Loss ratio 63.2 % 94.0 % 74.4 % 69.6 % 71.7 %
The Company’s incurred losses and LAE decreased 34.6% to $2,434.4 million in 2006 from $3,724.3 million in 2005, due to significantly reduced current year catastrophe losses and a reduction in current and prior years attritional losses, partially offset by increased prior years reserve development on catastrophe and A&E losses. Incurred losses and LAE in 2006 reflected ceded losses and LAE of $109.5 million compared to ceded losses and LAE in 2005 of $95.2 million.
Segment underwriting expenses decreased by 5.0% to $1,026.3 million in 2005 from $1,080.2 million in 2004. Commission, brokerage, taxes and fees decreased by $60.3 million, principally reflecting decreases in premium volume and changes in the mix of business. Segment other underwriting expenses increased by $6.4 million as the Company continued to expand operations. Contributing to the segment underwriting expense decreases were a 36.6% ($49.8 million) decrease in the Specialty Underwriting operation, a 3.8% ($14.9 million) decrease in the U.S. Reinsurance operation and a 0.7% ($1.3 million) decrease in the Bermuda operation, partially offset by a 4.2% ($7.2 million) increase in the International operation and a 2.7% ($4.9 million) increase in the U.S. Insurance operation. The changes for each operation’s expenses principally resulted from changes in commission expenses related to changes in premium volume and business mix by class and type and, in some cases, changes in the use of specific reinsurance, as well as the underwriting performance of the underlying business.
Investment Results. Net investment income increased 5.4% to $522.8 million in 2005 from $495.9 million in 2004, reflecting growth in invested assets tempered by lower investment yields and lower returns from limited partnership investments. Investable assets increased by $1.4 billion to $13.0 billion in 2005, principally reflecting the effects of investing $1,070.6 million cash flow from operations during the year and $758.2 million net proceeds from issuance of common shares, partially offset by $250.0 million in debt repayment. The lower investment yield reflects the Company’s elevated short-term investments following its common share capital raising in the fourth quarter, which also reduced the investment income portfolio duration. Investment income for the limited partnerships for the year ended December 31, 2005 and 2004 was $11.5 million and $41.8 million, respectively.
The detailed data required to evaluate ultimate losses for insurance business is accumulated from the Company’s underwriting and claim systems. Reserving for reinsurance requires evaluation of loss information received from ceding companies. Ceding companies report losses to the Company in many forms dependent on the type of contract and the negotiated reporting requirements. Generally, proportional/quota share contracts require the submission of a monthly/quarterly account, which includes premium and loss settlement activity for the period with corresponding reserves as established by the ceding company. This information is recorded into the Company’s records. For certain proportional contracts, there is also an individual loss reporting clause, which requires a detailed loss report on claims that exceed a certain dollar threshold or relate to a particular type of loss. Excess of loss and facultative contracts generally require individual loss reporting with precautionary notices generally sent when losses reach a significant percentage of the attachment point of the contract or when certain causes of loss or types of injury occur. All individual loss reports and supporting claim information are managed by the Company’s experienced claims staff. Based on its own evaluation of the claim, the Company may choose to establish additional case reserves (ACRs) as a supplement above the case reserves reported by the ceding company. To ensure ceding companies are submitting required and accurate data, the Underwriting, Claim, Reinsurance Accounting and Internal Audit departments of the Company perform various reviews of the ceding carriers, particularly larger ceding companies.
Given the inherent variability in loss reserves, the Company has developed an estimated range of possible gross reserve levels. This table of ranges by segment, accompanied by commentary on potential and historical variability, is included in Financial Condition under Loss and LAE Reserves. The ranges are statistically developed using the same exposure groups used in the reserve setting process and aggregated to the segment level. The starting point for developing the ranges is the reported reserves, which reflect the Company’s best estimate of ultimate unpaid losses. For each exposure group, the Company calculates a range for each year reflecting actuarial judgment for two variables. The first is the historical pattern of ratios of IBNR to premiums earned at the level of the underlying business’s maturity relative to its ultimate expected outcome. The second is the uncertainty associated with the underlying business’s position within its underwriting cycle. The ranges by year are then aggregated to develop a range for the exposure group taking into account correlations that exist. The exposure groups are then aggregated to segment, again accounting for existing correlations. The Company notes that its presentation of this information is not directly comparable to similar presentations of other companies as there are no consistently applied actuarial or accounting standards governing such presentations. The Company further notes that its recorded reserves reflect the Company’s best point estimate of its liabilities and that its actuarial methodologies focus on such point estimates around which ranges are subsequently developed.
The Company’s principal investment objectives are to ensure funds are available to meet its insurance and reinsurance obligations and to maximize after-tax investment income while maintaining a high quality diversified investment portfolio. Considering these objectives, the Company views its investment portfolio as having two components; 1) the investments needed to satisfy outstanding liabilities and 2) investments funded by the Company’s shareholders’ equity.
The Company has exposure to A&E losses through its Mt. McKinley operation with respect to insurance policies and through Everest Re with respect to reinsurance contracts. In each case, the Company’s management and analyses of its exposures take into account a number of features of its business that differentiate the Company’s exposures from many other insurers and reinsurers that have significant A&E exposures.
Mt. McKinley began writing small amounts of A&E exposed insurance in 1975 and increased the volume of its writings in 1977. These writings ceased in 1984, giving Mt. McKinley an approximate 10-year window of potential A&E exposure, which is appreciably shorter than is the case for many companies with significant A&E exposure. Additionally, due to changes in and standardization of policy forms, it is rare for policies in the 1970s and 1980s to have been issued without aggregate limits on the product liability coverage; policies issued in earlier decades were generally more likely to lack aggregate limits.
Virtually all of the Mt. McKinley policies that are still potentially exposed to claims have policy language providing that expenses are covered only within limits rather than in addition to limits. This is a substantial difference from primary coverage, which would most often cover expenses in addition to limits.
Industry analysts have developed a measurement, known as the survival ratio, to compare the A&E reserves among companies with such liabilities. The survival ratio is typically calculated by dividing a company’s current net reserves by the three year average of paid losses. Hence, the survival ratio equals the number of
The Company’s net three year survival ratio on its asbestos exposures only was 4.0 years for the period ended December 31, 2006. This three year survival ratio, when adjusted for the effect of the reinsurance ceded under the stop loss cover from LM, was 4.9 years and, when adjusted for settlements in place and structured settlements, which are either fully funded by reserves or subject to financial terms that substantially limit the potential variability in the liability, and the stop loss protection from LM, was 7.7 years.
The Company’s liquidity requirements are generally met from positive cash flow from operations. Positive cash flow results from reinsurance and insurance premiums being collected prior to disbursements for claims, which disbursements generally take place over an extended period after the collection of premiums, sometimes a period of many years. Collected premiums are generally invested, prior to their use in such disbursements, and
As the timing of payments for claims and benefits cannot be predicted with certainty, the Company maintains portfolios of long term invested assets with varying maturities, along with short-term investments that provide additional liquidity for payment of claims. At December 31, 2006 and December 31, 2005 the Company held cash and short-term investments of $1,556.4 million and $1,551.0 million, respectively. In addition to these cash and short-term investments at December 31, 2006, the Company had $0.6 billion, at fair value, of available for sale fixed maturity securities maturing within one year or less, $2.5 billion maturing within one to five years and $7.2 billion maturing after five years. The Company’s $1.6 billion of equity securities are comprised primarily of publicly traded securities that can be easily liquidated. These fixed maturity and equity securities, in conjunction with the short-term investments and positive cash flow from operations, provide adequate sources of liquidity for the expected payment of losses in the near future. The Company does not anticipate selling securities or using available credit facilities to pay losses and LAE but has the ability to do so. Sales of securities might result in realized capital gains or losses and the Company notes that at December 31, 2006 it had $471.7 million of net pre-tax unrealized appreciation, comprised of $594.5 million of pre-tax unrealized appreciation and $122.8 million of pre-tax unrealized depreciation.
In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157 “Fair Value Measurements” (“FAS 157”), which is effective for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. FAS 157 defines fair value, establishes a framework for measuring fair value consistently in GAAP and expands disclosures about fair value measurements. The Company will adopt FAS
Market Value Change from Base (%) 8.6 % 4.3 % 0.0 % -4.7 % -9.5 %
This report contains forward-looking statements within the meaning of the U.S. federal securities laws. The Company intends these forward-looking statements to be covered by the safe harbor provisions for forward-looking statements in the federal securities laws. In some cases, these statements can be identified by the use of forward-looking words such as “may”, “will”, “should”, “could”, “anticipate”, “estimate”, “expect”, “plan”, “believe”, “predict”, “potential” and “intend”. Forward-looking statements contained in this report include information regarding the Company’s reserves for losses and LAE, the adequacy of the Company’s provision for uncollectible balances, estimates of the Company’s catastrophe exposure, the effects of catastrophic events on the Company’s financial statements, the ability of Everest Re, Holdings and Bermuda Re to pay dividends and the settlement costs of the Company’s specialized equity put options. Forward-looking statements only reflect the Company’s expectations and are not guarantees of performance. These statements involve risks, uncertainties and assumptions. Actual events or results may differ materially from the Company’s expectations. Important factors that could cause the Company’s actual events or results to be materially different from the Company’s expectations include those discussed under the caption Item 1A. “Risk Factors”. The Company undertakes no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise.