Our corporate offices are located in 101,420 total square feet of leased space in Stamford, Connecticut. Our other locations occupy a total of 118,548 square feet, all of which are leased. The Americas division operates out of offices in New York, Stamford, Mexico City, Miami, Santiago and Toronto, the EuroAsia division operates out of offices in Paris, Singapore, Stockholm and Tokyo, the London Market division operates out of offices in London and Bristol, and the U.S. Insurance division operates out of offices in New York, Chicago and Napa.
We encourage you to read the consolidated financial statements included in this Annual Report on Form 10-K because they contain our complete consolidated financial statements for the years ended December 31, 2007, 2006,
and 2005. The results of operations for the year ended December 31, 2007 are not necessarily indicative of future results.
Inclusion of restricted common shares, stock options and the effect of the conversion of our convertible debt to common shares would have an antidilutive effect on the 2005 diluted earnings per common share (i.e., the diluted earnings per common share would be greater than the basic earnings per common share). Accordingly, such common shares were excluded from the calculations of the 2005 diluted earnings per common share. See Notes 2(l) and 4 to our consolidated financial statements included in this Annual Report on Form 10-K.
We are a leading underwriter of reinsurance, providing a full range of property and casualty products on a worldwide basis. We offer a broad range of both treaty and facultative reinsurance to property and casualty insurers and reinsurers. We also write insurance in the United States and through the Lloyd’s marketplace.
The property and casualty reinsurance and insurance industries use the combined ratio as a measure of underwriting profitability. The GAAP combined ratio is the sum of losses and loss adjustment expenses (“LAE”) incurred as a percentage of net premiums earned, plus underwriting expenses, which include acquisition costs and other underwriting expenses, as a percentage of net premiums earned. The combined ratio reflects only underwriting results, and does not include investment results. Underwriting profitability is subject to significant fluctuations due to catastrophic events, competition, economic and social conditions, foreign currency fluctuations and other factors. Our combined ratio was 95.5% for the year ended December 31, 2007, compared to 94.4% for the year ended December 31, 2006.
The London Market division is comprised of our Lloyd’s of London business, in which we participate through our 100% ownership of Newline, our London branch office and our London-based casualty insurer NICL. The London Market division writes insurance and reinsurance business worldwide, principally through brokers.
The consolidated financial statements and related notes included in Item 8 of this Annual Report on Form 10-K, have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) and include the accounts of Odyssey Re Holdings Corp. and its subsidiaries. For a discussion of our significant accounting policies, see Note 2 to our consolidated financial statements.
Consistent with our significant accounting policies, for our reinsurance business we utilize estimates in establishing premiums written, the corresponding acquisition expenses and unearned premium reserves. These estimates are required to reflect differences in the timing of the receipt of accounts from the ceding company and the actual due dates of the accounts at the close of each accounting period.
Our estimates are based on contract and policy terms. Estimates are based on information typically received in the form of a bordereau, broker notifications and/or discussions with ceding companies. These estimates, by necessity, are based on assumptions regarding numerous factors. These can include premium or loss trends, which can be influenced by local conditions in a particular region, or other economic factors and legal or legislative developments which can develop over time. The risk associated with estimating the performance under our contracts with our ceding companies is the impact of events or trends that could not have been reasonably anticipated at the time the estimates were performed. Our business is diversified across ceding companies and there is no individual ceding company which represents more than 2.4% of our gross premiums written in 2007. As a result, we believe the risks of material changes over time are mitigated.
cedant’s current estimate of the ultimate liability under the claim. Upon receipt of claim notices from cedants, we review the nature of the claim against the scope of coverage provided under the contract. Questions arise from time to time regarding the interpretation of the characteristics of a particular claim measured against the scope of contract terms and conditions. Reinsurance contracts under which we assume business generally contain specific dispute resolution provisions in the event that there is a coverage dispute with the ceding company. The resolution of any individual dispute may impact estimates of ultimate claims liabilities. Reported claims are in various stages of the settlement process. Each claim is settled individually based on its merits, and certain claims may take several years to ultimately settle, particularly where legal action is involved. Based on an assessment of the circumstances supporting the claim, we may choose to establish additional case reserves over the amount reported by the ceding company. Aggregate case reserves established in addition to reserves reported by ceding companies were $18.7 million and $17.2 million as of December 31, 2007 and December 31, 2006, respectively. Due to potential differences in ceding company reserving and reporting practices, we perform periodic audits of our ceding companies to ensure the underwriting and claims procedures of the cedant are consistent with representations made by the cedant during the underwriting process and meet the terms of the reinsurance contract. Our estimates of ultimate loss liabilities make appropriate adjustment for inconsistencies uncovered in this audit process. We also monitor our internal processes to ensure that information received from ceding companies is processed in a timely manner.
Adjustments to premium estimates generate appropriate adjustments to ultimate loss estimates in the quarter in which they occur using the BF and loss ratio methods. To estimate losses for more mature treaty years, we generally rely on the incurred loss development methodology, which does not rely on premium estimates. In addition, we may use other methods to estimate liabilities for specific types of claims. For property catastrophe losses, we may utilize vendor catastrophe models to estimate ultimate loss soon after a loss occurs, where loss information is not yet reported to us from cedants. The provision for asbestos loss liabilities is established based on an annual review of internal and external trends in reported loss and claim payments. IBNR is determined by subtracting the total of paid loss and case reserves including ACRs from ultimate loss.
We reported net adverse development for prior years of $40.5 million, $139.9 million, and $172.7 million for the years ended December 31, 2007, 2006, and 2005, respectively. The increases in prior year loss estimates for these periods were due to a reevaluation of loss reserve assumptions principally related to United States casualty business, including asbestos, written prior to 2002. Our actual loss emergence reported in 2007, 2006, and 2005 for United States casualty business written prior to 2002 was generally greater than expectations, which were based on historical loss emergence information available prior to 2007, 2006, and 2005, respectively. Upon consideration of this new loss emergence information received during 2007, 2006, and 2005, we revised the loss development assumptions used in our United States casualty business loss reserving analyses, which had the effect of increasing our loss estimates for this business.
excess workers’ compensation classes of business during these years were adversely impacted by the highly competitive conditions in the industry at that time. These competitive conditions resulted in price pressure and relatively broader coverage terms, thereby affecting the ability of standard actuarial techniques to generate reliable estimates of ultimate loss. Similarly, directors’ and officers’ professional liability lines were impacted by the increase in frequency and severity of claims resulting from an increase in shareholder lawsuits against corporations and their officers and directors, corporate bankruptcies and other financial and management improprieties in the 1990s and early 2000s.
The following table provides detail on net adverse (favorable) loss and LAE development for prior years, by division, for the years ended December 31, 2007, 2006, and 2005 (in millions):
The EuroAsia division reported net favorable loss development for prior years of $6.9 million, $9.0 million, and $8.7 million for the years ended December 31, 2007, 2006 and 2005, respectively. For the year ended December 31, 2007, the reduction in prior year loss estimates was principally attributable to favorable loss emergence on credit and miscellaneous property lines of business, partially offset by increased loss estimates on motor and liability exposures in the period. For the year ended December 31, 2006, the reduction in prior year loss estimates was driven by favorable loss emergence on property catastrophe, marine and credit lines of business in the period. For the year ended December 31, 2005, the reduction in prior year loss estimates was principally attributable to favorable loss emergence on liability and bond exposures, partially offset by adverse development on prior year catastrophes of $7.4 million predominantly attributable to unexpected loss emergence in the period resulting from Typhoon Songda and the Indonesian earthquake and resulting tsunami.
Estimates of reserves for unpaid losses and LAE are contingent upon legislative, regulatory, social, economic and legal events and trends that may or may not occur or develop in the future, thereby affecting assumptions of claim frequency and severity. Examples of emerging claim and coverage issues and trends in recent years that could affect reserve estimates include developments in tort liability law, legislative attempts at asbestos liability reform, an increase in shareholder derivative suits against corporations and their officers and directors, and increasing governmental involvement in the insurance and reinsurance industry. The eventual outcome of these events and trends may be different from the assumptions underlying our loss reserve estimates. In the event that loss trends diverge from expected trends during the period, we adjust our reserves to reflect the change in losses indicated by revised expected loss trends. On a quarterly basis, we compare actual emergence of the total value of newly reported losses to the total value of losses expected to be reported during the period and the cumulative value since the date of our last reserve review. Variation in actual loss emergence from expectations may result in a change in our estimate of losses and LAE reserves. Any adjustments will be reflected in the periods in which they become known, potentially resulting in adverse or favorable effects to our financial results. Changes in expected claim payment rates, which represent one component of losses and LAE emergence, may impact our liquidity and capital resources, as discussed below in “Liquidity and Capital Resources.”
The following table summarizes, by type of reserve, the unpaid losses and LAE reserves as of December 31, 2007 and 2006. Case reserves represent unpaid claim reports provided by cedants to us plus additional reserves determined by us. IBNR is the estimate of unreported loss liabilities established by us.
Estimation of ultimate asbestos and environmental liabilities is unusually complex due to several factors resulting from the long period between exposure and manifestation of these claims. This lag can complicate the identification of the sources of asbestos and environmental exposure, the verification of coverage and the allocation of liability among insurers and reinsurers over multiple years. This lag also exposes the claim settlement process to changes in underlying laws and judicial interpretations. There continues to be substantial uncertainty regarding the ultimate number of insureds with injuries resulting from these exposures.
We believe that these uncertainties and factors make projections of these exposures, particularly asbestos, subject to less predictability relative to non-environmental and non-asbestos exposures. Current estimates, as of December 31, 2007, of our asbestos and environmental losses and LAE reserves, net of reinsurance, are $222.4 million and $34.5 million, respectively. See Note 8 to the consolidated financial statements for additional historical information on losses and LAE reserves for these exposures.
The following table provides the gross and net asbestos and environmental losses and LAE incurred for the years ended December 31, 2007, 2006 and 2005 (in millions):
The number of environmental claims, with case reserves, as of December 31, 2007 was 605, amounting to $29.8 million in gross case losses and LAE reserves. The largest 10 reported claims accounted for 30.5% of the gross case reserves, with an average case reserve of $0.9 million. The number of environmental claims, with case reserves, as of December 31, 2006 was 738, amounting to $28.9 million in gross case losses and LAE reserves. The largest 10 reported claims accounted for 28.0% of the gross case reserves, with an average case reserve of $0.8 million. Overall gross case reserves increased in 2007, as newly reported claims and additional reported reserves on existing claims more than offset case reserve reductions associated with claim payments in the year. The environmental open claim count decreased by 133, or 18.0%, during calendar year 2007 due to the closing of many small case reserved claims not expected to generate a payment based on the most recent information available to us. Based on an aggregation of claims by insured, our 10 largest insured involvements accounted for 47.0% of our gross case reserves as of December 31, 2007, compared to 45.7% as of December 31, 2006. Net losses and LAE for the year ended December 31, 2007 for environmental claims were increased by $14.5 million, principally attributable to the annual review of this exposure.
The following table provides gross asbestos and environmental outstanding claim information for the years ended December 31, 2007 and 2006 (in millions):
The total amount of reinsurance recoverables on paid and unpaid losses as of December 31, 2007 and 2006 was $726.6 million and $798.8 million, respectively. We have established a reserve for potentially uncollectible reinsurance recoverables based upon an evaluation of each retrocessionaire and our assessment as to the collectability of individual balances. The reserve for uncollectible recoverables as of December 31, 2007 and 2006 was $44.4 million and $42.5 million, respectively, and has been netted against reinsurance recoverables on loss payments. We have also established a reserve for potentially uncollectible assumed reinsurance balances of $1.5 million and $1.9 million as of December 31, 2007 and 2006, respectively, which has been netted against premiums receivable.
ended December 2005, resulting in income of $11.3 million ($7.3 million after tax). There were no cessions to this agreement in 2006. We received $78.0 million in cash from nSpire Re on March 29, 2006, which reduced the outstanding recoverable. As the $78.0 million was received in advance of the payment of the underlying claims by us, it is included as an adjustment to net unpaid losses and loss adjustment expenses, which increased by $78.0 million. In connection with the receipt of this cash, we have recognized $19.3 million ($12.5 million after tax) of the cumulative deferred gain, an increase of $17.9 million ($11.7 million after tax) over the anticipated deferred gain amortization, as a reduction in losses and loss adjustment expenses.
During the second quarter of 2006, we commuted certain Whole Account Excess of Loss Agreements for total consideration of $80.6 million through the settlement of funds held under reinsurance contracts (included as a liability on our consolidated balance sheet) and the receipt of cash from the reinsurer, net of the settlement of outstanding commissions receivable. During the second quarter of 2006, the commutation of these contracts decreased our paid and unpaid reinsurance recoverables as of December 31, 2005 by $71.0 million. This commutation covered all outstanding Whole Account Excess of Loss Agreements applicable to underwriting and accident years 1999 and prior as well as the reinsurer’s participation on underwriting years 2000 and 2001.
The following table shows the amount of loss and LAE attributable to each coverage period ceded to the Whole Account Excess of Loss Agreements for the years ended December 31, 2007, 2006 and 2005 (in millions):
The following table provides a summary of the cumulative experience, including the income (loss) before income taxes, for two agreements in force at December 31, 2007, in each case since inception (in millions):
We have recorded interest expense associated with other ceded reinsurance agreements, and not reflected in the table above, of $975 thousand, $571 thousand and $485 thousand for the years ended December 31, 2007, 2006 and 2005, respectively.
The reinsurance recoverables on paid and unpaid losses related to the 2000 and 2001 underwriting years Whole Account Excess of Loss Agreements are $74.0 million and $122.2 million as of December 31, 2007 and 2006, respectively. Funds held under reinsurance contracts, related to these agreements, shown as a liability on our consolidated balance sheets, reflect $58.1 million and $83.4 million as of December 31, 2007 and 2006, respectively. Other collateral related to these agreements is $33.6 million and $43.2 million as of December 31, 2007 and 2006, respectively.
United States - Gross premiums written of $650.6 million for the year ended December 31, 2007 decreased $105.8 million, or 14.0%, compared to $756.4 million for the year ended December 31, 2006. The decrease in the United States relates to all classes of business. Property business decreased by $44.2 million, or 23.0%, to $148.1 million in 2007 from $192.3 million in 2006 as we reduced our proportional catastrophe exposed business in certain peak zones. Treaty and facultative casualty business decreased by $52.0 million, or 10.3%, to $452.0 million in 2007 from $504.0 million in 2006 due to an increase in competitive market conditions and the cancellation of certain business that did not meet our underwriting criteria. All other classes of business accounted for the remaining decrease of $9.6 million.
Latin America - Gross premiums written of $141.4 million for the year ended December 31, 2007 increased $6.5 million, or 4.8%, compared to $134.9 million for the year ended December 31, 2006. The increase is primarily the result of increased writings of property facultative business on both a new and renewal basis.
Canada - Gross premiums written of $43.3 million for the year ended December 31, 2007 increased $11.3 million, or 35.3%, compared to $32.0 million for the year ended December 31, 2006, due to the cancellation in 2006 of certain treaties, which included the return of unearned premium to the ceding company.
and health, aviation and credit and bond business. Gross premiums written from property business, which represents 61.5% of EuroAsia in 2007, increased by $7.1 million, or 2.1%, for the year ended December 31, 2007 driven by increases in the European and Middle East markets. The increase in marine business of $3.1 million, or 9.3%, and liability business of $4.5 million, or 19.2%, is related to increases in new and renewal business throughout Europe. Offsetting these increases are decreases in motor business of $5.4 million, or 6.3%, primarily related to European, Middle East and Asia business, credit and bond business of $3.9 million or $7.0% related to the European market, and accident and health and aerospace business of $0.2 million and $0.8 million, respectively.
U.S. Insurance. Gross premiums written in the U.S. Insurance division for the year ended December 31, 2007 were $532.3 million, an increase of $22.7 million, or 4.4%, as compared to $509.6 million for the year ended December 31, 2006. These amounts represent 23.3% of our gross premiums written for the year ended December 31, 2007 and 21.8% in 2006. Gross premiums written in our specialty insurance unit increased by $45.3 million, or 12.7%, offset by a decrease in medical malpractice business of $22.6 million, or 14.8%. Gross premiums written across each line of business is as follows:
Medical malpractice gross premiums written were $130.2 million for the year ended December 31, 2007, a decrease of $22.6 million, or 14.8%, from $152.8 million for the year ended December 31, 2006. The medical malpractice class of business is experiencing a softening market.
Commercial auto increased $16.8 million to $52.4 million for the year ended December 31, 2007, from $35.6 million for the year ended December 31, 2006. This increase resulted from increased production of ongoing accounts.
The decrease in net losses and LAE incurred was principally related to a decrease of $99.4 million in prior period losses, to $40.5 million for the year ended December 31, 2007, from $139.9 million for the year ended December 31, 2006, and a decline in net earned premium of $105.3 million. This decrease was partially offset by an increase in current year catastrophe losses of $71.0 million. Losses and LAE for the year ended December 31, 2007 included $40.5 million attributable to prior years, which reflected unfavorable emergence of $0.9 million on prior period catastrophe events. The remaining amount of prior period losses of $39.6 million in 2007 was predominantly attributable to increased loss estimates on non-catastrophe business in the Americas division of $131.4 million, which included $77.4 million for increased asbestos and environmental loss estimates, principally attributable to the annual review of these exposures, and $21.2 million related to settlement of litigation during the third quarter, with the remainder principally due to loss emergence greater than expectations in the period on U.S. casualty business. This increase was partially offset by reduced loss estimates due to loss emergence lower than expectations in the period on non-catastrophe business written in the London Market, EuroAsia and U.S. Insurance divisions. Losses and LAE for the year ended December 31, 2006 included $139.9 million attributable to prior years, which included $42.6 million on prior period catastrophe events, principally due to an increase in loss estimates on marine business for Hurricane Rita and the triggering of industry loss warranty contracts written by us for Hurricane Wilma due to unexpected deterioration in industry-wide Wilma loss estimates as well as unexpected loss emergence on Florida proportional property accounts in the period. The remaining amount of prior period losses of $97.3 million in 2006 was predominantly attributable to increased loss estimates on non-catastrophe business in the Americas division of $169.7 million, which included $27.1 million for increased asbestos loss estimates, principally attributable to the annual review of this exposure, with the remainder principally due to loss emergence greater than expectations in the period on U.S. casualty business. This increase was partially offset by reduced loss estimates due to loss emergence lower than expectations in the period on non-catastrophe business written in the London Market, EuroAsia and U.S. Insurance divisions.
Ceded losses and LAE incurred for the year ended December 31, 2007 decreased by $41.3 million, or 28.1%, to $105.9 million, from $147.2 million for the year ended December 31, 2006. This decrease was principally attributable to a $21.6 million decrease in cessions to the Whole Account Excess of Loss Agreements and the 1995 Stop Loss Agreement, and a decrease of $16.3 million related to cessions on our casualty facultative business.
The following tables reflect total losses and LAE as reported for each division and include the impact of catastrophe losses and prior period reserve development, expressed as a percentage of net premiums earned (“NPE”), for the years ended December 31, 2007 and 2006 (in millions):
EuroAsia Division - Losses and LAE increased $28.2 million, or 8.8%, to $348.6 million for the year ended December 31, 2007, from $320.4 million for the year ended December 31, 2006. This resulted in a loss and LAE ratio of 64.2% for the year ended December 31, 2007, compared to 60.3% for the year ended December 31, 2006. This increase in losses and LAE was principally due to an increase in current year catastrophe losses of $34.0 million, to $53.4 million for the year ended December 31, 2007 from $19.4 million for the year ended December 31, 2006, of which $44.7 million relates to Windstorm Kyrill, Jakarta floods and Cyclone Gonu. Losses and LAE for the year ended December 31, 2007 included a reduction in prior period losses of $6.9 million, principally attributable to favorable loss emergence on credit and miscellaneous property lines of business, partially offset by increased loss estimates on motor and liability exposures. Losses and LAE for the year ended December 31, 2006 included a reduction in prior period losses of $9.0 million, principally due to favorable emergence on property catastrophe, marine and credit lines of business in the period.
London Market Division - Losses and LAE decreased $32.1 million, or 17.6%, to $150.4 million for the year ended December 31, 2007, from $182.5 million for the year ended December 31, 2006. This resulted in a loss and LAE ratio of 49.0% for the year ended December 31, 2007, compared to 54.7% for the year ended December 31, 2006. The decrease in losses and LAE was principally due to a reduction in prior period losses of $32.2 million and a decline in net earned premium of $26.7 million, or 8.0%. For the year ended December 31, 2007, losses and LAE included $16.8 million attributable to Windstorm Kyrill and floods in the United Kingdom and reflected a reduction in prior period losses of $57.0 million, principally due to favorable emergence on liability, property catastrophe, and
other miscellaneous property lines of business in the period. For the year ended December 31, 2006, losses and LAE included a reduction of $24.8 million attributable to prior years, principally due to favorable emergence on satellite, accident and health, non-catastrophe property, and aviation exposures in the period, and included a $3.6 million increase on prior period catastrophe losses, principally Hurricane Rita.
U.S. Insurance Division - Losses and LAE increased $32.4 million, or 15.0%, to $247.9 million for the year ended December 31, 2007, from $215.5 million for the year ended December 31, 2006. This resulted in a loss and LAE ratio of 57.8% for the year ended December 31, 2007, compared to 55.8% for the year ended December 31, 2006. The increase in losses and LAE was principally related to an increase in net earned premium of $42.8 million, or 11.1%. For the years ended December 31, 2007 and 2006, prior period losses decreased by $38.7 million and $39.0 million, respectively, principally due to favorable emergence on medical malpractice business in each period.
Acquisition costs are reduced by ceding commissions related to our Whole Account and Facultative Excess of Loss Agreements, of $2.7 million and $1.5 million for the years ended December 31, 2007 and 2006, respectively. Ceding commissions due under certain of our Whole Account Excess of Loss Agreements are deferred and will be received by us in future periods. Ceding commissions related to our Whole Account Excess of Loss Agreements have therefore been recorded at their present value, with the discount amortized over the expected collection period. For years ended December 31, 2007 and 2006, the discount amortized and included in ceding commissions is $2.8 million and $1.8 million, respectively.
Other Underwriting Expenses. Other underwriting expenses for the year ended December 31, 2007 were $178.6 million, compared to $153.5 million for the year ended December 31, 2006. The other underwriting expense ratio, expressed as a percentage of net premiums earned, was 8.4% for the year ended December 31, 2007, compared to 6.9% for the year ended December 31, 2006. Other underwriting expenses increased while net premiums earned decreased, resulting in a higher other underwriting expense ratio in 2007 as compared to 2006. This increase in other underwriting expenses is principally attributable to an increase in compensation costs.
The following table reflects the acquisition and other underwriting expenses, expressed as a percentage of net premiums earned, for the years ended December 31, 2007 and 2006 for each of our divisions:
Net Investment Income. Net investment income for the year ended December 31, 2007 decreased by $157.7 million, or 32.4%, to $329.4 million, from $487.1 million for the year ended December 31, 2006. Net investment income is comprised of gross investment income of $368.1 million less investment expenses of $38.7 million for the year ended December 31, 2007, compared to gross investment income of $517.4 million less investment expenses of $30.3 million for the year ended December 31, 2006. The decrease in net investment income for the year ended December 31, 2007 is primarily attributable to the following:
an increase of $9.6 million in net investment income from equity securities for the year ended December 31, 2007 compared to the year ended December 31, 2006, excluding the effect of HWIC Asia. Included in net
investment income from equity securities is an other-than-temporary write-down of $5.3 million for the year ended December 31, 2007 related to Advent Capital (Holdings) PLC (“Advent”).
lower net realized investment gains on equity securities of $69.1 million for the year ended December 31, 2007. Realized investment gains include $119.2 million related to the sale of Hub International Limited shares and $75.1 million related to the redemption of HWIC Asia shares for the years ended December 31, 2007 and 2006, respectively. Net realized investment gains on equity securities also include other-than-temporary write-downs of $42.1 million and $17.1 million for the years ended December 31, 2007 and 2006, respectively.
During the year ended December 31, 2007, net realized investment gains were reduced by other-than-temporary impairment losses in the amount of $59.8 million relating to fixed income securities, common and preferred equities, which includes $5.3 million reflected in net investment income related to our investment in Advent. During the year ended December 31, 2006, net realized investment gains were reduced by other-than-temporary impairment losses in the amount of $28.1 million relating to fixed income, equity and other investments. Other-than-temporary impairments reflect situations where the fair value was below the cost of the securities and the ability of the security to recover its value could not be reasonably determined.
Other Expenses, Net. Other expenses, net for the year ended December 31, 2007, were $14.0 million, compared to $21.1 million for the year ended December 31, 2006. Other expenses are primarily comprised of operating expenses of our holding Company and include audit related fees, corporate-related legal fees, consulting fees, and compensation expense, including the amortization of restricted share grants. The decrease of $7.1 million for the year ended December 31, 2007 compared to 2006 is primarily comprised of: (i) a decrease of $2.3 million in compensation expense, (ii) a decrease of $2.3 million relating to contracts under deposit accounting, (iii) a decrease in legal fees of $1.7 million due to litigation settled in 2006, and (iv) a decrease in audit fees of $1.8 million; offset by: (v) an increase in foreign exchange related adjustments of $1.2 million.
Interest Expense. We incurred interest expense, related to our debt obligations, of $37.7 million and $37.5 million for the years ended December 31, 2007 and 2006, respectively. The higher amount of interest expense primarily reflects our $100.0 million senior notes offering completed in February 2006.
EuroAsia. Gross premiums written in the EuroAsia division for the year ended December 31, 2006 were $561.2 million, an increase of $17.4 million, or 3.2%, as compared to $543.8 million for the year ended December 31, 2005. These amounts represent 24.0% of our gross premiums written for the year ended December 31, 2006 and 20.7% in 2005. These amounts include $5.2 million of reinstatement premiums for the year ended December 31, 2005 compared to $0.5 million in 2006. The overall increase is primarily attributable to increases in property, marine, credit and bonds, and liability, offset by a decrease in motor business, accident and health and aviation. Gross premiums written from property business, which represents 60.8% of EuroAsia in 2006, increased by $15.0 million, or 4.6%, for the year ended December 31, 2006 driven by increases in the European and Middle East markets. The increase in marine business of $4.8 million, or 16.8%, and all other classes of business of $4.0 million, or 5.3%, is related to increases in new and renewal business throughout Europe. Offsetting these increases is a decrease in motor business of $3.4 million, or 3.8%, primarily related to European and Asia business and accident and health and aerospace business of $1.2 million and $1.8 million, respectively.
London Market. Gross premiums written in the London Market division for the year ended December 31, 2006 were $340.7 million, a decrease of $90.9 million, or 21.1%, as compared to $431.6 million for the year ended December 31, 2005. These amounts represent 14.6% of our gross premiums written for the year ended December 31, 2006 and 16.4% in 2005. These amounts include reinstatement premiums of $0.9 million and $33.2 million (all related to the London branch) for the years ended December 31, 2006 and 2005, respectively, which principally relate to Hurricanes Katrina, Rita and Wilma in 2005. Excluding reinstatement premiums in each period, gross premiums written would be $339.8 million and $398.4 million for the years ended December 31, 2006 and 2005, respectively, representing a decrease of $58.6 million, or 14.7%, over the period. Gross premiums written across each unit of the London Market division are as follows:
U.S. Insurance. Gross premiums written in the U.S. Insurance division for the year ended December 31, 2006 were $509.6 million, a decrease of $11.4 million, or 2.2%, as compared to $521.0 million for the year ended December 31, 2005. These amounts represent 21.8% of our gross premiums written for the year ended December 31, 2006 and 19.8% in 2005. Gross premiums written in our specialty insurance unit decreased by $13.6 million, or 3.7%, offset by an increase in medical malpractice business of $2.2 million, or 1.5%. Gross premiums written across each line of business is as follows:
Ceded Premiums Written. Ceded premiums written for the year ended December 31, 2006 decreased by $150.5 million, or 46.3%, to $174.8 million (7.5% of gross premiums written) from $325.3 million (12.4% of gross premiums written) for the year ended December 31, 2005. These amounts include reinstatement premiums paid of $2.9 million and $65.7 million for the years ended December 31, 2006 and 2005, respectively. Excluding reinstatement premiums in each period, ceded premiums written were $171.9 million for the year ended December 31, 2006 a decrease of $87.7 million, or 33.8%, as compared to $259.6 million for the year ended December 31, 2005.
Net Premiums Written. Net premiums written for the year ended December 31, 2006 decreased by $140.8 million, or 6.1%, to $2,160.9 million from $2,301.7 million for the year ended December 31, 2005. Net premiums written represent gross premiums written less ceded premiums written. Net premiums written decreased over 2005 at a lower rate than gross premiums written, reflecting the significant decrease in ceded premiums written in the period. Included in net premiums written are $2.5 million and $4.7 million of net reinstatement premiums received for the years ended December 31, 2006 and 2005, respectively, related to catastrophes. Excluding reinstatement premiums, net premiums written decreased by $138.6 million, or 6.0%, for the year ended December 31, 2006 over 2005.
Net Premiums Earned. Net premiums earned for the year ended December 31, 2006 decreased by $51.0 million, or 2.2%, to $2,225.8 million, from $2,276.8 million for the year ended December 31, 2005. Net premiums earned decreased in the Americas division by $76.1 million, or 7.2%, and in the London Market division by $52.6 million, or 13.6%, offset by increases in the EuroAsia division of $15.2 million, or 2.9%, and in the U.S. Insurance division of $62.5 million, or 19.3%. Included in net premiums earned are $2.5 million and $4.7 million of net reinstatement premiums received for the years ended December 31, 2006 and 2005, respectively,
related to catastrophes. Excluding reinstatement premiums, net premiums earned decreased by $48.8 million, or 2.1%, for the year ended December 31, 2006 over 2005.
Losses and Loss Adjustment Expenses. Net losses and LAE decreased $577.4 million, or 28.0%, to $1,484.2 million for the year ended December 31, 2006, from $2,061.6 million for the year ended December 31, 2005 as follows (in millions):
The decrease in net losses and LAE incurred was principally related to a decline in current year catastrophe events of $503.0 million, and a decrease in prior period losses of $32.8 million, to $139.9 million for the year ended December 31, 2006 from $172.7 million for the year ended December 31, 2005. Losses and LAE for the year ended December 31, 2006 included prior period losses of $139.9 million, which reflected $42.6 million for prior year catastrophe events, principally due to an increase in loss estimates on marine business for Hurricane Rita and the triggering of industry loss warranty contracts written by us for Hurricane Wilma due to unexpected deterioration in industry-wide Wilma loss estimates as well as unexpected loss emergence on Florida proportional property accounts in the period. The remaining amount of prior period losses of $97.3 million in 2006 was predominantly attributable to increased loss estimates on non-catastrophe business in the Americas division of $169.7 million, which included $27.1 million for increased asbestos loss estimates, principally attributable to the annual review of this exposure, with the remainder principally due to loss emergence greater than expectations in the period on U.S. casualty business. This increase was partially offset by reduced loss estimates due to loss emergence lower than expectations in the period on non-catastrophe business written in the London Market, EuroAsia and U.S. Insurance divisions. For the year ended December 31, 2005, current year catastrophe events of $537.9 million included $445.9 million related to Hurricanes Katrina, Rita, and Wilma, and $25.6 million related to Windstorm Erwin. Losses and LAE incurred during the year ended December 31, 2005 included prior period losses of $172.7 million, which included $15.0 million for prior year catastrophe events, principally due to an increase in loss estimates on the 2004 Florida Hurricanes, Typhoon Songda, and the Indonesian earthquake and resulting tsunami. The remaining amount of prior period losses of $157.7 million in 2005 was predominantly attributable to increased loss estimates on non-catastrophe business in the Americas division of $207.3 million, which included $41.2 million for increased asbestos loss estimates, principally attributable to the annual review of this exposure, with the remainder principally due to loss emergence greater than expectations in the period on U.S. casualty business. This increase was partially offset by reduced loss estimates due to loss emergence lower than expectations in the period on non-catastrophe business written in the London Market, EuroAsia and U.S. Insurance divisions.
Ceded losses and LAE incurred for the year ended December 31, 2006 decreased by $315.3 million, or 68.2%, to $147.2 million, from $462.5 million for the year ended December 31, 2005. This decrease was principally attributable to a decrease of $281.6 million in property catastrophe cessions, due to a decline in current year catastrophe events, and a $46.8 million decrease in ceded losses related to our U.S. Insurance operations, to $55.6 million for the year ended December 31, 2006 from $102.4 million for the year ended December 31, 2005, due to increased retentions. Cessions to the Whole Account Excess of Loss Agreements for the years ended December 31, 2006 and 2005 were $9.7 million and $16.5 million, respectively. As of December 31, 2006, the aggregate limits on the Whole Account Excess of Loss Agreements have been fully utilized.
London Market Division - Losses and LAE decreased $166.3 million, or 47.7%, to $182.5 million for the year ended December 31, 2006, from $348.8 million for the year ended December 31, 2005. This resulted in a loss and LAE ratio of 54.7% for the year ended December 31, 2006, compared to 90.3% for the year ended December 31, 2005. The decrease in losses and LAE was principally related to a decrease in current year catastrophes of $137.1 million and a decline in net premiums earned of $52.6 million, or 13.6%. Losses and LAE for the year ended December 31, 2006 included a benefit of $24.8 million attributable to prior years, principally due to favorable emergence on satellite, accident and health, non-catastrophe property, and aviation exposures in the period, and included $3.6 million of prior period catastrophe losses, principally Hurricane Rita. Losses and LAE for the year ended December 31, 2005 included a benefit of $22.8 million, principally due to favorable emergence on aviation, satellite and non-catastrophe property business in the period, and included $1.7 million of prior period catastrophe losses.
Other Underwriting Expenses. Other underwriting expenses for the year ended December 31, 2006 were $153.5 million, compared to $146.0 million for the year ended December 31, 2005. The other underwriting expense ratio, expressed as a percentage of net premiums earned, was 6.9% for the year ended December 31, 2006, compared to 6.4% for the year ended December 31, 2005. Other underwriting expenses increased while net premiums earned decreased, resulting in a higher other underwriting expense ratio in 2006 as compared to 2005. This increase in other underwriting expenses is attributable to an increase in personnel related costs and benefits, particularly in our Americas division.
an increase of $16.5 million for the year ended December 31, 2006 over 2005 in net income due to equity accounting of Advent Capital (Holdings) PLC, a Lloyd’s syndicate which is included in common stock, at equity. This resulted in net income of $1.1 million for the year ended December 31, 2006 compared to a net loss of $15.4 million in 2005, primarily reflecting catastrophe losses from Hurricanes Katrina, Rita and Wilma during 2005.
Net Realized Investment Gains. Net realized investment gains of $189.1 million for the year ended December 31, 2006 increased by $129.2 million from $59.9 million for the year ended December 31, 2005. The increase in net realized investment gains is principally due to higher gains from equity securities and other investments, which were offset by lower gains from fixed income securities and higher losses from derivative securities. The total net realized investment gains for the year ended December 31, 2006 of $175.4 million on equity securities, primarily reflect a net gain of $75.1 million related to the redemption of shares of HWIC Asia and the sale of unrelated equity securities. Net realized investment gains from equity securities also include realized losses of $17.1 million related to the other-than-temporary impairment of a security. Net realized investment gains from other investments were $86.5 million for the year ended December 31, 2006, representing a positive change of $134.5 million over 2005, primarily reflecting realized foreign exchange rate gains on short term securities.
Net realized investment gains from fixed income securities of $30.4 million for the year ended December 31, 2006 decreased by $51.6 million over 2005. Realized investment gains include mark-to-market movements on derivative securities, including credit default swaps and total return swaps on equity indexes. The net investment loss on derivative securities of $103.1 million for the year ended December 31, 2006 increased by $64.3 million over 2005.
During the year ended December 31, 2006, net realized investment gains were reduced by other-than-temporary impairment losses in the amount of $28.1 million, with $11.0 million relating to fixed income securities and other invested assets and $17.1 million relating to equity securities. Other-than-temporary impairments reflect situations where the fair value was below the cost of the securities and the ability of the security to recover its value could not be reasonably determined. Other-than-temporary impairments related to fixed income securities include $7.5 million for security which has no quoted price, to reflect the deterioration in the underlying financial position of the security. During the year ended December 31, 2005, net realized investment gains were reduced by other-than-temporary impairment losses in the amount of $54.9 million, with $37.3 million relating to fixed income securities and other invested assets and $17.6 million relating to equity securities. Other-than-temporary impairments related to fixed income securities include $19.4 million for securities which have no quoted prices, to reflect a deterioration in the underlying financial position of the securities.
Our shareholders’ equity increased by $571.1 million, or 27.4%, to $2,654.7 million as of December 31, 2007, from $2,083.6 million as of December 31, 2006. The net increase as of December 31, 2007 compared to December 31, 2006 was attributable to net income of $595.6 million, an increase to accumulated other comprehensive income of $59.7 million, an increase of $25.8 million related to the conversion of our Convertible Debt into shares of our common stock, and an increase of $10.6 million related to other items. These increases were offset by a decrease resulting from common and preferred dividends of $26.1 million and a decrease of $94.5 million related to the repurchase of our common stock. Our book value per common share was $36.78 as of December 31, 2007,
Although the obligations of our reinsurers to make payments to us are based on specific contract provisions, these amounts only become recoverable when we make a payment of the associated loss amount, which may be several years, or in some cases decades, after the actual loss occurred. Reinsurance recoverables on unpaid losses, which represent 88.6% of our total reinsurance recoverables as of December 31, 2007, will not be due for collection until some time in the future, and over this period of time, economic conditions and the operational performance of a
On November 28, 2006, we completed the private sale of $40.0 million aggregate principal amount of floating rate senior debentures, Series C (the “Series C Notes”), due on December 15, 2021. Interest on the Series C Notes accrues at a rate per annum equal to the three-month London Interbank Offer Rate (“LIBOR”), reset quarterly, plus 2.50%, and is payable quarterly in arrears on March 15, June 15, September 15 and December 15 of each year starting on March 15, 2007. We have the option to redeem the Series C Notes at par, plus accrued and unpaid interest, in whole or in part on any interest payment date on or after December 15, 2011. For the years ended December 31, 2007 and 2006, the average annual interest rate on the Series C Notes was 7.93% and 7.87%, respectively.
their par value, plus accrued and unpaid interest. For the year ended December 31, 2007, the average annual interest rate on each series of notes was 7.62%, compared to an average annual interest rate of 7.40% for the year ended December 31, 2006.
Please see Note 11 to our consolidated financial statements included in this Annual Report on Form 10-K for complete disclosure of our debt obligations, common shares and preferred shares.
We participate in Lloyd’s through our 100% ownership of Newline Syndicate 1218 (“Syndicate 1218”), through which we provide 100% of the capacity for Syndicate 1218. The results of Syndicate 1218 are consolidated in our consolidated financial statements. In support of Syndicate 1218’s capacity at Lloyd’s, Odyssey America has pledged U.S. Treasury Notes and cash, with a fair value of $204.1 million as of December 31, 2007, in a deposit trust account in favor of the Society and Council of Lloyd’s. These securities may be substituted with other securities at our discretion, subject to approval by Lloyd’s. The securities are carried at fair value and are included in investments and cash in our consolidated balance sheets. Interest earned on the securities is included in investment income. The pledge of assets in support of Syndicate 1218 provides us with the ability to participate in writing business through Lloyd’s, which remains an important part of our business. The pledged assets effectively secure the contingent obligations of Syndicate 1218 should it not meet its obligations. Odyssey America’s contingent liability to the
During the second quarter of 2004, Odyssey America pledged U.S. Treasury Notes with a par value of $162.0 million (“the pledged assets”), or approximately £110.0 million equivalent, to the Society and Council of Lloyd’s on behalf of Advent Capital (Holdings) PLC (“Advent”) to support Advent’s underwriting activities for the 2001 to 2005 underwriting years of account. Advent is 44.5% owned by Fairfax and its affiliates, which includes 8.1% held by us. nSpire Re had previously pledged assets at Lloyd’s on behalf of Advent pursuant to a November 2000 agreement with Advent. Advent is responsible for the payment of any losses to support its underwriting activities and the capital resources of Advent, including its funds deposited at Lloyd’s, are first available to support any losses prior to a draw down of Odyssey America’s pledged assets. In consideration of Odyssey America pledging the assets, nSpire Re agreed to pay Odyssey America a fee equal to 2.0% per annum of the pledged assets, which we considered to be representative of commercial market terms. The pledged assets continue to be owned by Odyssey America, and Odyssey America receives any investment income thereon. The securities are carried at fair value and are included in investments and cash in our consolidated balance sheets. Interest earned on the securities is included in investment income. As additional consideration for, and further protection of, the pledged assets, nSpire Re has provided Odyssey America with indemnification in the event of a draw down on the pledged assets. Odyssey America retains the right to withdraw the pledged assets at any time upon 180 days advance written notice to nSpire Re. nSpire Re retains the obligation to pledge assets on behalf of Advent. In any event, the placement of funds at Lloyd’s will automatically terminate effective no later than December 31, 2008 and any remaining pledged assets will revert to Odyssey America at that time. The pledge of assets is not considered material to our liquidity and capital resources. In January 2006, September 2006 and June 2007, Odyssey America received assets with par values of $48.6 million, $10.7 million and $14.6 million, respectively, in each case representing a permanent reduction and unconditional release of such amount, prior to the stated termination date, following the deposit by Advent of such amount in new funds at Lloyd’s. Following these returns of assets, and as of December 31, 2007, Odyssey America continues to have a par value of $88.0 million, or approximately £44.2 million equivalent, pledged to Lloyd’s in support of Advent and will continue to receive a fee for these pledged assets. The fair value of the pledged assets is $112.6 million, or approximately £56.6 million equivalent. We believe that the financial resources of Advent provide adequate protection to support its liabilities in the ordinary course of business.
These ratings are used by insurers, reinsurers and intermediaries as an important means of assessing the financial strength and quality of reinsurers. A reduction in our financial strength ratings could limit or prevent us from writing new reinsurance or insurance business. The financial strength ratings of our principal operating subsidiaries are: A.M. Best: “A” (Excellent); Standard & Poor’s: “A−” (Strong); and Moody’s: “A3” (Good). These ratings are based upon factors relevant to policyholders, agents and intermediaries and are not directed toward the protection of investors, nor are they recommendations to buy, sell or hold securities.
Our senior unsecured debt is currently rated “BBB-” by Standard & Poor’s, “Baa3” by Moody’s and “bbb” by A.M. Best. Our Series A and Series B preferred shares are currently rated “BB” by Standard & Poor’s, “Ba2” by Moody’s and “bb+” by A.M. Best. “See Part I, Item 1 - Business-Ratings” for further detail regarding our and our subsidiaries’ ratings.
On January 1, 2007, we adopted Statement of Financial Accounting Standard (“SFAS”) 155, “Accounting for Certain Hybrid Financial Instruments - an amendment of SFAS 133 and 140.” SFAS 155 applies to certain “hybrid financial instruments,” which are instruments that contain embedded derivatives. The standard established a requirement to evaluate beneficial interests in securitized financial assets to determine if the interests represent freestanding derivatives, or are hybrid financial instruments containing embedded derivatives requiring bifurcation. SFAS 155 permits an election for fair value measurement of any hybrid financial instrument containing an embedded derivative that otherwise would have required bifurcation under SFAS 133, including financial instruments previously recorded by us under SFAS 133. As a result of the adoption of SFAS 155 on January 1, 2007, we no longer bifurcate the embedded derivatives included in certain fixed income securities, and, beginning on January 1, 2007, changes in the fair value of the hybrid financial instruments are recorded as realized investment gains and losses in our consolidated statements of operations. Prior to the adoption of SFAS 155, changes in the fair value of the host instrument were recorded as unrealized investment gains and losses, a component of shareholders’ equity, while changes in the fair value of the embedded derivative were recorded as realized investment gains and losses. Upon adoption, we recorded a cumulative adjustment of $16.5 million to reclassify unrealized investment gains, net of tax, including foreign currency effects, to retained earnings as of January 1, 2007.
We elect to recognize accrued interest and penalties associated with uncertain tax positions as part of the income tax provision. As of December 31, 2007, we have not recorded any interest or penalties. We file income tax returns with various federal, state, and foreign jurisdictions. Our U.S. federal income tax returns for 1999 through 2006 remain open for examination and the Internal Revenue Service is currently examining our 2003 and 2004 returns. Income tax returns filed with various state and foreign jurisdictions remain open to examination.
Certain shortcomings are inherent in the method of analysis used in the computation of the fair value of fixed rate instruments. Actual values may differ from those projections presented should market conditions vary from assumptions used in the calculation of the fair value of individual securities, including non-parallel shifts in the term structure of interest rates and a change in individual issuer credit spreads.
We have exposure to credit risk, primarily as a holder of fixed income securities. We control this exposure by emphasizing investment grade ratings in the fixed income securities we purchase. We also have exposure to credit
In the first quarter of 2008, through February 15, we sold $670.0 million notional amount of credit default swaps (including virtually all of our credit default swaps referenced to U.S. bond guarantors) for gross proceeds of $161.0 million and gains on sale (being gains in excess of the mark-to-market value as at December 31, 2007) of $26.8 million. The net mark-to-market gain for the January 1 to February 15, 2008 period on the $4.4 billion notional amount of credit default swaps remaining at February 15, 2008 (including 2008 purchases of $47.5 million notional amount of credit default swaps for $1.4 million) was $152.6 million, representing total net gains related to credit default swaps for this period of $179.4 million.
As of December 31, 2007, our holdings of financial instruments without quoted prices, or “non-traded investments,” included a collateral loan, which was fully impaired during 2005. We periodically evaluate the carrying value of non-traded investments by reviewing the borrowers’ current financial positions, and the timeliness of their interest and principal payments. As a result of this review, we recognized an other-than-temporary write-down of $17.0 million for the year ended December 31, 2005 related to this loan.
In connection with the swap transactions, we own SPDRs and XLF index call options at a cost of $1.0 million and $9.4 million, with a strike price of approximately 127.8% and 99.8% of the notional amount of the swap transactions as of December 31, 2007 and December 31, 2006, respectively. A call option gives the purchaser the right, but not the obligation, to purchase an underlying security at a specific price or prices at or for a certain time. Our maximum potential loss on the swap and option transactions was $193.2 million and $0.9 million as of December 31, 2007 and December 31, 2006, respectively. We plan to continue to purchase short-dated call options in 2008 in an effort to reduce the maximum potential loss on the swaps to approximately 20% of the swap notional value. The call options are recorded at fair value in other invested assets, and changes in the fair value are recorded as a realized gain or loss in the consolidated statement of operations. For the year ended December 31, 2007, 2006 and 2005, call options had net realized losses of $3.7 million, $0.4 million and $10.6 million, respectively.
In addition, as of December 31, 2007 and December 31, 2006, we had short positions of $62.3 million and $115.3 million, respectively, of primarily equity securities, for which we recorded a liability equal to the underlying fair value of the securities of $60.7 million and $119.8 million, respectively. Net realized gains of $60.5 million, $3.0 million and $4.3 million for the twelve months ended December 31, 2007, 2006 and 2005, respectively, were recognized in our consolidated statements of operations. As of December 31, 2007 and December 31, 2006, we provided cash of $195.8 million and $208.6 million, respectively, as collateral for the borrowed securities. Our net investment income for the years ended December 31, 2007, 2006 and 2005 was reduced by $1.6 million, $7.2 million and $5.0 million, respectively, related to dividend and interest payments associated with the borrowed securities.
on the valuation of investment assets denominated in those respective foreign currencies would result in a $208.6 million decline in the fair value of our total investments and cash, before taxes.
We review our investment portfolio on a quarterly basis for declines in value, and specifically consider securities, the fair value of which have declined to less than 80% of their amortized cost at the time of review. Temporary declines in investments will be recorded as unrealized depreciation in accumulated other comprehensive income. If we determine that a decline is “other-than-temporary,” the carrying value of the investment will be written down to the fair value and a realized loss will be recorded in our consolidated statements of operations.
For further detail on our long term debt principal and interest payments, see Note 11 to our consolidated financial statements included in this Annual Report on Form 10-K. For further detail on our operating lease payments, see Note 14 to our consolidated financial statements included in this Annual Report on Form 10-K.
Consolidated Statements of Shareholders’ Equity for the years ended December 31, 2007, 2006 and 2005.
Report of Independent Registered Public Accounting Firm on Financial Statement Schedules.
I. Summary of Investments - Other than Investments in Related Parties as of December 31,
IV. Reinsurance for the years ended December 31, 2007, 2006 and 2005
VI. Supplementary Information (for Property-Casualty Insurance Underwriters) as of December 31, 2007, 2006, 2005 and for the years ended December 31, 2007, 2006 and 2005
Odyssey Re Holdings Corp. (together with its subsidiaries, the “Company” or “OdysseyRe”) is an underwriter of reinsurance, providing a full range of property and casualty products on a worldwide basis, and an underwriter of specialty insurance, primarily in the United States and through the Lloyd’s of London marketplace. Odyssey Re Holdings Corp. was formed as a holding company and incorporated in Delaware in 2001 in conjunction with its initial public offering. Odyssey Re Holdings Corp. owns all of the common shares of Odyssey America Reinsurance Corporation (“Odyssey America”), its principal operating subsidiary, which is domiciled in the state of Connecticut. Odyssey America directly or indirectly owns all of the common shares of the following domestic and foreign subsidiaries: Clearwater Insurance Company (“Clearwater”); Clearwater Select Insurance Company (“Clearwater Select”); Odyssey UK Holdings Corporation; Newline Underwriting Management Ltd., which owns and manages Newline Syndicate 1218, a member of Lloyd’s of London (collectively, “Newline”); Newline Insurance Company Limited (“NICL”); Hudson Insurance Company (“Hudson”); Hudson Specialty Insurance Company and Napa River Insurance Services, Inc. As of December 31, 2007, Fairfax Financial Holdings Limited (“Fairfax”), a publicly traded financial services holding company based in Canada, owned 61.0% of OdysseyRe.
The net amount of unrealized appreciation or depreciation of the Company’s investments, net of applicable deferred income taxes, is reflected in shareholders’ equity in accumulated other comprehensive income. A decline in the fair value of an investment below its cost or amortized cost that is deemed other-than-temporary is recorded as a realized investment loss in the consolidated statements of operations, resulting in a new cost or amortized cost basis for the investment. An other-than-temporary decline in the carrying value of an investment recorded in accordance with the equity method of accounting is recorded in net investment income in the consolidated statements of operations. Realized investment gains or losses are determined on the basis of average cost. Investment income, which is reported net of applicable investment expenses, is recorded as earned.
(c) Premium Revenue Recognition. Reinsurance assumed premiums written and related costs are based upon reports received from ceding companies. Where reinsurance assumed premiums written have not been reported by the ceding company, they are estimated, at the individual contract level, based on historical patterns and experience from the ceding company and judgments of the Company. Subsequent adjustments to premiums written, based on actual results or revised estimates from the ceding company, are recorded in the period in which they become known. Reinsurance assumed premiums written related to proportional treaty business are established on a basis that is consistent with the coverage periods under the terms of the underlying insurance contracts. Reinsurance assumed premiums written related to excess of loss and facultative reinsurance business are recorded over the coverage term of the contracts, which is generally one year. Unearned premium reserves are established for the portion of reinsurance assumed premiums written to be recognized over the remaining contract period. Unearned premium reserves related to proportional treaty contracts are computed based on reports received from ceding companies, which show premiums written but not yet earned. Premium adjustments made over the life of the contract are recognized as earned premiums based on the applicable contract period to which they apply. Insurance premiums are earned on a pro rata basis over the policy period, which is generally one year. A reserve for uncollectible premiums is established when considered appropriate.
(d) Deferred Acquisition Costs. Acquisition costs, which are reported net of acquisition costs ceded, consist of commissions and brokerage expenses incurred on insurance and reinsurance business written, and are deferred and amortized over the period in which the related premiums are earned, which is generally one year. Commission adjustments are accrued based on changes in premiums and losses recorded by the Company in the period in which they become known. Deferred acquisition costs are limited to their estimated realizable value based on the related unearned premium, which considers anticipated losses and loss adjustment expenses and estimated remaining costs of servicing the business, all based on historical experience. The realizable value of the Company’s deferred acquisition costs is determined without consideration of investment income.
(e) Goodwill and Intangible Assets. The Company accounts for goodwill and intangible assets in accordance with SFAS 141, “Business Combinations.” A purchase price paid that is in excess of net assets (“goodwill”) arising from a business combination is recorded as an asset, and is not amortized. Intangible assets with a finite life are amortized over the estimated useful life of the asset. Intangible assets with an indefinite useful life are not amortized. Goodwill and intangible assets are tested for impairment on an annual basis or more frequently if events or changes in circumstances indicate that the carrying amount may not be recoverable. If the goodwill or intangible asset is impaired, it is written down to its realizable value with a corresponding expense reflected in the consolidated statements of operations. The Company has determined that its goodwill and intangible assets are not impaired as of December 31, 2007 and 2006. Goodwill and intangible assets with an indefinite useful life are carried at $30.5 million and are reflected in other assets as of both December 31, 2007 and 2006, respectively. As of December 31, 2007 and 2006, intangible assets with a finite life are also reflected in other assets with a value of $4.3 million and $5.1 million, respectively. The Company amortized $0.8 million in each of the years ended December 31, 2007, 2006 and 2005 related to its intangible assets with a finite life.
The reserve for unpaid losses and loss adjustment expenses is based on the Company’s evaluations of reported claims and individual case estimates received from ceding companies for reinsurance business or the estimates advised by the Company’s claims adjusters for insurance business. The Company utilizes generally accepted actuarial methodologies to determine reserves for losses and loss adjustment expenses on the basis of historical experience and other estimates. The reserves are reviewed continually during the year and changes in estimates in losses and loss adjustment expenses are reflected as an expense in the consolidated statements of operations in the period the adjustment is made. Reinsurance recoverables on unpaid losses and loss adjustment expenses are reported as assets. A reserve for uncollectible reinsurance recoverables is established based on an evaluation of each reinsurer or retrocessionaire and historical experience. The Company uses tabular reserving for workers’ compensation indemnity reserves, which are considered to be fixed and determinable, and discounts such reserves using an interest rate of 3.5%. Losses have been discounted using the Life Table for Total Population, United States, 2004.
(h) Income Taxes. The Company records deferred income taxes to provide for the net tax effect of temporary differences between the carrying values of assets and liabilities in the Company’s consolidated financial statements and their tax bases. Such differences relate principally to deferred acquisition costs, unearned premiums, unpaid losses and loss adjustment expenses, investments and tax credits. Deferred tax assets are reduced by a valuation allowance when the Company believes it is more likely than not that all or a portion of deferred taxes will not be realized. As of December 31, 2007 and 2006, a valuation allowance was not required. During the third quarter of 2006, Fairfax reduced its ownership of the Company to below 80%, and as a result, the Company has been deconsolidated from the United States tax group of Fairfax. Accordingly, the Company has filed a separate consolidated tax return for the period August 29, 2006 to December 31, 2006 and will file a separate consolidated tax return for 2007. The deconsolidation has no effect on the Company’s tax position (see Note 13). The Company elected to recognize accrued interest and penalties, if any, if any, associated with uncertain tax positions as part of the income tax provision. As of December 31, 2007, the Company has not recorded any interest or penalties.
(i) Derivatives. The Company utilizes derivative instruments to manage against adverse changes in the value of its assets and liabilities. Derivatives include credit default swaps, call options and warrants, total return swaps, interest rate options, forward currency contracts and other equity and credit derivatives. In addition, the Company holds options on certain securities within its fixed income portfolio, which allows the Company to extend the maturity date on fixed income securities or convert fixed income securities to equity securities. Prior to the adoption of SFAS 155, “Accounting for Certain Hybrid Financial Instruments - an amendment of SFAS 133 and 140” on January 1, 2007 (see Note 3), conversion options and maturity extension features were bifurcated from the fixed income security and measured separately at fair value. All derivative instruments are recognized as either assets or liabilities on the consolidated balance sheet and are measured at their fair value. Gains or losses from changes in the derivative values are accounted for based on how the derivative is used and whether it qualifies for hedge accounting. As the Company’s derivative instruments do not qualify for hedge accounting, changes in fair value are included in realized investment gains and losses in the consolidated statements of operations. Margin balances required by counterparties in support of derivative positions are included in cash and cash equivalents held as collateral.
(j) Operating Segments. The Company has four operating segments to reflect the manner in which management monitors and evaluates the Company’s financial performance. The Company’s four segments include: Americas, EuroAsia, London Market and U.S. Insurance (see Note 12).
(k) Foreign Currency. Foreign currency transaction gains or losses resulting from a change in exchange rates between the currency in which a transaction is denominated, or the original currency, and the functional currency are reflected in the consolidated statements of operations in the period in which they occur. The Company translates the financial statements of its foreign subsidiaries and branches, which have functional currencies other than the United States dollar, into United States dollars by translating balance sheet accounts at the balance sheet date exchange rate and income statement accounts at the average exchange rate for the year. Translation gains or losses are recorded, net of deferred income taxes, as a component of accumulated other comprehensive income.
(p) Fixed Assets. Fixed assets, with a net book value of $12.5 million and $10.3 million as of December 31, 2007 and 2006, respectively, are included in other assets. Property and equipment are recorded at cost. Depreciation and amortization are computed on a straight-line basis over the following estimated useful lives:
In September 2006, the FASB issued SFAS 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans - an amendment of SFAS 87, 88, 106, and 132(R)”. SFAS 158 requires, as of December 31, 2006, the Company to recognize the overfunded or underfunded status of a defined benefit postretirement plan, including pension plans, as an asset or liability in its balance sheet, and to recognize changes in that funded status in the year in which the changes occur through other comprehensive income. The Company adopted the recognition provisions of SFAS 158. As a result of the adoption, as of December 31, 2006, the Company recorded a one-time charge of $15.7 million to increase other liabilities, a $5.5 million deferred tax asset and a $10.2 million decrease to accumulated other comprehensive income on its balance sheet. In addition, SFAS 158 requires that, as of December 31, 2008, employers measure plan assets and liabilities as of the date of their financial statements. SFAS 158 does not require retrospective application.
In December 2007, the FASB issued SFAS 141(R), “Business Combinations,” to replace SFAS 141, “Business Combinations.” While several items from SFAS 141 were retained, including the acquisition method of accounting and the recognition of intangible assets separately from goodwill, SFAS 141(R) broadens its scope and establishes a definition of the acquirer and the acquisition date. SFAS 141(R) should be applied on a prospective basis in the first annual reporting period beginning on or after December 15, 2008. Earlier application is prohibited.
Common stocks accounted for under the equity method of accounting were carried at $245.4 million as of December 31, 2006, reflecting gross unrealized appreciation of $25.7 million and gross unrealized depreciation of $4.1 million. Other invested assets, including amounts that were accounted for under the equity method of accounting, were carried at $136.1 million as of December 31, 2006, reflecting no gross unrealized appreciation and gross unrealized depreciation of $0.1 million.
The following table sets forth the components of net investment income for the years ended December 31, 2007, 2006, and 2005 (in thousands):
Net income of common stocks, at equity includes an other-than-temporary impairment of $5.3 million for the year ended December 31, 2007 related to the Company’s investment in Advent Capital (Holdings) PLC (“Advent”).
The following table sets forth the changes in unrealized net appreciation (depreciation) of investments, and the related tax effect, reflected in accumulated other comprehensive income for the years ended December 31, 2007, 2006, and 2005 (in thousands):
The Company believes the gross unrealized depreciation is temporary in nature and has not recorded a realized investment loss in its statement of operations related to these securities. Given the size of its investment portfolio and capital position, the Company has the ability and intent to hold these securities until the fair value recovers to its original cost.
For common stocks, at equity, as of December 31, 2007, the relative ownership held by the Company is: Fairfax Asia Limited (100% owned by Fairfax, which includes a 25.9% economic interest owned by the Company), TRG Holding Corporation (100% owned by Fairfax, which includes 13.0% owned by the Company), Advent (44.5% owned by Fairfax, which includes 8.1% owned by the Company) and MFXchange Holdings Inc. (“MFX”)
(100% owned by Fairfax, which includes 7.4% owned by the Company). Common stocks, at equity, and certain other invested assets, are recorded under the equity method of accounting based on the Company’s proportionate share of income or loss and changes in shareholders’ equity of the investee. Due to the timing of when financial information is reported by investees, results attributable to the investments are generally reported by the Company on a one month or one quarter lag. Dividends received by the Company from these entities were $4.7 million, $6.0 million, and $6.0 million for the years ended December 31, 2007, 2006, and 2005, respectively. The Company routinely evaluates the carrying value of these investments by reviewing, among other things, each investee’s current and expected operating performance and current and historical trading values of the issuer’s securities, where applicable.
The Company sold its 13.2% ownership (5.3 million shares) of Hub International Limited (“Hub”) during June 2007 to a group of private equity firms for $41.50 per share in cash; accordingly, the Company had no equity interest in Hub as of December 31, 2007.
The Company recognized a pre-tax realized investment gain of $119.2 million ($77.5 million, after tax) related to the sale of its ownership in Hub.
The Company’s equity in the net income of HWIC Asia is included in pre-tax net investment income and is comprised of the following items for the years ended December 31, 2006 and 2005 (in thousands):
Including pre-tax realized investment gains of $75.1 million for the year ended December 31, 2006, related to the redemption of HWIC Asia shares, total realized investment gains from the Company’s interest in HWIC Asia were $242.8 million and $27.9 million, pre-tax for the years ended December 31, 2006 and 2005, respectively.
The aggregate of the Company’s equity investees’ summarized financial information, and the Company’s proportionate share thereof, as of December 31, 2007 and 2006 and for the years ended December 31, 2007, 2006 and 2005, follows (in thousands):
Other invested assets totaled $412.7 million as of December 31, 2007, compared to $136.1 million as of December 31, 2006. The following table shows the components of other invested assets as of December 31, 2007 and 2006 (in thousands):
The Company’s hedge fund and private equity partnership investments may be subject to restrictions on redemptions or sales, which are determined by the governing documents thereof, and limit the Company’s ability to liquidate these investments in the short term. Due to a time lag in reporting by a majority of hedge fund and private equity fund managers, valuations for these investments are reported by OdysseyRe on a one month or one quarter lag. Income from hedge funds and private equity investments included in net investment income totaled $8.2 million, $29.3 million and $15.6 million for the years ended December 31, 2007, 2006 and 2005, respectively. With respect to the Company’s $27.2 million in private equity partnerships included in other invested assets as of December 31, 2007, the Company has commitments that may require additional funding of up to $14.0 million. Interest and dividend income, and realized and unrealized gains and losses of hedge funds and private equity partnerships are generally included in net investment income. Other invested assets include $6.7 million related to the Company’s investment in O.R.E Holdings Limited, which is net of an other-than-temporary write-down of $9.9 million, of which $7.5 million and $2.4 million was recognized during the years ended December 31, 2006 and 2005, respectively.
As of December 31, 2007 and 2006, the Company held one collateral loan which constituted a financial instrument without a quoted price, or a “non-traded investment.” This collateral loan was fully impaired during 2005. The Company periodically evaluates the carrying values of non-traded investments by reviewing the borrowers’ current financial position and the timeliness of their interest and principal payments. As a result of this review, the Company recognized an other-than-temporary write-down of $17.0 million for the year ended December 31, 2005 related to this loan.
The Company has utilized, and may continue to utilize, credit default swaps, call options and warrants, total return swaps, interest rate options, forward currency contracts and short sales to manage against adverse changes in the values of assets and liabilities. These products are not linked to specific assets and liabilities on the balance sheet
or to a forecasted transaction and, therefore, do not qualify for hedge accounting. The following table sets forth the Company’s derivative and short sale positions as of December 31, 2007 and 2006 (in thousands):
The Company has purchased credit default swaps, referenced to various issuers in the banking, mortgage and insurance sectors of the financial services industry, that provide a hedge against adverse movements in the fair value of investments and other corporate assets resulting from systemic financial and credit risk. These credit default swaps are acquired by Fairfax and assigned to the Company to facilitate administration of counterparty credit risk and collateral maintenance. Under a credit default swap, the Company agrees to pay at specified periods fixed premium amounts based on an agreed notional principal amount in exchange for the credit default protection on a specified asset. Credit default swaps are recorded at fair value in other invested assets, with the related changes in fair value recognized as a realized gain or loss in the period in which they occur. The credit default swap portfolio had an average term to expiration of 3.6 years as of December 31, 2007. The Company obtains market-derived fair values for its credit default swaps from third-party providers, principally broker-dealers. The Company assesses the reasonableness of the fair values obtained from these providers by comparison to models validated by qualified personnel, by reference to movements in credit spreads and by comparing the fair values to recent transaction prices for similar credit default swaps where available. The fair values of credit default swaps are subject to significant volatility given potential differences in the perceived risk of default of the underlying issuers, movements in credit spreads and the length of time to the contracts’ maturities. The fair value of the credit default swaps may vary dramatically either up or down in short periods, and their ultimate value may therefore only be known upon their disposition. As a result of the appreciation in the fair value of the credit default swaps, counterparties to these transactions are required to place government securities as collateral, pursuant to the swap agreements. The fair value of this collateral was $227.8 million at December 31, 2007. The Company does not have the right to sell or repledge this collateral, as it continues to be the property of the counterparties.
The Company has purchased total return swaps as an economic hedge against a general decline in the Company’s equity portfolio. The margin maintenance requirement related to the total return swaps was $205.7 million and $10.5 million as of December 31, 2007 and 2006, respectively. The swap transactions expire during the first half of 2008. As of December 31, 2007 and 2006, the Company has provided $210.9 million and $52.1 million, respectively, of U.S. Treasury bills as collateral for the swap transactions. The swap transactions are recorded at fair value in other invested assets as December 31, 2007 and other liabilities as of December 31, 2006, and changes in the fair value are recorded as realized gains or losses in the consolidated statement of operations in the period in which they occur.
In connection with the swap transactions, the Company owns Standard & Poor’s 500 depository receipts (“SPDRs”) and the Financial Select SPDR Fund (“XLF”) index call options with strike prices of approximately 127.8% and 99.8% of the notional amount of the swap transactions as of December 31, 2007 and 2006, respectively. A call option gives the purchaser the right, but not the obligation, to purchase an underlying security at a specific
price or prices at or for a certain time. The Company’s maximum potential loss on the swap and option transactions was $193.2 million and $0.9 million as of December 31, 2007 and 2006, respectively. The call options are recorded at fair value in other invested assets, and changes in the fair value are recorded as a realized gain or loss in the consolidated statements of operations.
The Company has investments in warrants, which are contracts that grant the holder the right to purchase an underlying financial instrument at a given price and time or at a series of prices and times. Warrants, which are included in other invested assets, are recorded at fair value with the related changes in fair value recognized as a realized gain or loss in the period in which they occur.
The Company has entered into forward currency contracts to manage its foreign currency exchange rate risk on a macro basis. Under a forward currency contract, the Company and the counterparty are obligated to purchase or sell an underlying currency at a specified price and time. Forward currency contracts are recorded at fair value in other liabilities, with the related changes in fair value recognized as a realized gain or loss in the period in which they occur.
In connection with the short sales described above, the Company purchased a SPDR call option as protection against a decline in the value of the short positions. The call option is recorded at fair value in other invested assets in the consolidated balance sheets and changes in the fair value are recorded as a realized gain or loss in the consolidated statements of operations in the period in which they occur.
The Company purchases interest rate options from time to time to protect it from movements in interest rates. Interest rate options give the Company the option, but not the obligation, to enter into an interest rate swap contract under which the Company would receive a floating interest rate and pay a fixed interest rate based on the notional amount of the contract. Interest rate options are recorded at fair value, with the related changes in fair value recognized as a realized gain or loss in the period in which they occur.
The Company holds options on certain securities within its fixed income portfolio, which allows the Company to extend the maturity date of fixed income securities or convert fixed income securities to equity securities. As a result of the adoption of SFAS 155 on January 1, 2007, the Company no longer bifurcates these options from the host fixed income securities, and, beginning on January 1, 2007, changes in the fair value of the hybrid financial instruments are recorded as realized investment gains and losses in the Company’s consolidated statements of operations. Prior to the adoption of SFAS 155, changes in the fair value of the host instrument were recorded as unrealized investment gains and losses, a component of shareholders’ equity, while changes in the fair value of the embedded options were recorded as realized investment gains and losses. Upon adopting SFAS 155, the Company recorded a cumulative adjustment of $16.5 million to reclassify unrealized investment gains, net of tax, including
The following table shows the components of the change in accumulated other comprehensive income, net of deferred income taxes, for the years ending December 31, 2007, 2006 and 2005 (in thousands):
The components of comprehensive income (loss) for the years ending December 31, 2007, 2006 and 2005 are shown in the following table (in thousands):
Windstorm Kyrill, $12.3 million for Cyclone Gonu and $10.0 million for the Mexico flood in Tabasco. For the year ended December 31, 2006, the total catastrophe losses did not include any significant loss events. For the year ended December 31, 2005, the total catastrophe losses of $537.9 million included net losses and loss adjustment expenses of $445.9 million, net of reinsurance of $241.1 million, related to Hurricanes Katrina, Rita and Wilma, which occurred during the third and fourth quarters of 2005. In addition, for the year ended December 31, 2005, the Company incurred losses of $25.6 million related to Windstorm Erwin.
Ceded unpaid losses and loss adjustment expenses were $643.5 million, $739.0 million and $1,206.8 million for the years ended December 31, 2007, 2006 and 2005, respectively. The decrease reflected in ceded unpaid losses and loss adjustment expenses for the year ended December 31, 2007 was principally attributable to a $49.3 million decrease in unpaid reinsurance recoverables related to the Company’s whole account aggregate excess of loss retrocessional agreements and a $27.5 million decrease in unpaid reinsurance recoverables related to miscellaneous excess of loss retrocessional agreements. The decrease reflected in ceded unpaid losses and loss adjustment expenses for the year ended December 31, 2006 was principally attributable to a $210.0 million decrease in property
Net losses and loss adjustment expenses incurred for asbestos claims increased $63.0 million, $27.1 million and $41.2 million for the years ended December 31, 2007, 2006 and 2005, respectively. The increases in net losses and loss adjustment expenses incurred were primarily attributable to the annual reviews of claim activity and loss emergence trend information obtained in the calendar periods from ceding companies and other industry sources. Upon consideration of this new loss emergence information received in 2007, 2006 and 2005, we revised the loss development assumptions used in our asbestos loss reserving analyses, which had the effect of increasing our asbestos loss estimates for these calendar periods. The increase in 2006 net losses and loss adjustment expenses incurred included a $17.3 million benefit resulting from the amortization of the deferred gain related to the 1995 Stop Loss Agreement and a loss of $3.8 million related to the commutation of this agreement in addition to a net reserve increase of $40.6 million. Also as a result of this commutation, net reserves were increased by $49.9 million and net paid losses were decreased by $63.4 million.
The Company’s survival ratio for asbestos and environmental related liabilities as of December 31, 2007 is 11 years. The Company’s underlying survival ratio for asbestos related liabilities is 11 years and for environmental related liabilities is 17 years. The asbestos and environmental related liability survival ratio represents the asbestos and environmental reserves, net of reinsurance, on December 31, 2007, divided by the average paid asbestos and environmental claims for the last three years of $22.8 million which are net of reinsurance but prior to amounts subject to cession to the 1995 Stop Loss Agreement.
The Company utilizes retrocessional agreements to reduce and spread the risk of loss on its insurance and reinsurance business and to limit our exposure to multiple claims arising from a single occurrence. The Company is subject to accumulation risk with respect to catastrophic events involving multiple treaties, facultative certificates and insurance policies. To protect against these risks, the Company purchases catastrophe excess of loss protection. The retention, the level of capacity purchased, the geographical scope of the coverage and the costs vary from year to year. In 2007, the Company purchased some non-U.S. catastrophe excess of loss protection as well as some specific protections for its facultative property accounts in Latin America and Asia. Additionally, the Company purchases specific protections related to the business underwritten by its U.S. Insurance division.
There is a credit risk with respect to reinsurance, which would become an ultimate liability of the Company in the event that such reinsuring companies are unable, at some later date, to meet their obligations under the reinsurance agreements in force. Reinsurance recoverables are recorded as assets and a reserve for uncollectible reinsurance recoverables is established, based on the Company’s evaluation of each retrocessionaires’ ability to meet their obligations under the agreements. Premiums written and earned are stated net of reinsurance ceded in the consolidated statements of operations. Direct, reinsurance assumed, reinsurance ceded and net amounts for the years ended December 31, 2007, 2006 and 2005 follow (in thousands):
The total amount of reinsurance recoverable on paid and unpaid losses as of December 31, 2007 and 2006 was $726.6 million and $798.8 million, respectively. The Company has established a reserve for potentially
The Company’s reinsurance protection, which covered certain amounts of its 1995 and prior unpaid losses and loss adjustment expenses (the “1995 Stop Loss Agreement”), provided by nSpire Re Limited (“nSpire Re”), a wholly-owned subsidiary of Fairfax, was commuted effective September 29, 2006, for consideration of $63.2 million. In accordance with the terms of the commutation agreement, the Company commuted ceded loss reserves of $71.8 million, resulting in a commutation loss of $5.5 million, pre-tax, for the year ended December 31, 2006. The 1995 Stop Loss Agreement was originally entered into with Skandia Insurance Company Ltd. (“Skandia”) in conjunction with the purchase of Clearwater in 1996. Pursuant to the agreement, the Company paid a premium of $60.5 million in 1995 for protection of $175.0 million in excess of Clearwater’s December 31, 1995 reserves for net unpaid losses and loss adjustment expenses and reserves for uncollectible reinsurance. In January 1999, the liabilities under the contract were assigned by Skandia to nSpire Re for $97.0 million in consideration. Following the assignment to nSpire Re, the Company accounted for the 1995 Stop Loss Agreement as retroactive reinsurance. Accordingly, losses ceded under the contract in excess of $97.0 million in the aggregate had been recorded as a deferred gain rather than as a benefit in the applicable periods. The deferred gain had been amortized into income over the estimated remaining settlement period of the underlying claims. As of December 31, 2005, the Company has utilized the full limit of $175.0 million under the 1995 Stop Loss Agreement. The Company ceded losses of $17.5 million to the 1995 Stop Loss Agreement, resulting in income of $11.3 million ($7.3 million after tax) for the year ended December 31, 2005. There were no cessions to this agreement in 2006. The Company received $78.0 million in cash from nSpire Re on March 29, 2006, which reduced the outstanding recoverable. As the $78.0 million was received in advance of the payment of the underlying claims by the Company, it is included as an adjustment to net unpaid losses and loss adjustment expenses, which increased by $78.0 million. In connection with the receipt of this cash, the Company has recognized $19.3 million ($12.5 million after tax) of the cumulative deferred gain, an increase of $17.9 million ($11.7 million after tax) over the anticipated deferred gain amortization, as a reduction in losses and loss adjustment expenses.
In each calendar year, subject to certain limits, the Company has the ability to cede losses that are attributable to the covered period until all applicable losses are paid and settled, which is typically several years beyond the covered period, or until the contract is terminated by the Company. The ability of the Company to cede losses in any given calendar year that are attributable to prior periods will depend on the nature of the risk which generated the loss, the time period from which the losses originate and whether there are limits remaining covering the subject period. Losses attributable to prior periods are ceded to the treaties and recorded in the period in which they are ceded. Additional premiums, if any, are determined and recorded in the period when losses are ceded. When additional premiums are due, the interest on the funds attributable to the additional premiums ceded is typically calculated based on the inception period of the contract and the cumulative interest expense is recognized in the period when additional premiums are due. As of December 31, 2007, the limits for the Whole Account Excess of Loss Agreements have been fully utilized or commuted.
The income (loss) before income taxes reflected in the Company’s statements of operations related to the Company’s Whole Account Excess of Loss Agreements and Facultative Excess of Loss Agreement, including the effect of commutations, for the years ended December 31, 2007, 2006 and 2005 is as follows (in thousands):
As indicated by the table above, for the years ended December 31, 2007, 2006 and 2005, the Company ceded $(0.1) million, $8.3 million and $18.7 million, respectively, of losses and loss adjustment expenses, primarily to the 2001 aggregate excess of loss treaty. The increases in losses ceded to the Company’s Whole Account and Facultative Excess of Loss Agreements, for the years ended December 31, 2006 and 2005 were primarily attributable to adverse loss development on casualty business written in 2001. Losses ceded to the Company’s Whole Account and Facultative Excess of Loss Agreements were minimal in 2007 and represented 1.1% of the Company’s pre-tax income in 2006, and 10.3% of pre-tax loss in 2005.
The reinsurance recoverables on paid and unpaid losses related to the 2000 and 2001 underwriting years Whole Account Excess of Loss Agreements are $74.0 million and $122.2 million as of December 31, 2007 and 2006, respectively. Funds held under reinsurance contracts related to these agreements, shown as a liability on the Company’s consolidated balance sheets, reflect $58.1 million and $83.4 million as of December 31, 2007 and 2006, respectively. Other collateral related to these agreements is $33.6 million and $43.2 million as of December 31, 2007 and 2006, respectively.
The Company’s ten largest reinsurers represent 49.1% of its total reinsurance recoverables as of December 31, 2007. Amounts due from all other reinsurers are diversified, with no other individual reinsurer representing more than $14.7 million, or 2.0%, of reinsurance recoverables as of December 31, 2007, and the average balance is less than $3.0 million. The Company held total collateral of $184.1 million as of December 31, 2007, representing 25.3% of total reinsurance recoverables. The following table shows the total amount that is recoverable from each of
Reinsurance recoverables were $798.8 million and collateral was $238.2 million, or 29.8% of the reinsurance recoverable balance, as of December 31, 2006.
The components of the Company’s debt obligations as of December 31, 2007 and 2006 were as follows (in thousands):
In June 2002, the Company issued $110.0 million aggregate principal amount of convertible senior debentures, due 2022 (the “Convertible Notes”). Interest accrued on the Convertible Notes at a fixed rate of 4.375% per annum, due semi-annually on June 15 and December 15. The Convertible Notes became redeemable at the Company’s option on June 22, 2005. Under certain conditions specified in the indenture under which the Convertible Notes were issued (the “Indenture”), each Convertible Notes holder had the right to request conversion of its Convertible Notes into 46.9925 of the Company’s common shares for every $1,000 principal amount of the Convertible Notes held by such holder, which represents a conversion price of $21.28 per share. These conditions included the common stock of the Company trading at or above $25.54 per share for a specified period of time. Pursuant to the terms of the Indenture, the Company was permitted to satisfy the conversion obligations in stock or in cash, or in a combination thereof. The conversion conditions were first satisfied on August 9, 2006, and in accordance with the Indenture, the Convertible Notes became convertible, at the option of the holders, on August 14, 2006. As of March 31, 2007, 1,885,143 shares of the Company’s common stock were issued to the Convertible Notes holders who elected to convert their Convertible Notes, of which 46,992 shares were converted during three months ended March 31, 2007. In March 2007, the Company announced that it had called for the redemption of the remaining $22.5 million principal value of the outstanding Convertible Notes. At the close of business on April 30, 2007, all holders of the Convertible Notes had exercised their rights of conversion with respect to the Convertible Notes. Accordingly, on May 1, 2007, the Company issued 1,056,107 shares of its common stock related to the final conversion of $22.5 million principal value of the Convertible Notes, and no Convertible Notes remained outstanding as of such date.
As of December 31, 2007, the aggregate maturities of the Company’s debt obligations, at face value, are as follows (in thousands):
On July 13, 2007, the Company entered into a $200.0 million credit facility (the “Credit Agreement”) with Wachovia Bank National Association (“Wachovia”), KeyBank National Association and a syndicate of lenders. The Credit Agreement provides for a five-year credit facility of $200.0 million, $100.0 million of which is available for direct, unsecured borrowings by the Company, and all of which is available for the issuance of secured letters of credit. The Credit Agreement contains an option that permits the Company to request an increase in the aggregate amount of the facility by an amount up to $100.0 million, to a maximum facility size of $300.0 million. Following such a request, each lender has the right, but not the obligation, to commit to all or a portion of the proposed increase. The Credit Agreement is for working capital and other corporate purposes, including the issuance of letters of credit to support the insurance and reinsurance business of the Company. The Credit Agreement replaced the Company’s three-year, $150.0 million credit facility entered into as of September 23, 2005, which has been terminated, and the obligations thereunder have been satisfied.
On June 15, 2007, the Company’s Board of Directors authorized a share repurchase program. Under the program, effective as of such date, the Company may repurchase shares of its common stock on the open market from time to time through June 15, 2009, up to an aggregate purchase price of $200 million. Shares repurchased under the program will be cancelled. Depending on market conditions and other factors, these repurchases may be commenced or suspended at any time, or from time to time, without prior notice. For the year ended December 31, 2007, the Company repurchased and retired 2,636,989 shares of its common stock, at a cost of $94.5 million, an average repurchase price of $35.83 per share.
Dividends on each series are deferrable on a non-cumulative basis, provided that no dividends or other distributions have been declared or paid or set apart for payment on any other class or series of the Company’s capital shares ranking junior to or equal with the preferred shares. Dividends on Series A and Series B preferred shares will each be payable when, as and if declared by the Company’s Board of Directors, quarterly in arrears on the 20th day of January, April, July, and October of each year. Deferred dividends on either series will not accrue interest prior to the date of redemption. On November 27, 2007, the Company’s Board of Directors declared quarterly dividends of $0.5078125 per share on the Company’s 8.125% Series A preferred shares and $0.526875 per share on the Company’s floating rate Series B preferred shares. The total dividends of $2.1 million were paid on January 20, 2008 to Series A and Series B preferred shareholders of record on December 31, 2007.
As of December 31, 2007, a subsidiary of Fairfax owned 253,599 shares and 70,000 shares of the Company’s Series A and Series B preferred stock, respectively.
The financial results of these divisions for the years ended December 31, 2007, 2006 and 2005 are as follows (in thousands):
Deferred federal and foreign income taxes reflect the tax impact of temporary differences between the amount of assets and liabilities for financial reporting purposes and such amounts as measured by tax laws and regulations.
Components of federal and foreign income tax assets and liabilities as of December 31, 2007 and 2006 follow (in thousands):
Domestic pre-tax income (loss) was $692.8 million, $513.2 million and ($225.9) million for the years ended December 31, 2007, 2006 and 2005, respectively. Foreign pre-tax income was $220.4 million, $226.0 million and $44.0 million for the years ended December 31, 2007, 2006 and 2005, respectively.
As a result of Fairfax reducing its ownership of the Company to below 80% during the third quarter of 2006, the Company was deconsolidated from the United States tax group of Fairfax, and, accordingly, the Company has filed a separate consolidated tax return for the period August 29, 2006 to December 31, 2006 and will file a separate consolidated tax return for 2007. The deconsolidation has no effect on the Company’s tax position. Prior to August 29, 2006, the Company was a member of the United States tax group of Fairfax and made payments to Fairfax in accordance with its tax sharing agreements. The Company paid federal and foreign income taxes of $224.6 million, $59.3 million and $63.4 million for the years ended December 31, 2007, 2006 and 2005, respectively. The Company, as of December 31, 2007, has a current tax payable of $45.9 million, which reflects $33.1 million payable to Fairfax and a net payable of $12.8 million to the U.S. federal government and various foreign governments. The Company’s tax payable was $68.1 million as of December 31, 2006, which reflects $75.8 million payable to Fairfax, principally offset by foreign tax payables and receivables from the U.S. federal government. The federal income tax provision is allocated to each of the Company’s subsidiaries in the consolidated group pursuant to a written agreement, on the basis of each subsidiary’s separate taxable income.
The Company files income tax returns with various federal, state, and foreign jurisdictions. The Company’s U.S. federal income tax returns for 1999 through 2006 remain open for examination. The Internal Revenue Service expects to complete their audit of the Company’s 2003 and 2004 tax returns and commence their audit of the Company’s 2005 and 2006 tax returns during 2008. Income tax returns filed with various state and foreign jurisdictions remain open to examination in accordance with individual statutes.
stated termination date, following the deposit by Advent of such amount in new funds at Lloyd’s. Following these returns of assets, and as of December 31, 2007, Odyssey America continues to have a par value of $88.0 million, or approximately £44.2 million equivalent, pledged to Lloyd’s in support of Advent and will continue to receive a fee for these pledged assets. The fair value of the pledged assets as of December 31, 2007 is $112.6 million, or approximately £56.6 million equivalent. OdysseyRe believes that the financial resources of Advent provide adequate protection to support its liabilities in the ordinary course of business.
The Company participates in Lloyd’s through its 100% ownership of Newline, through which the Company provides 100% of the capacity for Newline Syndicate 1218 (“Syndicate 1218”). The results of Syndicate 1218 are consolidated in the financial statements of the Company. In support of Syndicate 1218’s capacity at Lloyd’s, Odyssey America has pledged U.S. Treasury Notes and cash, with a fair value of $204.1 million as of December 31, 2007, in a deposit trust account in favor of the Society and Council of Lloyd’s. These securities may be substituted with other securities at the discretion of the Company, subject to approval by Lloyd’s. The securities are carried at fair value and are included in investments and cash in the Company’s consolidated balance sheets. Interest earned on the securities is included in investment income. The pledge of assets in support of Syndicate 1218 provides the Company with the ability to participate in writing business through Lloyd’s, which remains an important part of the Company’s business. The pledged assets effectively secure the contingent obligations of Syndicate 1218 should it not meet its obligations. Odyssey America’s contingent liability to the Society and Council of Lloyd’s is limited to the aggregate amount of the pledged assets. The Company has the ability to remove funds at Lloyd’s annually, subject to certain minimum amounts required to support its outstanding liabilities as determined under risk-based capital models and approved by Lloyd’s. The funds used to support outstanding liabilities are adjusted annually and the obligations of the Company to support these liabilities will continue until they are settled or the liabilities are reinsured by a third party approved by Lloyd’s. The Company expects to continue to actively operate Syndicate 1218 and support its requirements at Lloyd’s. The Company believes that Syndicate 1218 maintains sufficient liquidity and financial resources to support its ultimate liabilities and the Company does not anticipate that the pledged assets will be utilized.
As of July 14, 2000, Odyssey America agreed to guarantee the performance of all the insurance and reinsurance contract obligations, whether incurred before or after the agreement, of Compagnie Transcontinentale de Réassurance (“CTR”), a subsidiary of Fairfax, in the event CTR became insolvent and CTR was not otherwise indemnified under its guarantee agreement with a Fairfax affiliate. The guarantee, which was entered into while Odyssey America and CTR were each 100% owned by Fairfax, was provided by Odyssey America to facilitate the transfer of renewal rights to CTR’s business, together with certain CTR employees, to Odyssey America in 2000 in order to further expand the Company’s international reinsurance business. The guarantee was terminated effective December 31, 2001. There were no amounts received from CTR under the guarantee, and the Company did not provide any direct consideration for the renewal rights to the business of CTR. CTR was dissolved and its assets and
The Company and its subsidiaries are involved from time to time in ordinary litigation and arbitration proceedings as part of the Company’s business operations. In management’s opinion, the outcome of these suits, individually or collectively, is not likely to result in judgments that would be material to the financial condition or results of operations of the Company.
Rental expense, before sublease income under these operating leases, was $8.2 million, $9.8 million and $11.1 million for the years ended December 31, 2007, 2006 and 2005, respectively. The Company recovered pre-tax amounts of $0.1 million, $0.1 million and $0.2 million for the years ended December 31, 2007, 2006 and 2005, respectively, from subleases.
The following is the consolidated statutory basis net income (loss) and policyholders’ surplus of Odyssey America and its subsidiaries, for each of the years ended and as of December 31, 2007, 2006 and 2005 (in thousands):
The statutory provision for potentially uncollectible reinsurance recoverables due from unauthorized companies is reduced to the extent collateral is held by Clearwater or Hudson. Pursuant to indemnification agreements between the Company and Clearwater, and between the Company and Hudson, the Company provides letters of credit and/or cash in respect of uncollateralized balances due from unauthorized reinsurers. The use of such
collateral provided by the Company is a permitted accounting practice approved by the Insurance Department of the State of Delaware, the domiciliary state of Clearwater and Hudson. The Company has provided a $20.5 million letter of credit to Clearwater and a $0.5 million letter of credit to Hudson as of December 31, 2007, which have been used as collateral in regard to the indemnification agreements. The indemnification agreements do not affect the accompanying consolidated financial statements.
The Company has entered into various reinsurance arrangements with Fairfax and its affiliates. The approximate amounts included in or deducted from income, expense, assets and liabilities in the accompanying consolidated financial statements, with respect to reinsurance assumed and ceded, as of and for the years ended December 31, 2007, 2006 and 2005 follow (in thousands):
Due to expense sharing and investment management agreements with Fairfax and its affiliates, the Company has accrued on its consolidated balance sheet amounts receivable from affiliates of $1.0 million and $0.9 million as of December 31, 2007 and 2006, respectively, and amounts payable to affiliates of $4.6 million and $4.3 million as of December 31, 2007 and 2006, respectively.
In September 2006, the FASB issued SFAS 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans - an amendment of SFAS 87, 88, 106, and 132(R)”. SFAS 158 requires, as of December 31, 2006, the Company to recognize the overfunded or underfunded status of a defined benefit postretirement plan, including pension plans, as an asset or liability in its balance sheet and to recognize changes in that funded status in the year in which the changes occur through comprehensive income. The Company adopted the recognition provisions of SFAS 158, which resulted in a reduction of accumulated other comprehensive income of $10.2 million as of December 31, 2006. In addition, SFAS 158 requires that, as of December 31, 2008, employers measure plan assets and liabilities as of the date of their financial statements. The Company has elected to apply the “fifteen-month” approach to measure plan assets, which will require the Company to measure plan assets as of its current measurement date, October 1, for a fifteen-month period through December 31, 2008. SFAS 158 does not require retrospective application.
The weighted average assumptions used to calculate the net periodic benefit cost for the years ended December 31, 2007, 2006 and 2005 are as follows:
The accumulated benefit obligation for the Plan is $52.5 million and $45.8 million as of the 2007 and 2006 measurement dates, respectively. As the fair value of the Plan assets exceeds the accumulated benefit obligation, the Company did not recognize an additional minimum pension liability under SFAS 132 as of the 2005 measurement date.
The investment policy for the Plan is to invest in highly-rated, lower-risk securities that preserve the investment asset value of the Plan while seeking to maximize the return on those invested assets. The Plan assets as of December 31, 2007 and 2006 are invested principally in highly-rated fixed income securities. The long term rate of return assumption is based on the fixed income securities portfolio. The actual return on assets has historically been in line with the Company’s assumptions of expected returns. During 2007, the Company contributed $4.0 million to the Plan. Based on the Company’s current expectations, the 2008 contribution should approximate $4.0 million.
The Company estimates that it will record a $17.2 million net loss related to the net periodic benefit cost during the year ended December 31, 2008. The Company does not expect any refunds of Plan assets during the year ended December 31, 2008.
The Company also maintains two non-qualified excess benefit plans (“Excess Plans”) that provide more highly compensated officers and employees with defined retirement benefits in excess of qualified plan limits imposed by federal tax law. The following tables set forth the combined amounts recognized for the Supplemental Plan, which has a measurement date of October 1, and the Supplemental Employee Retirement Plan, which has a measurement date of December 31, in the Company’s consolidated financial statements as of December 31, 2007 and 2006 (in thousands):
The net amount recognized in the consolidated balance sheets related to the accrued pension cost of $16.7 million and $16.3 million, as of December 31, 2007 and 2006, respectively, is included in other liabilities. The net amount of pre-tax accumulated other comprehensive loss is $3.7 million and $4.1 million as of December 31, 2007 and 2006, respectively.
Net periodic benefit cost included in the Company’s consolidated statement of operations for the years ended December 31, 2007, 2006 and 2005 is comprised of the following components (in thousands):
The accumulated benefit obligation for the Excess Plans is $12.1 million and $11.7 million as of December 31, 2007 and 2006, respectively.
The Company provides certain health care and life insurance (“postretirement”) benefits for retired employees. Substantially all employees may become eligible for these benefits if they reach retirement age while working for the Company. The Company’s cost for providing postretirement benefits other than pensions is accounted for in
accordance with SFAS 106 “Employers’ Accounting for Postretirement Benefits Other Than Pensions.” The following tables set forth the amounts recognized for the postretirement benefit plan, which has a measurement date of January 1, in the Company’s consolidated financial statements as of December 31, 2007 and 2006 (in thousands):
Net periodic benefit cost included in the Company’s consolidated statements of operations for the years ended December 31, 2007, 2006 and 2005 is comprised of the following components (in thousands):
The accumulated benefit obligation for the postretirement benefit plan was $14.2 million and $13.0 million as of December 31, 2007 and 2006, respectively.
The Company also maintains a defined contribution profit sharing plan for all eligible employees. Each year, the Board of Directors may authorize payment of an amount equal to a percentage of each participant’s basic annual earnings based on the experience of the Company for that year. These amounts are credited to the employee’s account maintained by a third party, which has contracted to provide benefits under the plan. No contributions were authorized in 2007, 2006, or 2005.
As of December 31, 2007, there was $0.1 million of unrecognized compensation cost related to unvested options from the 2002 Option Plan, which is expected to be recognized over a remaining weighted-average vesting period of 1.3 years. The total intrinsic value of options exercised during the year ended December 31, 2007 was approximately $3.0 million, as compared to $1.7 million and $0.5 million of total intrinsic value of options exercised during the year ended December 31, 2006 and 2005, respectively.
The assumptions used in the Black-Scholes option pricing model to determine the fair value of options granted under the 2002 Option Plan follows:
The risk-free interest rate is based on a bond equivalent yield at the time of the grant with maturity dates that coincide with the expected life of the options. The expected life of the options is based on a calculation which estimates future exercise patterns based on the Company’s historical experience. The expected volatility for grants is based on the historical volatility of the Company’s stock price using weekly closing prices of the Company’s stock since the initial public offering of the Company in June 2001 and the volatility of others in the industry.
In 2001, the Company adopted the 2001 Option Plan, which provides for the grant of stock options with a grant price of zero to officers and key employees of the Company employed outside of the United States. Options granted under the 2001 Option Plan generally vest and become exercisable in equal installments over three or five years from the date of grant. Amounts granted in 2001 vest and become exercisable in two equal installments on the fifth and tenth anniversary of the grant dates. Awards under each of the 2001 Option Plan and the Restricted Share Plan (described below) may not exceed an aggregate of 10% of the Company’s issued and outstanding shares of common stock as of the last business day of the previous calendar year. The Company had 71,140,948 issued and outstanding shares of common stock as of December 31, 2006.
As of December 31, 2007, there was $2.1 million of unrecognized compensation cost related to unvested options granted from the 2001 Option Plan, which is expected to be recognized over a remaining weighted-average vesting period of 2.1 years. The total fair value of the options exercised from the 2001 Option Plan during the year ended December 31, 2007 was $0.8 million, as compared to the total fair value of the options exercised during the year ended December 31, 2006 and 2005 of $1.1 million and $0.1 million, respectively.
Had compensation costs for the year ended December 31, 2005 related to option awards and employees’ purchase rights been determined under a fair value alternative method as stated in SFAS 148 “Accounting for Stock-Based Compensation - Transition and Disclosure, an amendment of SFAS 123,” the Company would have been required to prepare a fair value model for such options and employees’ purchase rights and record such amount in the consolidated financial statements as compensation expense, and the Company’s net loss and loss per common
share for the year ended December 31, 2005 would have been increased to the following pro forma amounts (in thousands, except per share data):
The Company previously underwrote assumed financial guaranty reinsurance. The maximum exposure to loss, in the event of nonperformance by the underlying insured and assuming that the underlying collateral proved to be of no value, related to this business was $27.1 million and $30.8 million as of December 31, 2007 and 2006, respectively. It is the responsibility of the ceding insurer to collect and maintain collateral under financial guaranty reinsurance. The Company ceased writing financial guaranty business in 1992.
The Company has been provided with a geographic distribution of the debt service from all of its cedants. The following table summarizes the information which has been received by the Company from its cedants (in millions):
A summary of selected quarterly financial information follows for each of the quarters in the years ended December 31, 2007 and 2006 (in thousands, except share amounts):
Due to changes in the number of weighted average common shares outstanding during 2007 and 2006, the sum of quarterly earnings per common share amounts will not equal the total for the year.