The worldwide reinsurance and insurance businesses are highly competitive, as well as cyclical by product and market. Competition in the types of reinsurance and insurance business that the Company underwrites is based on many factors, including the perceived overall financial strength of the reinsurer or insurer, ratings of the reinsurer or insurer by A.M. Best and/or Standard & Poor’s, underwriting expertise, the jurisdictions where the reinsurer or insurer is licensed or otherwise authorized, capacity and coverages offered, premiums charged, other terms and conditions of the reinsurance and insurance business offered, services offered, speed of claims payment and reputation and experience in lines written. These factors operate at the individual market participant level to varying degrees, as applicable to the specific participant’s circumstances. They also operate in aggregate across the reinsurance industry more generally, contributing, in combination with economic conditions and variations in the reinsurance buying practices of insurance companies (by participant and in the aggregate), to cyclical movements in reinsurance rates, terms and conditions and ultimately reinsurance industry aggregate financial results.
These segments are managed in a carefully coordinated fashion with strong elements of central control, with respect to pricing, risk management, control of aggregate exposures to catastrophic events, capital, investments and support operations. Management monitors and evaluates the financial performance of these operating segments based upon their underwriting results. Underwriting results include earned premium less losses and LAE incurred, commission and brokerage expenses and other underwriting expenses and are analyzed using ratios, in particular loss, commission and brokerage and other underwriting expense ratios, which, respectively, divide incurred losses, commissions and brokerage and other underwriting expenses by earned premium. For selected financial information regarding these segments, see Note 16 of Notes to Consolidated Financial Statements.
The Company’s loss ratio, which is calculated by dividing incurred losses and LAE by current year net premiums earned, improved by 21.5 points to 69.3% over the comparable 2005 period, principally due to a 30.5 point improvement on current year catastrophe losses, partially offset by 5.8 points of increased prior years reserve strengthening.
Underwriting Expenses. The Company’s expense ratio, which is calculated by dividing underwriting expenses by net premiums earned, was 23.9% in 2006 compared to 25.3% in 2005.
Net realized capital gains of $35.0 million in 2006 emanated from realized capital gains on the Company’s investments of $39.6 million, resulting principally from gains on equity securities of $31.2 million and fixed maturities of $8.4 million, partially offset by $4.6 million of realized losses on equity securities. Net realized capital gains were $64.6 million in 2005, reflecting realized capital gains on the Company’s investments of $75.9 million, resulting principally from gains on fixed maturities of $34.5 million and equity securities of $16.1 million, coupled with $25.3 million of gains from the sale of the Company’s interest only strips of mortgage-backed securities (“interest only strips”) portfolio, partially offset by $11.3 million of realized capital losses, which included $4.1 million related to the write-downs in the value of interest only strips deemed to be impaired on an other than temporary basis in accordance with Emerging Issues Task Force Issue No. 99-20, “Recognition of Interest Income and Impairment of Purchased and Retained Beneficial Interests in Securitized Financial Assets” (“EITF 99-20”).