Marine, technical risk and aviation 68,986 (28,861) 40,125 Property 77,426 (45,653) 31,773 -------- --------- ------- 146,412 (74,514) 71,898 -------- --------- ------- TOTAL LOSSES AND LOSS EXPENSES INCURRED $199,107 $(115,768) $83,339 ======== ========= =======
including those related to natural catastrophe events. We expect that the companies to which insurance has been ceded or reinsurance has been retroceded will be recoverable. The average credit rating of these entities is rated "A" (excellent) by A.M. Best.
Our investment income depends on the average invested assets in our investment portfolios and the yield that we earn on those invested assets. Our investment yield is a function of market interest rates and the credit quality and maturity period of our invested assets. Our investment portfolio consists principally of fixed income securities, short-term liquidity funds, cash, and cash equivalents. In addition, we realize capital gains or losses on sales of investments as a result of changing market conditions, including changes in market interest rates and changes in the credit quality of our invested
Net loss and loss expenses, which are net of loss and loss expenses recovered under our ceded reinsurance contracts, depend on the number and type of insurance and reinsurance contracts we write and reflect our best estimate of ultimate losses and loss expenses we expect to incur on each contract written using various actuarial analyses. Actual losses and loss expenses will depend on actual costs to settle insurance and reinsurance claims. Our ability to accurately estimate expected ultimate loss and loss expense at the time of pricing each insurance and reinsurance contract and the occurrence of unexpected high loss severity catastrophe events are critical factors in determining our profitability.
The financial ratios we use include the net loss and loss expense ratio, the acquisition expense ratio and the general and administrative expense ratio. Our net loss and loss expense ratio is calculated as net losses and loss expenses incurred divided by net premiums earned. Because our underwriting portfolios continue to change significantly, we expect that our net loss ratios may continue to be volatile. Our acquisition expense ratio is calculated by dividing acquisition expenses by net premiums earned. Our net loss and loss expense ratio and acquisition expense ratio provide a measure of the current profitability of the earned portions of our written insurance and reinsurance contracts. Our
The following is a discussion of Quanta Holdings' consolidated results of operations for the years ended December 31, 2005 and 2004. Comparisons between the year ended December 31, 2004 and the period from May 23, 2003 (date of incorporation) to December 31, 2003 are not meaningful because we commenced substantive operations on September 3, 2003 and during the period from May 23, 2003 (date of incorporation) to December 31, 2003, we wrote only a small number of insurance and reinsurance contracts. We separately provide a discussion for the period from May 23, 2003 (date of incorporation) to December 31, 2003. The discussion and analysis of Quanta Holdings' results include the results of ESC, our predecessor, from September 3, 2003, the date Quanta Holdings acquired ESC, through December 31, 2004.
Our total net loss ratio (calculated by dividing net losses and loss expenses by net premiums earned) was 89.0% for the year ended December 31, 2005, an increase of 5.1% compared to a total net loss ratio of 83.9% for the year ended December 31, 2004. The increase in the total net loss ratio is due both to the greater magnitude of the hurricanes that occurred in the second half of 2005 as compared to those that occurred in the third quarter of 2004 and to the oil pipeline loss. However, the extent of
Our acquisition expense ratio for the year ended December 31, 2005 was 19.1%, a decrease of 3.7% compared to our acquisition expense ratio of 22.8% for the year ended December 31, 2004. The decrease is due to four factors. First, during 2005, our earned premium was more heavily weighted towards specialty insurance, which carries lower acquisition costs than specialty reinsurance. Second, we are paying less fronting costs on our specialty insurance lines because we are licensed in more states and no longer need to utilize fronting companies to the same extent in order to write our business. Third, our ceding commission income that we are recovering on our specialty insurance segment's reinsurance treaties increased during 2005 as a result of the restructuring of those treaties during the second quarter of 2005. Finally, we paid less commission in our HBW program during 2005 because the contracts contain sliding scale commission provisions that vary with changes in the selected loss ratio. Deferred acquisition costs include, as of December 31, 2005, $33.1 million of acquisition expenses on written contracts of insurance and reinsurance that will be amortized in future periods as the premiums written to which they relate are earned.
Interest expense. Interest expense was $4.2 million for the year ended December 31, 2005, an increase of $4.1 million compared to $0.1 million for the year ended December 31, 2004 and relates to the interest expense on our junior subordinated debentures.
The following is a discussion of our net underwriting results and profitability measures by segment for the years ended December 31, 2005 and 2004, and separately for the period from May 23, 2003 (date of incorporation) to December 31, 2003. Since we commenced substantive operations on September 3, 2003 and only wrote a small number of insurance and reinsurance contracts during the period from May 23, 2003 (date of incorporation) to December 31, 2003, comparisons between the year ended December 31, 2004 and the period from May 23, 2003 (date of incorporation) to December 31, 2003 are not meaningful.
The following table summarizes our net underwriting results and profitability measures for our segments for the years ended December 31, 2005 and 2004.
2005 2004 ------------------- ------------------- ($ in thousands) Gross Net Gross Net premiums premiums premiums premiums written written written written -------- -------- -------- -------- Technical risk property(1)......... $187,474 $114,377 $142,838 $101,650 Professional liability(2).......... 129,238 94,334 47,286 36,467 Environmental liability............ 40,009 23,464 35,914 20,906 Fidelity and crime................. 13,197 6,654 9,040 4,243 Surety............................. 12,041 9,370 5,627 5,301 Trade credit and political risk.... 7,574 6,022 1,875 1,754 Structured insurance............... 1,289 1,289 -- -- Other.............................. 1,201 1,053 -- -- -------- -------- -------- --------- Total.............................. $392,023 $256,563 $242,580 $170,321 ======== ======== ======== ========
As part of our year-end closing process, we strengthened our loss reserves for 2005 by approximately $13.2 million. Given the immaturity of our business and very limited claims history, we have relied on pricing, loss and expense data accumulated by our consulting actuary, historical industry results, and to a limited extent, our own reported claims history in establishing loss ratios for each line of business. Although we have not experienced significant reported claims in our specialty insurance lines, other than those related to the 2005 hurricanes and the oil pipeline, we have worked closely with our independent loss specialist and concluded to generally strengthen our loss ratios in our HBW program, Lloyd's and environmental lines with respect to the year ended December 31, 2005.
additional number of employees hired throughout 2004 and 2005. The increase is also attributed to severance costs, increases in auditing fees, fees associated with ongoing efforts relating to Sarbanes-Oxley Section 404 compliance and costs relating to information technology development, which were allocated to our specialty reinsurance segment. Our general and administrative expense ratio was 15.1% for the year ended December 31, 2005 compared to 13.2% for the year ended December 31, 2004.
Quanta Holdings is organized as a Bermuda holding company, and as such, has no direct operations of its own. Our assets consist of investments in our subsidiaries through which we conduct substantially all of our insurance, reinsurance and technical services operations. As of December 31, 2005, we had operations in the U.S., Bermuda, Ireland and the U.K., including Syndicate 4000.
We are subject to large losses, including those relating to the 2005 hurricanes. Since the timing and amount of losses from such exposures is unknown, we invest our assets so that should an event occur, we would have sufficient liquidity to pay claims on the underlying contracts. As of December 31, 2005, the average duration of our investment portfolio was approximately 2.6 years with an average credit rating of approximately "AA+." If a default occurs under the credit agreement, our lenders may require us to cash collateralize a portion or all of the outstanding letters of credit issued under the facility, which may be accomplished through the substitution or liquidation of collateral. These events may cause us to incur capital losses. Should additional loss events actually occur, we believe we have dedicated assets, including cash equivalents and other short-term investments, in such a manner that cash would be on hand to pay those claims. As a result of these steps, we believe we have sufficient liquidity to meet the currently foreseen need of our clients. We also believe our operating subsidiaries have sufficient assets to pay their respective currently foreseen liabilities as they become due. We also believe that our operating subsidiaries can distribute sufficient funds to Quanta Holdings to enable Quanta Holdings to pay its currently foreseen liabilities as they become due, subject to the constraints under the Companies Act that affect our ability to pay dividends on our shares.
Some of our contracts include retrospective rating provisions that adjust estimated premiums or acquisition expenses based upon experience and underwriting results. We also write certain structured insurance and reinsurance contracts as risk management solutions that cannot otherwise be provided by traditional contracts. Typically, we assume a measured amount of risk in exchange for a premium, a specified portion of which may be returnable to the insured based on the level of loss experience or underwriting profitability. Adjustments related to retrospective rating provisions that adjust estimated premiums or acquisition expenses are recognized over contract periods in accordance with the underlying contract terms based on current experience under the contracts. Reinstatement premiums that reinstate coverage limits under pre-defined contract terms and are triggered by the occurrence of a loss are written and earned at the time the associated loss event occurs. The original contract premium is earned over the remaining exposure period of the contract. Profit commissions are expenses that vary with and are directly related to acquiring new and renewal insurance and reinsurance business. Profit commission accruals are recorded in acquisition costs and are adjusted at the end of each reporting period based on the experience of the underlying contract. No claims bonuses are accrued as a reduction of earned premium and are adjusted at the end of each reporting period based on the experience of the underlying contract. Retrospective rating adjustments are necessarily based on underwriting results that include certain estimates relating to premiums and losses, and are therefore subject to adjustment as underwriting experience develops and actual underwriting results become known.
As of December 31, 2005, our net deferred tax assets were $24.8 million against which we provided a 100% valuation allowance on the basis that, given our limited operating history, the realization of deferred tax assets from our anticipated future taxable income is neither assured nor accurately determinable. If we subsequently assess that the valuation allowance, or any portion thereof, is no longer required an income tax benefit will be recorded in net income in the period in which such assessment is made.
Our publicly traded and non-publicly traded fixed maturity, short-term investments and equity securities that are classified as available-for-sale are recorded at estimated fair value with the difference between cost or amortized cost and fair value, net of the effect of taxes, included as a separate component of accumulated other comprehensive income (loss) in the consolidated balance sheet. Our publicly traded and non-publicly traded fixed maturity and short-term investments that are classified as trading are recorded at estimated fair value with the change in fair value included in net realized gains on investments in the consolidated statement of operations and comprehensive (loss) income.
Short-term investments include highly liquid debt instruments and commercial paper that are generally due within one year of the date of purchase and are held as part of our investment portfolios that are managed by independent investment managers. The fair value of publicly traded securities is based upon quoted market prices. The estimated fair value of non-publicly traded securities is based on independent third party pricing sources.
In December 2004, the FASB issued Statement of Financial Accounting Standards ("SFAS") No. 123 (revised 2004) "Share-based payment" ("SFAS 123(R)"). SFAS 123(R) replaces SFAS No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123") and supersedes Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" and related interpretations ("APB 25"). Generally, the approach in SFAS 123(R) is similar to SFAS 123, however, SFAS 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the consolidated financial statements based on their fair values and, accordingly, SFAS 123(R) does not allow pro forma disclosure as an alternative to financial statement recognition. SFAS 123(R) is effective for the beginning of the first annual period beginning after September 15, 2005.