We underwrite insurance and reinsurance on a global basis. Our business currently consists of two distinct global underwriting platforms: AXIS Insurance and AXIS Re. We have three reportable operating segments: insurance, reinsurance and corporate. Our insurance segment is further sub-divided into two-sub segments: global insurance and U.S. insurance.
For business written under a proportional contract, similar to our line slip business, we are able to reasonably estimate the premium written by reference to an initial estimate of expected ceded premium received from our clients. In most cases, the treaties are not new and the client can use historical experience to estimate the amount of premium. We may adjust the initial estimate of premium, and any adjustment is usually a result of the underwriter’s prior experience with a client. We actively monitor the development of actual premium data and, if an adjustment in the premium estimate is warranted, it will be recorded in the period during which the adjustment is determined. During the years ended December 31, 2005, 2004 and 2003, proportional premiums accounted for 15%, 10% and 7%, respectively, of total gross premiums written.
The $525.3 million increase in net premiums earned resulted primarily from our reinsurance segment, which reported an increase in net premiums earned of $469.6 million. Premiums are earned over the term of the policies in proportion to the risks to which they relate. As the level of net premiums written increases, the level of net premiums earned also increases. Given net premiums written increased for 2005, our net premiums earned also increased.
The combination of the three hurricanes resulted in a record level of insured catastrophe losses for a given year, with Hurricane Katrina the largest insured event in history. The industry losses estimated by Risk Management Solutions, a risk modeling agency, currently stand at $40 billion to $60 billion for Hurricane Katrina, $4.0 billion to $7.0 billion for Hurricane Rita and $8.0 billion to $12.0 billion for Hurricane Wilma. The estimates as to the size of the industry loss vary significantly due primarily to the extent of damage, the delay in adjusting losses in the affected areas and the interpretation of coverage under insurance contracts.
Acquisition Costs. The acquisition cost ratio for the year ended December 31, 2005 was 13.2% compared to 13.8% for the year ended December 31, 2004. The decrease was principally the result of a reduction of $54.5 million in the amounts expensed under our incentive commission arrangements with brokers from 2004, following agreement as to the amounts due under such arrangements. Excluding incentive commissions, the acquisition cost ratio for the year ended December 31, 2005 increased to 13.7% compared to 11.7% for the year ended December 31, 2004. This was primarily due to a change in our business mix with a higher percentage of net earned premiums generated by our reinsurance segment, which has a higher acquisition cost ratio. For the year ended December 31, 2005, 52.9% of our net earned premiums was generated by our reinsurance segment compared to 43.5% for the year ended December 31, 2004.
General and Administrative Expenses. The $25.5 million increase in general and administration expenses was generated principally by an increase in compensation costs due primarily to an increase in headcount from the continued expansion of operations in the U.S. The general and administrative expense ratio for the year ended December 31, 2005 was 8.3% compared to 9.2% for the year ended December 31, 2004. The decrease was primarily due to an increase in net premiums earned.
Other Insurance Related (Loss) Income. Other insurance related loss primarily related to the movement in the fair value of our insurance contracts that meet the definition of derivatives. These contracts typically insure a portfolio of sovereign debt securities against the risk of default. During the year ended December 31, 2005, all contracts accounted for as derivatives expired.
General and Administrative Expenses. Our general and administrative expenses ratio was consistent with the prior year.
segment we primarily purchase reinsurance as and when market opportunities arise to mitigate the impact from catastrophe loss events. Consequently, the level of premiums ceded can fluctuate period to period. The decrease was primarily due to changes in the timing of the renewal of ceded reinsurance contracts. Following the losses generated by the hurricanes in September 2004, we exhausted some of our reinsurance coverage and purchased new protections.
which there is a prepayment risk, prepayment assumptions are evaluated and revised as necessary. Any adjustments required due to the change in effective yields and maturities are recognized on a prospective basis through yield adjustments.
Reinsurance experienced $114.3 million of net favorable prior period development, representing 15.0% of the reserve for losses and loss expenses at December 31, 2004. This compares with 2004 net favorable prior period development of $74.9 million, or 26.1% of the reserve for losses and loss expenses at December 31, 2003, and 2003 net favorable prior period development of $28.1 million, or 33.7% of the reserve for losses and loss expenses at December 31, 2002. The favorable development for all years was due to lower than expected losses on short tail lines of business. In 2005, the favorable development was largely generated by the 2004 accident year on the catastrophe line of business.
During the year ended December 31, 2005, the change in fair value of these contracts resulted in a net loss of $5.9 million (2004: $11.3 million net gain; 2003: $25.0 million net gain). The Company had no contracts outstanding as at December 31, 2005. Included in insurance and reinsurance premium balances receivable was a net asset relating to these contracts of $8.3 million as at
As at December 31, 2005, 19,650,509 common shares (2004: 19,619,152; 2003: 19,690,692) would be issued pursuant to the warrants, if all warrants were exercised at an average price of $12.46 (2004: $12.48; 2003; $12.43). As at December 31, 2005, the Company had accrued $19.8 million (2004: $9.3 million) of cash dividends relating to the anti-dilution provision in respect of the warrants. The expiration date for the warrants is November 20, 2011.
The following is a summary of stock options and related activity:
AXIS Specialty entered into an advisory agreement in November 2001 with MMC Capital, Inc., which was assigned to Stone Point Capital LLC. (“Stone Point”). Under this agreement, Stone Point from time to time provides advice and assistance to the Company in connection with transactions and other matters as may be agreed by Stone Point and the Company. The agreement has a five year term during which AXIS Specialty pays an annual fee of $1.0 million. During the year ended December 31, 2005, AXIS Specialty incurred $1.0 million (2004: $1.0 million; 2003: $1.0 million) of fees and expenses to Stone Point pursuant to this agreement of which $250 (2004: $250) was included in accounts payable and accrued expenses.