We terminated our lease in Bermuda on October 30, 2011 and entered into a new lease for new premises (14,000 square feet). The term of the rental lease agreement is for ten years from September 1, 2011, with a break clause at five years and an additional five-year option commencing September 2021.
For our U.K.-based reinsurance and insurance operations, on April 1, 2005, Aspen U.K. signed an agreement (following our entry in October 2004 into a heads of terms agreement) with B.L.C.T. (29038) Limited (the landlord), Tamagon Limited and Cleartest Limited in connection with leasing office space in London of approximately a total of 49,500 square feet covering three floors. The term of each lease for each floor commenced in November 2004 and runs for 15 years. In 2007, the building was sold to Tishman International. The terms of the lease remain unchanged. Each lease will be subject to 5-yearly upwards-only rent reviews. We also license office space within the Lloyd’s building on the basis of a renewable 24-month lease. We also entered into two new leases for two additional premises in London (18,000 square feet total), which expire in December 2014 and March 2016. Each lease has a further negotiable extension provision. In 2011, we entered into three two-year serviced office contracts for ARML in Bristol, Glasgow and Birmingham.
The following table sets forth our selected historical financial information for the periods ended and as of the dates indicated. The summary income statement data for the twelve months ended December 31, 2011, 2010, 2009, 2008 and 2007 and the balance sheet data as of December 31, 2011, 2010, 2009, 2008 and 2007 are derived from our audited consolidated financial statements. The consolidated financial statements as of December 31, 2011, and for each of the twelve months ended December 31, 2011, 2010 and 2009, and the report thereon of KPMG Audit Plc, an independent registered public accounting firm, are included elsewhere in this report. These historical results, including the ratios presented below, are not necessarily indicative of results to be expected from any future period. You should read the following selected consolidated financial information along with the information contained in this report, including Item 8, “Financial Statements and Supplementary Data” and Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the audited consolidated financial statements, condensed consolidated financial statements and related notes included elsewhere in this report.
Diluted book value per share is calculated based on total shareholders’ equity excluding the aggregate value of the liquidation preferences of our preference shares, at December 31, 2007, 2008, 2009, 2010 and 2011, divided by the number of dilutive equivalent shares outstanding of 88,268,968, 83,705,984, 86,465,357, 74,172,657 and 73,355,674 at December 31, 2007, 2008, 2009, 2010 and 2011, respectively. At December 31, 2007, 2008, 2009, 2010 and 2011, there were 2,758,295, 2,199,481, 3,137,763, 3,664,644 and 2,699,976 of dilutive equivalent shares, respectively. Potentially dilutive shares outstanding are calculated using the treasury method and all relate to employee, director and investor options. In calculating the number of shares outstanding as at December 31, 2007 for this purpose, we have deducted shares delivered to us and canceled on January 22, 2008 pursuant to our accelerated share repurchase agreement.
Though these conditions impacted our financial results for the year, we continued to execute our strategy and adjusted our tactics as required to protect our balance sheet, preserve shareholder value and position our business for future growth.
Investment management. During 2011, we diversified our investment strategy and invested $175.0 million into a global equity income portfolio. We also increased our interest rate swaps program from a total notional amount of $500 million to $1 billion, due to mature between August 2, 2012 and November 9, 2020. Entering into these additional interest rate swaps will partially mitigate the expected negative impact of rises in interest rates on the market value of our fixed income portfolio.
Net income. For 2011, we reported a loss after taxes of $105.8 million, compared to income after taxes of $312.7 million in 2010 and income after taxes of $473.9 million in 2009. The significant decrease in net income from 2010 was due to total net losses after tax of $485.4 million from natural disasters in 2011 which included $223.7 million from the Japanese earthquake and tsunami, $93.8 million from the U.S. storms, $53.5 million from the Thai floods, $60.1 million from the 2011 New Zealand earthquake, $18.1 million from the Australian floods and $36.2 million from other natural catastrophes. The decrease in net income in 2010 over 2009 was due to a combination of reduced underwriting performance mainly arising from $180.7 million of pre-tax catastrophe losses, following earthquakes in Chile and New Zealand in 2010 and a $63.0 million pre-tax reduction in prior year reserve releases.
Gross written premiums. Total gross written premiums increased by 6.3% in 2011 compared to 2010 and by 0.5% compared to 2009. The changes in our segment gross written premiums for the twelve months ended December 31, 2011 and 2010 are as follows, with reductions shown as negative percentages.
The increase in gross written premiums in 2011 was principally attributable to the insurance segment. Gross written premiums in our reinsurance segment have increased due to growth in our property catastrophe and specialty reinsurance business lines, which recognized loss-related additional premiums, offset by decreased premiums written in property risk excess and international casualty reinsurance within our other property reinsurance and casualty reinsurance lines, respectively. Gross written premiums in our insurance segment have increased by 11.6% from 2010, mainly due to the property and the financial and professional lines. Increases in gross written premium in property included our program business, as well as increases in U.S. property which benefited from rate increases in the year. Our financial and professional lines have benefited from increased demand for our kidnap and ransom products. Gross written premiums in our casualty insurance lines have reduced when compared to 2010 as we declined business that did not meet our profitability requirements coupled with higher client retention in some classes.
The policy acquisition expense ratio has increased to 18.4% in 2011. The increase is due mainly to the increase in reinsurance costs which have added 0.5 percentage points to the acquisition expense ratio, and to a change in the mix of business written across both segments where we have written a greater proportion of business with higher average commission rates. The policy acquisition expense ratio reduced to 17.3% in 2010 mainly as a result of a reduction in profit-related commissions in our reinsurance segment. In 2009, the policy acquisition expense ratio increased to 18.3% from 17.6% in 2008 due to the impact of profit-related commission.
The general, administrative and corporate expense ratio has increased from 13.6% to 14.8% in 2011 as a result of expenses increasing from $258.6 million in 2010 to $280.2 million in 2011. The increase in general, administrative and corporate expenses is due to our continued build out of our U.S. insurance infrastructure and operations, the U.K. regional platform and the Swiss insurance operations. The ratio has also been adversely affected by the increased reinsurance costs. The general, administrative and corporate expense ratio of 13.6% for 2010 is broadly in line with 2009 with the increased expenditure associated with our expansion into the U.S. admitted market and U.K. regional distribution network balanced by reductions in profit-related compensation in 2010.
Change in fair value of derivatives. In the twelve months ended December 31, 2011, we recorded a reduction in the fair value of derivatives of $59.9 million (2010 - $0.2 million; 2009 - $8.0 million). This includes a loss of $64.4 million in the value of our interest rate swaps which we entered into during 2010 and 2011. In the twelve months ended December 31, 2010, we recorded a reduction of $7.0 million (2009 - $8.0 million) in the estimated fair value of our credit insurance contract. On October 26, 2010, we gave notice of our intention to cancel our credit insurance contract with effect from November 28, 2010. The notice of cancellation triggered a final payment of $1.9 million to the contract counter-parties.
At December 31, 2011, we held eight foreign currency derivative contracts to purchase $192.4 million of U.S. and foreign currencies. The foreign currency contracts are recorded as derivatives at fair value with changes recorded as a change in fair value of derivatives in the statement of operations. At December 31, 2010 and December 31, 2009, there were no outstanding foreign currency contracts. For the twelve months ended December 31, 2011, foreign currency contracts increased net income by $4.5 million.
Other revenues and expenses. Other revenues and expenses in 2011 included $6.7 million of foreign currency exchange losses (2010 - $2.2 million gains; 2009 - $2.0 million gains) and $30.3 million of realized and unrealized investment gains (2010 - $50.6 million; 2009 - $11.4 million). Realized and unrealized gains included $27.5 million (2010 - $38.0 million; 2009 - $13.7 million) of net realized gains from the fixed income maturities available for sale portfolio, $4.5 million (2010 - $8.4 million; 2009 - $3.0 million) of net realized gains from our fixed income maturities trading portfolio, $3.3 million net unrealized losses (2010 - $1.8 million gain; 2009 - $15.6 million gain) from our fixed income maturities trading portfolio, $1.5 million of net realized losses from our equity investments (2010 - $Nil; 2009 - $Nil) and $3.1 million (2010 - $2.7 million; 2009 - $2.3 million) representing our share of earnings from our investment in Cartesian Iris. We have also recognized $6.8 million (2010 - income of $9.7 million; 2009 - income $8.0 million) of other expenses for the year ending December 31, 2011 which is primarily due to losses associated with funds withheld contracts. In 2011, we had no other-than-temporary impairment charges on our investments (2010 - $0.3 million; 2009 - $23.2 million). Interest payable was $30.8 million in 2011 (2010 - $16.5 million; 2009 - $15.6 million).
Dividends. The quarterly dividend has been maintained at $0.15 per ordinary share for 2009, 2010 and 2011. Dividends paid on the preference shares in 2011 were $22.8 million. Dividends paid on the preference shares in 2010 were $22.8 million, $1 million lower than the prior year, as a result of repurchasing 2.7 million of our 7.401% $25 liquidation value preference shares (NYSE:AHL-PA) at a price of $12.50 per share.
Shareholders’ equity and financial leverage. Total shareholders’ equity decreased from $3,241.9 million at the end of December 31, 2010 to $3,172.9 million as at December 31, 2011. The most significant movements were:
As at December 31, 2011, the remainder of our total shareholders’ equity was funded by two classes of preference shares with a total value as measured by their respective liquidation preferences of $363.2 million (2010 - $363.2 million) less issue costs of $9.6 million (2010 - $9.6 million).
Our Senior Notes were the only material debt that we had issued as of December 31, 2011 and 2010 (2011 - $500.0 million; 2010 - $500.0 million). Management monitors the ratio of debt to total capital, with total capital being defined as shareholders’ equity plus outstanding debt. At December 31, 2011, this ratio was 13.6% (2010 - 13.3%; 2009 - 7.0%).
Our preference shares are classified in our balance sheet as equity but may receive a different treatment in some cases under the capital adequacy assessments made by certain rating agencies. We also monitor the ratio of the total of debt and hybrids to total capital which was 23.2% as of December 31, 2011 (2010 - 22.8%; 2009 - 17.0%). The increase in the 2010 ratio reflects our issuance of $250.0 million 6% Senior Notes in December 2010. We set targets for financial leverage which we believe provide an appropriate balance between improving returns to our ordinary shareholders while maintaining the levels of financial strength expected by our customers and by the rating agencies. For this purpose, we define financial leverage as the ratio of long-term debt and ‘hybrid’ capital to total
Liquidity. Management monitors the liquidity of Aspen Holdings and of each of its Operating Subsidiaries. With respect to Aspen Holdings, management monitors its ability to service debt, to finance dividend payments and to provide financial support to the Operating Subsidiaries. During the year ended December 31, 2011, Aspen Holdings received a $52.6 million payment of inter-company interest in respect of an inter-company loan from Aspen U.K. Holdings. In addition, Aspen Holdings received dividends of $85.0 million (2010 - $203.0 million) from Aspen U.K. Holdings and $100.0 million (2010 - $120.0 million) from Aspen Bermuda.
For casualty renewals, the market conditions remain challenging in U.K. liability, however we experienced significant price increases of approximately 13% on our global excess casualty account.
In aviation, a small proportion of our account renews in January and while the overall market and airline sector remain over-served by competition, we expect that our unique approach will continue to yield good profits.
Costa Concordia cruise liner. The Costa Concordia cruise liner incident which took place off the coast of western Italy on January 13, 2012 is a complex loss and there are various factors and uncertainties which will have an impact on the quantum of loss. Aspen has exposure in both its insurance and reinsurance segments, mainly arising from its marine hull and marine liability insurance accounts. We expect that our loss from the insurance business will be contained within our outwards reinsurance program and that our retained loss will be less than $30 million before reinstatement premiums. In the reinsurance segment, our exposure arises from the specialty reinsurance account, and losses are expected to be less than 1% of the market loss. We are at an early stage in assessing the loss from Costa Concordia and these figures represent our current view.
We believe that the following critical accounting policies affect the more significant estimates used in the preparation of our consolidated financial statements. A statement of all the significant accounting policies we use to prepare our financial statements is included in the Notes to the consolidated financial statements. If factors such as those described in Item 1A, “Risk Factors” cause actual events to differ from the assumptions used in applying the accounting policy and calculating financial results, there could be a material adverse effect on our results of operations, financial condition and liquidity.
Property treaty pro rata made a significant contribution to our reinsurance segment where we wrote $136.0 million in gross written premium in 2011 (2010 - $135.0 million), or 11.5% of our reinsurance segment, of which $46.7 million was estimated (2010 - $31.8 million) and $89.3 million was reported by the cedants (2010 - $103.2 million). We estimate that the impact of a $1 million change in our estimated gross premiums written in our property treaty pro rata business would have an impact of $0.1 million on our net income before tax for our property reinsurance segment at December 31, 2011 (2010 - $0.2 million), excluding the impact of fixed costs such as reinsurance premiums and operating expenses.
We anticipate that ultimate premiums might reasonably be expected to vary by up to 5% as a result of variations in one or more of the assumptions described above, although larger variations are possible. Based on gross written premiums of $136.0 million (2010 - $135.0 million) in our property reinsurance treaty pro rata account as of December 31, 2011, a variation of 5% could increase or reduce net income before taxation by approximately $0.9 million (2010 - $1.2 million).
Premiums receivable. Premiums receivable are recorded as amounts due less any required provision for doubtful accounts. A significant portion of amounts included as premiums receivable, which represent estimated premiums written, net of commissions, is not currently due based on the terms of the underlying contracts. In determining whether or not any bad debt provision is necessary, we consider the financial security of the policyholder, past payment history and any collateral held. We have not made a provision for doubtful accounts in relation to assumed premium estimates. In addition, based on the above process, management believes that the premium estimates included in premiums receivable will be collectable and, therefore, we have not maintained a bad debt provision for doubtful accounts on the premiums at December 31, 2011.
Credit insurance contract. On November 28, 2006, the Company entered into a credit insurance contract which, subject to its terms, insured us against losses due to the inability of one or more of our reinsurance counterparties to meet their financial obligations to us. We considered this contract to be a financial guarantee insurance contract that did not qualify for exemption from treatment for accounting purposes as a derivative. This is because it provided for the final settlement, expected to take place two years after expiry of cover, to include an amount attributable to outstanding and IBNR claims which may not at that point of time be due and payable to us.
As a result of the application of derivative accounting rules under ASC 815, the contract was treated as an asset and measured at the directors’ estimate of its fair value. Changes in the estimated fair value from time to time were included in the consolidated statement of operations. On October 26, 2010, we gave notice of our intention to cancel our credit insurance contract with effect from November 28, 2010. The notice of cancellation triggered a final payment of $1.9 million to the contract counter-parties.
Foreign exchange contracts. The Company uses forward exchange contracts to manage foreign currency risk. A forward foreign currency exchange contract involves an obligation to purchase or sell a specified currency at a future date at a price set at the time of the contract. Foreign currency exchange
contracts will not eliminate fluctuations in the value of the Company’s assets and liabilities denominated in foreign currencies, but rather allows it to establish a rate of exchange for a future point in time. The increase in the number of contracts purchased in 2011 compared to 2010 is due to hedging against foreign currency losses from the earthquakes in New Zealand and Japan. The foreign currency contracts are recorded as derivatives at fair value with changes recorded as a change in fair value of derivative in the Company’s statement of operations.
At December 31, 2011, we held eight foreign currency derivative contracts to purchase $192.4 million of foreign currencies. At December 31, 2010 and December 31, 2009, there were no outstanding foreign currency contracts. For the twelve months ended December 31, 2011, the impact of foreign currency contracts on net income was $4.5 million (2010 - $Nil).
Interest rate swaps. As at December 31, 2011, we held a number of standard fixed for floating interest rate swaps with a total notional amount of $1.0 billion (2010 - $0.5 billion) due to mature between August 2, 2012 and November 9, 2020. The swaps are used in the ordinary course of the Company’s investment activities to partially mitigate the negative impact of rises in interest rates on the market value of our fixed income portfolio. As at December 31, 2011, there was a charge in respect of the interest rate swaps of $64.4 million (2010 - $6.8 million gain).
As at December 31, 2011, cash collateral with a fair value of $43.7 million was transferred to our counterparties to support the current valuation of the of the interest rate swaps. As at December 31, 2011, no non-cash collateral (2010 - $7.7 million) was transferred to us by our counterparty. In accordance with FASB ASC 860 Topic Transfers and Servicing, transfers of cash collateral are recorded on the balance sheet within Derivatives at Fair Value, while transfers in respect of non-cash collateral are disclosed but not recorded. No amount was recorded in our balance sheet as at December 31, 2011 (2010 - $Nil) for the pledged assets.
In general terms, the IELR method is most appropriate for lines of business and/or accident years where the actual paid or reported loss experience is not yet mature enough to modify our initial expectations of the ultimate loss ratios. Typical examples would be recent accident years for lines of business in the casualty reinsurance segment. The BF method is generally appropriate where there are few reported claims and a relatively less stable pattern of reported losses. Typical examples would be our treaty risk excess line of business in our reinsurance segment and marine hull line of business in our insurance segment. The Chain Ladder method is appropriate when there are relatively stable patterns of loss emergence and a relatively large number of reported claims. Typical examples are the U.K. commercial property and U.K. commercial liability lines of business in the international insurance segment.
reflecting many factors such as changes in legislative conditions, changes in judicial interpretation of legal liability policy coverages and inflation. Our actuaries collaborate with underwriting, claims, legal and finance in identifying factors which are incorporated in their range of ultimates in which management’s best estimate is most likely to fall. The actuarial ranges are not intended to include the minimum or maximum amount that the claims may ultimately settle at, but are designed to provide management with ranges from which it is reasonable to select a single best estimate for inclusion in our financial statements.
Estimates of IBNR are generally subject to a greater degree of uncertainty than estimates of the cost of settling claims already notified to us, where more information about the claim event is generally available. IBNR claims often may not be apparent to the insured until many years after the event giving rise to the claims has happened. Lines of business where the IBNR proportion of the total reserve is high, such as liability insurance, will typically display greater variations between initial estimates and final outcomes because of the greater degree of difficulty of estimating these reserves.
Lines of business where claims are typically reported relatively quickly after the claim event tend to display lower levels of volatility between initial estimates and final outcomes. Reinsurance claims are subject to a longer time lag both in their reporting and in their time to final settlement. The time lag is a factor which is included in the projections to ultimate claims within the actuarial analyses and helps to
The selected best estimate of reserves is typically in excess of the mean of the actuarial reserve estimates. The Company believes that there is potentially significant risk in estimating loss reserves for long-tail lines of business and for immature accident years that may not be adequately captured through traditional actuarial projection methodologies. As discussed above, these methodologies usually rely heavily on projections of prior year trends into the future. In selecting its best estimate of future liabilities, the Company considers both the results of actuarial point estimates of loss reserves as well as the potential variability of these estimates as captured by a reasonable range of actuarial reserve estimates. In determining the appropriate best estimate, the Company reviews (i) the position of overall reserves within the actuarial reserve range, (ii) the result of bottom up analysis by accident year reflecting the impact of parameter uncertainty in actuarial calculations, and (iii) specific qualitative
Actuarial range of gross reserves. The following tables show the 10th percentile, 25th percentile, actuarial mean estimate, 75th percentile and 90th percentile together with the actual percentile that the selected loss reserves represent. The following table sets out the actuarial range of gross reserves for each of our segments and compares it to management’s selected best estimate as at December 31, 2011. Management’s selected reserves include unallocated claims handling expenses which remain unchanged across all reserve distributions.
The above represents a distribution from our internal capital model for reserving risk based upon our current state of knowledge and application of actuarial principles. The model itself has many explicit and implicit assumptions relating to the incurred pattern of claims, the expected ultimate settlement amount, inflation and dependencies between lines of business. If any of these assumptions underlying the model were to prove incorrect, then a materially different reserving distribution may result.
If the ultimate liabilities equate to the mean actuarial estimate, then the impact from the change in loss reserves would be to increase net income before tax by $397.6 million (being the difference above
between the selected loss reserves of $4,525.2 million and the mean value of $4,127.6 million), although the impact of such a change is unlikely to be recognized in one calendar year due to the unwinding of experience against expectations taking many years.
Conversely, if the ultimate liabilities equate to the estimated 90th percentile, then the impact from the change in loss reserves would be to reduce net income before tax by $3.9 million (being the difference between the selected loss reserves of $4,525.2 million and the 90th percentile value of $4,529.1 million), although the impact of such a change is unlikely to be recognized in one calendar year.
Actuarial range of net reserves. In determining the range of net reserves, we estimate recoveries due under our proportional and excess of loss reinsurance programs. For proportional reinsurance we apply the appropriate cession percentages to estimate how much of the gross reserves will be collectable. For excess of loss recoveries, individual large losses are modeled through our reinsurance program. An assessment is also made of the collectability of reinsurance recoveries taking into account market data on the financial strength of each of the reinsurance companies. The net actuarial range for reserves for losses and loss expenses assuming that net reserves move in proportion to gross would be between $3,785.6 million at the 10th percentile and $4,529.1 million at the 90th percentile. The actual net reserves established as at December 31, 2011 were $4,098.6 million (2010 - $3,540.6 million).
comprehensive income. The cost basis of the investment is reduced accordingly and no adjustments to the cost basis are made for subsequent recoveries in value.
Although the Company reviews each security on a case by case basis, it has also established parameters to help identify securities in an unrealized loss position which are other-than-temporarily impaired. These parameters focus on the extent and duration of the impairment and for both fixed maturities and equities the Company considers declines in value to a level 20% or more below cost for 12 consecutive months to indicate that the security may be other-than-temporarily impaired.
At each balance sheet date, management assesses the need to establish a valuation allowance that reduces deferred tax assets when it is more likely than not that all, or some portion, of the deferred tax asset will not be realized. The valuation allowance is based on all available information including projections of future taxable income from each tax-paying component in each tax jurisdiction and available tax planning strategies. Estimates of future taxable income incorporate several assumptions that may differ from actual experience. Differences in our assumptions and resulting estimates could have a material adverse impact on our financial results of operations and liquidity. Any such differences are recorded in the period in which they become known.
Our consolidated financial statements are prepared in accordance with U.S. GAAP. The discussions that follow include tables and discussions relating to our consolidated income statement and our segmental operating results for the twelve months ended December 31, 2011, 2010 and 2009.
Gross written premiums. The following table analyzes the overall change in gross written premiums in the twelve months ended December 31, 2011, 2010 and 2009. The amounts shown as ‘underlying premiums’ exclude reinstatement premiums and other premiums receivable directly related to losses arising from all catastrophic events in 2011.
Gross written premiums in 2011 increased by 6.3%, with increases across both segments. Gross written premiums in our reinsurance segment increased by 2.2% due to increases in property catastrophe and specialty reinsurance, which recognized loss-related additional premiums, offset by decreased premiums written in property risk excess and international casualty within our other property reinsurance and casualty reinsurance lines, respectively.
Gross written premiums in our insurance segment increased by 11.6% to $1,020.3 million for 2011 from $914.6 million in 2010. The increase in gross written premium is mainly attributable to the property lines and the financial and professional lines. Increases in gross written premium in property included our program business as well as increases in U.S. property which benefited from rate increases in the year. Our financial and professional lines have benefited from increased demand for our kidnap and ransom products. Gross written premiums in our casualty insurance lines have reduced where we declined business that did not meet our profitability requirements coupled with higher client retention in some classes.
Gross premiums earned. Gross premiums earned reflect the portion of gross written premiums which are recorded as revenues over the policy periods of the risks we write. The earned premium recorded in any year includes premium from policies incepting in prior years and excludes premium to be earned subsequent to the balance sheet date. Gross premiums earned in 2011 increased by 2.2% compared to 2010 reflecting the increase in gross written premium earlier in the year, in particular in insurance and the $32.5 million of reinstatement and loss-related additional premiums associated with the catastrophe losses in the year.
Gross premiums earned in 2010 increased by 2.9% compared to 2009 reflecting the higher written premium earlier in the year and the $12.0 million of reinstatement premiums from the Chilean earthquake.
The loss ratio for 2011 of 82.4% has increased by 16.6 percentage points compared to 2010. The increase is due mainly to the 2011 catastrophes offset by the $70.9 million increase in reserve releases. Prior year reserve releases in our reinsurance segment increased from $65.6 million in 2010 to
The underlying changes in accident year loss ratios by segment are also shown in the table below. The total loss ratio represents the calendar year GAAP loss ratio. The prior year adjustment in the table below reflects prior-year reserve movement and premium adjustments. The current year adjustments represent catastrophe loss events which reflect net claims and reinstatement premium adjustments.
The policy acquisition ratio, gross of the effect of reinsurance, has increased to 16.2% in 2011 from 15.7% for 2010 mainly as a result of increased commission in our insurance segment due to changes in the mix of business written. The policy acquisition ratio, gross of the effect of reinsurance, reduced to 15.7% for the twelve months ended December 31, 2010 from 16.4% for the comparative period in 2009 mainly as a result of a reduction in profit related commissions in our reinsurance segment. General, administrative and corporate expenses increased by 8.3% from $258.6 million in 2010 to $280.2 million in 2011, with the increased expenditure associated with our expansion into the U.S. admitted market and U.K. regional distribution network balanced by reductions in profit-related compensation in 2011.
Changes in the acquisition and operating expense ratios to gross earned premiums, and the impact of reinsurance on net earned premiums by segment for each of the twelve months ended December 31, 2011, 2010 and 2009 are shown in the following tables:
Other revenues and expenses. Other revenues and expenses in 2011 included $6.7 million of foreign currency exchange losses (2010 - $2.2 million gains; 2009 - $2.0 million gains) and $30.3 million of realized and unrealized investment gains (2010 - $50.6 million gains; 2009 - $11.4 million gains). Realized and unrealized gains included $27.5 million (2010 - $38.0 million; 2009 - $13.7 million) of net realized gains from the fixed income maturities available for sale portfolio, $4.5 million (2010 - $8.4 million; 2009 - $3.0 million) of net realized gains from our fixed income maturities trading portfolio, $3.3 million net unrealized losses (2010 - $1.8 million gain; 2009 - $15.6 million gain) from our fixed income maturities trading portfolio, $1.5 million of net realized losses from our equity investments (2010 - $Nil; 2009 - $Nil) and $3.1 million (2010 - $2.7 million; 2009 - $2.3 million) representing our share of earnings from our investment in Cartesian Iris. In 2011, we also recognized $6.8 million (2010 - income of $9.1 million) of other expenses primarily due to losses associated with funds withheld contracts. We had no other-than-temporary impairment charges on our investments in 2011 (2010 - $0.3 million; 2009 - $23.2 million). Interest payable was $30.8 million in 2011 (2010 - $16.5 million; 2009 - $15.6 million). The increase was due to our issuance of an additional $250 million of 6.0% Senior Notes in December 2010.
Income/(loss) before tax. In 2011, losses before tax were $143.0 million, comprised of $294.7 million of underwriting losses, $225.6 million in net investment income, $59.9 million of losses from changes in fair value of derivatives, $23.6 million of net realized and unrealized investment and foreign exchange losses, $30.8 million of interest expense and $6.8 million of other expenses. In 2010, income before tax was $340.3 million and comprised mainly $63.1 million of underwriting profit,
Income tax expense/credit. There was an income tax credit of $37.2 million in 2011 compared to a $27.6 million tax expense in 2010 and a $60.8 million tax expense in 2009. The effective tax rate in 2011 was 26.0% compared to 8.1% in 2010 and 11.4% in 2009. The tax credit in 2011 is primarily due to the geographic distribution of catastrophe losses, adjustments to prior year positions and changes in U.K. tax corporation rates. The reduction in the effective tax rate in 2010 is the result of proactive fiscal and balance sheet management and the distribution of underwriting results across our entity balance sheets. The reduction in the effective tax rate for 2009 was mainly driven by the distribution of insurance and investment-related losses within the group in the fourth quarter of 2008.
We are organized into two business segments: Reinsurance and Insurance. We have considered similarities in economic characteristics, products, customers, distribution, the regulatory environment of our operating segments and quantitative thresholds to determine our reportable segments. The reinsurance segment consists of four principal lines of business: property catastrophe reinsurance, other property reinsurance, casualty reinsurance and specialty reinsurance. The insurance segment consists of property insurance, casualty insurance, marine, energy and transportation insurance and financial and professional lines insurance.
The following tables summarize gross and net premiums written and earned, underwriting results, and combined ratios and reserves for each of our business segments for the twelve months ended December 31, 2011, 2010 and 2009.
The total group general and administrative expense ratio includes the impact from corporate expenses.
The net reserves for loss and loss adjustment expenses have been represented to correctly show the split between the segments. The total for December 31, 2010 remains unchanged.
Our reinsurance segment consists of property catastrophe, other property reinsurance, casualty and specialty reinsurance. For a more detailed description of this segment, see Part I, Item 1, “Business - Business Segments - Reinsurance” and Note 5 of our consolidated financial statements.
Gross written premiums. Gross written premiums in this segment were broadly in line with those in 2010 and 2009. Increased written premium in specialty reinsurance were attributable to growth in credit and surety and the recognition of loss-related additional premiums. We wrote more property catastrophe premium due to the impact of reinstatement premiums and some favorable pricing following the natural catastrophes in 2011. The increases are offset by reductions in casualty reinsurance where we continued to experience challenging market conditions and prices that did not meet our profitability requirements.
In 2010, gross written premiums reduced slightly from 2009 despite a $38.6 million increase in premiums in property catastrophe reinsurance which included $12.0 million of reinstatement premiums associated with the Chilean earthquake. The increase was in contrast to reductions across our other reinsurance lines. Written premium in other property reduced as a result of higher cedant retentions, while challenging market conditions continued in casualty reinsurance. Specialty reinsurance premiums increased marginally with reductions in our structured risk portfolio being offset by premiums written in our then newly-established credit and surety and non-U.S. agriculture accounts.
Reinsurance ceded. Total reinsurance ceded of $89.4 million increased by $45.7 million from 2010. The reinsurance segment recognized the costs of catastrophe programs purchased to provide additional cover for the third quarter’s wind season after the first two quarters’ catastrophe events. Total reinsurance ceded of $43.7 million in 2010 decreased by $15.6 million from 2009, as we decided to selectively reduce some of our outwards reinsurance.
We purchased $59.3 million of reinsurance contracts during 2009 which was attributable to a combination of specific reinsurance purchased to cover our then newly established lines of business and some higher renewal rates on existing reinsurance.
Losses and loss adjustment expenses. The loss ratio in 2011 was 97.7% compared to 60.7% in 2010. The increase in the loss ratio is attributable to a high frequency of catastrophe losses in 2011 with $253.7 million from the Japanese earthquake and tsunami, $109.2 million from U.S. storms (including Hurricane Irene), $73.3 million from the New Zealand earthquake, $65.7 million from the Thai floods, $22.3 million from the Australian floods and $28.3 million from other natural catastrophes (U.S., Scandinavian and Asian weather-related events). All losses are net of reinsurance recoveries but before reinstatement premiums and tax. The increase in losses has been partly mitigated by a $6.7 million increase in prior year reserve releases compared to 2010.
The net loss ratio for 2010 was 60.7% compared to 42.2% in 2009. The increase in the loss ratio was attributable to losses of $180.7 million ($168.7 million net of reinstatement premiums) relating to
Our insurance segment consists of property insurance, casualty insurance, marine, energy and transportation insurance and financial and professional lines insurance. For a more detailed description of this segment, see Part I, Item 1, “Business - Business Segments - Insurance” and Note 5 of our consolidated financial statements.
Overall premiums increased by 11.6% in 2011 compared to 2010. The increase in gross written premiums was mainly attributable to the financial and professional lines where we experienced additional demand, in particular for our kidnap and ransom products which form part of our financial and political risk business, and to the continued development of our U.S. professional lines business. Increases in gross written premium in property included our program business as well as increases in U.S. property which benefited from rate increases in the year. Gross written premiums in our casualty insurance lines
Overall premiums increased by 2.6% in 2010 compared to 2009. Gross written premiums increased in both the property insurance and financial and professional lines where we wrote business that met our profitability requirements. This compensated for difficult trading conditions in our casualty insurance and marine, energy and transportation lines.
Reinsurance ceded. Reinsurance costs increased by 33.3% for the insurance segment in 2011 when compared with 2010 as we purchased advanced protection for our new U.S. professional lines business as well as an increase in the U.S. property program.
Losses and loss adjustment expenses. The loss ratio for 2011 was 60.6% compared to 73.3% for 2010 (2009 - 67.3%). The improvement in the loss ratio is attributable to a $20.0 million prior year reserve release compared to a $44.2 million reserve strengthening in 2010. In 2011, we experienced limited catastrophe losses in this segment of $14.2 million, while 2010 was impacted by $35.3 million of net losses ($39.5 million including reinstatements) from two oil pipeline spills and a gas explosion in California in addition to $10.7 million of losses from the Deepwater Horizon oil spill. The reserve releases for 2011 came primarily from our property, U.K. liability and aviation accounts partly offset by deterioration in financial and professional lines where we experienced higher than expected claims development from the professional liability lines.
Policy acquisition, general and administrative expenses. Policy acquisition expenses of $149.3 million for 2011 were equivalent to 19.1% of net premiums earned (2010 - $126.1 million or 16.7% of net earned premium). This was mainly due to an increase in premiums written as well as to a change in the mix of business written where we have written a lower proportion of casualty business which has lower average commission rates and a higher proportion of energy, U.S. property and kidnap and ransom business which incur higher commission rates. General and administrative expenses of $125.7 million in 2011 have increased from $99.4 million in 2010 mainly due to our continued build out of our U.S. operations.
Policy acquisition expenses for 2010 increased by $6.6 million from 2009 with the cost increase reflecting the increase in gross written premiums. General and administrative expenses of $99.4 million for the twelve months ended December 31, 2010 decreased by $1.3 million from 2009 due to 2009 including higher performance-related compensation costs reflecting our performance in such year. Nevertheless, we had increased expenditure in 2010 associated with our expansion into the U.S. admitted market and U.K. regional distribution network offset by reductions in profit-related compensation in 2010.
Fixed maturities. At December 31, 2011, the average credit quality of our fixed income book was “AA,” with 94% of the portfolio being graded “A” or higher. At December 31, 2010, the average credit quality of our fixed income book was “AA+,” with 96% of the portfolio being graded “A” or higher.
Our fixed income portfolio duration was 2.2 years which decreased from 2.9 years at the end of 2010 including the impact of the interest rate swaps.
Other investments. On May 19, 2009, Aspen Holdings invested $25.0 million in Cartesian Iris 2009A L.P. through our wholly-owned subsidiary, Acorn Limited. Cartesian Iris 2009A L.P. is a Delaware Limited Partnership formed to provide capital to Iris Re, a Class 3 Bermudian reinsurer focusing on insurance-linked securities. On June 1, 2010, the investment in Cartesian Iris 2009A L.P. matured and was reinvested in the Cartesian Iris Offshore Fund L.P. The Company is not committed to making further investments in Cartesian Iris Offshore Fund L.P. Accordingly, the carrying value of the investment represents the Company’s maximum exposure to a loss as a result of its involvement with the partnership at each balance sheet date.
The Company’s fixed income maturity securities are classified as either available for sale or trading and carried at fair value. At December 31, 2011 and December 31, 2010, the Company’s fixed income instruments were valued by pricing services, index providers or broker-dealers, using standard market
conventions. The market conventions utilize market quotations, market transactions in comparable instruments and various relationships between instruments including, but not limited to, yield to maturity, dollar prices and spread prices in determining value. The pricing sources are primarily internationally recognized independent pricing services and broker-dealers.
For securities that may trade less frequently or do not trade on a listed exchange, these pricing services and index providers may use matrix pricing consisting of observable market inputs to estimate the fair value of a security. These observable market inputs include: reported trades, benchmark yields, broker-dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, reference data, and industry and economic factors. Additionally, pricing services and index providers may use a valuation model such as an option adjusted spread model commonly used for estimating fair values of mortgage-backed and asset-backed securities. Neither the Company, nor its index providers, derives dollar prices using an index as a pricing input for any individual security.
Broker-Dealers. We obtain quotes from broker-dealers who are active in the corresponding markets when prices are unavailable from independent pricing services or index providers. Generally, broker-dealers value securities through their trading desks based on observable market inputs. Their pricing methodologies include mapping securities based on trade data, bids or offers, observed spreads and performance on newly issued securities. They may also establish pricing through observing secondary trading of similar securities. Quotes from broker-dealers are non-binding.
The Company obtains prices for all of its fixed income investment securities via its third-party accounting service provider, in the majority of cases receiving a number of quotes so as to obtain the most comprehensive information available to determine a security’s fair value. A single valuation is applied to each security based on the vendor hierarchy maintained by our third-party accounting service provider.
At December 31, 2011, we obtained an average of 2.6 quotes per fixed income investment, compared to 2.9 quotes at December 31, 2010. Pricing sources used in pricing our fixed income investments at December 31, 2011 and December 31, 2010, respectively, were as follows:
At December 31, 2011, pricing for approximately 83% (2010 - 85%) of our total fixed income maturities was based on prices provided by internationally recognized index providers. A summary of securities priced using pricing information from index providers at December 31, 2011 and December 31, 2010 is provided below:
The Company, in conjunction with its third-party accounting service provider, obtains an understanding of the methods, models and inputs used by the third-party pricing service and index provider to assess the on-going appropriateness of vendors’ prices. The Company and its third-party accounting service provider also have controls in place to validate that amounts provided represent fair values. Processes to validate and review pricing include, but are not limited to:
The Company’s fixed income securities are traded on the over-the-counter market based on prices provided by one or more market makers in each security. Securities such as U.S. Government, U.S. Agency, Foreign Government and investment grade corporate bonds have multiple market makers in addition to readily observable market value indicators such as expected credit spread, except for Treasury securities, over the yield curve. The Company uses a variety of pricing sources to value our fixed income securities including those securities that have pay down/prepay features such as mortgage-backed securities and asset-backed securities in order to ensure fair and accurate pricing. The fair value estimates for the investment grade securities in the Company’s portfolio do not use significant unobservable inputs or modeling techniques.
indirectly, which are Level 2 inputs in the fair value hierarchy. As identified in the table above, these securities are also valued using prices supplied by index providers
Guaranteed Investments. The following table presents the breakdown of investments which are guaranteed by mono-line insurers (“Wrapped Credit” disclosure) and those that have explicit government guarantees. The standalone rating is determined as the senior unsecured debt rating of the issuer. Where the credit ratings were split between the two main rating agencies (S&P’s and Moody’s), the lowest rating was used.
Other-than-temporary Impairment of Investments. We review all our available for sale investment portfolio on an individual security basis for potential impairment each quarter based on criteria including issuer-specific circumstances, credit ratings actions and general macro-economic conditions. The difference between the amortized cost/cost and the estimated fair market value of available for sale investments is monitored to determine whether any investment has experienced a decline in value that is believed to be other-than-temporary. A security is impaired when the fair value is below its amortized cost/cost.
In our review of fixed maturity investments, other-than-temporary impairment (“OTTI”) is deemed to occur when there is no objective evidence to support recovery in value of a security and a) we intend to sell the security or more likely than not will be required to sell the security before recovery of its adjusted amortized cost basis or b) it is deemed probable that we will be unable to collect all amounts due according to the contractual terms of the individual security. In the first case, the entire unrealized loss position is taken as an OTTI charge to realized losses in earnings. In the second case, the unrealized loss is separated into the amount related to credit loss and the amount related to all other factors. The OTTI charge related to credit loss is recognized in realized losses in earnings and the amount related to all other factors is recognized in other comprehensive income. The cost basis of the investment is reduced accordingly and no adjustments to the cost basis are made for subsequent recoveries in value.
Equity securities do not have a maturity date and therefore our review of these securities utilizes a higher degree of judgment. In our review, we consider our ability and intent to hold an impaired equity security for a reasonable period of time to allow for a full recovery. Where a security is considered to be other-than-temporarily impaired, the entire charge is recognized in realized losses in earnings. Again, the cost basis of the investment is reduced accordingly and no adjustments to the cost basis are made for subsequent recoveries in value.
Although we review each security on a case by case basis, we have also established parameters to help identify securities in an unrealized loss position which are other-than-temporarily impaired. These parameters focus on the extent and duration of the impairment and for both fixed maturities and equities we consider declines in value of greater than 20% for 12 consecutive months to indicate that the security may be other-than-temporarily impaired. The total other-than-temporary impairment for the twelve months ended December 31, 2011 was $Nil (2010 - $0.3 million).
For a discussion of our valuation techniques within the fair value hierarchy, see Note 6 of the consolidated financial statements for the twelve months ended December 31, 2011.
Provision is made at the end of each year for the estimated cost of claims incurred but not settled at the balance sheet date, including the cost of IBNR claims. The estimated cost of claims includes expenses to be incurred in settling claims and a deduction for the expected value of salvage and other recoveries. Estimated amounts recoverable from reinsurers on unpaid losses and loss adjustment expenses are calculated to arrive at a net claims reserve. As required under U.S. GAAP, no provision is made for our exposure to natural or man-made catastrophes other than for events occurring before the balance sheet date.
54.3%, respectively). The following tables analyze gross and net loss and loss adjustment expense reserves by segment as at December 31, 2011 and 2010:
Reinsurance. Net reserve releases for the year ended December 31, 2011 in the reinsurance segment were $72.3 million. Property reinsurance had releases of $44.8 million, primarily on the risk excess and facultative accounts due to better than expected claims development. Specialty reinsurance had releases of $29.7 million, primarily in the marine, aviation and contingency accounts as a result of favorable claims experience.
Insurance. The $19.4 million deterioration in the year was the result of strengthening in three out of the four business lines. We released $6.5 million from property from better than expected experience. Casualty was strengthened by $3.0 million which was primarily a result of worse than expected experience in relation to New York contractors’ liability business offset partially by releases in U.K. liability which had better than expected experience. Reserve strengthening from financial and professional lines was attributable to increased reserves on the financial institutions line in response to the global financial crisis. Marine, energy and transportation reserves were strengthened from worse than expected development on the 2007 accident year in our marine, energy and construction liability account.
Other than the matters described above, we did not make any significant changes in assumptions used in our reserving process. However, because the period of time we have been in operation is
Management monitors the ratio of debt to total capital, with total capital being defined as shareholders’ equity plus outstanding debt. At December 31, 2011, this ratio was 13.6% (2010 - 13.3%, 2009 - 7.0%).
Our preference shares are classified in our balance sheet as equity but may receive a different treatment in some cases under the capital adequacy assessments made by certain rating agencies. Such securities are often referred to as ‘hybrids’ as they have certain attributes of both debt and equity. We also monitor the ratio of the total of debt and hybrids to total capital and this stands at 23.2% as of December 31, 2011 (2010 - 22.8%).
On February 9, 2010, our Board authorized a new repurchase program for up to $400 million of ordinary shares of which $192.4 million remained available as at December 31, 2011. The authorization for the remaining amount of the repurchase program was extended by the Board at its meeting on February 2, 2012.
On June 29, 2011, an agreement was signed to repurchase 254,107 shares from the Names’ Trustee for a total consideration of $6.4 million. The transaction was completed on August 10, 2011.
Access to capital. Our business operations are in part dependent on our financial strength and the market’s perception thereof, as measured by shareholders’ equity, which was $3,172.0 million at December 31, 2011 (2010 - $3,241.9 million). We believe our financial strength provides us with the flexibility and capacity to obtain funds through debt or equity financing. However, our continuing ability to access the capital markets is dependent on, among other things, market conditions, our operating results and our perceived financial strength. We regularly monitor our capital and financial position, as well as investment and security market conditions, both in general and with respect to Aspen Holdings’ securities. Our ordinary shares and all our preference shares are listed on the NYSE. On December 15,
2010, we filed an unlimited shelf registration statement for the issuance and sale of securities from time to time.
Operating subsidiaries. As of December 31, 2011, the Operating Subsidiaries held approximately $1,377.1 million (2010 - $1,104.4 million) in cash and short-term investments that are readily realizable securities. Management monitors the value, currency and duration of cash and investments held by its Operating Subsidiaries to ensure that they are able to meet their insurance and other liabilities as they become due and was satisfied that there was a comfortable margin of liquidity as at December 31, 2011 and for the foreseeable future.
We manage these risks by making regular forecasts of the timing and amount of expected cash outflows and ensuring that we maintain sufficient balances in cash and short-term investments to meet these estimates. Notwithstanding this policy, if these cash flow forecasts are incorrect, we could be
forced to liquidate investments prior to maturity, potentially at a significant loss. Historically, we have not had to liquidate investments to maintain sufficient levels of liquidity.
Consolidated cash flows for the twelve months ended December 31, 2010. Total net cash flow from operating activities in 2010 was $624.6 million, a decrease of $20.0 million from 2009. For the twelve months ended December 31, 2010, our cash flows from operations provided us with sufficient liquidity to meet our operating requirements. We paid net claims of $666.8 million in 2010 and received $17.6 million from market securities and net purchases and sales of equipment during the period. We paid ordinary and preference share dividends of $69.3 million, and $407.8 million was used to repurchase ordinary shares. At December 31, 2010, we had a balance of cash and cash equivalents of $1,179.1 million. The balance of cash and cash equivalents increased from the issuance of $250.0 million of additional Senior Notes in December 2010.
The facility can be used by any of the Borrowers to provide funding for our Operating Subsidiaries, to finance the working capital needs of the Company and our subsidiaries and for general corporate purposes of the Company and our subsidiaries. The revolving credit facility further provides for the issuance of collateralized and uncollateralized letters of credit. Initial availability under the facility is $280.0 million and the Company has the option (subject to obtaining commitments from acceptable lenders) to increase the facility by up to $75.0 million. The facility will expire on July 30, 2013. As of December 31, 2011, no borrowings were outstanding under the credit facilities. The fees and interest rates on the loans and the fees on the letters of credit payable by the Borrowers increased based on the consolidated leverage ratio of the Company.
On February 28, 2011, Aspen U.K. and Aspen Bermuda entered into an amendment to the $200.0 million secured letter of credit facility agreement with Barclays Bank plc dated as of October 6, 2009. The Amendment extends the maturity date of the credit facility to December 31, 2013. All letters of credit issued under the facility will be used to support reinsurance obligations of the parties to the agreement and their respective subsidiaries. As at December 31, 2011, we had $49.8 million of outstanding collateralized letters of credit under this facility.
The following table summarizes our contractual obligations (other than our obligations to employees, our Perpetual Preferred Income Equity Replacement Securities (“Perpetual PIERS”) and our Perpetual Non-Cumulative Preference Shares (“Perpetual Preference Shares”)) under long-term debt, operating leases and reserves relating to insurance and reinsurance contracts as of December 31, 2011:
In estimating the time intervals into which payments of our reserves for losses and loss adjustment expenses fall, as set out above, we have utilized actuarially assessed payment patterns. By the nature of the insurance and reinsurance contracts under which these liabilities are assumed, there can be no certainty that actual payments will fall in the periods shown and there could be a material acceleration or deceleration of claims payments depending on factors outside our control. This uncertainty is heightened by the relatively short time in which we have operated, thereby providing limited Company-specific claims loss payment patterns. The total amount of payments in respect of our reserves, as well as the timing of such payments, may differ materially from our current estimates for the reasons set out above under “- Critical Accounting Policies - Reserves for Losses and Loss Expenses.”
We also seek to take into account the projected impact of inflation on the likely actions of central banks in the setting of short-term interest rates and consequent effects on the yields and prices of fixed interest securities. As of February 2012, we consider that although inflation is currently low, in the medium-term there is a risk that inflation, interest rates and bond yields may rise, resulting in a decrease in the market value of certain of our fixed interest investments.
Adjusted diluted book value per ordinary share, a non-GAAP measure, is calculated by adding back ordinary dividends to shareholders’ equity at the end of the year. We believe that adding back ordinary dividends provides a more consistent and useful measurement of total shareholder value, which supplements GAAP information.