Our outlook for 2009 is influenced by a number of factors. We believe the current financial crisis and the large property catastrophe losses in 2008 have significantly curtailed the capacity of the insurance industry. This, together with the tightening of the credit markets that is likely to limit capital investment in the insurance industry and elsewhere in 2009, points to the development of an improved pricing environment for insurance companies. We believe that pricing improvements will initially occur in the shorter tail lines such as property and aviation, and then as the year progresses, migrate to some of the longer tail casualty lines of business. The changes being made to our investment mix are expected to improve our underwriting capacity. This additional capacity, together with the growth in our underwriting platforms, positions us well to capitalize on this improved pricing environment.
We accrue for reinstatement premiums resulting from losses recorded. Such accruals are based upon contractual terms and the only element of management judgment involved is with respect to the amount of losses recorded. Changes in estimates of losses recorded on contracts with reinstatement premium features will result in changes in reinstatement premiums based on contractual terms. Reinstatement premiums are recognized at the time we record losses and are earned on a pro-rata basis over the coverage period. Reinstatement premiums assumed and ceded for each of the three years to December 31, 2008 are not material to our financial results.
Our Bermuda/Dublin casualty insurance loss reserves, which include case reserves, amounts for IBNR reserves and loss adjustment expenses, are compiled on a portfolio basis and are computed on an undiscounted basis. The majority of the insurance business we have written is casualty business. Historically, losses associated with casualty business have had a long claim-tail, which is the time period between the occurrence of a loss and the time it is settled by the insurer. Casualty losses are also generally more susceptible to litigation and can be significantly affected by changing contract interpretations and a changing legal environment. Due to the long claim-tail nature of casualty business, a high degree of judgment is involved in establishing loss reserves.
We, together with Alstra, have designed ongoing due diligence processes with respect to funds and their managers, which processes are designed to assist us in assessing the quality of information provided by, or on behalf of, each fund and in determining whether such information continues to be reliable or whether further review is necessary. Certain funds do not provide full transparency of their underlying holdings; however, we obtain the audited financial statements for every fund annually, and regularly review and discuss the fund performance with the fund managers to corroborate the reasonableness of the reported net asset values. While reported net asset value is the primary input to the review, when the net asset value is deemed not to be indicative of fair value, we may incorporate adjustments to the reported net asset value. Such adjustments may involve significant management judgment.
Net losses and loss expenses. The increase in both net losses and the loss ratio in 2008 is principally attributable to higher property catastrophe losses, partly offset by a greater amount of favorable prior year loss reserve development compared to 2007. The principle components of the net loss for 2008 were the following:
Reinsurance premiums ceded. Reinsurance premiums ceded were principally related to quota share treaties that we utilize to manage our retained exposure, and, therefore, will tend to fluctuate in line with gross premiums written. The ratio of reinsurance premiums ceded to gross premiums written for the year ended December 31, 2008 was 50.9% compared to 52.8% for the year ended December 31, 2007. The decreased ratio is principally related to the decrease in the percentage ceded under several of our reinsurance quota share treaties and the decrease in the cost of excess of loss reinsurance.
For the period from November 6 to December 31, 2008, our Max at Lloyd’s segment produced a loss before taxes of $0.1 million, with gross premiums written of $8.8 million.
Foreign exchange losses. Foreign exchange losses for the year ended December 31, 2008 of $10.6 million arose in connection with the purchase of Max UK. We purchased British pounds in advance of the acquisition of Max UK and before the transaction closed the value of the British pound dropped significantly relative to the U.S. dollar. Foreign exchange gains and losses for the years 2007 and 2006 were not significant to our operating results.
We own a trading portfolio and an available for sale portfolio of fixed maturities securities. We record both investment portfolios at fair value on our balance sheet. On our trading portfolio, the unrealized gain or loss associated with the difference between the fair value and the amortized cost of the investments is recorded in net income as a net realized gain or loss. On our available for sale portfolio, the unrealized gain or loss associated with the difference between the fair value and the amortized cost of the investments is recorded in other comprehensive income in the equity section of our balance sheet. Fixed maturities are subject to fluctuations in fair value due to changes in interest rates, changes in issuer specific circumstances, such as credit rating changes, and changes in industry specific circumstances, such as movements in credit spreads based on the market’s perception of industry risks. As a result of these potential fluctuations, it is possible to have significant unrealized gains or losses on a security. Our strategy for our fixed maturities portfolios is to
We are able to redeem the alternative investments held through Max Diversified on the same terms that the underlying funds can be liquidated. In general, the funds in which Max Diversified is invested require at least 30 days notice of redemption, and may be redeemed on a monthly, quarterly, semi-annually, annual, or longer basis, depending on the fund.
As of December 31, 2008, the financial strength ratings of our non-Lloyd’s reinsurance and insurance subsidiaries were “A-” by A.M. Best, “A” by Fitch, and “A3” by Moody’s. The Syndicates share the Lloyd’s market rating of “A+” by S&P, “A” by A.M. Best, and “A+” by Fitch. These ratings reflect each rating agency’s opinion of our financial strength, operating performance and ability to meet obligations. If an independent rating agency downgrades or withdraws any of our ratings, we could be severely limited or prevented from writing any new insurance or reinsurance contracts, which would significantly and negatively affect our business. Insurer financial strength ratings are based upon factors relevant to policyholders and are not directed toward the protection of investors.