When determining reserves, we also consider additional historical data, industry loss trends, legal developments, changes in social attitudes and economic conditions, including the effects of inflation. Rapidly changing economic conditions will increase the inherent uncertainty of the reserve estimates. As additional data becomes available and is reviewed, we revise our Bermuda/Dublin reinsurance reserve estimates to reflect this additional data, which may result in increases or decreases to reserves for insured events of prior years. These adjustments are recorded in the period they are determined. The table below breaks our Bermuda/Dublin reinsurance reserves as of December 31, 2009 and 2008 into casualty and property components.
Our balance sheet reserves for 2001 and each subsequent balance sheet date through 2004 in the above tables shows the effects of the development on two specific contracts recorded in 2005. The development on these two contracts in the years subsequent to 2004 has not been significant. The first contract increased 2001 reserves by $50.2 million, with the recording of such increased losses triggering additional premiums and interest on additional premiums of $49.3 million, which are not reflected in the table above. The second contract increased 2002 reserves by $49.6 million, 2003 reserves by $64.8 million and 2004 reserves by $15.3 million, for a total increase of $129.7 million. The adverse development triggered additional premiums and interest on such additional premiums of $105.3 million, which are not reflected in the table above.
establish these estimates based upon transaction specific historical experience, information provided by the ceding company and industry experience studies. Actual results could differ materially from these estimates. As the experience on the contracts emerges, the assumptions are reviewed by management. We determine whether actual and anticipated experience indicates that existing policy reserves, together with the present value of future gross premiums, are sufficient to cover the present value of future benefits, settlement and maintenance costs and to recover unamortized acquisition costs. If such a review produces reserves in excess of those currently held then the lock-in assumptions are revised and a life and annuity benefit is recognized at that time.
Net favorable loss development of prior year reserves in 2008 of $68.1 million compared to $49.3 million of net favorable development in 2007. This loss development arises from the re-estimation of liabilities from our quarterly and annual actuarial review process. It includes gains on the final settlement, or commutation, of prior year reinsurance reserves, and excludes changes in reserves resulting from changes in premium estimates;
Interest expense relates to interest on funds withheld from reinsurers, certain deposit liabilities, and the variable quota share retrocession agreement with Grand Central Re. The interest expense on funds withheld from Grand Central Re is based on the average of two total return fixed maturity indices, which varies from period to period.
premiums ceded to premiums written has trended downwards over the last two years and we expect this to continue and then stabilize as the segment’s capital base increases.
Net realized and unrealized gains (losses) on investments include the following:
We reduced the allocation to our hedge fund portfolio from 14.1% of invested assets as of December 31, 2008 to 6.0% as of December 31, 2009. The objective of our hedge fund portfolio is to achieve a market neutral/absolute return strategy, with diversification by strategy and underlying fund. A market neutral strategy strives to generate consistent returns in both up and down markets by selecting long and short positions with a total net exposure of zero. Returns are derived from the long/short spread, or the amount by which long positions outperform short positions. The objective of an absolute return strategy is to provide stable performance regardless of market conditions, with minimal correlation to market benchmarks.
Certain funds in which we are invested have a lock-up period. A lock-up period refers to the initial amount of time an investor is contractually required to invest before having the ability to redeem. Funds that do provide for periodic redemptions may, depending on the funds’ governing documents, have the ability to deny or delay a redemption request, called a gate. The fund may implement this restriction because the aggregate amount of redemption requests as of a particular date exceeds a specified level, generally ranging from 15% to 25% of the fund’s net assets. The gate is a method for executing an orderly redemption process which allows for redemption requests to be executed in a timely manner to reduce the possibility of adversely affecting the remaining investors in the fund.
In the ordinary course of business, we are required to provide letters of credit or other regulatory approved security to certain of our clients to meet contractual and regulatory requirements. As of December 31, 2009, we had two letter of credit facilities totaling $675.0 million with an additional $200.0 million available subject to certain conditions. On that date, we had $461.3 million in letters of credit outstanding under these facilities. We also have a GBP 90.0 million ($145.5 million) letter of credit facility supporting our Funds at Lloyd’s commitments, of which GBP 63.6 million ($102.9 million) was utilized as of December 31, 2009. Each of our credit facilities requires that we comply with certain covenants, which may include a minimum consolidated tangible net worth, a minimum insurer financial strength rating and restrictions on the payment of dividends. We were in compliance with all the covenants of each of our credit facilities at December 31, 2009.