We operate in the United States, Bermuda, Europe and Singapore. We own the property in which our offices are located in Dublin, Ireland, and we lease office space in the other countries. We renew and enter into new leases in the ordinary course of business as required. Our worldwide headquarters office is located at 92 Pitts Bay Road, Pembroke, Bermuda. We believe that our office space is sufficient for us to conduct our operations for the foreseeable future.
Diluted book value per common share: Diluted book value per common share represents total common shareholders’ equity divided by the number of common shares and diluted common share equivalents outstanding, using the treasury stock method. We consider diluted book value per common share an appropriate measure of our returns to common shareholders, as we believe growth in our book value on a diluted basis ultimately translates into growth of our stock price. Diluted book value per share was $28.79, $23.45 and $18.34 at December 31, 2007, 2006 and 2005, respectively. The increase in each of the last two years reflects the generation of earnings from operations, which substantially increased our common shareholders’ equity base.
Cash dividends per common share: Our dividend policy is an integral part of the value we create for our shareholders. Our cash dividends declared in 2007 were $0.68 per common share compared to $0.615 and $0.60 per common share in 2006 and 2005, respectively. Our Board of Directors reviews our dividend policy on a regular basis and in December 2007, they authorized a 12% increase in the quarterly dividend.
The following table breaks out net income into three components; underwriting income, investment income and net realized gains/losses, and other revenues and expenses. Underwriting income on a segment basis is a measure of underwriting profitability that takes into account net premiums earned and other insurance related income as revenue and net losses and loss expenses, acquisition costs and underwriting related general and administrative costs as expenses. Underwriting income is the difference between these revenue and expense items. Because our investment portfolio is managed on a total return basis, we have reviewed investment income and net realized gains/losses together. Other revenues and expenses represent corporate expenses, foreign exchange gains/losses, interest expense and income tax expense.
2007 versus 2006: Net income available to common shareholders for 2007 increased 14% over 2006, reflecting higher investment income and additional underwriting income from our insurance and reinsurance segments. The increase in investment income was primarily driven by a 21% increase in our average cash and investment balances together with an increase in our effective yield. Our insurance and reinsurance segments both benefited from additional prior period reserve development in 2007 compared with 2006, in what were years of limited major loss activity.
2007 versus 2006: Gross premiums written in 2007 were largely flat relative to 2006. In our insurance segment, increases in political risk, professional lines and U.S. exposed catastrophe property premium were offset by the impact of competitive market conditions and rate pressures in our other lines. In our reinsurance segment, favorable foreign exchange rates in 2007 relative to 2006 offset an otherwise slight reduction in gross premiums written this year. This reduction was primarily due to a large 16-month property proportional treaty written in the fourth quarter of 2006 which did not come up for renewal in 2007 and also the impact of increased client retentions in our professional lines book. These reductions were mostly offset by our increased participation in business in the U.S. and European reinsurance markets this year.
2006 versus 2005: The growth in net premiums written in 2006 was impacted by significant inward and outward reinstatement premiums in 2005, associated with KRW. Excluding these amounts, net premiums written in our insurance and reinsurance segments increased by 15% and 8%, respectively, primarily reflecting growth in gross premiums written.
2006 versus 2005: The growth in net premiums earned in 2006 was impacted by significant reinstatement premiums earned and amortized in 2005, following KRW. Excluding these amounts, net premiums earned in our insurance and reinsurance segments increased by 1% and 9%, respectively, primarily reflecting growth in net premiums written in the year. The rate of growth in our insurance segment was reduced by changes in business mix.
The following table provides a break down of our combined ratio:
(1) Our general and administration expense ratio includes corporate expenses not allocated to our underwriting segments of 2.1%, 2.2% and 1.8%, for 2007, 2006 and 2005, respectively. These costs are discussed further in “Other Revenue and Expenses” below.
The movements in our current year loss ratios primarily reflect changes in business mix and the level of loss activity each year, rather than from any significant changes in our underlying actuarial assumptions. We experienced below average catastrophe and attritional loss activity during 2007 and 2006, compared to 2005 when we incurred significant losses on KRW.
During 2007, a number of large financial institutions incurred significant financial losses relating to delinquencies in the U.S. sub-prime residential mortgage market. Many other companies were also negatively impacted by the write down of investments exposed to the credit market deterioration. These events triggered claims against directors and officers of these institutions as well as providers of professional services. We have reviewed our portfolio for any potential losses relating to these events, including a contract by contract analysis of our exposure to all known suits filed. As a result, we identified potential exposure on some directors and officers and errors and omissions contracts within our insurance segment. While this resulted in a slight increase to the initial expected loss ratios on these related line classes, overall, the current accident year loss ratio on our professional lines book was consistent with 2006 due to the offsetting impact of business mix changes within this book. With regard to the professional lines within our reinsurance business, given the emergence of bankruptcies and other business failures, and the uncertainty in this area, we increased our initial expected loss ratio on those potentially impacted classes. However, this did not have a significant impact on our overall reinsurance current year loss ratio in 2007 as compared with 2006.
Prior period development was the net favorable result of several underlying reserve developments on prior accident years, identified during our quarterly reserving process. The following table provides a break down of prior period development by segment:
The amounts above were almost entirely generated from our short-tail lines of business. For our long tail lines, our loss experience from older accident years is generally considered insufficiently developed as yet to recognize deviations from our initial expectations. We have also experienced some adverse reserve development in the last three years, most notably in 2006, when we strengthened our KRW reserves by $105 million, or 3.9 ratio points. The size and complexity of KRW resulted in some claims that increased over previously reported damage estimates.
In addition to this broader claims experience, favorable reserve development has also occurred as a result of us being able to take down provisions for specific catastrophe events. On contracts that respond to highly visible, major events, we establish IBNR where potential exposure has been identified. However, in a number of instances, mainly within our excess of loss catastrophe reinsurance business, it transpired that claims did not develop to a sufficient level to reach our attachment points.
For further detail on the prior period development refer to the segment discussions below. Conditions and trends that affected the development of liabilities in the past may not necessarily occur in the future. Accordingly, it is inappropriate to anticipate future redundancies or deficiencies based on historical experience.
2007 versus 2006: Our acquisition cost ratio in 2007 of 14.1% was comparable with 2006. While we experienced a shift in business mix towards reinsurance business, which typically has higher acquisition costs compared to our insurance segment, costs in our insurance segment were lower this year. This was due to an increase in ceding commissions received as a result of our expanded reinsurance program. Our gross acquisition cost ratio in 2007 of 15.3% was consistent with the prior year.
2006 versus 2005: Our acquisition cost ratio in 2006 of 14.4%, increased by 1.2 ratio points over 2006, primarily reflecting changes in business mix in our insurance segment.
(1) The average investment balances are calculated by taking the average of the month-end balances during the year.
Our investment strategy is to take a long-term view by actively managing our investment portfolio to maximize total return (see below) within specific guidelines, designed to minimize risk. Our fixed maturities portfolio is considered available for sale and reported at fair value. The effect of market movements on our available for sale investment portfolio impacts net income (through net realized gains/losses) when securities are sold or when “other than temporary” impairments are recorded on invested assets. Additionally, net income is impacted (through net realized gains/losses) by changes in the fair value of investment derivatives, mainly forward contracts. Changes in unrealized appreciation and depreciation on available for sale securities, which result from the revaluation of securities held, are reported as a separate component of accumulated other comprehensive income in shareholders’ equity. The following table provides a breakdown of our net realized investment gains/losses:
Our portfolio is managed to maximize total return within certain guidelines and constraints. In assessing returns under this approach, we include net investment income, net realized investment gains and losses and the change in unrealized gains and losses generated by our investment portfolio.
2006 versus 2005: The increase in our total return between 2005 and 2006 was due to a growing allocation to our higher returning other investments and more significantly an increase in short and intermediate U.S. interest rates which stemmed from the increases in the Federal Funds rate which began in the mid part of 2004 and continued in 2005 and 2006. Despite the steady increase in yield over this period, the magnitude of the rate increases in 2005 had such a negative impact on the fair value of the fixed maturity portfolio that the realized losses and unrealized losses more than offset the increase in yield in that year.
Corporate expenses: Our corporate expenses include holding company costs necessary to support our worldwide insurance and reinsurance operations and costs associated with operating as a publicly-traded company. As a percentage of net premiums earned, corporate expenses were 2.1%, 2.2% and 1.8% for 2007, 2006 and 2005, respectively.
Income tax expense: Income tax expense is generated primarily through our foreign operations in the United States and Europe. Our effective tax rate on net income, which we calculate as income tax expense divided by income before income tax, was 3.7% for 2007 compared with 3.4% in 2006 and 6.0% in 2005. Changes in our effective tax rate in the last two years primarily reflect variances in the distribution of net income among our various taxable jurisdictions.
2006 versus 2005: Gross premiums written in 2006 increased 10% versus 2005, reflecting growth in several lines of business. The increase in property premium was primarily due to significant rate increases for natural peril-exposed property and offshore energy risks in the U.S. and Gulf of Mexico, following KRW. Gross premiums written in our political risk book increased through a combination of additional underwriting resource and new market opportunities. Our professional lines unit generated additional premiums during 2006 reflecting an expansion of our London and U.S. operations in recent years. The increase in premium in our marine line was largely associated with growth of two custom accounts which we began to write in 2005. Partially offsetting these increases was our reduced participation for terrorism and aviation business due to pricing considerably below our threshold. We also experienced a reduction in excess and surplus primary liability premium, which was primarily due to a more competitive market.
2007 versus 2006: Premiums ceded in 2007 were $713 million, or 35% of gross premiums written, compared with $610 million, or 29% of gross premiums written in 2006. The increase in premiums ceded was largely related to the impact of changes in business mix and additional reinsurance cover purchased during the year. While we significantly reduced gross premiums written on our aviation and terrorism lines during 2007, we offset these reductions with growth of our political risk, property and professional lines business. Because we have historically purchased more reinsurance cover on our property and professional lines business relative to our aviation and terrorism lines, this change in business mix had the effect of increasing our ceded premium ratio. Furthermore, we also purchased additional coverage this year, both on our professional lines quota share reinsurance and also on our worldwide property program.
2006 versus 2005: Premiums ceded in 2006 were $610 million, or 29% of gross premiums written, compared with $707 million, or 38% of gross premiums written in 2005. The decrease was primarily due to lower ceded reinstatement premiums. These were significantly higher in 2005 following our utilization of reinsurance protections on KRW.
2006 versus 2005: The 9% growth in net premium earned in 2006 was impacted by KRW related ceded reinstatement premiums, amortized in 2005. Net premiums earned otherwise increased 1%, compared with growth in net premiums written in the year of 15% (also excluding KRW reinstatements). Net premium earned growth was reduced by the fact that a significant portion of our net premium written in 2006 was generated from our political risk book. This business typically provides multi-year coverage and therefore the earning of this premium is spread over a greater number of periods. In addition, premiums earned on our aviation line decreased significantly in 2006 having substantially reduced our participation for this business in recent years.
We recognized net favorable prior period reserve development of $214 million, $168 million and $269 million, in 2007, 2006 and 2005, respectively. These amounts were almost entirely generated from our short-tail lines of business.
For our long tail lines, our loss experience on older accident years is generally considered insufficiently developed as yet to recognize deviations from our initial expectations. The only two significant exceptions to this both occurred during 2007. First, we recognized $15 million, or 1.3 ratio points, of favorable development on our directors and officers’ liability business. This related to a specific claim, which we had previously made provision for, but removed following a favorable court ruling. Second, we recognized $6 million, or 0.5 ratio points, of adverse development on our accident year 2004 and 2005 casualty reserves, due to a higher than expected emergence of claims on a specific program.
We expect competition and rate pressures to further intensify across the insurance marketplace during 2008. The benign insured catastrophe season in 2007 combined with increasing capacity in the market is expected to contribute towards an even more competitive pricing environment throughout our property lines. For catastrophe-exposed property and energy business, this pressure is against historically-high price levels, and therefore we still foresee the opportunity to target business that meets our pricing threshold. For U.S. retail property business, we are beginning to witness pressure on terms and conditions, including increased sub limits and lower deductibles, and we continue to maintain our cautious posture on this line. Our aviation and terrorism lines continue to be under significant pricing pressure and we expect to reduce our participation on this business further in 2008.
In our liability business, we continue to witness increasing competitive pricing pressure, particularly on our larger U.S. excess and surplus accounts. In our professional lines business, there remain some pricing pressures, although we are now witnessing some moderation in competition in our financial institutions business, driven by the impact of deterioration in the credit markets. We believe our areas of focus in both our liability and professional lines business still contain good profit potential, but risk selection and overall execution strategy have become more critical.
2006 versus 2005: Gross premiums written in 2005 were inflated by significant KRW related reinstatement premiums. Excluding the impact of these, which were mostly on our catastrophe book, gross premiums written increased 8% in 2006. This growth was primarily due to an expansion of our U.S. and European operations, which allowed us to increase our market penetration for professional lines and liability business in particular. We also wrote new property exposed engineering business, included within our “other” line of business.
2006 versus 2005: Our current year loss ratio in 2006 was 34.6 ratio points lower than in 2005, reflecting an absence of major catastrophe losses in 2006 compared to 2005 when we incurred significant losses on KRW.
We recognized net favorable development of $123 million, $49 million and $114 million, in 2007, 2006 and 2005 respectively. These amounts were almost entirely generated from our short-tail lines of business. For our long tail lines, our loss experience on older accident years is generally considered insufficiently developed as yet to recognize deviations from our initial expectations. The only significant adverse development on our long tail lines in the last three years was on our motor liability account. Due to higher than expected loss emergence on this account, in 2006 we increased our accident year 2004 and 2005 expected ultimate losses on this account by $9 million, or 0.7 percentage points.
The net favorable reserve development on our short tail lines, which we have recognized with the emergence of better than expected loss experience, is summarized as follows:
2007: The majority of the net favorable development in 2007 was related to our catastrophe and property lines of business, principally from accident year 2006. For these lines, accident year 2006 has largely proven to be a benign loss year with limited late reported loss activity and minimal deterioration on previously reported claims.
2006: The majority of net favorable development in 2006 was generated from our accident year 2004 and 2003 catastrophe and property lines of business. We experienced net adverse development of $72 million, or 5.2 ratio points, from accident year 2005 which was largely related to reserve strengthening on KRW reserves. The nature and extent of KRW resulted in some claims that increased over previously reported damage estimates.
Our investment strategy is to invest primarily in debt instruments of high credit quality issuers and to limit the amount of credit exposure with respect to particular ratings categories and any one issuer. Within our fixed income portfolio, we attempt to limit our credit exposure by purchasing fixed income investments rated BBB or higher. In addition, we have limited our exposure to any single issuer to 5% or less of our portfolio for securities rated A- or above and 3% or less of our portfolio for securities rated between BBB and BBB+. At December 31, 2007 and 2006, we did not have an aggregate exposure to any single issuer of 10% or more of our shareholders’ equity, other than with respect to U.S. government and agency securities. At December 31, 2007 and 2006, all of the fixed maturity securities were investment grade with 78.6% and 84.1%, respectively, rated AA- or better, with an overall weighted average rating of AA+, based on ratings assigned by Standard & Poor’s.
The duration target range for our investment portfolios is two to four years. The duration of an investment is based on the maturity of the security and also reflects the payment of interest and the possibility of early principal payment of such security. We seek to use investment performance benchmarks that reflect this duration target. With respect to the duration of our investment portfolio, we manage asset durations to both maximize return given market conditions and provide sufficient liquidity to cover future loss payments. In a low interest rate environment, the overall duration of our fixed maturity investments tends to be shorter and in a high interest rate environment, such durations tend to be longer. At December 31, 2007 and 2006, our invested assets had an approximate average duration of 2.7 and 3.0 years, respectively. When incorporating our other cash and cash equivalents into this calculation, the average duration at December 31, 2007 and 2006 is reduced to 2.5 and 2.6 years, respectively.
During 2007, we sold our life settlement contracts investment. As discussed in Notes 5 (b) and 8 (c) of the Consolidated Financial Statements, in Item 8 of this report, on September 26, 2007, we sold our Note at par to a related party of the SPE (“buyer”), which resulted in the deconsolidation of the life settlement contracts. On the same day, this Note was repurchased by the SPE using proceeds from the issuance of a newly issued $400 million 10-year asset-backed note to the buyer. We simultaneously entered into an insurance contract with the buyer whereby we agreed to indemnify the buyer in the event of non-payment on the principal of this security. In doing so, we continue to have an implicit interest in the original life settlements portfolio and the related longevity risk exposure. However, as a result of not having a direct interest through the Note and a new hedging program put in place by the SPE, we have significantly reduced our exposure to interest rate risk.
The decreases in our collateralized loan obligations and short duration high yield fund were due to sales and redemptions, respectively, in order to reduce our exposure to credit risk. The credit funds increased as we subscribed into a credit strategies fund in the fourth quarter to take advantage of the credit market dislocation. The increase in the hedge funds is due to positive returns generated during the year, including a net redemption of $4 million during the year.
The above balances are all held within investment grade tranches, with 98% rated Agency or AAA and the remainder rated AA. The duration and weighted average life of these investments at December 31, 2007 was 1.61 and 2.39 years, respectively.
With respect to the rest of our investment portfolio, our exposure to credit risk is broadly diversified by industry, concentration and geography through our investments in high grade fixed maturities and our other investments. Some of the markets for these asset classes have experienced higher than typical volatility during 2007, as a result of the financial market instability and widening credit spreads on corporate and structured credit assets. However, these market developments did not have a material adverse impact on our results during 2007. Although we experienced a reduction in net investment income on our credit related funds compared to 2006, these funds still produced positive returns for the year. Our book value was negatively impacted through an increase in unrealized losses on our corporate and asset-backed fixed income securities, however, this was more than offset by the positive impact on our U.S. treasury positions.
All asset-backed securities, including those with sub-prime exposure, are reviewed as part of our ongoing other-than-temporary-impairment monitoring process. We continue to monitor our exposures, and to the extent market disruptions continue, our financial position may be negatively impacted. For further information on the investment portfolio, including analysis of rating and maturity distributions, refer to Note 5 of the Consolidated Financial Statements, included in Item 8.
Liquidity is a measure of a company’s ability to generate sufficient cash flows to meet short-term and long-term cash requirements of its business operations. As a holding company, AXIS Capital has no substantial operations of its own and its assets consist primarily of investments in its subsidiaries. Accordingly, AXIS Capital’s future cash flows depend primarily upon the availability of dividends or other statutorily permissible payments from its subsidiaries. See Item 8, Note 17, to the Consolidated Financial Statements for further discussion.
Our net cash flows from operating activities were $1,573 million in 2007, compared with $1,613 million in 2006. These amounts reflect net income for each year, adjusted for non-cash items and changes in working capital. Net income in 2007 of $1,092 million compared with $963 million in the prior year. In 2007, significant adjustments included an increase in unpaid losses and loss expenses of $572 million (2006: $272 million) and unearned premiums of $131 million (2006: $255 million), offset by an increase in net insurance and reinsurance receivable balances of $155 million (2006: $119 million).
Cash flows are affected by claim payments that, due to the nature of our operations, may comprise large loss payments on a limited number of claims and which can fluctuate significantly from period to period. The irregular timing of these loss payments can create significant variations in cash flows from operations between periods. However, our diversified portfolio and risk management practice has demonstrated our ability to withstand extraordinary losses, as was the case in 2005. To further ensure the sufficiency of funds to settle unforeseen claims, our investment portfolio includes a significant portion of highly liquid securities (cash and cash equivalents, short-term investments and high grade fixed maturity securities). We also maintain a $1.5 billion credit facility, as disclosed in Item 8, Note 9 (b) of the Consolidated Financial Statements. We believe that our cash balances, cash flows from operations and the liquidity provided by our credit facility will continue to be sufficient to meet our future cash requirements.
Preferred Shares: During 2005, we issued $250 million of series A and $250 million of series B Preferred shares. For further information refer to Item 8, Note 12 (b) of the Consolidated Financial Statements.
A summary of our share repurchases in 2007 is disclosed in Item 8, Note 12 (a), of the Consolidated Financial Statements.
On October 3, 2005, we filed an unallocated universal shelf registration statement with the SEC that was declared effective on October 11, 2005. Under the shelf registration statement, we may issue up to $1.5 billion of equity, debt, trust preferred securities or a combination of these securities. On November 21, 2005, we completed a common share offering of 6,800,000 shares at $29.42 per share raising aggregate net proceeds of $200 million. In addition, we issued $250 million of series B preferred shares under this shelf registration statement. The remaining capacity at December 31, 2007 was $1.1 billion.
These ratings are based upon factors relevant to policyholders, agents and intermediaries and are not directed toward the protection of investors. Such ratings are not recommendations to buy, sell or hold securities. Debt ratings apply to short-term and long-term debt as well as preferred stock. These ratings are assessments of the likelihood that we will make timely payments of principal, interest and preferred share dividends.
The following are the most recent financial strength and claims paying ratings from internationally recognized agencies in relation to our principal insurance and reinsurance subsidiaries:
“A Standard & Poor’s issuer credit rating is a current opinion of an obligor’s overall financial capacity (its creditworthiness) to pay its financial obligations. This opinion focuses on the obligor’s capacity and willingness to meet its financial commitments as they come due.”
An obligor rated ‘A’ has strong capacity to meet its financial commitments but is somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than obligors in higher-rated categories.
The “A” rating is the sixth highest out of twenty-one rating levels.
“Moody’s Insurance Financial Strength Ratings are opinions of the ability of insurance companies to repay punctually senior policyholder claims and obligations.”
Insurance companies rated A offer good financial security. However, elements may be present which suggest a susceptibility to impairment sometime in the future.
1. Estimated gross loss payments. Given the limited loss payout pattern information specific to our experience, we have used industry data, on a line by line basis, to estimate our expected payments. The amount and timing of actual loss payments may differ materially from the estimated payouts in the table above. For further discussion refer to our critical accounting estimates section below.
2. Operating lease obligations: We lease office space in the countries in which we operate under operating leases which expire at various dates. We renew and enter into new leases in the ordinary course of business as required.
3. Reinsurance purchase commitments: During 2007, we purchased reinsurance coverage for our insurance lines of business. The minimum reinsurance premiums are contractually due on a quarterly basis in advance.
5. Senior notes (including interest payments): For further information on the repayment terms of amounts due on our senior unsecured debt refer to Item 8, Note 9 (a), to the Consolidated Financial Statements.
6. Investment commitments: During September 2007, we made an investment commitment of $75 million in an alternative investment fund, of which $36 million was still outstanding at December 31, 2007.
Case reserves - cost of claims that were reported to us but not yet paid, and
For reported losses, management primarily establishes case reserves based on the amounts reported from insureds or ceding companies. Management may also establish additional case reserves on reported claims which are not considered adequately reserved. At December 31, 2007, additional case reserves were $70 million, or 4% of our total case reserves compared to $41 million, or 2%, respectively at December 31, 2006.
Case reserves are established on a case by case basis within the parameters of coverage provided in the insurance and reinsurance contracts. The method of establishing case reserves for reported losses differs among our segments.
The reserving process for our reinsurance operations is more complicated than for our insurance operations. For reported losses, we generally establish case reserves based on reports received primarily from brokers and also from ceding companies. With respect to contracts written on an excess of loss basis, we typically are notified of insured losses on specific contracts and record a case reserve for the estimated amount of the ultimate expected liability arising from the claim. With respect to contracts written on a pro rata basis, we typically receive aggregated claims information and record a case reserve based on this information.
In order to reflect this increased level of uncertainty in establishing our case reserves, some of our underwriting, claims and reserving practices have been modified for our reinsurance business. In deciding whether to provide treaty reinsurance, we carefully review and analyze the cedant’s underwriting and risk management practices to ensure appropriate underwriting, data capture and reporting procedures. We undertake an extensive program of cedant audits, utilizing outsourced legal and industry expertise when necessary. This allows us to review a cedant’s claims administration to ensure that its claim reserves are consistent with reinsured exposures, are adequately established and are properly reported in a timely manner, and to verify that claims are being handled appropriately. For those losses where we receive contract-specific loss notifications, our claims department evaluates each notification and, as discussed above, may record additional case reserves if claims are not considered to be adequately reserved by the ceding company. This requires considerable judgment. Where claims information is received in an aggregated form, our reinsurance contracts typically require that pre-defined large losses must be separately notified so that these losses can be adequately evaluated.
Initial expected loss ratio method (“IELR”): This method calculates an estimate of ultimate losses by applying an estimated loss ratio to an estimate of ultimate earned premium for each underwriting year. The estimated loss ratio is based on pricing information and industry data and is independent of the current claim experience to date. This method is appropriate for classes of business where the actual paid or reported loss experience is not yet mature enough to override our initial expectations of the ultimate loss ratios.
Bornhuetter-Ferguson (“BF”): The BF method uses as a starting point an assumed IELR and blends in the loss ratio implied by the claims experience to date by using benchmark loss development patterns. The BF method allows a logical transition between the IELR and Chain Ladder methods. This method is appropriate for accident years at an early stage of claim development or where claim development observed to date is not considered sufficiently credible as a basis of projection under the Chain Ladder method.
The weight given to a particular actuarial method is dependent upon the characteristics specific to each class of business, including: the types of coverage and the expected claim-tail. Short-tail exposures describe classes of business for which losses are usually known and paid within a relatively short period after a loss event has occurred. Our short-tail lines include the majority of our property, marine, terrorism and aviation classes of business within our insurance segment, and the majority of our property and catastrophe classes of business within our reinsurance segment.
Due to the relatively short reporting development pattern for our short-tail lines, our estimate of ultimate losses responds quickly to the latest loss data, and therefore we typically assign credibility to methods that incorporate actual loss emergence, sooner than would be the case for medium to long-tail lines at a similar stage of development. In doing so, we primarily select the BF method due to the low frequency, high severity nature of much of our business (which limits the usefulness of the Chain Ladder method). In addition, the significant growth of our business in the last five years has generally reduced the degree to which we can rely upon our own development trends from older accident years.
The following tables provide a break down of our net loss reserves by segment and type of exposure:
Implicit in the actuarial methodologies utilized above are two critical reserving assumptions; the selected IELR for each accident year and the expected loss emergence profiles. We regularly monitor these assumptions and, at each quarter end, undertake a full actuarial review. Any adjustments that result from this review are recorded in the quarter in which they are identified.
For our insurance business, the current accident year IELRs are primarily developed using industry benchmarks adjusted for changes in pricing, terms and conditions observed by our underwriters. In 2005, we began to give varying levels of weight to our own loss experience on certain classes of business within our property and marine lines of business.
Given our limited operating history and developing book of business, our loss development factors continue to be primarily established using industry benchmarks. These factors are only revised when the weight of our own actual experience becomes sufficiently credible to identify deviations from the market based assumptions. The most significant change made to our loss emergence patterns to date was on our terrorism and aviation lines. In 2005, having observed a lack of claims development on these lines, we adjusted our loss development assumptions on these lines to incorporate reporting that was more prompt than we had originally expected.
On contracts that respond to highly visible, major loss events, we establish IBNR where potential exposure has been identified. When a significant loss event occurs, we review our contracts to determine those that could be potentially exposed to the loss event. We contact brokers and clients to determine their estimate of involvement and the extent to which their programs are affected. We may also use computer modeling to estimate loss exposures under the actual event scenario. We use Risklink licensed by RMS, Classic/2 and CATRADER licensed by AIR and WORLDCAT Enterprise licensed by Eqecat. As part of the underwriting process, we obtain exposure data from our clients, so that when an event occurs we can run the models to produce an estimate of the losses incurred by clients on programs that we insure or reinsure. Typically, we derive our estimate for the losses from a catastrophic event by blending all of the sources of loss information available to us. This estimate is derived by the claims team and, where there are no reported case reserves, we establish a separate provision for IBNR. Because much of our excess insurance and excess of loss reinsurance business has high attachment points, there is significant judgment required in estimating whether claims will exceed those attachment points. The inherent uncertainties relating to coverage and damage assessment on catastrophe events, together with our typically large line sizes, add to the complexity of estimating our potential exposure.
While we believe that our loss reserves at December 31, 2007 are adequate, new information, events or circumstances, unknown at the original valuation date, may lead to future developments in our ultimate losses significantly greater or less than the reserves currently provided. The actual final cost of settling both claims outstanding at December 31, 2007 and claims expected to arise from unexpired period of risk is uncertain. There are many other factors that would cause our reserves to increase or decrease, which include, but are not limited to, changes in claim severity, changes in the expected level of reported claims, judicial action changing the scope and/or liability of coverage, changes in the regulatory, social and economic environment and unexpected changes in loss inflation.
Changes to our previous estimate of prior year loss reserves can impact the reported calendar year underwriting results by worsening our reported results if reserves prove to be deficient or improving our reported results if reserves prove to be redundant.
Reinsurance recoverable balances include amounts owed to us in respect of paid and unpaid ceded losses and loss expenses and are presented net of a reserve for non-recoverability. At December 31, 2007 and 2006, reinsurance recoverable balances were $1,357 million and $1,359 million, respectively. In establishing our reinsurance recoverable balances, significant judgment is exercised by management in determining the amount of unpaid losses and loss expenses to be ceded as well as our ability to cede losses and loss expenses under our reinsurance contracts.
Our ceded unpaid losses and loss expenses consist of two elements, those for our gross case reserves and those for our gross IBNR. Recoveries on our gross case estimates are determined on a case-by-case basis by applying the terms of any applicable reinsurance recoveries to the individual case estimates. As the gross case estimates are adjusted over time in accordance with the settlement of the claim, the corresponding ceded case estimates will be adjusted. Recoveries on gross IBNR are developed as part of our loss reserving process. Consequently, the estimation of ceded unpaid losses and loss expenses is subject to similar risks and uncertainties as the estimation of gross IBNR (see “Reserve for Losses and Loss Expenses”). In our reinsurance segment, our reinsurance coverage is principally limited to industry loss warranty contracts. Under these types of contracts a recovery will only be made following a predefined industry loss of a particular size and frequency.
As the majority of the reinsurance recoverable balances will not be due for collection until some point in the future, the recoverability of such amounts may ultimately differ materially from the recorded amounts due to the ability and willingness of reinsurers to pay our claims, for reasons including insolvency, contractual dispute over contract language or coverage and for other reasons. Additionally, over this period of time, the economic conditions and operational performance of a particular reinsurer may change and consequently these changes may affect the reinsurer’s willingness and ability to meet their contractual obligations to us. Accordingly, we review our reinsurance recoverable balances on a quarterly basis to estimate and record a valuation provision for potential uncollectible amounts, with changes in the provision flowing through earnings.
Where actual reported premium deviates from the estimate, we carry out an analysis to determine the cause and may, if necessary, adjust the estimated premium in the period in which the determination was made. Line slip premium accounted for 3% of total gross premiums written in each of the last three years. Our line slip contracts are predominately written in our insurance segment and within our property, marine, political risk and aviation lines of business. Our limited historical experience has shown that estimated premiums from line slip contracts have varied and have been adjusted by up to approximately 10%, although larger variations, both positive and negative, are possible. A 10% variation in the our line slip premiums receivable balance at December 31, 2007, after considering the related expected losses and loss expenses and acquisition costs, would increase or decrease our pre tax net income by approximately $5 million.
Where actual reported premium deviates from the estimate, we carry out an analysis to determine the cause and may, if necessary, adjust the estimated premium in the period in which the determination was made. During 2007, 2006 and 2005, proportional premiums accounted for 13%, 14% and 15%, respectively, of total gross premiums written. Our proportional contracts are predominately written in our reinsurance segment and within our property, professional lines and casualty lines of business. Our limited historical experience has shown that estimated premiums from proportional contracts have varied and have been adjusted by up to approximately 10%, although larger variations, both positive and negative, are possible. A 10% variation in the our proportional premiums receivable balance at December 31, 2007, after considering the related expected losses and loss expenses and acquisition costs, would increase or decrease our pre tax net income by approximately $11 million.
Consolidated Statements of Comprehensive Income for the years ended December 31, 2007, 2006 and 2005
Consolidated Statements of Cash Flows for the years ended December 31, 2007, 2006 and 2005
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2007, based on the criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 25, 2008 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
AXIS Capital Holdings Limited (“AXIS Capital”) is the Bermuda-based holding company for the AXIS group of companies, collectively the “Company”. AXIS Capital was incorporated on December 9, 2002, under the laws of Bermuda. Through its subsidiaries organized in Bermuda, Ireland and the United States, AXIS Capital provides a broad range of insurance and reinsurance products on a worldwide basis under two distinct global underwriting platforms, AXIS Insurance and AXIS Re. In these notes, the terms “we,” “us,” “our,” or the “Company” refer to AXIS Capital and its direct and indirect subsidiaries.
The terms “FAS” and “FASB” used in these notes refer to Statements of Financial Accounting Standards issued by the Financial Accounting Standards Board, a United States based accounting standard setter. These consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”). The consolidated financial statements include all variable interest entities (VIEs) for which we are the primary beneficiary. All significant inter-company accounts and transactions have been eliminated.
While the amounts included in the consolidated financial statements reflect management’s best estimates and assumptions, these amounts could ultimately differ from those estimates. Any such adjustments are reflected in income in the period in which they become known. Certain reclassifications have been made to prior period amounts to conform to the current period presentation. In particular, we reclassified the additional capital above par value on our Series A and B preferred shares from additional paid-in capital to the preferred shares caption in our Consolidated Balance Sheets and Statements of Changes in Shareholders’ Equity. Tabular dollars and share amounts are in thousands, except per share amounts. All amounts are reported in U.S. dollars. Our significant accounting policies are as follows:
Net investment income is recognized when earned and includes interest and dividend income together with amortization of market premiums and discounts using the effective yield method and is net of investment management fees and other expenses. For mortgage-backed securities and any other holdings for which there is a prepayment risk, prepayment assumptions are evaluated and revised as necessary. Any adjustments required due to the change in effective yields and maturities are recognized on a prospective basis through yield adjustments.
We account for our collateralized loan obligations (“CLOs”), investment funds and life settlement contracts at fair value. Interest, dividend income, income distributions, changes in net asset values, and realized gains and losses are included in net investment income. We have no significant influence and do not and have not participated in the management of CLOs, investment funds or the life settlement contracts. Many of the investments are subject to restrictions on redemptions and sales which are determined by the governing documents and limit our ability to liquidate these investments in the short term.
Within our reserving process, management utilizes the initial expected loss ratio method (“IELR”), chain ladder and Bornhuetter-Ferguson (“BF”) actuarial methods. The IELR method estimates ultimate losses based on pricing information and industry data. The BF method uses as a starting point an assumed IELR and blends in the loss ratio implied by the claims experience to date. The chain ladder method uses the historical development profile of claims experienced on older accident years to project the more recent, less developed accident years to their ultimate position. The basis of our selected single point best estimate on a particular line of business is often a blend of the results from two or more methods (e.g. weighted averages). Our estimate is highly dependent on management’s judgment as to which method(s) is most appropriate for a particular accident year and class of business. Our methodology changes over time as new information emerges regarding underlying loss activity and other data issues.
Our functional currency is the U.S. dollar. We remeasure monetary assets and liabilities denominated in foreign currencies at year end exchange rates, with the resulting foreign exchange gains and losses recognized in the Consolidated Statements of Operations. Revenues and expenses in foreign currencies are converted at average exchange rates during the year. In the case of foreign currency denominated fixed maturity investments, the change in exchange rates between the local currency and our functional currency at each balance sheet date represents an unrealized appreciation or decline in value of these securities, and is included as a component of accumulated other comprehensive income.
We account for our derivative instruments using FAS No. 133, Accounting for Derivative Instruments and Hedging Activities (“FAS 133”). For non-hedging transactions, FAS 133 generally requires an entity to recognize all derivatives as either assets or liabilities in the balance sheet and measure those instruments at fair value with movements in fair value reflected in earnings. We may enter into derivative instruments such as futures, options, interest rate swaps and foreign currency forward contracts in order to manage duration and foreign currency exposure, obtain exposure to a particular financial market or for yield enhancement. We manage the exposure to these instruments based on guidelines established by management and these derivative instruments are carried at fair value with the corresponding changes in fair value recognized in the Consolidated Statements of Operations in the period that they occur.
From time to time we enter into insurance and reinsurance contracts that meet the definition of a derivative contract under FAS 133. We record these contracts at fair value with any changes in the value reflected in other insurance related income in the Consolidated Statements of Operations. Generally, the contracts are modeled on prevailing market conditions and certain other factors relating to the structure of the contracts. Our model takes into account movements on credit spreads and credit qualities. When data is not readily available from the market, we use data from independent counterparties.
We currently use foreign currency forward contracts to minimize the effect of fluctuating foreign currencies and to gain exposure to interest rate differentials between differing market rates. Foreign currency forward contracts purchased are not specifically identifiable against cash, any single security or any groups of securities and, therefore, do not qualify and are not designated as a hedge for financial reporting purposes. Realized and unrealized gains (losses) on foreign currency forward contracts that are purchased as part of our investment strategies are recognized in realized investment gains (losses) in the Consolidated Statements of Operations.
In accordance with FAS No. 142, Goodwill and Other Intangible Assets, we classify intangible assets into three categories: (1) intangible assets with finite lives subject to amortization, (2) intangible assets with indefinite lives not subject to amortization, and (3) goodwill. For intangible assets with finite lives, we amortize the value of the assets over their useful lives. The estimated remaining useful lives for these assets range from 3 to 12 years. We also test assets for impairment if conditions exist that indicate the carrying value may not be recoverable. Such conditions may include an economic downturn in a geographic market or change in the assessment of future operations. We record an impairment charge when the carrying value of the finite lived intangible assets is not recoverable by the cash flows generated from the use of the asset.
In December 2007, the FASB issued FAS No. 141(R), Business Combinations (“FAS 141(R)”) and FAS No. 160, Noncontrolling Interests in Consolidated Financial Statements-an amendment of Accounting Research Bulletin No. 51 (“FAS 160”). SFAS 141(R) requires the acquiring entity in a business combination to recognize the full fair value of assets acquired and liabilities assumed in the transaction (whether a full or partial acquisition); establishes the acquisition-date fair value as the measurement objective for all assets acquired and liabilities assumed; requires expensing of most transaction and restructuring costs; and requires the acquirer to provide additional disclosures on the nature and financial effect of the business combination. FAS 141(R) applies to all transactions or other events in which the acquirer obtains control of one or more businesses, even if control is not obtained by purchasing equity interests or net assets. FAS 160 requires reporting entities to present noncontrolling (minority) interests as equity (as opposed to as a liability or mezzanine equity) and provides guidance on the accounting for transactions between an entity and noncontrolling interests. Both FAS 141(R) and FAS 160 apply prospectively to business combinations for which the acquisition date is on or after December 15, 2008, except for the presentation and disclosure requirements of FAS 160 which will be applied retrospectively for all periods presented.
Our reinsurance segment provides treaty and facultative property and casualty reinsurance to insurance companies on a worldwide basis. The product lines in this segment are catastrophe, property, professional liability, credit and bond, motor, liability and other.
The following tables summarize the underwriting results of our operating segments for the last three years and the carrying values of goodwill and intangible assets:
(1) This balance excludes $6,438 of intangible assets relating to SERP (see Note 4)
The following table presents our gross premiums written by segment and line of business:
The amortized cost and fair values of our fixed maturity investments were as follows:
The following tables summarize the fixed income securities in an unrealized loss position and the aggregate fair value and gross unrealized loss by length of time the security has continuously been in an unrealized loss position:
At December 31, 2007, there were approximately 1,440 securities (2006: 1,945) in an unrealized loss position with a fair value of $2,718 million (2006: $4,418 million). Of these securities, there are 1,065 securities (2006: 1,497) that have been in an unrealized loss position for 12 months or greater with a fair value of $1,422 million (2006: $2,639 million). At December 31, 2007 and 2006 none of these securities were considered to be other than temporarily impaired. The unrealized losses from these securities were not a result of credit, collateral or structural issues. In 2007, we recorded an impairment charge of $9 million (2006: $5 million and 2005: nil) relating to 67 securities (2006: 36 securities) that we determined to be other than temporarily impaired, included in net realized investment gains (losses) in the Consolidated Statements of Operations.
The following summarizes information regarding the credit ratings of our fixed maturity portfolio:
On December 20, 2006, we purchased a 20-year asset-backed note (“Note”) in the amount of $400 million issued by a special-purpose entity (“SPE”). Through the purchase of this Note, we assumed longevity risk on 222 life insurance policies for a period of 20 years. We determined the SPE was a variable interest entity and through ownership of the Note we became its primary beneficiary. Accordingly, we consolidated the SPE, as well as the underlying SPEs, in our December 31, 2006 Consolidated Balance Sheet and eliminated all inter-company balances including the Note. At December 31, 2006, the consolidated assets and liabilities of the SPEs consisted primarily of restricted cash of $65 million, life settlement contracts portfolio of $378 million and other liability of $43 million.
On September 26, 2007, we sold the Note for a cash consideration of $400 million to a related party of the SPE (“buyer”), resulting in the deconsolidation of the SPE (see Note 8 (c)). Accordingly, from September 27, 2007, we have not included the results, assets and liabilities of the SPE in our Consolidated Financial Statements. Net investment income relating to the results of the SPE was negligible for 2007. The $400 million repurchase agreement used to finance the purchase of the Note was also terminated on September 26, 2007. During 2007, we recorded interest expense of $19 million (2006: nil) relating to the repurchase agreement.
Net investment income on our other investments includes interest, dividend income, income distributions, changes in net asset values, and realized gains and losses. During 2007, we recorded net realized losses on our other investments of $4 million (2006 and 2005: nil).
Proceeds from sales of fixed maturities classified as available for sale were $6,785 million, $4,124 million and $6,307 million in 2007, 2006 and 2005 respectively. The gross gains and losses on those sales are included in the table above.
Favorable development on our short tail lines has primarily been due to there being significantly fewer late reported claims than we anticipated through our reserving process. The deviation between expected and actual claims experience is often greater for a company like ours that has a limited operating history and therefore relies more heavily upon industry based loss development profiles. Given the inherent limitations of this, our estimate of ultimate losses in prior years have included additional IBNR reserves intended to reflect reporting delays and other uncertainties specific to our business. These include the inherent delays we expect to arise from obtaining loss information on excess layers of business across our diverse worldwide exposures. As it has transpired, our actual claims experience in each of the last three years has been better than we projected, with late reporting being less prevalent than we anticipated.
Reinsurance recoverable and the provision for unrecoverable reinsurance by segment were as follows:
During 2007, we recorded realized and unrealized gains of $1 million (2006: $6 million loss; 2005: $5 million gain) on foreign currency forward contracts used to manage foreign currency exposures in the balance sheet. At December 31, 2007, the net contractual amount of these foreign currency forward contracts was $122 million (2006: $10 million) with an unrealized gain of $2 million (2006: $1 million loss; 2005: $1 million gain).
During 2006, we entered into a $100 million Total Return Swap Facility (the “Facility”) with a financial institution for the purpose of accessing and isolating natural peril exposures embedded in capital market instruments. We utilized half of the Facility to enter into a $50 million catastrophe-related total return swap transaction, which was collateralized by a lien over a portfolio of the Company’s investment grade securities. During 2007, we earned contract payments, net of the Facility fee, in exchange for assuming losses from qualifying earthquake loss events. This income was included in other insurance related income (loss) in the Consolidated Statements of Operations. At December 31, 2007 and 2006, the fair value of the total return swap was negligible. The Facility will terminate on September 15, 2009.
During 2005, we terminated all existing reinsurance contracts that were accounted for as derivatives. The change in fair value of these contracts resulted in a net loss of $6 million.
On November 15, 2004, we issued $500 million of senior unsecured debt (“Senior Notes”) at an issue price of 99.785%, generating net proceeds of $496 million. The Senior Notes bear interest at a rate of 5.75%, payable semi-annually in arrears on June 1 and December 1 of each year, beginning on June 1, 2005. Unless previously redeemed, the Senior Notes will mature on December 1, 2014. We may redeem the Senior Notes at any time and from time to time, in whole or in part, at a “make-whole” redemption price. The Senior Notes indenture contains various covenants, including limitations on liens on the stock of restricted subsidiaries, restrictions as to the disposition of the stock of restricted subsidiaries and limitations on mergers and consolidations. We were in compliance with all the covenants contained in the Senior Notes indenture at December 31, 2007 and 2006.
At December 31, 2007, we had a $1.5 billion credit facility agreement with a syndicate of lenders. The credit agreement is an unsecured five-year facility that allows us to issue letters of credit up to the full amount of the facility and to borrow up to $500 million for general corporate purposes, with total usage not to exceed $1.5 billion. The credit facility will expire on August 25, 2010. On September 26, 2007, we amended the facility to modify certain definitions in order to permit dividend payments on existing and future preferred and hybrid securities notwithstanding certain events of default. All other terms and conditions remain unchanged.
The credit agreement contains various loan covenants, including limitations on the incurrence of future indebtedness, future liens, fundamental changes, investments and certain transactions with affiliates. The facility requires that we maintain 1) a minimum consolidated net worth of $2.0 billion plus (A) 25% of consolidated net income (if positive) of AXIS Capital for each semi-annual fiscal period ending on or after December 31, 2005 plus (B) an amount equal to 25% of the net cash proceeds received by AXIS Capital from the issuance of its capital stock during each such semi-annual fiscal period; and 2) a maximum debt to total capitalization ratio 0.35:1.0.
We were in compliance with all covenants at December 31, 2007 and 2006. At December 31, 2007, we had letters of credit outstanding of $306 million (2006: $365 million). There was no debt outstanding under the credit facility at December 31, 2007 and 2006.
Concentration of credit risk with respect to reinsurance recoverable balances is limited due to the number of reinsurers used on our reinsurance programs. At December 31, 2007, the top ten reinsurers accounted for 62% of reinsurance balances recoverable, one of which accounted for 16% of this balance. Of the 62%, 55 percentage points are with reinsurers rated A+, with the remainder rated A, by A.M Best.
We lease office space in the countries in which we operate under operating leases which expire at various dates. We renew and enter into new leases in the ordinary course of business as required. During 2007, total rent expense with respect to these operating leases was $12 million (2006: $10 million: 2005: $8 million). Future minimum lease payments under our leases are expected to be as follows:
In 2005, a putative class action lawsuit was filed against our U.S. insurance subsidiaries. In re Insurance Brokerage Antitrust Litigation was filed on August 15, 2005 in the United States District Court for the District of New Jersey and includes as defendants numerous insurance brokers and insurance companies. The lawsuit alleges antitrust and Racketeer Influenced and Corrupt Organizations Act (“RICO”) violations in connection with the payment of contingent commissions and manipulation of insurance bids and seeks damages in an unspecified amount. On October 3, 2006, the District Court granted, in part, motions to dismiss filed by the defendants, and ordered plaintiffs to file supplemental pleadings setting forth sufficient facts to allege their antitrust and RICO claims. After plaintiffs filed their supplemental pleadings, defendants renewed their motions to dismiss. On April 15, 2007, the District Court dismissed without prejudice plaintiffs’ complaint, as amended, and granted plaintiffs thirty (30) days to file another amended complaint and/or revised RICO Statement and Statements of Particularity. In May 2007, plaintiffs filed (i) a Second Consolidated Amended Commercial Class Action complaint, (ii) a Revised Particularized Statement Describing the Horizontal Conspiracies Alleged in the Second Consolidated Amended Commercial Class Action Complaint, and (iii) a Third Amended Commercial Insurance Plaintiffs’ RICO Case Statement Pursuant to Local Rule 16.1(B)(4). On June 21, 2007, the defendants filed renewed motions to dismiss. On September 28, 2007, the District Court dismissed with prejudice plaintiffs’ antitrust and RICO claims and declined to exercise supplemental jurisdiction over plaintiffs’ remaining state law claims. On October 10, 2007, plaintiffs filed a notice of appeal of all adverse orders and decisions to the United States Court of Appeals for the Third Circuit. We believe that the lawsuit is completely without merit and we continue to vigorously defend the filed action.
The number of antidilutive common share equivalents that were not included in the above computation of diluted earnings per common share was: 2007: nil, 2006: 881,980 and 2005: 1,106,499.
On November 23, 2005, we issued $250 million of 7.50% series B Preferred shares with a liquidation preference of $100.00 per share. We may redeem the shares on or after December 1, 2015 at a redemption price of $100.00 per share. Dividends on the series B Preferred shares if, as and when declared by our board of directors will be payable initially at a fixed rate per annum equal to 7.50% of the liquidation preference on the first day of March, June, September and December of each year, commencing on March 1, 2006, up to but not including December 1, 2015. Commencing on March 1, 2016, the dividend rate on the series B Preferred shares will be payable at a floating rate. During a floating rate period, the floating rate per annum will be reset quarterly at a rate equal to 3.4525% plus the 3-month LIBOR Rate. Dividends on the series B Preferred shares are non-cumulative. Consequently, if the board of directors does not declare a dividend for any dividend period, holders of the series B Preferred shares will not be entitled to receive a dividend for such period, and such undeclared dividend will not accumulate and will not be payable. For 2007 and 2006, the total dividends declared on series B Preferred share was $7.50 per share.
Following our shareholders’ approval at the Annual General Meeting held in May 2007, we amended our bye-laws to permit common shares repurchased to be held in treasury. During 2007, of the total share repurchases disclosed above, 5,466,044 shares were held in treasury.
We have several defined contribution plans that are self directed. Generally, mutual funds are made available pursuant to which employees and we contribute a percentage of the employee’s gross salary into the plan each month. During 2007, our total contribution expenses were $10 million (2006: $8 million and 2005: $7 million).
The weighted-average assumptions used to determine our net periodic pension cost and benefit obligations were:
Over the years we have issued stock options, restricted stocks, and phantom stock units to our employees and directors but none of these awards were subject to performance and market conditions. At December 31, 2007, 4,963,500 million equity-based awards remain available for grant under the 2007 Plan. Subsequent to December 31, 2007, we granted 29,201 common shares and phantom stock units to our directors on January 15, 2008, at a fair value of $38.92 per share and 1,558,150 restricted shares to our employees on February 4, 2008, at a fair value of $39.20 per share.
The following is a summary of stock options as of December 31, 2007, and related activity for the year ended:
* The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value (the difference between our closing stock price on the December 31, 2007, and the exercisable price, multiplied by the number of in-the-money-options) that would have been received by the stock option holders had all stock option holders exercised their stock options on December 31, 2007.
We have determined the fair value of restricted share grants using the closing price of our shares on the New York Stock Exchange on the day of the grant. The following table provides a reconciliation of the beginning and ending balance of unvested restricted stock for the year ended December 31, 2007:
During 2007, we granted 1,596,400 restricted shares (2006: 1,299,332; 2005: 900,934) to our employees and directors, with a weighted average grant-date fair value per share of $33.02 (2006: $31.01; 2005: $28.35). The total fair value of shares vested during 2007 was $13 million (2006: $3 million; 2005: $26 million). During 2007, we expensed $34 million (2006: $21 million; 2005: $20 million) in respect of restricted stock, and recorded tax benefits thereon of $6 million (2006: $3 million; 2005: $5 million). At December 31, 2007, there was $47 million of unrecognized compensation cost related to restricted stock awards, which is expected to be recognized over the weighted average period of 1.4 years. The grants in 2006 include 145,000 of modified grants issued pursuant to a severance agreement.
The collateral manager of four of our CLO’s is Blackstone Debt Advisors L.P., who is entitled to management fees payable by the collateralized obligations in the ordinary course of business. We also have investments in three hedge funds and a credit fund that are managed by Blackstone Alternative Asset Management, LP, who is entitled to management fees in the ordinary course of business. During 2007, total management fees to the Blackstone Group was $4 million (2006: $2 million). We pay Marsh & McLennan Companies, Inc (“Marsh”) brokerage and commissions, which vary based on the amount of business produced. In addition, we pay fees to Marsh relating to accounting and human resources consulting services and the placement of insurance. Effective May 2005, Marsh ceased to be a related party. We incurred brokerage fees and commissions during 2005 of $92 million.
Under current Bermuda law, we are not required to pay any taxes in Bermuda on its income or capital gains. We have received an undertaking from the Minister of Finance in Bermuda that, in the event of any taxes being imposed, we will be exempt from taxation in Bermuda until March 2016.
We also have operating subsidiaries and branch operations in Ireland, the United Kingdom, Singapore, and Switzerland which are subject to the relevant taxes in those jurisdictions. Our various European operating subsidiaries and branch operations in Ireland, the United Kingdom, and Switzerland are not under examination in any of these tax jurisdictions, but generally remain subject to examination for tax years 2003-2007.
The unaudited statutory capital and surplus, for our principal operating subsidiaries at December 31, 2007 and 2006 was as follows:
Our U.S. operations required statutory capital and surplus is determined using risk based capital tests, which is the threshold that constitutes the authorized control level. If a company falls below the control level, the commissioner is authorized to take whatever regulatory actions considered necessary to protect policyholders and creditors. The maximum dividend that may be paid by our U.S. insurance subsidiaries is restricted by the regulatory requirements of the domiciliary states. Generally, the maximum dividend that may be paid by each of our U.S. insurance subsidiaries is limited to unassigned surplus (statutory equivalent of retained earnings) and cannot exceed 10% of total statutory capital and surplus. At December 31, 2007, the maximum dividend that our U.S. insurance operations could pay without regulatory approval was approximately $71 million.
Our Irish subsidiaries are restricted from declaring dividends only out of “profits available for distribution”, which represents accumulated realized profits less its accumulated realized losses. Such profits may not include profits previously realized either by distribution or capitalization and such losses do not include amounts previously written-off in a reduction or reorganization of capital. At December 31, 2007, the maximum dividends our Irish subsidiaries could pay, without prior approval, having met minimum levels of statutory capital and surplus requirements, was approximately $57 million.