For asbestos, a range is developed for each policyholder based on variations in the estimates of the future number of claimants and number of years in the available coverage period (if unknown). For environmental exposures, a range is developed based on variations in alleged site costs and variations in the number of years over which such costs may be allocated. The actuarial point estimate is principally the average of the low estimate and the high estimate for each policyholder.
In 2007, the Company increased environmental reserves by $22.2 million as compared to increases of $9.9 million and $6.6 million, respectively, in 2006 and 2005. The increase was driven by a newly reported large claim, identification of additional policies associated with existing policyholders and a slight increase in the number of sites for policyholders with previously reported claims. In addition, the Company also incurred losses for settlements which secured broader releases on certain active exposures. An analysis of gross and net reserves from environmental exposures is presented in Note 5 to the consolidated financial statements included in “Item 8. Financial Statements and Supplementary Data”.
For the year ended December 31, 2006, gross premiums written in property lines increased by $111.5 million, or 32.1%, as compared to the year ended December 31, 2005. This increase included $33.5 million of Fairmont premiums. Excluding Fairmont, gross premiums written in property lines increased by $78.0 million, or 22.4%, in the year ended December 31, 2006, primarily due to significant rate increases and an increase in new business, partially offset by a reduction in renewal retention rates. The increase in pricing and new business in 2006 was attributable to a significant hardening of the property market in the aftermath of the 2005 hurricane activity, due to limited availability of catastrophe reinsurance and higher reinsurance rates.
The accident year loss and LAE ratio improved from 69.4% in 2006 to 68.9% in 2007. The improvement from 2006 to 2007 is primarily due to lower catastrophe losses in 2007 as compared to 2006. Catastrophes added approximately 1.3 and 2.3 points to the Company’s accident year loss and LAE ratios in 2007 and 2006, respectively. Results for accident year 2006 were also adversely affected by unfavorable loss emergence in property, reflecting an increased frequency of large fire losses over this period, particularly with respect to habitational business as noted below.
The accident year loss and LAE ratio decreased from 72.4% in 2005 to 69.4% in 2006. This decrease was primarily due to the lack of major catastrophe activity in 2006 while accident year 2005 included the effects of the 2005 hurricanes (Katrina, Rita and Wilma) of $92.3 million. Catastrophes added approximately 2.3 and 9.4 points to the Company’s accident year loss and LAE ratios in 2006 and 2005, respectively, and added approximately 9.9 and 55.3 points to the property accident year loss and LAE ratios, respectively. The increase in the accident year loss and LAE ratio in 2006, exclusive of the major catastrophes in the prior years, was largely attributable to the property line of business in which the Company experienced increased frequency of large fire losses and a significant rise in the cost of reinsurance. Commercial automobile was also adversely affected by an increase in large claims in 2006.
The decrease in the other lines loss ratio from 2005 to 2006 and continuing to 2007 reflects the runoff of the Company’s surety line of business, which began in 2005.
Premiums withheld from reinsurers pursuant to reinsurance contracts are included in funds held under reinsurance contracts on the consolidated balance sheets. Interest accrues on these funds in accordance with the contract terms and is included as a reduction of investment income on the consolidated statements of income. Interest on funds held under reinsurance contracts is charged at rates between 7% and 7.5% per annum as specified in the related reinsurance contract.
The Company participates in tax sharing agreements that provide for the inclusion of the Company in the consolidated federal income tax returns of Fairfax Inc. (the “Fairfax Group”), as well as the consolidated or combined state income or franchise tax returns of Fairfax Inc. Subject to these tax sharing agreements, every member of the Fairfax Group is severally liable for the federal income tax liabilities of the Fairfax Group and may be liable under similar rules for state income or franchise taxes of the entire group. Under the tax sharing agreements, Crum & Forster and its insurance subsidiaries make payments to Fairfax Inc. equal to the amounts of federal income taxes that each company would pay, subject to some adjustments, as if they each had filed their own separate federal income tax returns, as well as their shares of any state income or franchise taxes. Fairfax stands in the place of the tax authority for administering federal income tax payments, including the requirement to honor all valid tax elections.
On March 15, 2007, the Company sold its 1.1% ownership interest in Odyssey to TIG Insurance Company (“TIG”), a subsidiary of Fairfax, for proceeds of $30,160 and a realized investment gain of $8,300.
At December 31, 2007, reinsurance recoverable includes $396,219 and $388,248 related to prospective and retroactive corporate aggregate reinsurance contracts, respectively, of which $493,9771 has been recognized as a reduction of incurred losses and LAE on the Company’s consolidated statements of income. A summary of these corporate aggregate reinsurance contracts and the amounts of reinsurance recoverable thereunder follows:
The second contract, covering substantially all lines of business, provides $100,000 of limit in excess of a retention for accident periods prior to August 13, 1998, the date of acquisition of the Company by Fairfax. The contract contains sublimits relating to asbestos, environmental and latent, construction defect and other losses and is subject to a maximum economic loss provision. Premium for this contract was $32,597. The contract is on a funds held basis with interest credited at 7%. The Company may commute the contract any time the funds held balance is positive. In the fourth quarter of 2006, cessions under this contract were reversed due to favorable loss development of the underlying policies covered by this contract. As a result, the Company reduced the funds held balance to offset amounts due the Company at December 31, 2006, pursuant to the aforementioned commutation provision. At December 31, 2007 and December 31, 2006, the Company had no cumulative ceded losses under this contract and net paid premiums of $32,597 prior to 2005. None of the $100,000 coverage under this treaty is available for asbestos or environmental development.
Effective January 1, 2006, the Company, in connection with its assumption of the Fairmont business, entered into a reinsurance agreement with Markel Insurance Company of Canada (“Markel”), an affiliate of Fairfax, under which the Company has agreed to provide commercial auto coverage to U.S. or Canadian domiciled companies, for which Markel has written the Canadian auto coverage business, and to cede 100% of the coverage provided by the Company to Markel. During the years ended December 31, 2007 and December 31, 2006, the Company ceded premiums of $1,966 and $1,175, respectively, to Markel and had a reinsurance recoverable balance of $1,587 and $285, respectively, at December 31, 2007 and December 31, 2006.
Increasing the assumed health care cost trend rates by one percentage point in each year would increase the accumulated postretirement benefit obligation at December 31, 2007 by $1,200, and the aggregate of the service and interest cost components of net periodic postretirement benefit expense for 2007 by $65. Conversely, decreasing the assumed health care cost trend rates by one percentage point in each year would decrease the accumulated postretirement benefit obligation at December 31, 2007 by $901, and the aggregate of the service and interest cost components of net periodic postretirement benefit expense for 2007 by $49. The Company’s expected contribution to the Plan in 2008 is $1,030.