Gross premiums earned during 2007 were $623.6 million, a decrease of 11% compared to 2006. This decrease was the result of the aforementioned decrease in, as well as the timing of the writing of, gross premiums in 2007.
We estimated our gross and net loss and LAE reserves using the methodology outlined in our “Summary of Critical Accounting Estimates” contained in Item 7 herein. We did not make any significant changes in the assumptions or methodology used in our reserving process during the year ended December 31, 2007.
The significant increase in our incentive compensation from 2006 to 2007 is the result of: (i) having two cycles of performance shares outstanding versus only one cycle during 2006 (all performance shares issued for the 2005 - 2007 performance period were cancelled without payment as there was no expected payout related to this tranche due to the adverse financial effects of the 2005 hurricanes); (ii) having two cycles of restricted share units (“RSUs”) outstanding versus only one cycle outstanding during 2006 (we began utilizing RSUs as a primary source of our incentive compensation in 2006); and (iii) incurring approximately $0.9 million in incentive compensation during the second half of 2007 in connection with our newly established insurance and reinsurance operations. The significant increase in incentive compensation from 2005 to 2006 is primarily due to a 2005 reversal of all of our outstanding incentive compensation liabilities to zero due to the adverse financial effects of the 2005 hurricanes.
Net foreign exchange gains (losses) during the years ended December 31, 2007, 2006 and 2005 were $6.1 million, $10.8 million and $(10.0) million, respectively. Our net foreign exchange gains (losses) arise from the effects of fluctuations in exchange rates relating to our investments, premiums receivable and loss reserves that are denominated in foreign currencies. The foreign exchange gains (losses) during 2007, 2006 and 2005 are primarily due to the weakening (strengthening) of the U.S. dollar against the various foreign currencies in which we transact.
In November 2007, we acquired MUSIC for $9.8 million and acquired, as part of the acquisition, $3.1 million of cash and cash equivalents.
During 2007, we repurchased 3,776,989 common shares, through a series of public transactions, for a total purchase price $63.8 million of which $4.1 million was unsettled at December 31, 2007.
During 2006, we issued the Junior Subordinated Debt and the Blue Ocean Debt and received cash proceeds of $173.3 million.
Loss and LAE reserves are estimates of amounts needed to pay losses and related expenses in the future for insured events that have already occurred. The process of estimating loss and LAE reserves involves a considerable degree of judgement and is inherently uncertain.
The nature and extent of management judgment involved in the reserving process depends upon whether the subject business is insurance or reinsurance and whether it is written on an excess of loss or a proportional basis.
Most of our reinsurance contracts comprise business which has both a low frequency of claims occurrence and a high potential severity of loss, such as claims arising from natural catastrophes, terrorism, large individual property risks, and aviation risks. Given the high-severity, low-frequency nature of these events, the losses typically generated do not lend themselves to traditional actuarial reserving methods. Therefore, our reserving approach for these types of coverages is generally to estimate the ultimate cost associated with a single loss event rather than analyzing the historical development patterns of past losses as a means of estimating ultimate losses for an entire accident year. We generally estimate our reserves for these large events on a contract-by-contract basis by means of a review of policies with known or potential exposure to a particular loss event.
We do not typically experience significant claims processing backlogs. Following a major catastrophic event, claims processing backlogs may occur. At December 31, 2007 and 2006, we did not have a significant backlog in either our insurance or reinsurance claims processing.
As of December 31, 2007 and 2006, we estimate that a 10% change in our net loss and LAE reserves would result in an increase or decrease of our net income and shareholders’ equity by $70.8 million and $89.2 million, respectively. The net income and shareholders’ equity impact of the change in net reserves may be partially offset by adjustments to items such as reinstatement premium, profit commission expense or other corporate expenses.
Each RSU represents a phantom restricted share which vests ratably in equal tranches, typically over three-to-five year periods, subject to the employee remaining employed at the applicable vesting date. RSUs are payable only in common shares, or in common shares net of applicable tax withholdings, at the end of the RSU term. Holders of RSUs are not entitled to voting rights but are entitled to receive cash dividends and distributions.