Our corporate offices are located in 101,420 total square feet of leased space in Stamford, Connecticut. Our other locations occupy a total of 121,086 square feet, all of which are leased. The Americas division operates out of offices in New York, Stamford, Mexico City, Miami, Santiago and Toronto, the EuroAsia division operates out of offices in Paris, Singapore, Stockholm and Tokyo, the London Market division operates out of offices in London and Bristol, and the U.S. Insurance division operates out of offices in New York, Chicago and Napa.
Our gross premiums written for the year ended December 31, 2005 were $2,626.9 million, a decrease of $23.9 million, or 0.9%, compared to gross premiums written for the year ended December 31, 2004 of $2,650.8 million. Our business outside of the United States accounted for 44.8% of our gross premiums written for the year ended December 31, 2005, compared to 45.7% for the year ended December 31, 2004. For the years ended December 31, 2005 and 2004, our net premiums written were $2,301.7 million and $2,361.8 million, respectively. For the year ended December 31, 2005, we had a net loss available to common shareholders of $105.4 million and for the year ended December 31, 2004, we had net income of $198.3 million. As of December 31, 2005, we had total assets of $8.6 billion and total shareholders’ equity of $1.6 billion.
The property and casualty reinsurance and insurance industries use the combined ratio as a measure of underwriting profitability. The GAAP combined ratio is the sum of losses and loss adjustment expenses (“LAE”) incurred as a percentage of net premiums earned, plus underwriting expenses, which include acquisition costs and other underwriting expenses, as a percentage of net premiums earned. The combined ratio reflects only underwriting results, and does not include investment results. Underwriting profitability is subject to significant fluctuations due to catastrophic events, competition, economic and social conditions, foreign currency fluctuations and other factors. Our combined ratio was 117.6% for the year ended December 31, 2005, compared to 97.2% for the year ended December 31, 2004.
The accompanying consolidated financial statements and related notes have been prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) and include the accounts of
Acquisition costs consist of commissions and brokerage expenses incurred on insurance and reinsurance business written. These costs are deferred and amortized over the period in which the related premiums are earned, which is generally one year. Deferred acquisition costs are limited to their estimated realizable value based on the related unearned premiums, which considers anticipated losses and LAE and estimated remaining costs of servicing the business, all based on our historical experience. The estimates are continually reviewed by us and any adjustments are made in the accounting period in which an adjustment is considered necessary.
The U.S. Insurance division reported net favorable loss development for prior years of $9.0 million and $1.2 million for calendar years 2005 and 2004, respectively, and net adverse development for the 2003 calendar year of $1.4 million. The reduction in prior year loss estimates during calendar year 2005 results from favorable loss emergence trends for medical malpractice.
The Whole Account Excess of Loss Agreements provide that we may withhold a significant portion of the premium payable to the retrocessionaires in funds held accounts, which, under certain circumstances, may be set-off against the retrocessionaires’ losses and other obligations owed to us. These funds are shown as a liability in our consolidated balance sheets as funds held under reinsurance contracts. Interest on the funds held account, calculated using a contractual fixed interest rate of approximately 7.0% for those agreements with amounts ceded, is credited quarterly by us, which results in an increase in the funds held account balance and is recorded as an expense, reducing our investment income. Loss payments are deducted from the funds held account balance, which reduces the liability as such payments are made.
subject written premium income for underwriting year 1998, and 18.9% for 1999 and 2000. A minimum interest credit is applied to the loss payment account, equal to the one year U.S. Treasury Bill yield plus 75 basis points. As of December 31, 2005, the loss payment account had a zero balance.
Net premiums earned for the year ended December 31, 2005 were reduced by $13.9 million in premiums ceded to our Whole Account and Facultative Excess of Loss Agreements, which represent an increase of $7.3 million, or 110.8%, from $6.6 million for the year ended December 31, 2004.
The following table reflects losses and LAE for the London Market division as reported, and includes the impact of catastrophe losses and prior period reserve development, expressed as a percentage of net premiums earned for the years ended December 31, 2005 and 2004 (in millions):
For the London Market division, losses and LAE increased 18.8% to $348.8 million for the year ended December 31, 2005 from $293.6 million for the year ended December 31, 2004. This resulted in a loss and LAE ratio of 90.3% for the year ended December 31, 2005, compared to 69.4% for the year ended December 31, 2004. The increase in losses and LAE was related to losses of $141.6 million from catastrophe events, of which $131.9 million is attributable to Hurricanes Katrina, Rita and Wilma. Losses and LAE in the 2005 period include a benefit of $23.6 million attributable to 2004 and prior years, principally related to satellite, non-catastrophe property and auto liability exposures (includes $1.7 million of prior period catastrophe losses). For the year ended December 31, 2004, losses and LAE reflect $21.4 million for property catastrophe events including the 2004 Florida Hurricanes. Losses and LAE in the 2004 period include a benefit of $0.2 million attributable to 2003 and prior years (includes a benefit of $0.3 million from prior period catastrophe losses).
Acquisition Costs. Acquisition costs for the year ended December 31, 2005 were $470.2 million, a decrease of $45.7 million or 8.9%, compared to $515.9 million for the year ended December 31, 2004. The resulting acquisition expense ratio, expressed as a percentage of net premiums earned, was 20.6% for the year ended December 31, 2005, compared to 22.1% for the year ended December 31, 2004, a decrease of 1.5 points. The Americas and London Market divisions’ acquisition ratios decreased by 2.1 points and 2.4 points respectively, due to the change in composition of the mix of business written, while the EuroAsia division had a slight increase of 0.5 points. The U.S. Insurance division increased 3.9 points due to a decrease in ceded commissions as the division continues to increase its net retentions.
Our total effective annualized yield on average invested assets, net of expense but before the impact of interest expense from funds held balances and the positive impact of realized gains attributable to HWIC Asia, was 3.8% and 3.9% for the years ended December 31, 2005 and 2004, respectively. Also excluding the negative impact of the 2005 losses attributable to Advent, our total effective annualized yield, net of expenses but before the impact of interest expense from funds held balances, was 4.1% and 3.8% for each of the years ended December 31, 2005 and 2004, respectively.
Interest expense on funds held primarily relates to our Whole Account and Facultative Excess of Loss Agreements, which is included in investment expenses, was $18.7 million for the year ended December 31, 2005, representing a decrease of $1.4 million, or 7.0%, from $20.1 million for the year ended December 31, 2004. The lower amount of interest expense was due to reduced amounts ceded to the treaties in 2004, which resulted in lower interest expense associated with ceded amounts during the period.
securities and other invested assets and $17.6 million relating to equity securities. Other-than temporary impairments reflect situations where the market value was below the cost of the securities and the ability of the security to recover its value could not be reasonably determined. Other-than temporary impairments also include $19.4 million for securities which have no quoted prices, to reflect the deterioration in the underlying financial position of the securities. There were no other-than-temporary impairment losses during the year ended December 31, 2004.
Gross Premiums Written. Gross premiums written for the year ended December 31, 2004 increased by $98.5 million, or 3.9%, to $2,650.8 million, from $2,552.3 million for the year ended December 31, 2003, as reflected in the following table (in millions):
Americas. Gross premiums written in the Americas division for the year ended December 31, 2004 were $1,257.5 million, a decrease of $158.0 million or 11.2% as compared to $1,415.5 million for the year ended December 31, 2003. These amounts represented 47.4% of our gross premiums written for the year ended December 31, 2004 and 55.5% in 2003. Gross premiums written in 2004 include reinstatement premiums of $5.0 million which principally relates to the 2004 Florida Hurricanes. Excluding reinstatement premiums in 2004, gross premiums written would be $1,252.5 million for the year ended December 31, 2004, representing a decrease of $163.0 million, or 11.5% over the period. Gross premiums written across each geographic region of the Americas are as follows:
Our total effective annualized yield on average invested assets, net of expenses but excluding the impact of interest expense from funds held balances and the positive impact of realized gains attributable to our equity investment in HWIC Asia, was 3.9% and 3.6% for the years ended December 31, 2004 and 2003, respectively.
During 2004, we did not recognize any other-than-temporary impairment losses on our investment portfolio. Included in net realized investment gains, for the year ended December 31, 2003 are $58.8 million of realized losses on the other-than-temporary write-down of certain fixed income and equity securities.
In June 2002, we issued $110.0 million aggregate principal amount of convertible senior debentures due 2022 (“Convertible Notes”). Interest accrues on the Convertible Notes at a fixed rate of 4.375% per annum, which is due semi-annually on June 15 and December 15. The Convertible Notes have been redeemable at our option since June 22, 2005. Each holder of Convertible Notes may, at its option, require us to repurchase all or a portion of its Convertible Notes on June 22, 2007, 2009, 2012 and 2017. Under certain circumstances specified in the indenture under which the Convertible Notes were issued, each Convertible Notes holder has the right to convert its Convertible Notes into 46.9925 of our common shares for every $1,000 principal amount of the
During the second quarter of 2004, Odyssey America pledged to the Society and Council of Lloyd’s the equivalent of £110 million of U.S. Treasury Notes (“the pledged assets”) on behalf of Advent Capital (Holdings) PLC (“Advent”) to support Advent’s underwriting activities for the 2001 to 2005 underwriting years of account. Advent is 46.8% owned by Fairfax and its affiliates, which includes 15.0% held by us. nSpire Re Limited (“nSpire Re”), a subsidiary of Fairfax, had previously pledged assets at Lloyd’s on behalf of Advent pursuant to a November 2000 agreement with Advent. Advent is responsible for the payment of any losses to support its underwriting activities and the capital resources of Advent are first available to support any losses prior to a draw down of Odyssey America’s pledged assets. In consideration of Odyssey America pledging the assets, nSpire Re agreed to pay Odyssey America a fee equal to 2.0% per annum of the pledged assets, which we consider to be representative of commercial market terms. The pledged assets continue to be owned by Odyssey America, and Odyssey America receives any investment income thereon. The securities are carried at fair value under total investments and cash in our consolidated financial statements and are classified as available for sale. As additional consideration for, and further protection of, the pledged assets, nSpire Re has provided Odyssey America with indemnification in the event of a draw down on the pledged assets. Odyssey America retains the
The Emerging Issues Task Force (“EITF”) Issue 4-08 “The Effect of Contingently Convertible Instruments on Diluted Earnings Per Share,” which is effective for periods ending after December 15, 2004, requires that the dilutive effect of contingently convertible debt securities, with a market price threshold, should be included in diluted earnings per common share. The terms of our convertible senior debentures (see Note 12 to our consolidated financial statements included in this Form 10-K) meet the criteria defined in EITF Issue 4-08, and accordingly, the effect of conversion of our convertible notes to common shares has been assumed when calculating our diluted earnings per common share for those periods where the effect is dilutive. The diluted earnings per common share for the year ended December 31, 2003 have been restated to conform to the requirements of EITF Issue 4-08. See Note 5 to our consolidated financial statements included in this Form 10-K.
The term “market risk” refers to the risk of loss arising from adverse changes in prices. We believe that we are principally exposed to four types of market risk related to our investment operations. These risks are interest rate risk, credit risk, equity price risk and foreign currency risk. Market sensitive instruments discussed in this section principally relate to our fixed income securities and common stocks carried at fair value which are classified as available for sale. As of December 31, 2005, our total investments and cash of $5.9 billion includes $2.6 billion of fixed income securities that are subject primarily to interest rate risk and credit risk.
The following table provides a payment schedule of present and future obligations (in millions):
(v) Other unrelated adjustments of an immaterial nature that were previously recorded by the Company in the first quarter of 2005. As part of the restatement, these adjustments were applied to the periods in which they occurred. There is no cumulative effect to shareholders’ equity as of September 30, 2005, with the net effect of increasing the net loss for the nine months ended September 30, 2005 by $5.3 million and increasing 2004 net income by $5.3 million.
(h) Income Taxes. The Company records deferred income taxes to provide for the net tax effect of temporary differences between the carrying values of assets and liabilities in the Company’s consolidated financial statements and their tax bases. Such differences relate principally to deferred acquisition costs, unearned premiums, unpaid losses and loss adjustment expenses and investments. When appropriate, deferred tax assets are reduced by a valuation allowance when the Company believes it is more likely than not that all or a portion of deferred taxes will not be realized. The Company is a member of the United States tax group of Fairfax. Inclusion
In connection with the short sales described above, the Company purchased a SPDR call option as protection at a cost of $1.5 million. The call option is recorded at fair value in other liabilities in the consolidated balance sheet and changes in the fair value are recorded as a realized gain or loss in the consolidated statements of operations in the period in which they occur. As of December 31, 2005 and 2004, the net change in the fair value of the call option resulted in a net realized loss of $1.2 million and a net realized gain of $0.4 million, respectively.
Several individual reinsurers are part of the same corporate group. The following table shows the five largest aggregate amounts that are recoverable from all individual entities that form part of the same corporate group as of December 31, 2005 and the amount of collateral held from each group (in thousands).
In December 2001, the Company issued $100.0 million aggregate principal amount of senior notes due November 30, 2006, pursuant to a private placement. Interest accrues on the senior notes at a fixed rate of 7.49% per annum, which is due semi-annually on May 31 and November 30. In November 2003 and June 2002, the Company prepaid $50.0 million and $10.0 million, respectively, aggregate principal amount of the 7.49% senior notes. Immediately following the issuance of the 7.49% senior notes, the Company entered into an interest rate swap agreement that effectively converted the fixed 7.49% interest rate into a variable rate of interest. In May 2003, the Company settled the interest rate swap for a pre-tax gain of $6.4 million. In accordance with hedge accounting, a basis adjustment equivalent to the $6.4 million pre-tax gain was made, increasing the carrying value of the 7.49% senior notes. The basis adjustment is being recognized into income over the remaining life of the 7.49% senior notes. In conjunction with the prepayment of the 7.49% senior notes, a portion of the basis adjustment was immediately realized. As of December 31, 2005, the aggregate principal amount of the 7.49% senior notes outstanding was $40.0 million and the remaining basis adjustment was $0.7 million. Pursuant to the terms of the Company’s 7.49% senior notes, the Company is subject to certain covenants, none of
which significantly restricts the Company’s operating activities or dividend-paying ability. The Company was in compliance with all covenants.
The Company’s assumed financial guaranty reinsurance exposure to loss, in the event of nonperformance by the underlying insured and assuming underlying collateral proved to be of no value, was $35.3 million and $55.7 million as of December 31, 2005 and 2004, respectively. It is the responsibility of the ceding insurer to collect and maintain collateral under financial guaranty reinsurance. The Company ceased writing financial guaranty business in 1992.