In addition, the Seller provides protection to the Company with respect to third party reinsurance receivables and recoverables related to the Winterthur Business which are $2.0 billion in the aggregate as of December 31, 2004. There are two levels of protection from the Seller for these balances:
During 2002, the Company decreased the estimate of other reserves at the beginning of 2002 by a net amount of $45 million, consisting of a decrease in reserves relating to the excess casualty insurance business of $114 million partially offset by increases in prior year reserves for satellite lines of $30 million and other casualty insurance lines of $39 million. Estimated ultimate loss reserves were reduced for excess casualty insurance based upon lower than expected actual reported loss experience for business written in years 1997 and prior. A lack of available industry data resulted in more actuarial judgment being involved in establishing IBNR loss reserves for this line of business in the earlier years, as mentioned above under “Critical Accounting Policies and Estimates” - Unpaid losses and loss expenses and unpaid loss and loss expenses recoverable. Estimated loss reserves were then regularly updated to take into account actual claims reported. The adverse development experienced in the satellite lines was due to several satellite malfunctions which caused an increase in actual reported loss activity that was greater than expected. The adverse development for the other casualty lines was for business written in 1999 through 2001. In these years, premium rates for casualty business had declined due to competitive market pressures and in 2002, there was an increase in the size of claims reported that was higher than expected.
1. Second and fourth quarters of 2004 - two large U.K. portfolio contracts, representing $995 million in net premiums earned and related claims and policy benefits.
The Company acquired cash and investment assets related to the future policy benefit reserves assumed at inception of these large contracts. While the Company expects to write more of these contracts, the frequency of these transactions will likely continue to be irregular.
Net income from investment affiliates includes earnings from the Company’s investments in closed-end investment funds and partnerships and similar vehicles. Net income from investment affiliates increased in 2004 as compared to 2003 primarily due to an increase in the size of the alternative investment portfolio. Net income from investment affiliates increased significantly in 2003 as compared to 2002 due mainly to the strong
Guaranteed investment contracts are initially recorded at an amount equal to the assets received. The Company may use derivative instruments in order to hedge the Company’s exposure to fluctuations in interest rates related to these contracts. Changes in the fair value of the hedging instrument are recognized in income. The change in the fair value of the hedged item, attributable to the hedged risk, is recorded as an adjustment to the carrying amount of the hedged item and is recognized in income.
The Seller’s submission is closer to the valuation developed by the independent actuary and, as such, the Seller’s submission is the actual final seasoned amount.
As a result of the new information obtained in the claims audit review, the Company performed a supplemental analysis of its North American casualty reinsurance lines of business specific to the nature of individual cedents’ circumstances. The Company separately reviewed the historical loss development of its major cedents using several actuarial methodologies; where the analysis of a cedent’s experience concluded that the experience was worse than the Company’s historical loss development experience, the Company projected that cedent’s ultimate loss based on the cedent’s own experience. In addition, the Company assumed that the more recent experience was more indicative of future loss development by selecting development patterns that were based on the most recent experience rather than on the Company’s or cedent’s longer term historical experience.
31, 2004 approximately $1.9 billion of the 3-year facility was in use in the form of letters of credit while the 364-day facility was unutilized at that date.
Credit derivatives are recorded at fair value. In determining the fair value of credit derivatives, management differentiates between investment and non-investment grade exposures and models them separately. Management estimates fair value for investment grade exposures by monitoring changes in credit quality and selecting appropriate market indices to determine credit spread movements over the life of the contracts. The determination of the credit spread movements is the basis for calculating the fair value. For credit derivatives that are non-investment grade appropriate market indices are not readily available. Accordingly, the Company uses an alternative fair value method-
The Company uses foreign exchange contracts to manage its exposure to the effects of fluctuating foreign currencies on the value of certain of its foreign currency fixed maturities and equity securities investments. These contracts are not designated as specific hedges for financial reporting purposes and therefore, realized and unrealized gains and losses on these contracts are recorded in income in the period in which they occur. These contracts generally have maturities of three months or less. In addition, certain of the Company’s investment managers may, subject to investment guidelines, enter into forward contracts where potential gains may exist. The Company has exposure to foreign currency exchange rate fluctuations through its operations and in its investment portfolio. The Company’s net foreign currency denominated payable on foreign exchange contracts as at December 31, 2004 was $3.8 million and the net foreign currency denominated receivable was $31.1 million at December 31, 2003, with a net unrealized loss of $11.8 million as at December 31, 2004 and $6.7 million as at December 31, 2003.
In July 2003, the Company entered into a contingent capital transaction with an aggregate value of $500.0 million. This transaction also provides the Company with an insurance trust that provides the Company with statutory relief under state insurance regulations in the U.S. Under the terms of this facility, the Company has acquired an irrevocable put option to issue preference ordinary shares into a trust in return for proceeds raised from investors. This put
The Company is unable to make full recovery of the reinsurance recoverables related to the Winterthur Business, either from third parties or from the Seller under the additional protections.
At December 31, 2004 and 2003, $3.0 billion and $2.7 billion of letters of credit were outstanding, 6.6% and 8.7% of which were collateralized by the Company’s investment portfolio, supporting U.S. non-admitted business and the Company’s Lloyd’s Syndicates’ capital requirements.
Includes 14,455 options outstanding and exercisable, with an average exercise price of $40.89 that have no expiration date. These options are not included in the calculation of the average remaining contractual life.
Shareholders’ equity at December 31, 2004 and 2003 reflected tax benefits of $3.6 million and $2.9 million, respectively, related to compensation expense deductions for stock options exercised for one of the Company’s U.S. subsidiaries.