varies widely depending on the type of coverage, the contractual reporting terms (which are affected by market conditions and practices) and other factors. Due to the lack of standardization of the terms and conditions of reinsurance contracts, the wide variability of coverage provided to individual clients and the tendency of those coverages to change rapidly in response to market conditions, the ongoing economic impact of such uncertainties and inconsistencies cannot be reliably measured. Additional risks to us involved in the reporting of retrocessional contracts include varying reserving methodologies used by the original cedants and an additional reporting lag due to the time required for the retrocedant to aggregate its assumed losses before reporting them to us. Additionally, the number of contractual intermediaries is normally greater for retrocessional business than for insurance and reinsurance business, thereby further increasing the time lag and imprecision associated with loss reporting.
Since we rely on ceding company estimates of paid losses, case reserves and IBNR reserves in the process of establishing our own loss and LAE reserves, we maintain certain procedures designed to mitigate the risk that such information is incomplete or inaccurate. These procedures may include: (i) comparisons of expected premiums to reported premiums, which helps us to identify delinquent client periodic reports; (ii) ceding company audits to facilitate loss reporting and identify inaccurate or incomplete claim reporting; and (iii) underwriting reviews to ascertain that the losses ceded are covered as provided under the contract terms. We also use catastrophe model outputs and industry market share information to evaluate the reasonableness of reported losses, which are also compared to loss reports received from other cedants. In addition, each subsequent year of loss experience with a given cedant provides additional insight into the accuracy and timeliness of previously reported information. These procedures are incorporated in our internal controls process on an ongoing basis and are regularly evaluated and amended as market conditions, risk factors, and unanticipated areas of exposure develop. Our claims handling follow-up actions do not permit us to capture data which records the extent to which ceding company claims are subsequently adjusted as a result of these activities, nor do they permit us to determine the extent to which our actions influence the accuracy of subsequent cedant reporting. However, unreliable reporting is a factor which influences our underwriters’ willingness to offer terms to potential cedants. We believe that our diligence in these matters promotes better reporting by brokers and cedants over the long term. In our relatively short history, disputes with ceding companies have been rare and those which have not been resolved in negotiation have been resolved through arbitration in accordance with contractual provisions.
Estimating loss reserves for our modest book of longer-tail casualty reinsurance business, which can be either on an excess-of-loss or proportional basis, involves further uncertainties. In addition to the uncertainties inherent in the reserving process referred to above, casualty business can be subject to longer reporting lags than property business and claims often take several years to settle. During this period additional factors and trends will be revealed and, as they become apparent, we may adjust our reserves. There is also the potential for the emergence of new types of losses within our casualty book. Therefore, any factors that extend the time until claims are settled add uncertainty to the reserving process. At December 31, 2011 and 2010, we recorded gross loss and LAE reserves related to our casualty business of $249.4 million and $210.7 million, respectively.
We do not typically experience significant claims processing backlogs, although such backlogs may occur following a major catastrophic event. At December 31, 2011 and 2010, we did not have a significant backlog in either our insurance or reinsurance claims processing.
We believe that our reserves for loss and LAE are sufficient to cover losses that fall within the terms of our policies and agreements with our insured and reinsured customers on the basis of the methodologies used to estimate those reserves. However, there can be no assurance that our actual losses will not exceed our total loss and LAE reserves.
The following tables provide the details of our gross case reserves and IBNR, by line of business, at December 31, 2011 and 2010:
We have determined that our best estimates for our gross loss and LAE reserves at December 31, 2011 and 2010 were $1,077.1 million and $784.6 million, respectively. Of these estimates, at December 31, 2011 and 2010, $119.9 million and $108.0 million related to our direct insurance and facultative business, respectively, and $957.2 million and $676.6 million related to our reinsurance business, respectively.
Though we are principally a provider of reinsurance, we write both insurance and reinsurance contracts.
Premiums written are recognized as revenues, net of any applicable underlying reinsurance coverage, and are earned over the term of the related policy or contract. For direct insurance, facultative reinsurance and losses-occurring contracts, the earnings period is the same as the reinsurance contract. For risks-attaching contracts, the earnings period is based on the terms of the underlying insurance policies.
Insurance and facultative reinsurance contracts are written based on agreed upon terms and conditions which include a stated premium for coverages provided. The stated premium is then recorded as written premium at the effective date of the policy. In general, if the terms and conditions change during the policy period, either through policyholder request or underwriting audit, the policy would be endorsed to reflect the change in coverage. This endorsement usually generates a change to the policy premium which is then recorded as an adjustment to our written premiums.
For pro-rata contracts and certain excess-of-loss contracts in which a deposit or minimum premium is not specified in the contract, we record an estimate of written premiums in the period in which the underlying insurance policies incept. These premium estimates are based on information provided by ceding companies at the inception of the contract. When the actual premium is reported by the ceding company, typically on a quarterly or six month lag, it may be significantly higher or lower than the estimate.
In the normal course of business, we purchase reinsurance from third parties in order to manage our exposures. The amount of ceded reinsurance that we buy varies from year to year depending on our risk appetite, as well as the availability and cost of the reinsurance coverage. Ceded reinsurance premiums are accounted for on a basis consistent with those used in accounting for the underlying premiums assumed, and are reported as a reduction of net premiums written.
Certain of our assumed pro-rata contracts incorporate reinsurance protection provided by third-party reinsurers that inures to our benefit. These reinsurance premiums are reported as a reduction in our gross premiums written.
RSUs are phantom (as opposed to actual) Common Shares which, depending on the individual award, vest in equal tranches over a one to five-year period, subject to the recipient maintaining a continuous relationship with us (as an employee, a director or a consultant) through the applicable vesting date. Holders of RSUs are not entitled to voting rights but are entitled to receive payments equivalent to any dividends and distributions declared on the Common Shares underlying the RSUs.
As part of our principal long-term incentive compensation for employees, we grant “Variable RSUs”. Variable RSUs are contingent awards in which the actual number of RSUs to be awarded is dependent upon our corporate (as opposed to individual) performance during the initial year of the award cycle (the “Initial RSU Period”), meaning that the number of RSUs expected to be awarded for that cycle may fluctuate during that one-year period. For the years covered by this report, the actual number of Variable RSUs to be awarded has been based on a targeted return on equity (“ROE”) assuming a standardized investment return. ROE is computed by dividing our adjusted comprehensive income or loss (based on the sum of our actual underwriting result and standard investment result) by our actual average common shareholders’ equity for the Initial RSU Period. Adjusted comprehensive income, for these purposes, is our actual comprehensive income or loss less dividends declared on our Preferred Shares, if any, less the actual investment return on our investments, investment-related derivatives and cash and cash equivalents, plus a standardized investment return on our investments, cash and cash equivalents.
From time to time we also grant “Fixed RSUs” as a supplemental component of our ongoing long-term incentive compensation for certain of our employees and directors. The number of Fixed RSUs is fixed and determinable on the grant date. Fixed RSUs are typically granted for the following purposes: (i) to induce individuals to join our company; (ii) to retain certain key employees; (iii) to reward employees for exhibiting outstanding individual performance; and (iv) as remuneration to non-management members of the Boards of Directors of the Company and MUAL. Additionally, when the actual number of Variable RSUs to be awarded has been formally determined, they are effectively converted into Fixed RSUs.
For the 2009-2012 Variable RSU award cycle, the targeted performance metric was based on a 2009 ROE of 9.77%. At an achieved ROE of 9.77% (our target), we would have expected to grant approximately 650,000 Variable RSUs to participants. At an achieved ROE of 3.77% (our threshold), we would not have expected to grant any Variable RSUs to participants. At an achieved ROE of 19.77% (our maximum), we would have expected to grant approximately 1,300,000 Variable RSUs to participants. Throughout the Initial RSU Period for this cycle, our quarterly Variable RSU accrual for this cycle varied in response to actual year-to-date results achieved and ranged from as many as 1,260,327 RSUs (as recorded at December 31, 2009) to as few as 685,717 RSUs (as recorded at March 31, 2009). Based on our actual ROE achieved for 2009 of 19.11%, the final number of Variable RSUs granted for the 2009-2012 Variable RSU award cycle was determined to be 1,273,118 RSUs (or 193% of the target RSUs for that cycle) by the Compensation Committee in March 2010, after which these awards were effectively converted to Fixed RSUs.
For the 2010-2013 Variable RSU award cycle, the targeted performance metric was based on a 2010 ROE of 9.69%. At an achieved ROE of 9.69% (our target), we would have expected to grant approximately 580,000 Variable RSUs to participants. At an achieved ROE of 3.69% (our threshold), we would not have expected to grant any Variable RSUs to participants. At an achieved ROE of 19.69% (our maximum), we would have expected to grant approximately 1,160,000 Variable RSUs to participants. Throughout the Initial RSU Period for this cycle, our quarterly Variable RSU accrual for this cycle varied in response to actual year-to-date results achieved and ranged from as many as 725,922 RSUs (as recorded at December 31, 2010) to as few as 408,084 RSUs (as recorded at June 30, 2010). Based on our actual ROE achieved for 2010 of 11.94%, the final number of Variable RSUs granted for the 2010-2013 Variable RSU award cycle was determined to be 713,741 RSUs (or 123% of the target RSUs for that cycle) by the Compensation Committee in March 2011, after which these awards were effectively converted to Fixed RSUs.
For the years covered by this report, we assumed an RSU forfeiture rate of between zero and 14.5%, depending on the nature and term of the individual awards and past and recent experience. Our forfeiture assumptions serve to reduce the unamortized grant date fair value of our outstanding RSUs as well as the associated RSU expense. As RSUs are actually forfeited, the number of RSUs outstanding is reduced and the remaining unamortized grant date fair value is compared to assumed forfeiture levels. True-up adjustments are made as deemed necessary.
During 2011, 2010 and 2009, we recognized $7.5 million, $13.5 million and $14.8 million of RSU expense, respectively.