The following overview of our 2004, 2005 and 2006 operating results and financial condition is intended to identify important themes and should be read in conjunction with the more detailed discussion further below.
Net income. For 2006 we reported income after taxes of $378.1 million with positive contributions from all of our four operating segments and an increase of 68.5% in net investment income.
January is an important renewal month for our reinsurance segment and much of our specialty lines, representing about 30% of our expected gross premium for the full year.
Casualty Reinsurance. Casualty reinsurance pricing is reflecting modest declines in rates on original business, particularly on programs with zero or minimal loss activity. In our international casualty account, we recorded average rate declines on a premium weighted average basis of approximately 3%. In our U.S. casualty treaty account we expect rates to trend down, with workers’ compensation catastrophe reinsurance experiencing the most downward movement.
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 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.
The latest estimate of the insured loss arising from Hurricane Katrina published by PCS on December 8, 2006 was $40.679 billion which entitles the Company to a recovery of approximately $21 million of which $19.7 million was paid to us during 2006. Based on the record of increasing PCS estimates following previous natural catastrophe losses in the United States, we expect that future estimates by PCS of this loss will increase. We have taken this and the illiquid nature of the catastrophe risk transfer swap market into account in our valuation of this contract as at December 31, 2006. As there is no quoted market value available for this derivative, the fair value is determined by management using internal models taking into account changes in the market for catastrophe reinsurance contracts with similar economic characteristics and the potential for recoveries from events preceding the valuation date. The amount recognized could be materially different from the amount realized in actual payments to us made under the contract.
The following tables summarize gross and net premiums written and earned, underwriting results, and combined ratios and reserves for each of our four business segments for the twelve months ended December 31, 2006, 2005 and 2004.
The reduction in gross written premiums in the property reinsurance segment in 2006 was due to the change in our approach to catastrophe risk management which resulted in the planned non-renewal of, or reduced participation in, certain catastrophe exposed contracts, particularly in the risk excess and proportional lines of business. There was also a reduction in loss related reinstatement premiums between 2005 and 2006 of $59.6 million. In 2004 reinstatement premiums and other similar revenues of $14.7 million were recognized.
Reinsurance ceded. Reinsurance costs in 2006 decreased by $146.7 million compared to 2005 primarily as a result of the $116.5 million of additional ceded premiums to reinstate reinsurance protections following the 2005 hurricanes (2004-$104.4 million). There was also less spent in 2006 on lower level retrocessional contracts that respond to a second or subsequent loss in the same year because the market for this type of cover became prohibitively expensive following the multiple storm losses of 2004 and 2005.
There were no material property reinsurance losses reported in 2006 year and therefore the most significant loss reported in the year has been the deterioration in the 2005 hurricane loss estimates in the period. The balance of losses, excluding the losses described above, was $174.2 million in 2006 (2005-$185.7 million, 2004-$82.8 million) representing 35.5% of net premiums earned (2005- 37.3%, 2004-17.6%). In 2006, we also recorded a $5.3 million reserve strengthening in addition to that required for the 2005 windstorm losses. This represented 1% of net earned premiums. Similarly, in 2005 additions to reserves of $13.9 million represented 2.8% of net earned premiums whereas in 2004, we recognized a $17.1 million reserve release (3.6% of net earned premiums). In 2004, we benefited from a very low level of reported losses, whereas in 2005 and 2006, we experienced a higher than expected level of attritional losses mainly from lower layers of risk excess programs which have now been discontinued.
Gross premiums written. Gross premiums written decreased by 7.8% in 2006 compared to 2005. The table below shows our gross premiums written for each line of business for each of 2006, 2005 and 2004, and the percentage change in gross premiums written for each line:
The reduction in U.S. treaty business in 2006 was due to the $3.0 million reduction in premiums written by our structured risk team (2006-$52.4 million; 2005-$55.4 million) and a slight reduction in premiums written by our U.K.-based U.S. Casualty team. The reduction in premium for the non-U.S. treaty business line was due to a slight reduction in premium rates in 2006 and the loss of a small number of large contracts. The increase in U.S. Casualty business in 2005 was mainly due to the impact of the new structured business and also a decision to expand this business line.
Losses and loss adjustment expenses. Losses and loss adjustment expenses decreased by $42.7 million between 2006 and 2005 due to the recognition of $60.3 million of prior year reserve releases, an increase of $46.4 million over the $13.9 million released in 2005. Our losses and loss adjustment expenses increased in 2005 by $76.1 million from $252.2 million in 2004, which was as a result of the expansion in premiums written and in line with the increase in the gross premiums earned between 2004 and 2005.
segment until a considerable time has passed, however incurred claims development in the twelve months ended December 31, 2004 resulted in a small increase in the projected loss ratio for this class of business giving rise to a strengthening of reserves of $0.6 million.
As at December 31, 2006 and 2005, Aspen Holdings held $46.0 million and $203.7 million, respectively, in cash and cash equivalents which management considers sufficient to provide us liquidity at such time. Of the funds held at December 31, 2005 $150.0 million was subsequently applied to provide additional capital funding to Aspen Re. Holding company liquidity depends on dividends, capital distributions and interest payments from our Insurance Subsidiaries.
In 2006, Aspen U.K. Holdings paid us a dividend of $35 million (2005 - $17.0 million). No other dividends were paid to us in 2006 or 2005. We also received interest of $26 million (2005 - $26.0 million) from Aspen U.K. Holdings in respect of an intercompany loan.
The ability of our Insurance Subsidiaries to pay us dividends or other distributions is subject to the laws and regulations applicable to each jurisdiction, as well as the Insurance Subsidiaries’ need to maintain capital requirements adequate to maintain their insurance and reinsurance operations and their financial strength ratings issued by independent rating agencies. For a discussion of the various restrictions on our ability and our Insurance Subsidiaries’ ability to pay dividends, see ‘‘Business-Regulatory Matters’’ in Part I, Item 1 in this report.