The Company’s reinsurance premiums are earned in proportion to the amount of reinsurance protection provided over the terms of the applicable risk period established in the reinsurance contract. Reinsurance contracts written on a losses occurring basis cover losses which occur during the term of the reinsurance contract, typically 12 months. Accordingly, the Company earns the premium on a losses occurring reinsurance contract evenly over the reinsurance contract term. Losses occurring reinsurance contracts accounted for approximately 25%, 21%, and 19% of the Company’s gross premiums written during the years ended December 31, 2010, 2009, and 2008, respectively. Reinsurance contracts written on a policies attaching basis cover losses from the underlying insurance policies incepting during the terms of the reinsurance contracts. Losses under a policies attaching reinsurance contract may occur after the end date of the reinsurance contract, so long as they are losses from policies which began during the reinsurance contract period. The Company typically earns the premiums for policies attaching reinsurance contracts over a 24 month period in proportion to the amount of reinsurance protection provided to reflect the extension of the risk period past the term of the contract and the varying levels of reinsurance protection provided during the reinsurance contract period. Policies attaching reinsurance contracts accounted for approximately 21%, 22%, and 18% of the Company’s gross premiums written during the years ended December 31, 2010, 2009, and 2008, respectively.
Under U.S. GAAP, the Company is not permitted to establish loss reserves until the occurrence of an actual loss event. Once such an event occurs, the Company establishes reserves based upon estimates of total losses incurred by the ceding companies or insureds as a result of the event, its estimate of the potential losses incurred, and its estimate of the portion of such loss the Company has insured or reinsured. As a result, only loss reserves applicable to losses incurred up to the financial statement date may be recorded, with no allowance for the provision of a contingency reserve to account for expected future losses. Losses arising from future events will be estimated and recognized at the time the loss is incurred and could be substantial. See ‘‘Reserve for Losses and Loss Expenses’’ below for further discussion.
Based on the above review, the Company will challenge any prices for a security that are not considered representative of fair value.
If the amortized cost of the Company’s fixed income portfolio is, based upon the judgment of management, unlikely to be recovered, the Company writes down the investment by the amount representing the credit related portion of the decline in value, thereby establishing a new cost basis. The amount of the write-down is recognized in earnings as an OTTI loss. The new cost basis is not changed for subsequent recoveries in fair value.
The Company produced net income of $364.7 million in 2010 compared to $536.1 million in 2009 and $98.6 million in 2008. The decrease in net income for 2010 compared to 2009 was partly due to a decrease in net investment income of $83.8 million related primarily to mark to market adjustments on the Company’s Other Investments and a lower yielding fixed income portfolio. In addition, the Company experienced higher losses incurred in 2010 than 2009 arising from specific events including the Chilean earthquake, the New Zealand earthquake and European Windstorm Xynthia as well as higher attritional catastrophe losses.
The net loss ratio reflected lower favorable prior year loss reserve development recorded for 2010 as compared to 2009 and 2008. Prior year loss reserves were reduced in 2010 by $46.9 million as compared to reductions of $92.1 million and $71.0 million for the years ended December 31, 2009 and 2008. Of the lines of business in the Company’s Insurance segment, the short tail property, long tail healthcare liability and other agriculture lines experienced significant net reductions in the Company’s estimated losses for prior accident years in 2010 as claims have not materialized as originally estimated by the Company. These reductions were offset by increases in the workers’ compensation line of business.
Includes agency mortgage-backed securities of $906.8 million and $956.3 million at December 31, 2010 and 2009, respectively.
The table also shows the cumulative paid amounts as of successive years with respect to the reserve liability. All amounts reflect the conversion from the original currency of the underlying business if not initially denominated in U.S. dollars. The data in the table has been restated using the rate of exchange to U.S. dollars as of December 31, 2010. Information presented herein may differ materially from that reported in the Company’s financial statements due to differences in foreign currency exchange rates.
Ceded premiums written were $289.5 million for the year ended December 31, 2010, $415.4 million for the year ended December 31, 2009 and $462.1 million for the year ended December 31, 2008. The decrease in ceded premiums written was due to increased retentions in our U.S. insurance operations, specifically related to the agriculture and property lines. The Company’s U.S. and Bermuda insurance operating subsidiaries use proportional and excess reinsurance to protect larger limits on certain business written by this segment. Excess reinsurance coverage is often purchased in relation to the property insurance line to protect against catastrophic events. Our agriculture line of business participates in a crop reinsurance program sponsored by the U.S. federal government.
The Company’s intangible assets and goodwill are tested at least annually for impairment and more often if a triggering event is deemed to have occurred. Impairment testing is performed based upon estimates of the fair value of the “reporting unit” to which the goodwill relates. The reporting unit is the operating segment or a business one level below that operating segment if discrete financial information is prepared and regularly reviewed by management at that level. The fair value of the reporting unit is impacted by the performance of the business. If it is determined that the goodwill has been impaired, the Company must write down the goodwill by the amount of the impairment, with a corresponding charge to net income.
The Company has a stock-based employee and non-employee director equity incentive plan (“2007 Equity Incentive Plan”) and other stock plans which are described more fully in Note 15. The fair value of the compensation cost incurred under these plans is measured at the grant date and is expensed over the period for which the employee is required to provide services in exchange for the award. Forfeiture benefits are estimated at the time of grant and incorporated in the determination of share-based compensation costs. Awards under the 2007 Equity Incentive Plan vest over four years for employees and one year for non-employee directors.
Additional disclosures are required about a company’s involvement in variable interest entities and an ongoing assessment of whether a company is the primary beneficiary. An entity is required to be re-evaluated as a variable interest entity when the holders of the equity investment at risk, as a group, lose the power from voting rights or similar rights to direct the activities that most significantly impact the entity’s economic performance.
In July 2010, the FASB issued ASU 2010-20, which requires additional disclosures about the credit quality of financing receivables and allowances for credit losses. The additional requirements include disclosure of the nature of credit risks inherent in financing receivables, how credit risk is analyzed and assessed when determining the allowance for credit losses, and the reasons for the change in the allowance for credit losses. The disclosures are effective for interim and annual reporting periods ending on or after December 15, 2010. The adoption of this guidance did not have a material impact on the Company’s consolidated financial statements.
The components of net investment income for the years ended December 31, 2010, 2009 and 2008 are as follows:
Balances include amounts related to collateralized debt obligations held with total fair values of $6.7 million.
The following table provides a roll-forward of the amount related to credit losses recognized in earnings for which a portion of an OTTI was recognized in accumulated other comprehensive income for the year ended December 31, 2010:
The Company is involved in the normal course of business with VIEs primarily as a passive senior investor in residential and commercial mortgage-backed securities and through its interests in other investments in alternative and high yield loan funds that are structured as limited partnerships considered to be third party VIEs. The Company determined that it was not the primary beneficiary for any of these investments as of December 31, 2010. The Company reassesses its VIE determination with respect to an entity on an ongoing basis. In addition, the Company believes its exposure to loss with respect to these investments is generally limited to the investment carrying amounts reported in the Company’s consolidated balance sheet and any unfunded partnership commitments.
Government and agencies securities - These securities are generally priced by pricing services or index providers. The pricing services or index providers may use current market trades for securities with similar quality, maturity and coupon. If no such trades are available, the pricing service typically uses analytical models which may incorporate option adjusted spreads, daily interest rate data and market/sector news. The Company generally classifies the fair values of government and agencies securities in Level 2. Current issue U.S. government securities are generally valued based on Level 1 inputs, which use the market approach valuation technique.
There were no material changes in the Company’s valuation techniques during 2010.
During 2010, the Company’s estimated ultimate losses for prior accident years were reduced by $126.8 million (2009 - $150.9 million; 2008 - $156.5 million) due to lower claims emergence than originally estimated by the Company. During 2010, the Company experienced favorable development in the Reinsurance segment of $79.9 million in the short tail, long tail and other reserve categories. In the Insurance segment, the Company experienced $46.9 million of favorable development across the long tail, short tail and other reserve categories. During 2009, the Company experienced favorable development in the Reinsurance segment of $58.8 million in the short tail, long tail and other reserve categories. In the Insurance segment, the Company experienced $92.1 million of favorable development across the long tail, short tail and other reserve categories during 2009. During 2008, the Company experienced favorable development in the Reinsurance segment of $85.5 million in the short tail, long tail and other reserve categories. In the Insurance segment, the Company experienced $71.0 million of favorable development primarily in relation to the long tail reserve categories during 2008.
The following table shows an analysis of goodwill and intangible assets for the years ended December 31, 2010 and 2009:
Of the 2010 current income tax (expense) benefit, $27.7 million related to taxes incurred in the United States (2009 - $6.5 million; 2008 - $22.8 million) and Nil related to current income tax benefits in the United Kingdom (2009 - Nil and 2008 - $11.0 million). Of the deferred income tax benefit, $21.4 million and Nil related to deferred income tax benefits in the United States and the United Kingdom, respectively (2009 - $5.3 million and Nil; 2008 - $22.0 million and Nil).
Deferred income taxes represent the tax effect of the differences between the book and tax bases of assets and liabilities. Net deferred income tax assets and liabilities consisted of the following as of December 31, 2010 and 2009: