The following is a discussion and analysis of our results of operations for the year ended December 31, 2010, compared with the year ended December 31, 2009 and the year ended December 31, 2009, compared with the year ended December 31, 2008. The following also includes a discussion of our liquidity and capital resources at December 31, 2010. This discussion and analysis should be read in conjunction with the audited consolidated financial statements and related notes included in this filing. This filing contains forward-looking statements that involve risks and uncertainties. Actual results may differ materially from the results described or implied by these forward-looking statements. See “Note on Forward-Looking Statements.”
Our expenses primarily consist of: 1) net claims and claim expenses incurred on the policies of reinsurance and insurance we sell; 2) acquisition costs which typically represent a percentage of the premiums we write; 3) operating expenses which primarily consist of personnel expenses, rent and other operating expenses; 4) corporate expenses which include certain executive, legal and consulting expenses, costs for research and development, and other miscellaneous costs, including those associated with operating as a publicly traded company; 5) redeemable noncontrolling interest - DaVinciRe, which represents the interest of third parties with respect to the net income of DaVinciRe; and 6) interest and dividend costs related to our debt and preference shares. We are also subject to taxes in certain jurisdictions in which we operate; however, since the majority of our income is currently earned in Bermuda, a non-taxable jurisdiction, the tax impact to our operations has historically been minimal.
For smaller events including localized severe weather events such as windstorms, hail, ice, snow, flooding, freezing and tornadoes, which are not necessarily prominent, public occurrences, we initially place greater reliance on catastrophe bulletins published by statistical reporting agencies to assist us in determining what events occurred during the reporting period than we do for large events. This includes reviewing Catastrophe Bulletins published by Property Claim Services for U.S. catastrophes. We set our initial estimates of reserves for claims and claim expenses for these smaller events based on a combination of our historical market share for these types of losses and the estimate of the total insured industry property losses as reported by statistical reporting agencies, although we generally make significant adjustments based on our current exposure to the geographic region involved as well as the size of the loss and the peril involved. This approach supplements our approach for estimating losses for larger catastrophes, which as discussed above, includes discussions with brokers and ceding companies, reviewing individual contracts impacted by the event, and modeling the loss in our REMS© system. Approximately one year from the date of loss for these small events, we estimate IBNR for these events by using an actuarial technique. The actuarial technique is to use the paid Bornhuetter-Ferguson actuarial method in estimating IBNR. The paid Bornhuetter-Ferguson actuarial method loss development factors are selected based on a review of our historical experience and these factors are reviewed at least annually. There were no changes to the paid loss development factors over the last three years.
We define our Insurance segment to include underwriting that involves understanding the characteristics of the underlying insurance policy. Our principal contracts currently include insurance policies and quota share reinsurance with respect to risks including: 1) commercial property, which principally includes catastrophe-exposed commercial property products; 2) commercial multi-line, which includes commercial property and liability coverage, such as general liability, automobile liability and physical damage, building and contents, professional liability and various specialty products; and 3) personal lines property, which principally includes homeowners personal lines property coverage and catastrophe exposed personal lines property coverage.
In our Insurance business, it is often necessary to estimate portions of premiums written from quota-share contracts and the related commission expense. Management estimates these amounts based on discussions with ceding companies, together with historical experience and judgment. Total premiums written estimated in our Insurance segment at December 31, 2010 were $0.2 million (2009 - $5.6 million, 2008 - $12.9 million), and total estimated premiums earned were $nil (2009 - $1.2 million, 2008 - $2.5 million). Total earned commissions estimated at December 31, 2010 were $6.1 million (2009 - $3.2 million, 2008 - $2.4 million). Management tracks the actual premium received and commissions incurred and compares this to the estimates previously booked. Such estimates are subject to adjustment in subsequent periods when actual figures are recorded. To date, such subsequent adjustments have not been material.
Significantly Improved Investment Results - our net investment income was $318.2 million in 2009, a $304.3 million increase from $13.9 million in 2008, we generated $93.7 million of net realized and unrealized gains on fixed maturity investments, an increase of $82.2 million from $11.5 million in 2008, and our net other-than-temporary impairments were $22.4 million in 2009, a $192.4 million decrease from $214.9 million in 2008. Overall, our investment results increased by $579.0 million to $389.4 million in 2009, from negative $189.6 million in 2008. The increase in our investment results was primarily due to higher total returns on certain non-investment grade allocations which are included in other investments, higher returns on hedge funds and private equity investments and the contraction of credit spreads on our fixed maturity investments. The reduction in net other-than-temporary impairments was due in part to our adoption in the second quarter of 2009 of new guidance on the recognition and presentation of other-than-temporary impairments (see “Note 6. Investments in our Notes to Consolidated Financial Statements” for additional information), as well as improving market conditions for investments;
The following is a summary of our gross reinsurance premiums written, excluding premiums assumed from our Insurance segment, allocated to the territory of coverage exposure:
During 2010, we experienced $157.5 million of favorable development on prior year reserves due to reductions of
During 2010, our cash and cash equivalents increased $74.6 million, to $277.7 million at December 31, 2010, compared to $203.1 million at December 31, 2009, which excludes a decrease of $3.9 million in cash and cash equivalents related to discontinued operations held for sale. The following discussion of our cash flows includes the results of operations and financial position of our discontinued operations held for sale at December 31, 2010, related to the sale of substantially all of our U.S.-based insurance operations.
Renaissance Trading maintains a brokerage facility with a leading prime broker, which has an associated margin facility. This margin facility, which we believe allows Renaissance Trading to prudently manage its cash position related to its exchange traded products, is supported by a $10.0 million guarantee issued by RenaissanceRe. Interest on amounts outstanding under this facility is at overnight LIBOR plus 75 basis points. At December 31, 2010, $nil was outstanding under the facility.
At December 31, 2010, our fixed maturity investments and short term investment portfolio had a dollar-weighted average credit quality rating of AA (2009 - AA). At December 31, 2010, our average yield to maturity on our fixed maturity investments and our short term investment portfolio was 2.1% (2009 - 2.3%). At December 31, 2010, our non-investment grade fixed maturity investments totaled $125.2 million or 3.0% of our fixed maturity investments (2009 - $85.2 million or 2.1%, respectively). In addition, within our other investments category we have several funds that invest in non-investment grade fixed income securities and non-investment grade cat-linked securities. At December 31, 2010, the funds that invest in non-investment grade fixed income securities and non-investment grade cat-linked securities totaled $331.2 million (2009 - $410.8 million).
Under the terms of certain reinsurance contracts, certain of our subsidiaries and joint ventures are required to provide letters of credit to reinsureds in respect of reported claims and/or unearned premiums. Our Reimbursement Agreement as of December 31, 2010, made available to certain of our operating subsidiaries and joint ventures letters of credit having an aggregate face amount not to exceed $1.0 billion. As discussed above in “Management’s Discussion and Analysis of Financial Condition and Results of Operations, Capital Resources,” the commitments under the Reimbursement Agreement were subsequently reduced to $700.0 million effective February 15, 2011, and if the sale of substantially all of our U.S.-based insurance operations is consummated, we expect to reduce the commitments under the Reimbursement Agreement by an additional $100 million to $600 million. To support the Reimbursement Agreement, certain of our participating operating subsidiaries and joint ventures have pledged RIHL shares and other securities owned by them as collateral.
With only four other years since 1851 having the level of named Atlantic windstorm formation as 2010, it proved to be an active year meteorologically, although these material tropical windstorms did not make significant landfall in the U.S. Atlantic and Gulf Coast regions and accordingly did not give rise to meaningful insured losses. This followed a similar industry outcome in 2009, in which U.S. coastal regions exposed to severe hurricane risk benefited from an unusually inactive year meteorologically in the Atlantic basin, which we believe was in part attributed to that year’s El Nino effect. As a result, insured industry losses from Atlantic windstorms in each of 2009 and 2010 were relatively benign, particularly in the Eastern and Southeastern U.S. This was in contrast to
In 2007, the State of Florida enacted legislation to expand the FHCF’s provision of below-market rate reinsurance to up to $28.0 billion per season (the “2007 Florida Bill”). In May of 2009, the Florida legislature enacted Bill No. CS/HB 1495 (the “2009 Bill”), which will gradually phase out $12.0 billion in optional reinsurance coverage under the FHCF over the succeeding five years. The 2009 Bill increased the cost of the optional coverage, which is believed to have contributed to reductions in the amount of this coverage purchased by eligible insurers until the phase-out is complete. The 2009 Bill similarly allows the state-sponsored property insurer, Citizens, to raise its rates up to 10% starting in 2010 and every year thereafter, until such time that it has sufficient funds to pay its claims and expenses. For 2010, the approved rate increase for Citizens was approximately 5%. The rate increases and cut back on coverage by FHCF and Citizens are expected to support a relatively increased role of the private insurers in Florida, a market in which we have established substantial market share. This legislation may, however, take several years to have a significant effect on the private market; moreover, its impact may not be sufficient to restore stability to the Florida market in light of certain trends that are adversely impacting the stability of local market participants, such as practices and findings relating to sinkhole claims, and the statutes of limitations on alleged windstorm claims from prior accident years. These factors have contributed, for example, to a return to rapid growth in the policies issued by Citizens rather than by private market insurers, diminishing the market in turn for our own coverages. While legislation intended to ameliorate these and other issues for the Florida market is expected to be introduced in the 2011 session, there can be no assurance that any such legislation will be enacted or that it will indeed succeed in improving the strength and stability of the Florida market.