Our internal reserve review included a review of the exposures in our insurance and reinsurance businesses to losses stemming from the sub-prime mortgage sector. We conservatively estimate our net losses as of December 31, 2007 to be approximately $10.0 and $8.0 million in our insurance and reinsurance businesses, respectively. These estimates were within our original loss estimates for those lines and no additional reserves were recorded for sub-prime losses during the year ended December 31, 2007. We believe that any future development will not have a material impact on net income due to the reinsurance and retrocessional protection in place for these risks.
Additional premiums assumed and ceded, related additional acquisition costs, related net losses and the net impact on operating results for each of the three years to December 31, 2007 are as follows:
Our property reinsurance loss reserves are established on a contract-by-contract basis, based on expected loss ratios, losses reported by clients and our assessment of potential losses from catastrophe events, which are initially based on catastrophe model aggregate assessments and location specific assessments when available. Loss estimates are subsequently refined based on broker advices and client notifications.
As a reinsurer, we rely on loss data reported by our clients when calculating our reserves. The quality of the loss data varies from client to client. On a periodic basis, the clients’ loss data is analyzed by our actuarial and claims management teams to ascertain its quality and credibility. This process may involve comparisons with submission data and industry loss data, claim audits and inquiries about the methods of establishing case reserves or reserves associated with large industry events. There is often a time lag between our clients establishing case reserves and re-estimating their reserves, and notifying us of the new or revised case reserves. On casualty reinsurance transactions, the reporting lag will generally be 60-90 days after the end of a reporting period, but can be longer than this in some cases. Appropriate selection of loss development and trending techniques is used to mitigate these problems. We utilize the latest information received from our clients and work to ensure that the loss data is current. However, due to the varying quality of data from our reinsureds and the inherent reporting delays, our property and casualty reinsurance reserves will have more uncertainty than our property and casualty insurance reserves, where we receive loss information directly from our insureds.
We establish and review our property and casualty insurance loss reserves on a quarterly basis. The process for adjusting our property and casualty insurance loss reserves is based upon loss reports received from clients, which are input into actuarial models. We use a variety of actuarial techniques and methods in estimating our ultimate liability for property
Net favorable loss development for our property and casualty insurance segment of $8.8 million arising from the re-estimation of liabilities principally relating to property contacts which had exposure to the 2005 hurricanes.
The U.S. excess and surplus lines insurance segment has its own portfolio of fixed maturities investments. The investment income earned by our U.S. subsidiaries is reported in that segment.
Gross premiums written. Gross premiums written for the property and casualty reinsurance segment for the year ended December 31, 2007 were $345.2 million compared to $423.6 million for the year ended December 31, 2006, a decrease of 18.5%. Gross premiums written for excess liability, professional liability, whole account and workers compensation lines decreased in total by $115.1 million largely as a result of the non-renewal of four contracts and the restructuring of two reinsurance contracts at renewal. In addition, there was a reduction of $9.3 million in premium estimates on contracts written in prior periods. This reduction includes a $15.2 million adjustment to previously recognized additional premiums on one contract where we are entitled to additional premiums should losses exceed pre-determined, contractual thresholds. Based on updated information received from the client during the year, our estimate of losses has been revised downwards, resulting in a corresponding adjustment to premiums. These decreases were partially offset by growth in property and property catastrophe and marine and energy business where pricing remained at satisfactory levels. Our emphasis in recent years has been to write smaller accounts with a greater number of clients and vary the underlying exposures assumed. As a result, we expect fewer significant premium adjustments or additional premiums than in prior years. The level of business written in future periods will vary, perhaps materially, based on market conditions and management’s assessment of the adequacy of premium rates relative to the underlying risk being assumed.
Reinsurance premiums ceded. Reinsurance premiums ceded for property and casualty reinsurance for the year ended December 31, 2007 were $44.6 million compared to $35.3 million for the year ended December 31, 2006, an increase of 26.3%. The increase was principally attributable to our reinsurance quota share treaty that is utilized to manage our retained exposure on our property business. We also purchased additional excess of loss protection for our property and aviation reinsurance business in the year ended December 31, 2007.
Net favorable development of $36.0 million arising from the re-estimation of liabilities from our quarterly and annual actuarial review process. During the year ended December 31, 2007, a large number of contracts were adjusted to reflect either favorable or adverse development which has aggregated to produce net favorable development. There were no individual contracts or lines of business with significant development. Marine, medical malpractice, professional liability and workers’ compensation all had between $5.0 million and $10.0 million in favorable development, with most other lines of business having between $nil and $5.0 million in favorable development;
Gross premiums written. Gross premiums written for the property and casualty insurance segment for the year ended December 31, 2007 were $382.9 million compared to $396.6 million for the year ended December 31, 2006, a decrease of 3.5%. The decrease is principally attributable to the reduction of gross premiums written in the excess liability line of business as a result of increased competition for appropriately priced business. This decrease is offset by increased gross premiums written in the aviation and professional liability business. Typically, insurance business is written on an individual risk excess of loss basis with contractually defined premiums rather than estimates, which generally results in no material premium adjustments.
Net investment income and gains on alternative investments. The overall performance of our fixed maturities portfolio and alternative investment portfolio is discussed within the corporate function results of operations as we manage investments for our non-U.S. segments on a consolidated basis.
The casualty business we write generally has a long claim-tail and we expect that we will generate significant operating cash flow as we accumulate loss and benefit reserves on our balance sheet. As we continue to diversify into property, property catastrophe and aviation business, which generally has a short claim-tail, and as losses are incurred, we expect potential volatility in our operating cash flow levels. We believe that our loss and benefit reserves currently have an average duration of approximately 5.0 years and we expect to see increases in the amount of expected loss payments in future periods with a resulting decrease in operating cash flow. We do not expect loss payments to exceed the premiums generated and therefore expect to have continued positive cash flow. However, actual premiums written and collected and losses and benefits paid in any period could vary from our expectations and could have a meaningful effect on operating cash flow.
Financial Accounting Standard No. 160-Noncontrolling Interests in Consolidated Financial Statements - an Amendment of ARB No. 51