The table below breaks out net income into three components: underwriting income, investment income and net realized gains/losses, and other revenues and expenses. Underwriting income on a segment basis is a measure of underwriting profitability that takes into account net premiums earned and other insurance related income as revenue and net losses and loss expenses, acquisition costs and underwriting related general and administrative costs as expenses. Underwriting income is the difference between these revenue and expense items. Our investment portfolio is managed on a total return basis and we have therefore reviewed investment income and net realized gains/losses together. Other revenues and expenses represent corporate expenses, foreign exchange gains/losses, interest expense and income tax expense.
Income tax expense: Income tax is generated primarily through our foreign operations in the United States and Europe. Our effective tax rate may vary between periods depending on the distribution of net income or losses among our various taxable jurisdictions. Our effective tax rate, which we calculate as income tax expense or recovery divided by income or loss before income tax, was 4.9% for 2008 compared with 3.7% in 2007 and 3.4% in 2006. The increase in our effective tax rate in 2008 was associated with the establishment of a full valuation allowance ($30 million) against net deferred tax assets arising from U.S. realized capital losses and investment impairments arising during the year, due to insufficient positive evidence currently for recognition. Excluding this item, we otherwise recorded a tax benefit in 2008, primarily as a result of taxable losses in our U.S. subsidiaries.
(1) Our general and administration expense ratio includes corporate expenses not allocated to our underwriting segments of 2.7%, 2.1% and 2.2%, for 2008, 2007 and 2006, respectively. These costs are discussed further in “Other Revenue and Expenses”, above.
Industry-wide insured losses and our own loss estimates for Hurricanes Gustav and Ike are subject to change as claims continue to be reported and adjusted. Actual losses may ultimately differ materially from current loss estimates.
Our current year loss ratio in 2007 increased slightly over the prior year, largely reflecting a shift in business mix towards longer-tail lines. Because our long tail lines typically have a higher initial expected loss ratio relative to our short tail lines, this resulted in a slight increase in our overall current year loss ratio. We experienced below average catastrophe and attritional loss activity in both 2007 and 2006.
Net adverse development of $8 million on the liability lines of our insurance segment. This was largely due to higher than expected loss emergence on a specific program across several accident years.
2008 versus 2007: Our general and administrative ratio in 2008 of 12.5% increased 1.4 ratio points over 2007. The increase was due to a combination of lower net premiums earned, additional headcount and higher share-based compensation costs. This was partially offset by a reduction in accrued incentive-based compensation as compared to the prior year, which is based on our operating results.
An increase in most of our initial expected loss ratio (“ILER”) method selections, reflecting the impact of pricing deterioration across most of our portfolio, partially offset by more favorable pricing on our ceded reinsurance.
Net favorable prior period reserve development of $65 million from our credit and political risk line of business, the majority of which was generated from accident years 2004 to 2006.
2008 versus 2007: Gross premiums written in 2008 benefited from a weakened U.S. dollar relative to 2007. In particular, the U.S. dollar was weaker against the Euro at our major renewal of January 1. This primarily impacted our property, credit and bond and motor lines of business. Gross premiums written otherwise decreased 3% in 2008, which was partially due to the impact of premium adjustments on prior year proportional and excess of loss professional lines and liability contracts. In 2008, we recorded negative premium adjustments of $18 million and $13 million on our professional lines business and liability business, respectively, compared to positive adjustments of $8 million and $6 million, respectively in the prior year.
Net premiums earned in our reinsurance segment in 2008 were largely unchanged with 2007, generally reflecting stability in our gross premiums written over the last three years, as discussed above. The 10% increase in net premiums earned in 2007 versus 2006 primarily reflects the impact of significantly expanding our U.S. and European reinsurance operations in 2004 and 2005.
$6 million of net adverse development on our property lines of business, represented by $40 million of adverse development on accident year 2005, partially offset by favorable development on accident years 2004 and prior. The adverse development on accident year 2005 was related to KRW reserve strengthening in connection with claim deterioration on our pro-rata line.
AXIS Capital Holdings Limited (“AXIS Capital”) is the Bermuda-based holding company for the AXIS group of companies, collectively the “Company”. AXIS Capital was incorporated on December 9, 2002, under the laws of Bermuda. Through its subsidiaries and branches organized in Bermuda, Europe, Australia, Singapore, Canada and the United States, AXIS Capital provides a broad range of insurance and reinsurance products on a worldwide basis under two distinct global underwriting platforms, AXIS Insurance and AXIS Re. In these notes, the terms “we,” “us,” “our,” or the “Company” refer to AXIS Capital and its direct and indirect subsidiaries.
effectiveness both at the inception and on an ongoing basis. We evaluate the effectiveness of our designated hedges on a retrospective and prospective basis using the period-to-period dollar offset method. Using this method, if the hedge correlation is within the range of 80% to 125%, we consider the hedge effective and apply hedge accounting.
We are required to maintain assets on deposit with various regulatory authorities to support our insurance and reinsurance operations. The assets on deposit are available to settle insurance and reinsurance liabilities. We also utilize trust accounts to collateralize business with our insurance and reinsurance counterparties. These trust accounts generally take the place of letter of credit requirements. The assets in trust as collateral are primarily highly rated fixed maturity securities. The fair value of our restricted assets was as follows:
We purchase treaty and facultative reinsurance to reduce exposure to a large loss or a series of large losses. Facultative reinsurance provides for all or a portion of the insurance provided by a single policy and each policy reinsured is individually negotiated. Treaty reinsurance provides for a specified type or category of risks. The reinsurance agreements are written on either an excess of loss or quota share basis. Excess of loss covers provide a contractually set amount of cover after an excess point has been reached. This excess point can be based on the size of an industry loss or a fixed monetary amount. These covers can be purchased on a package policy basis, which provide cover for a number of lines of business within one contract. Quota share covers provide a proportional amount of coverage from the first dollar of loss. All of these reinsurance covers provide for recovery of a portion of losses and loss expenses from reinsurers. Under our reinsurance security policy, we predominantly cede our business to reinsurers rated A- or better by S&P and/or A.M. Best. We remain liable to the extent that reinsurers do not meet their obligations under these agreements either due to solvency issues, contractual disputes or some other reason.
Mortgage derivatives are commonly referred as to be announced mortgage-backed securities. In accordance with FAS 133, these securities are accounted for as derivatives. As part of our investment strategy, we may from time to time invest in mortgage derivatives. At December 31, 2008 and 2007, we had no outstanding mortgage derivatives.
pleadings, defendants renewed their motions to dismiss. On April 15, 2007, the District Court dismissed without prejudice plaintiffs’ complaint, as amended, and granted plaintiffs thirty (30) days to file another amended complaint and/or revised RICO Statement and Statements of Particularity. In May 2007, plaintiffs filed (i) a Second Consolidated Amended Commercial Class Action complaint, (ii) a Revised Particularized Statement Describing the Horizontal Conspiracies Alleged in the Second Consolidated Amended Commercial Class Action Complaint, and (iii) a Third Amended Commercial Insurance Plaintiffs’ RICO Case Statement Pursuant to Local Rule 16.1(B)(4). On June 21, 2007, the defendants filed renewed motions to dismiss. On September 28, 2007, the District Court dismissed with prejudice plaintiffs’ antitrust and RICO claims and declined to exercise supplemental jurisdiction over plaintiffs’ remaining state law claims. On October 10, 2007, plaintiffs filed a notice of appeal of all adverse orders and decisions to the United States Court of Appeals for the Third Circuit, and a hearing is scheduled for April 2009. We believe that the lawsuit is completely without merit and we continue to vigorously defend the filed action.
The following is a summary of stock options outstanding and exercisable at December 31, 2008, and related activity for the year ended: