Newswires
ALLIED WORLD ASSURANCE CO HOLDINGS, AG – 10-K – Management’s Discussion and Analysis of Financial Condition and Results of Operations.
| Edgar Online, Inc. |
Some of the statements in this Form 10-K include forward-looking statements within the meaning of The Private Securities Litigation Reform Act of 1995 that involve inherent risks and uncertainties. These statements include in general forward-looking statements both with respect to us and the insurance industry. Statements that are not historical facts, including statements that use terms such as "anticipates," "believes," "expects," "intends," "plans," "projects," "seeks" and "will" and that relate to our plans and objectives for future operations, are forward-looking statements. In light of the risks and uncertainties inherent in all forward-looking statements, the inclusion of such statements in this Form 10-K should not be considered as a representation by us or any other person that our objectives or plans will be achieved. These statements are based on current plans, estimates and expectations. Actual results may differ materially from those projected in such forward-looking statements and therefore you should not place undue reliance on them. Important factors that could cause actual results to differ materially from those in such forward-looking statements are set forth in Item 1A. "Risk Factors" in this Form 10-K. We undertake no obligation to release publicly the results of any future revisions we make to the forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. 65
--------------------------------------------------------------------------------
Table of Contents Overview Our Business We write a diversified portfolio of property and casualty insurance and reinsurance internationally through our subsidiaries and branches based inBermuda ,Europe ,Hong Kong</location>, Singapore andthe United States as well as our Lloyd's Syndicate 2232. We manage our business through three operating segments: U.S. insurance, international insurance and reinsurance. As ofDecember 31, 2011 , we had approximately$11.1 billion of total assets,$3.1 billion of total shareholders' equity and$3.9 billion of total capital, which includes shareholders' equity and senior notes. During the year endedDecember 31, 2011 , we experienced rate increases on property lines that had experienced significant loss activity on a year-to-date basis. We also continued to see rate improvement on our general casualty line of business while rates continued to decline in some of our other casualty lines. We believe these premium rate decreases are generally due to increased competition and excess capacity over the past several years. Despite the challenging pricing environment, we believe that there are opportunities where certain products have adequate premium rates and that the expanded breadth of our operations allows us to target those classes of business. Given these trends, we continue to be selective in the insurance policies and reinsurance contracts we underwrite. Our consolidated gross premiums written increased by$181.1 million , or 10.3%, for the year endedDecember 31, 2011 compared to the year endedDecember 31, 2010 . Our net income for the year endedDecember 31, 2011 decreased by$390.5 million , or 58.7%, to$274.5 million compared to$665.0 million for the year endedDecember 31, 2010 . The decrease in net income for the year endedDecember 31, 2011 compared to the year endedDecember 31, 2010 was primarily due to lower total return from investments and higher net losses and loss expenses from property catastrophe losses of$171.8 million in theAsia-Pacific region ,$53.7 million from the Midwestern U.S. storms,$43.0 million related to theThailand floods and$23.7 million from Hurricane Irene.
Recent Developments
OnSeptember 15, 2011 , we reached a mutual agreement with Transatlantic to terminate our previously announced merger agreement. Under the terms of the termination agreement, we received a termination fee of$35.0 million plus a$13.3 million partial reimbursement for merger-related expenses. We received an additional fee of$66.7 million from Transatlantic onNovember 23, 2011 , upon its execution of a merger agreement with Alleghany Corporation. 66
--------------------------------------------------------------------------------
Table of Contents Financial Highlights Year Ended December 31, 2011 2010 2009 ($ in millions except share and per share data) Gross premiums written $ 1,939.5 $
1,758.4 $ 1,696.3 Net income 274.5 665.0 606.9 Operating income 183.7 397.8 537.7 Basic earnings per share: Net income $ 7.21 $ 14.30 $ 12.26 Operating income $ 4.82 $ 8.56 $ 10.86 Diluted earnings per share: Net income $ 6.92 $ 13.32 $ 11.67 Operating income $ 4.63 $ 7.97 $ 10.34 Weighted average common shares outstanding: Basic 38,093,351 46,491,279 49,503,438 Diluted 39,667,905 49,913,317 51,992,674 Basic book value per common share $ 83.44 $ 80.75 $ 64.61 Diluted book value per common share $ 80.11 $ 74.29 $ 59.56 Annualized return on average equity (ROAE), net income 8.9 % 21.9 % 22.6 % Annualized ROAE, operating income 6.0 % 13.1 % 20.0 %
Non-GAAP Financial Measures
In presenting the company's results, management has included and discussed certain non-GAAP financial measures, as such term is defined in Item 10(e) of Regulation S-K promulgated by theSEC . Management believes that these non-GAAP measures, which may be defined differently by other companies, better explain the Company's results of operations in a manner that allows for a more complete understanding of the underlying trends in the Company's business. However, these measures should not be viewed as a substitute for those determined in accordance with U.S. GAAP. 67
--------------------------------------------------------------------------------
Table of Contents
Operating income & operating income per share
Operating income is an internal performance measure used in the management of our operations and represents after-tax operational results excluding, as applicable, net realized investment gains or losses, net impairment charges recognized in earnings, net foreign exchange gain or loss, impairment of intangible assets and other non-recurring items. We exclude net realized investment gains or losses, net impairment charges recognized in earnings, net foreign exchange gain or loss and other non-recurring items from our calculation of operating income because these amounts are heavily influenced by and fluctuate in part according to the availability of market opportunities and other factors. We exclude impairment of intangible assets as these are non-recurring charges. We have excluded from our operating income the aggregate$101.7 million termination fee received resulting from our previously announced merger agreement with Transatlantic as this is a non-recurring item. In addition to presenting net income determined in accordance with U.S. GAAP, we believe that showing operating income enables investors, analysts, rating agencies and other users of our financial information to more easily analyze our results of operations and our underlying business performance. Operating income should not be viewed as a substitute for U.S. GAAP net income. The following is a reconciliation of operating income to its most closely related U.S. GAAP measure, net income. Year Ended December 31, 2011 2010 2009 ($ in millions except per share data) Net income $ 274.5 $ 665.0 $ 606.9 Add after tax affect of: Net realized investment gains (0.2 ) (267.7 ) (126.4 ) Net impairment charges recognized in earnings - 0.1 49.6 Impairment of intangible assets - - 6.9 Other income - termination fee (93.7 ) - - Foreign exchange loss 3.1 0.4 0.7 Operating income $ 183.7 $ 397.8 $ 537.7 Basic per share data: Net income $ 7.21 $ 14.30 $ 12.26 Add after tax affect of: Net realized investment gains (0.01 ) (5.75 ) (2.55 ) Net impairment charges recognized in earnings - - 1.00 Impairment of intangible assets - - 0.14 Other income - termination fee (2.46 ) Foreign exchange loss 0.08 0.01 0.01 Operating income $ 4.82 $ 8.56 $ 10.86 Diluted per share data: Net income $ 6.92 $ 13.32 $ 11.67 Add after tax affect of: Net realized investment gains (0.01 ) (5.36 ) (2.43 ) Net impairment charges recognized in earnings - - 0.96 Impairment of intangible assets - - 0.13 Other income - termination fee (2.36 ) Foreign exchange loss 0.08 0.01 0.01 Operating income $ 4.63 $ 7.97 $ 10.34 68
--------------------------------------------------------------------------------
Table of Contents
Diluted book value per share
We have included diluted book value per share because it takes into account the effect of dilutive securities; therefore, we believe it is an important measure of calculating shareholder returns. Year Ended December 31, 2011 2010 2009 ($ in millions except share and per share data) Price per share at period end $ 62.93 $ 59.44 $ 46.07 Total shareholders' equity $ 3,149.0 $ 3,075.8 $ 3,213.3 Basic common shares outstanding 37,742,131 38,089,226 49,734,487 Add: Unvested restricted share units 249,251 571,178 915,432 Performance based equity awards 889,939 1,440,017 1,583,237 Employee purchase plan 11,053 10,576 - Dilutive options/warrants outstanding 1,525,853 3,272,739 6,805,157 Weighted average exercise price per share $ 45.72 $ 35.98 $ 34.44 Deduct: Options bought back via treasury method (1,108,615 )
(1,980,884 ) (5,087,405 )
Common shares and common share equivalents outstanding 39,309,612 41,402,852 53,950,908 Basic book value per common share $ 83.44 $ 80.75 $ 64.61 Diluted book value per common share $ 80.11 $
74.29 $ 59.56
Annualized return on average equity
Annualized return on average shareholders' equity ("ROAE") is calculated using average equity, excluding the average after tax unrealized gains or losses on investments. We present ROAE as a measure that is commonly recognized as a standard of performance by investors, analysts, rating agencies and other users of our financial information. Annualized operating return on average shareholders' equity is calculated using operating income and average shareholders' equity, excluding the average after tax unrealized gains or losses on investments. Year Ended December 31, 2011 2010 2009 ($ in millions) Opening shareholders' equity $ 3,075.8 $
3,213.3
Adjusted opening shareholders' equity $ 3,018.7 $ 3,063.5 $ 2,311.3 Closing shareholders' equity $ 3,149.0 $
3,075.8
Adjusted closing shareholders' equity $ 3,134.5 $ 3,018.7 $ 3,063.5 Average shareholders' equity $ 3,076.6 $ 3,041.1 $ 2,687.3 Net income available to shareholders $ 274.5 $ 665.0 $ 606.9 Annualized return on average shareholders' equity - net income available to shareholders 8.9 %
21.9 % 22.6 %
Operating income available to shareholders $ 183.7 $ 397.8 $ 537.7 Annualized return on average shareholders' equity - operating income available to shareholders 6.0 % 13.1 % 20.0 % 69
--------------------------------------------------------------------------------
Table of Contents Relevant Factors Revenues We derive our revenues primarily from premiums on our insurance policies and reinsurance contracts, net of any reinsurance or retrocessional coverage purchased. Insurance and reinsurance premiums are a function of the amounts and types of policies and contracts we write, as well as prevailing market prices. Our prices are determined before our ultimate costs, which may extend far into the future, are known. In addition, our revenues include income generated from our investment portfolio, consisting of net investment income and net realized investment gains or losses. Investment income is principally derived from interest and dividends earned on investments, partially offset by investment management and custodial expenses and fees paid to our custodian bank. Net realized investment gains or losses include gains or losses from the sale of investments, as well as the change in the fair value of investments that we mark-to-market through net income. Due to changes in the recognition and presentation of other-than-temporary impairments ("OTTI") of our available for sale debt securities based on guidance issued by the FASB in April 2009 , OTTI, which was previously included in "net realized investment gains or losses", has been presented separately in the consolidated income statements as "net impairment charges recognized in earnings". See "-Critical Accounting Policies-Other-Than-Temporary Impairments of Investments" for further discussion of the recognition and presentation of OTTI. Expenses Our expenses consist largely of net losses and loss expenses, acquisition costs, and general and administrative expenses. Net losses and loss expenses incurred are comprised of three main components:
• losses paid, which are actual cash payments to insureds and reinsureds, net
of recoveries from reinsurers; • outstanding loss or case reserves, which represent management's best
estimate of the likely settlement amount for known claims, less the portion
that can be recovered from reinsurers; and • reserves for losses incurred but not reported, or "IBNR", which are
reserves (in addition to case reserves) established by us that we believe
are needed for the future settlement of claims. The portion recoverable
from reinsurers is deducted from the gross estimated loss.
Acquisition costs are comprised of commissions, brokerage fees and insurance taxes. Commissions and brokerage fees are usually calculated as a percentage of premiums and depend on the market and line of business. Acquisition costs are reported after (1) deducting commissions received on ceded reinsurance, (2) deducting the part of acquisition costs relating to unearned premiums and (3) including the amortization of previously deferred acquisition costs.
General and administrative expenses include personnel expenses including stock-based compensation expense, rent expense, professional fees, information technology costs and other general operating expenses.
Ratios
Management measures results for each segment on the basis of the "loss and loss expense ratio," "acquisition cost ratio," "general and administrative expense ratio," "expense ratio" and the "combined ratio." Because we do not manage our assets by segment, investment income, interest expense and total assets are not allocated to individual reportable segments. General and administrative expenses are allocated to segments based on various factors, including staff count and each segment's proportional share of gross premiums written. The loss and loss expense ratio is derived by dividing net losses and loss expenses by net premiums earned. The acquisition cost ratio is derived by dividing acquisition costs by net premiums earned. The general and administrative expense ratio is derived by dividing general and administrative expenses by net premiums earned. The expense ratio is the sum of the acquisition cost ratio and the general and administrative expense ratio. The combined ratio is the sum of the loss and loss expense ratio, the acquisition cost ratio and the general and administrative expense ratio. 70
--------------------------------------------------------------------------------
Table of Contents
Critical Accounting Policies It is important to understand our accounting policies in order to understand our financial position and results of operations. Our consolidated financial statements reflect determinations that are inherently subjective in nature and require management to make assumptions and best estimates to determine the reported values. If events or other factors cause actual results to differ materially from management's underlying assumptions or estimates, there could be a material adverse effect on our financial condition or results of operations. The following are the accounting estimates that, in management's judgment, are critical due to the judgments, assumptions and uncertainties underlying the application of those estimates and the potential for results to differ from management's assumptions.
Reserve for Losses and Loss Expenses
Reserves for losses and loss expenses by segment as of
U.S. Insurance International Insurance Reinsurance Total December 31, December 31, December 31, December 31, 2011 2010 2009 2011 2010 2009 2011 2010 2009 2011 2010 2009 ($ in millions) Case reserves$ 387.6 $ 295.3 $ 268.1 $ 522.6 $ 498.3 $ 570.4 $ 456.2 $ 373.0 $ 313.5 $ 1,366.4 $ 1,166.5 $ 1,152.0 IBNR 1,274.8 1,136.4 985.6 1,726.4 1,728.4 1,786.0 857.5 847.8 838.2 3,858.7 3,712.7 3,609.8 Reserve for losses and loss expenses 1,662.4 1,431.7 1,253.7 2,249.0 2,226.7 2,356.4 1,313.7 1,220.8 1,151.7 5,225.1 4,879.2 4,761.8 Reinsurance recoverables (438.3 ) (396.6 ) (351.8 ) (564.3 ) (531.0 ) (566.3 ) (0.3 ) - (1.9 ) (1,002.9 ) (927.6 ) (920.0 ) Net reserve for losses and loss expenses$ 1,224.1 $ 1,035.1 $ 901.9 $ 1,684.7 $ 1,695.7 $ 1,790.1 $ 1,313.4 $ 1,220.8 $ 1,149.8 $ 4,222.2 $ 3,951.6 $ 3,841.8 The reserve for losses and loss expenses is comprised of two main elements: outstanding loss reserves, also known as case reserves, and reserves for IBNR. Outstanding loss reserves relate to known claims and represent management's best estimate of the likely loss settlement. IBNR reserves relate primarily to unreported events that, based on industry information, management's experience and actuarial evaluation, can reasonably be expected to have occurred and are reasonably likely to result in a loss to our company. IBNR reserves also relate to estimated development of reported events that based on industry information, management's experience and actuarial evaluation, can reasonably be expected to reach our attachment point and are reasonably likely to result in a loss to our company. We also include IBNR changes in the values of claims that have been reported to us but are not yet settled. Each claim is settled individually based upon its merits and it is not unusual for a claim to take years after being reported to settle, especially if legal action is involved. As a result, reserves for losses and loss expenses include significant estimates for IBNR reserves. The reserve for IBNR is estimated by management for each line of business based on various factors, including underwriters' expectations about loss experience, actuarial analysis, comparisons with the results of industry benchmarks and loss experience to date. The reserve for IBNR is calculated as the ultimate amount of losses and loss expenses less cumulative paid losses and loss expenses and case reserves. Our actuaries employ generally accepted actuarial methodologies to determine estimated ultimate loss reserves. While management believes that our case reserves and IBNR are sufficient to cover losses assumed by us, there can be no assurance that losses will not deviate from our reserves, possibly by material amounts. The methodology of estimating loss reserves is periodically reviewed to ensure that the assumptions made continue to be appropriate. To the extent actual reported losses exceed estimated losses, the carried estimate of the ultimate losses will be increased (i.e., unfavorable reserve development), and to the extent actual reported losses are less than estimated losses, the carried estimate of ultimate losses will be reduced (i.e., favorable reserve development). We record any changes in our loss reserve estimates and the related reinsurance recoverables in the periods in which they are determined. 71
--------------------------------------------------------------------------------
Table of Contents
The estimate of reserves for our property insurance and property reinsurance lines of business relies primarily on traditional loss reserving methodologies, utilizing selected paid and reported loss development factors. In the property lines of business, claims are generally reported and paid within a relatively short period of time ("shorter tail lines") during and following the policy coverage period. This generally enables us to determine with greater certainty our estimate of ultimate losses and loss expenses. Our casualty insurance and casualty reinsurance lines of business include general liability risks, healthcare and professional liability risks. Claims may be reported or settled several years after the coverage period has terminated for these lines of business ("longer tail lines"), which increases uncertainties of our reserve estimates in such lines. In addition, our attachment points for these longer tail lines are often relatively high, making reserving for these lines of business more difficult than shorter tail lines due to having to estimate whether the severity of the estimated losses will exceed our attachment point. We establish a case reserve when sufficient information is gathered to make a reasonable estimate of the liability, which often requires a significant amount of information and time. Due to the lengthy reporting pattern of these casualty lines, reliance is placed on industry benchmarks supplemented by our own experience. For expected loss ratio selections, we are giving greater consideration to our existing experience supplemented with analysis of loss trends, rate changes and experience of peer companies. Our reinsurance treaties are reviewed individually, based upon individual characteristics and loss experience emergence. Loss reserves on assumed reinsurance have unique features that make them more difficult to estimate than direct insurance. We establish loss reserves upon receipt of advice from a cedent that a reserve is merited. Our claims staff may establish additional loss reserves where, in their judgment, the amount reported by a cedent is potentially inadequate. The following are the most significant features that make estimating loss reserves on assumed reinsurance difficult:
• Reinsurers have to rely upon the cedents and reinsurance intermediaries to
report losses in a timely fashion. • Reinsurers must rely upon cedents to price the underlying business appropriately. • Reinsurers have less predictable loss emergence patterns than direct
insurers, particularly when writing excess-of-loss reinsurance.
For excess-of-loss reinsurance, cedents generally are required to report losses that either exceed 50% of the retention, have a reasonable probability of exceeding the retention or meet serious injury reporting criteria. All reinsurance claims that are reserved are reviewed at least every six months. For quota share reinsurance treaties, cedents are required to give a periodic statement of account, generally monthly or quarterly. These periodic statements typically include information regarding written premiums, earned premiums, unearned premiums, ceding commissions, brokerage amounts, applicable taxes, paid losses and outstanding losses. They can be submitted 60 to 90 days after the close of the reporting period. Some quota share reinsurance treaties have specific language regarding earlier notice of serious claims. Reinsurance generally has a greater time lag than direct insurance in the reporting of claims. The time lag is caused by the claim first being reported to the cedent, then the intermediary (such as a broker) and finally the reinsurer. This lag can be up to six months or longer in certain cases. There is also a time lag because the insurer may not be required to report claims to the reinsurer until certain reporting criteria are met. In some instances this could be several years while a claim is being litigated. We use reporting factors based on data from theReinsurance Association of America to adjust for time lags. We also use historical treaty-specific reporting factors when applicable. Loss and premium information are entered into our reinsurance system by our claims department and our accounting department on a timely basis. We record the individual case reserves sent to us by the cedents through the reinsurance intermediaries. Individual claims are reviewed by our reinsurance claims department and adjusted as deemed appropriate. The loss data received from the intermediaries is checked for reasonableness and for known events. Details of the loss listings are reviewed during routine claim audits. 72
--------------------------------------------------------------------------------
Table of Contents
The expected loss ratios that we assign to each treaty are based upon analysis and modeling performed by a team of actuaries. The historical data reviewed by the team of pricing actuaries is considered in setting the reserves for each cedent. The historical data in the submissions is matched against our carried reserves for our historical treaty years. Loss reserves do not represent an exact calculation of liability. Rather, loss reserves are estimates of what we expect the ultimate resolution and administration of claims will cost. These estimates are based on actuarial and statistical projections and on our assessment of currently available data, as well as estimates of future trends in claims severity and frequency, judicial theories of liability and other factors. Loss reserve estimates are refined as experience develops and as claims are reported and resolved. In addition, the relatively long periods between when a loss occurs and when it may be reported to our claims department for our casualty insurance and casualty reinsurance lines of business increase the uncertainties of our reserve estimates in such lines. We utilize a variety of standard actuarial methods in our analysis. The selections from these various methods are based on the loss development characteristics of the specific line of business. For lines of business with long reporting periods such as casualty reinsurance, we may rely more on an expected loss ratio method (as described below) until losses begin to develop. For lines of business with short reporting periods such as property insurance, we may rely more on a paid loss development method (as described below) as losses are reported relatively quickly. The actuarial methods we utilize include: Paid Loss Development Method. We estimate ultimate losses by calculating past paid loss development factors and applying them to exposure periods with further expected paid loss development. The paid loss development method assumes that losses are paid at a consistent rate. The paid loss development method provides an objective test of reported loss projections because paid losses contain no reserve estimates. In some circumstances, paid losses for recent periods may be too varied for accurate predictions. For many coverages, especially casualty coverages, claim payments are made slowly and it may take years for claims to be fully reported and settled. These payments may be unreliable for determining future loss projections because of shifts in settlement patterns or because of large settlements in the early stages of development. Choosing an appropriate "tail factor" to determine the amount of payments from the latest development period to the ultimate development period may also require considerable judgment, especially for coverages that have long payment patterns. As we have limited payment history, we have had to supplement our paid loss development patterns with appropriate benchmarks. Reported Loss Development Method. We estimate ultimate losses by calculating past reported loss development factors and applying them to exposure periods with further expected reported loss development. Since reported losses include payments and case reserves, changes in both of these amounts are incorporated in this method. This approach provides a larger volume of data to estimate ultimate losses than the paid loss development method. Thus, reported loss patterns may be less varied than paid loss patterns, especially for coverages that have historically been paid out over a long period of time but for which claims are reported relatively early and have case loss reserve estimates established. This method assumes that reserves have been established using consistent practices over the historical period that is reviewed. Changes in claims handling procedures, large claims or significant numbers of claims of an unusual nature may cause results to be too varied for accurate forecasting. Also, choosing an appropriate "tail factor" to determine the change in reported loss from the latest development period to the ultimate development period may require considerable judgment. As we have limited reported history, we have had to supplement our reported loss development patterns with appropriate benchmarks. Expected Loss Ratio Method. To estimate ultimate losses under the expected loss ratio method, we multiply earned premiums by an expected loss ratio. The expected loss ratio is selected utilizing industry data, historical company data and professional judgment. This method is particularly useful for new insurance companies or new lines of business where there are no historical losses or where past loss experience is not credible.
Bornhuetter-Ferguson Paid Loss Method. The Bornhuetter-Ferguson paid loss method is a combination of the paid loss development method and the expected loss ratio method. The amount of losses yet to be paid is based upon the expected loss ratios and the expected percentage of losses unpaid. These
73
--------------------------------------------------------------------------------
Table of Contents
expected loss ratios are modified to the extent paid losses to date differ from what would have been expected to have been paid based upon the selected paid loss development pattern. This method avoids some of the distortions that could result from a large development factor being applied to a small base of paid losses to calculate ultimate losses. This method will react slowly if actual loss ratios develop differently because of major changes in rate levels, retentions or deductibles, the forms and conditions of reinsurance coverage, the types of risks covered or a variety of other changes. Bornhuetter-Ferguson Reported Loss Method. The Bornhuetter-Ferguson reported loss method is similar to the Bornhuetter-Ferguson paid loss method with the exception that it uses reported losses and reported loss development factors. During 2011, 2010 and 2009, we adjusted our reliance on actuarial methods utilized for certain casualty lines of business and loss years within our U.S. insurance and international insurance segments from using a blend of the Bornhuetter-Ferguson reported loss method and the expected loss ratio method to using only the Bornhuetter-Ferguson reported loss method. We also began adjusting our reliance on actuarial methods utilized for certain other casualty lines of business and loss years within all of our operating segments including the reinsurance segment, by placing greater reliance on the Bornhuetter-Ferguson reported loss method than on the expected loss ratio method. Placing greater reliance on more responsive actuarial methods for certain casualty lines of business and loss years within each of our operating segments is a natural progression as we mature as a company and gain sufficient historical experience of our own that allows us to further refine our estimate of the reserve for losses and loss expenses. We believe utilizing only the Bornhuetter-Ferguson reported loss method for older loss years will more accurately reflect the reported loss activity we have had thus far in our ultimate loss ratio selections, and will better reflect how the ultimate losses will develop over time. We will continue to utilize the expected loss ratio method for the most recent loss years until we have sufficient historical experience to utilize other acceptable actuarial methodologies.
We expect that the trend of placing greater reliance on more responsive actuarial methods, for example from the expected loss ratio method to the Bornhuetter-Ferguson reported loss method, to continue as both (1) our loss years mature and become more statistically reliable and (2) as we build databases of our internal loss development patterns. The expected loss ratio remains a key assumption as the Bornhuetter-Ferguson methods rely upon an expected loss ratio selection and a loss development pattern selection. The key assumptions used to arrive at our best estimate of loss reserves are the expected loss ratios, rate of loss cost inflation, selection of benchmarks and reported and paid loss emergence patterns. Our reporting factors and expected loss ratios are based on a blend of our own experience and industry benchmarks for longer tailed business and primarily our own experience for shorter tail business. The benchmarks selected were those that we believe are most similar to our underwriting business. Our expected loss ratios for shorter tail lines change from year to year. As our losses from shorter tail lines of business are reported relatively quickly, we select our expected loss ratios for the most recent years based upon our actual loss ratios for our older years adjusted for rate changes, inflation, cost of reinsurance and average storm activity. For the shorter tail lines, we initially used benchmarks for reported and paid loss emergence patterns. As we mature as a company, we have begun supplementing those benchmark patterns with our actual patterns as appropriate. For the longer tail lines, we continue to use benchmark patterns, although we update the benchmark patterns as additional information is published regarding the benchmark data. For shorter tail lines, the primary assumption that changed during both 2011 as compared to 2010 and 2010 as compared to 2009 as it relates to prior year losses was actual paid and reported loss emergence patterns were generally less severe than estimated for each year due to lower frequency and severity of reported losses. As a result of this change, we recognized net favorable prior year reserve development in both 2011 and 2010. However, we did experience significant property insurance and property reinsurance losses, which resulted in us increasing our reserves related to current year losses. Of the
--------------------------------------------------------------------------------
Table of Contents
property insurance and property reinsurance lines of business,$98.3 million was catastrophe related (Chilean andNew Zealand earthquakes and the Australian floods), and$22.7 million related to attritional losses. We will continue to evaluate and monitor the development of these losses and the impact it has on our current and future assumptions. We believe recognition of the reserve changes in the period they were recorded was appropriate since a pattern of reported losses had not emerged and the loss years were previously too immature to deviate from the expected loss ratio method in prior periods. The selection of the expected loss ratios for the longer tail lines is our most significant assumption. Due to the lengthy reporting pattern of longer tail lines, we supplement our own experience with industry benchmarks of expected loss ratios and reporting patterns in addition to our own experience. For our longer tail lines, the primary assumption that changed during both 2011 as compared to 2010 and 2010 as compared to 2009 as it relates to prior year losses was using the Bornhuetter-Ferguson loss development method for certain casualty lines of business and loss years as discussed above. This method calculated a lower projected loss ratio based on loss emergence patterns to date. As a result of the change in the expected loss ratio, we recognized net favorable prior year reserve development in 2011, 2010 and 2009. We believe that recognition of the reserve changes in the period they were recorded was appropriate since a pattern of reported losses had not emerged and the loss years were previously too immature to deviate from the expected loss ratio method in prior periods. Our overall change in the loss reserve estimates related to prior years decreased as a percentage of total carried reserves during 2011. On an opening carried reserve base of$3,951.6 million , after reinsurance recoverable, we had a net decrease of$253.5 million , or 6.4%, during 2011, and for 2010 we had a net decrease of$313.3 million , or 8.2%, on an opening carried reserve base of$3,841.8 million , after reinsurance recoverables. We believe that these changes are reasonable given the long-tail nature of our business. There is potential for significant variation in the development of loss reserves, particularly for the casualty lines of business due to their long tail nature and high attachment points. The maturing of our casualty insurance and reinsurance loss reserves have caused us to reduce what we believe is a reasonably likely variance in the expected loss ratios for older loss years. As ofDecember 31, 2011 and 2010, we believe reasonably likely variances in our expected loss ratio in percentage points for our loss years are as follows: As of December 31, Loss Year 2011 2010 2004 2.0 % 4.0 % 2005 4.0 % 6.0 % 2006 6.0 % 8.0 % 2007 8.0 % 10.0 % 2008 10.0 % 10.0 % 2009 10.0 % 10.0 % 2010 10.0 % 10.0 % 2011 10.0 % - The change in the reasonably likely variance for the 2004 through 2007 loss years in 2011 compared to 2010 is due to giving greater weight to the Bornhuetter-Ferguson loss development method for additional lines of business during 2011 and additional development of losses. The reasonably likely variance of our expected loss ratio for all loss years for our casualty insurance and casualty reinsurance lines of business was seven percentage points as ofDecember 31, 2011 and 2010. If our final casualty insurance and reinsurance loss ratios vary by seven percentage points from the expected loss ratios in aggregate, our required net reserves after reinsurance recoverable would increase or decrease by approximately$598.1 million . Because we expect a small volume of large claims, it is more difficult to estimate the ultimate loss ratios, so we believe the variance of our loss ratio selection could be relatively wide. This would result in either an increase or decrease to income, before income taxes, and total shareholders' equity of approximately$598.1 million . As ofDecember 31, 2011 , this represented approximately 19% of total shareholders' equity. In terms of liquidity, our contractual obligations for reserves for losses and loss expenses would also increase or decrease by approximately$598.1 million after reinsurance recoverable. If our obligations were to increase by$598.1 million , we believe we currently have sufficient cash 75
--------------------------------------------------------------------------------
Table of Contents
and investments to meet those obligations. We believe showing the impact of an increase or decrease in the expected loss ratios is useful information despite the fact that we have realized only net favorable prior year loss development each calendar year. We continue to use industry benchmarks to supplement our expected loss ratios, and these industry benchmarks have implicit in them both favorable and unfavorable loss development, which we incorporate into our selection of the expected loss ratios.
The following tables provide our ranges of loss and loss expense reserve estimates by business segment as of
Reserve for Losses and Loss Expenses Gross of Reinsurance Recoverable(1) Carried Low High Reserves Estimate Estimate ($ in millions) U.S. insurance $ 1,662.4 $ 1,342.3 $ 1,857.5
International insurance 2,249.0 1,696.9
2,527.8 Reinsurance 1,313.7 1,067.7 1,511.2 Reserve for Losses and Loss Expenses Net of Reinsurance Recoverable(2) Carried Low High Reserves Estimate Estimate ($ in millions) U.S. insurance $ 1,224.1 $ 984.3 $ 1,360.2
International insurance 1,684.7 1,262.7
1,899.0 Reinsurance 1,313.4 1,067.4 1,510.4
(1) For statistical reasons, it is not appropriate to add together the ranges of
each business segment in an effort to determine the low and high range around
the consolidated loss reserves. On a gross basis, the consolidated low estimate is$4,369.0 million and the consolidated high estimate is$5,634.4 million .
(2) For statistical reasons, it is not appropriate to add together the ranges of
each business segment in an effort to determine the low and high range around
the consolidated loss reserves. On a net basis, the consolidated low estimate
is
Our range for each business segment was determined by utilizing multiple actuarial loss reserving methods along with various assumptions of reporting patterns and expected loss ratios by loss year. The various outcomes of these techniques were combined to determine a reasonable range of required loss and loss expense reserves. While we believe our approach to determine the range of loss and loss expense is reasonable, there are no assurances that actual loss experience will be within the ranges of loss and loss expense noted above. Our selection of the actual carried reserves has typically been above the midpoint of the range. As ofDecember 31, 2011 , we were 4.5% above the midpoint of the consolidated net loss reserve range. We believe that we should be prudent in our reserving practices due to the lengthy reporting patterns and relatively large limits of net liability for any one risk of our direct excess casualty business and of our casualty reinsurance business. Thus, due to this uncertainty regarding estimates for reserve for losses and loss expenses, we have carried our consolidated reserve for losses and loss expenses, net of reinsurance recoverable, above the midpoint of the low and high estimates for the consolidated net losses and loss expenses. We believe that relying on the more prudent actuarial indications is appropriate for these lines of business.
Ceded Reinsurance
We cede insurance to reinsurers in order to limit our maximum loss, to protect against concentration of risk within our portfolio and to manage our exposure to catastrophic events. Because the ceding of insurance does not discharge us from our primary obligation to the insureds, we remain liable to the extent that our reinsurers do not meet their obligations under the reinsurance agreements. Therefore, we regularly evaluate the financial condition of our reinsurers and monitor concentration of credit risk. No provision has been made for unrecoverable reinsurance as ofDecember 31, 2011 and 2010 as we believe that all reinsurance balances will be recovered. 76
--------------------------------------------------------------------------------
Table of Contents
When we reinsure a portion of our exposures, we pay reinsurers a portion of premiums received on the reinsured policies. Total premiums ceded pursuant to reinsurance contracts entered into by our company with a variety of reinsurers were$405.8 million ,$365.9 million and$375.2 million for the years endedDecember 31, 2011 , 2010 and 2009, respectively.
The following table illustrates our gross premiums written and ceded for the years ended
Gross Premiums Written and Premiums Ceded Year Ended December 31, 2011 2010 2009 ($ in millions) Gross $ 1,939.5 $ 1,758.4 $ 1,696.3 Ceded (405.8 ) (365.9 ) (375.2 ) Net $ 1,533.8 $ 1,392.5 $ 1,321.1
Ceded as percentage of gross 20.9 % 20.8 % 22.1 %
The following table illustrates the effect of our reinsurance ceded strategies on our results of operations: Year Ended December 31, 2011 2010 2009 ($ in millions) Premiums written ceded 405.8 365.9 375.2 Premiums earned ceded 366.3 365.3 381.2 Losses and loss expenses ceded 214.6 165.8 196.6 Acquisition costs ceded 92.6 81.5 79.6 We had net cash outflows relating to ceded reinsurance activities (premiums paid less losses recovered and net ceding commissions received) of approximately$148.3 million ,$128.5 million and$116.0 million for the years endedDecember 31, 2011 , 2010 and 2009, respectively. The net cash outflows in all years are reflective of fewer losses that were recoverable under our reinsurance coverages. Our reinsurance treaties are generally purchased on an annual basis and are therefore subject to yearly renegotiation. The treaties typically specify ceding commissions, and include provisions for required reporting to the reinsurers, responsibility for taxes, arbitration of disputes and the posting of security for the reinsurance recoverable under certain circumstances, such as a downgrade in the reinsurer's financial strength rating. The amount of risk ceded by us to reinsurers is subject to maximum limits which vary by line of business and by type of coverage. We also purchase a limited amount of facultative reinsurance, which provides cover for specified policies, rather than for whole classes of business. The examples below illustrate the types of treaty reinsurance arrangements in force atDecember 31, 2011 : • General Property: We purchased both quota share reinsurance for our
general property business written in our U.S. insurance and international
insurance segments, as well as excess-of-loss cover providing protection
for specified classes of catastrophe. We have also purchased a limited
amount of facultative reinsurance, which provides cover for specified
general property policies.
• General Casualty: We have purchased variable quota share reinsurance for
our general casualty business since
percentage ceded varied by both location of writing office and by limits
reinsured, with a significantly larger cession being effective for policies
above
general casualty business written in our Asian branch offices. • Professional Liability: For professional liability policies, our
reinsurance varied by writing office and by policy type. Professional
liability policies written in our
quota- 77
--------------------------------------------------------------------------------
Table of Contents
share reinsured with cession percentages dependent upon location.
Additionally, the professional liability policies written in the United
States, as well as those originating within our Asian branch offices were
reinsured on an excess-of-loss basis.
• Healthcare: We purchased quota share and excess-of-loss reinsurance
protection for our healthcare line of business written by our
U.S. offices, respectively. As is the case with general casualty and professional liability, our healthcare business originating inAsia is under an excess-of-loss reinsurance arrangement. The following table illustrates our reinsurance recoverable as ofDecember 31, 2011 and 2010: Reinsurance Recoverable as of December 31, 2011 2010 ($ in millions) Ceded case reserves $ 196.5 $ 206.2 Ceded IBNR reserves 806.4 721.4 Reinsurance recoverable $ 1,002.9 $ 927.6 As noted above, we remain obligated for amounts ceded in the event our reinsurers do not meet their obligations. Accordingly, we have evaluated the reinsurers that are providing reinsurance protection to us and will continue to monitor their credit ratings and financial stability. We generally have the right to terminate our treaty reinsurance contracts at any time, upon prior written notice to the reinsurer, under specified circumstances, including the assignment to the reinsurer byA.M. Best of a financial strength rating of less than "A-." As ofDecember 31, 2011 , approximately 98% of ceded case reserves and 99% of our ceded IBNR were recoverable from reinsurers who had anA.M. Best rating of "A-" or higher. We determine what portion of the losses will be recoverable under our reinsurance policies by reference to the terms of the reinsurance protection purchased. This determination is necessarily based on the underlying loss estimates and, accordingly, is subject to the same uncertainties as the estimate of case reserves and IBNR reserves.
The following table shows our reinsurance recoverables by operating segment as of
As of December 31, 2011 2010 ($ in millions) U.S. insurance $ 438.3 $ 396.6 International insurance 564.3 531.0 Reinsurance 0.3 - Total reinsurance recoverable $ 1,002.9 $ 927.6 Historically, our reinsurance recoverables related primarily to our property lines of business, which being short tail in nature, are not subject to the same variations as our casualty lines of business. However, during 2011 and 2010 we have increased the amount of reinsurance we utilize for our casualty lines of business in the U.S. insurance and international insurance segments; and as such, the reinsurance recoverables from our casualty lines of business have increased over the past several years. As the reinsurance recoverables are subject to the same uncertainties as the estimate of case reserves and IBNR reserves, if our final casualty insurance ceded loss ratios vary by eight percentage points from the expected loss ratios in aggregate, our required reinsurance recoverable would increase or decrease by approximately$134.6 million . This would result in either an increase or decrease to income before income taxes and shareholders' equity of approximately$134.6 million . As ofDecember 31, 2011 , this amount represented approximately 4% of total shareholders' equity. 78
--------------------------------------------------------------------------------
Table of Contents
Premiums and Acquisition Costs
Premiums are recognized as written on the inception date of a policy. For certain types of business written by us, notably reinsurance, premium income may not be known at the contract inception date. In the case of quota share reinsurance assumed by us, the underwriter makes an estimate of premium income at inception as the premium income is typically derived as a percentage of the underlying policies written by the cedents. The underwriter's estimate is based on statistical data provided by reinsureds and the underwriter's judgment and experience. Such estimations are refined over the reporting period of each treaty as actual written premium information is reported by ceding companies and intermediaries. Management reviews estimated premiums at least quarterly and any adjustments are recorded in the period in which they become known. As ofDecember 31, 2011 , our changes in premium estimates have been adjustments ranging from approximately negative 6% for the 2009 treaty year to approximately 22% for the 2005 treaty year. Applying this range to our 2011 quota share reinsurance treaties, our gross premiums written in the reinsurance segment could decrease by approximately$13.9 million or increase by approximately$47.7 million over the next three years. Given the recent trend of downward adjustments on premium estimates, we believe a reasonably likely change in our premium estimate would be the midpoint of the 6% and 22%, or 8%, for a change of$16.9 million . There would also be a related increase in loss and loss expenses and acquisition costs due to the increase in gross premiums written. It is reasonably likely as our historical experience develops that we may have fewer or smaller adjustments to our estimated premiums, and therefore could have changes in premium estimates lower than the range historically experienced. Total premiums estimated on quota share reinsurance contracts for the years endedDecember 31, 2011 , 2010 and 2009 represented approximately 11%, 13% and 12%, respectively, of total gross premiums written. Other insurance and reinsurance policies can require that the premium be adjusted at the expiry of a policy to reflect the risk assumed by us. Premiums resulting from such adjustments are estimated and accrued based on available information.
Fair Value of Financial Instruments
In accordance with U.S. GAAP, we are required to recognize certain assets at their fair value in our consolidated balance sheets. This includes our fixed maturity investments and other invested assets. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. There is a three-level valuation hierarchy for disclosure of fair value measurements. The valuation hierarchy is based upon whether the inputs to the valuation of an asset or liability are observable or unobservable in the market at the measurement date, with quoted market prices being the highest level (Level 1) and unobservable inputs being the lowest level (Level 3). A fair value measurement will fall within the level of the hierarchy based on the input that is significant to determining such measurement. The three levels are defined as follows: • Level 1: Observable inputs to the valuation methodology that are quoted prices (unadjusted) for identical assets or liabilities in active markets.
• Level 2: Observable inputs to the valuation methodology other than
quoted market prices (unadjusted) for identical assets or
liabilities
in active markets. Level 2 inputs include quoted prices for similar assets and liabilities in active markets, quoted prices for identical assets in markets that are not active and inputs other than quoted prices that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the asset or liability.
• Level 3: Inputs to the valuation methodology which are unobservable
for the asset or liability. At each measurement date, we estimate the fair value of the financial instruments using various valuation techniques. We utilize, to the extent available, quoted market prices in active markets or observable market inputs in estimating the fair value of our financial instruments. When quoted market prices or observable market inputs are not available, we utilize valuation techniques that rely on unobservable inputs to estimate the fair value of financial instruments. The following describes the valuation techniques we used to determine the fair value of financial instruments held as ofDecember 31, 2011 and what level within the U.S. GAAP fair value hierarchy the valuation technique resides. 79
--------------------------------------------------------------------------------
Table of Contents
U.S. government and U.S. government agencies: Comprised primarily of bonds issued by the U.S. Treasury, theFederal Home Loan Bank , the Federal Home Loan Mortgage Corporation and the Federal National Mortgage Association. The fair values of U.S. government securities are based on quoted market prices in active markets, and are included in the Level 1 fair value hierarchy. We believe the market for U.S. Treasury securities is an actively traded market given the high level of daily trading volume. The fair values of U.S. government agency securities are priced using the spread above the risk-free yield curve. As the yields for the risk-free yield curve and the spreads for these securities are observable market inputs, the fair values of U.S. government agency securities are included in the Level 2 fair value hierarchy.
Non-U.S. government and government agencies: Comprised of fixed income obligations of non-U.S. governmental entities. The fair values of these securities are based on prices obtained from international indices and are included in the Level 2 fair value hierarchy.
States, municipalities and political subdivisions: Comprised of fixed income obligations of U.S. domiciled state and municipality entities. The fair values of these securities are based on prices obtained from the new issue market, and are included in the Level 2 fair value hierarchy. Corporate debt: Comprised of bonds issued by corporations that are diversified across a wide range of issuers and industries. The fair values of corporate bonds that pay a floating rate coupon are priced using the spread above the London Interbank Offered Rate yield curve and the fair values of corporate bonds that are long term are priced using the spread above the risk-free yield curve. The spreads are sourced from broker-dealers, trade prices and the new issue market. As the significant inputs used to price corporate bonds are observable market inputs, the fair values of corporate bonds are included in the Level 2 fair value hierarchy. Mortgage-backed: Principally comprised of residential and commercial mortgages originated by both U.S. government agencies (such as the Federal National Mortgage Association) and non-U.S. government agency originators. The fair values of mortgage-backed securities originated by U.S. government agencies and non-U.S. government agencies are based on a pricing model that incorporates prepayment speeds and spreads to determine the appropriate average life of mortgage-backed securities. The spreads are sourced from broker-dealers, trade prices and the new issue market. As the significant inputs used to price the mortgage-backed securities are observable market inputs, the fair values of these securities are included in the Level 2 fair value hierarchy, unless the significant inputs used to price the mortgage-backed securities are broker-dealer quotes and we are not able to determine if those quotes are based on observable market inputs, in which case the fair value is included in the Level 3 fair value hierarchy. Asset-backed: Principally comprised of bonds backed by pools of automobile loan receivables, home equity loans, credit card receivables and collateralized loan obligations originated by a variety of financial institutions. The fair values of asset-backed securities are priced using prepayment speed and spread inputs that are sourced from the new issue market or broker-dealer quotes. As the significant inputs used to price the asset-backed securities are observable market inputs, the fair values of these securities are included in the Level 2 fair value hierarchy, unless the significant inputs used to price the asset-backed securities are broker-dealer quotes and we are not able to determine if those quotes are based on observable market inputs, in which case the fair value is included in the Level 3 fair value hierarchy.
Equity securities: The fair value of the equity securities are priced from market exchanges and therefore included in the Level 1 fair value hierarchy.
Other invested assets: Comprised of funds invested in a range of diversified strategies. In accordance with U.S. GAAP, the fair values of the funds are based on the net asset value of the funds as reported by the fund manager, which we believe is an unobservable input, and as such, the fair values of the funds are included in the Level 3 fair value hierarchy. Senior notes: The fair value of the senior notes is based on trades as reported inBloomberg . As ofDecember 31, 2011 , the 7.50% Senior Notes and 5.50% Senior Notes (each as defined in Note 9 of the notes to consolidated financial statements) were traded at 114.3% and 100.4% of their principal amount, providing an effective yield of 4.0% and 5.4%, respectively. The fair value of the senior notes is included in the Level 2 fair value hierarchy. 80
--------------------------------------------------------------------------------
Table of Contents
The following table shows the pricing sources of our fixed maturity investments held as of
Fair Value of Fixed Maturity Percentage of Investments as of Total Fixed Fair Value December 31, 2011 Maturity Hierarchy Pricing Sources ($ in millions) Investments Level Barclays indices $ 4,044.1 62.2 % 1 and 2 Interactive Data Pricing 996.5 15.3 2 Reuters pricing service 458.8 7.1 2 Broker-dealer quotes 343.9 5.3 3 Merrill Lynch indices 160.0 2.5 2 International indices 115.4 1.8 2 Other sources 380.0 5.8 2 $ 6,498.7 100.0 %
The following table shows the pricing sources of our fixed maturity investments held as of
Fair Value of Fixed Maturity Percentage of Investments as of Total Fixed Fair Value December 31, 2010 Maturity Hierarchy Pricing Sources ($ in millions) Investments Level Barclays indices $ 4,684.6 70.3 % 1 and 2 Interactive Data Pricing 997.7 15.0 2 Reuters pricing service 252.8 3.8 2 Broker-dealer quotes 221.3 3.3 3 Merrill Lynch indices 166.9 2.5 2 International indices 68.6 1.0 2 Other sources 269.1 4.1 2 $ 6,661.0 100.0 % Barclays indices: We use Barclays indices to price our U.S. government, U.S. government agencies, corporate debt, agency and non-agency mortgage-backed and asset-backed securities. There are several observable inputs that the Barclays indices use in determining its prices which include among others, treasury yields, new issuance and secondary trades, information provided by broker-dealers, security cash flows and structures, sector and issuer level spreads, credit rating, underlying collateral and prepayment speeds. For U.S. government securities, traders that act as market makers are the primary source of pricing; as such, for U.S. government securities we believe the Barclays indices reflect quoted prices (unadjusted) for identical securities in active markets.
Interactive Data Pricing: We use Interactive Data Pricing to price our U.S. government agencies, municipalities, non-agency mortgage-backed and asset-backed securities. There are several observable inputs that Interactive Data Pricing uses in determining its prices which include among others, benchmark yields, reported trades and issuer spreads.
Reuters pricing service: We use the Reuters pricing service to price our U.S. government agencies, corporate debt, agency and non-agency mortgage-backed and asset-backed securities. There are several observable inputs that the Reuters pricing service uses in determining its prices which include among others, option-adjusted spreads, treasury yields, new issuance and secondary trades, sector and issuer level spreads, underlying collateral and prepayment speeds.
Broker-dealer quotes: We also utilize broker-dealers to price our agency and non-agency mortgage-backed and asset-backed securities. The pricing sources include
81
--------------------------------------------------------------------------------
Table of Contents
Merrill Lynch Index: We use the Merrill Lynch indices to price our non-U.S. government and government agencies securities, corporate debt, municipalities and asset-backed securities. There are several observable inputs that the Merrill Lynch indices use in determining its prices, which include reported trades and other sources.
Standard & Poor's Securities Evaluation: We use Standard & Poor's to price our U.S. government agencies, corporate debt, municipalities, mortgage-backed and asset-backed securities. There are several observable inputs that Standard & Poor's uses in determining its prices which include among others, benchmark yields, reported trades and issuer spreads. International indices: We use international indices, which include theFTSE , Deutche Teleborse and the Scotia Index, to price our non-U.S. government and government agencies securities. The observable inputs used by international indices to determine its prices are based on new issuance and secondary trades and information provided by broker-dealers.
Other sources: We utilize other indices and pricing services to price various securities. These sources use observable inputs consistent with indices and pricing services discussed above.
We utilize independent pricing sources to obtain market quotations for securities that have quoted prices in active markets. In general, the independent pricing sources use observable market inputs, including, but not limited to, investment yields, credit risks and spreads, benchmarking of like securities, non-binding broker-dealer quotes, reported trades and sector groupings to determine the fair value. For a majority of the portfolio, we obtained two or more prices per security as ofDecember 31, 2011 . When multiple prices are obtained, a price source hierarchy is utilized to determine which price source is the best estimate of the fair value of the security. The price source hierarchy emphasizes more weighting to significant observable inputs such as index pricing and less weighting towards non-binding broker quotes. In addition, to validate all prices obtained from these pricing sources including non-binding broker quotes, we also obtain prices from our investment portfolio managers and other sources (e.g., another pricing vendor), and compare the prices obtained from the independent pricing sources to those obtained from our investment portfolio managers and other sources. We investigate any material differences between the multiple sources and determine which price best reflects the fair value of the individual security. There were no material differences between the prices from the independent pricing sources and the prices obtained from our investment portfolio managers and other sources as ofDecember 31, 2011 . There have been no material changes to any of our valuation techniques from those used as ofDecember 31, 2010 . Based on all reasonably available information received, we believe the prices that were obtained from inactive markets were orderly transactions and therefore, reflected the current price a market participant would pay for the asset. Since fair valuing a financial instrument is an estimate of what a willing buyer would pay for our asset if we sold it, we will not know the ultimate value of our financial instruments until they are sold. We believe the valuation techniques utilized provide us with the best estimate of the price that would be received to sell our assets in an orderly transaction between participants at the measurement date.
Other-Than-Temporary Impairment of Investments
EffectiveApril 1, 2009 , we are required to recognize OTTI in the consolidated income statements if we intend to sell the debt security or if it is more likely than not we will be required to sell a debt security before the recovery of its amortized cost basis. In addition, we are required to recognize OTTI if the present value of the expected cash flows of a debt security is less than the amortized cost basis of the debt security ("credit loss").
For our debt securities that are within the scope of the new guidance we have applied the following policy to determine if OTTI exists at each reporting period:
• Our debt securities are managed by external investment portfolio managers.
We require them to provide us with a list of debt securities they intend to
sell at the end of the reporting period. Any impairment in these securities
is recognized as OTTI, as the difference between the amortized cost and fair value and is recognized in the income statement. 82
--------------------------------------------------------------------------------
Table of Contents
• At each reporting period we determine if it is more likely than not we will
be required to sell a debt security before the recovery of its amortized
cost basis. We analyze our current and future contractual and
non-contractual obligations and our expectation of future cash flows to
determine if we will need to sell debt securities to fund our obligations.
We consider factors such as trends in underwriting profitability, cash
flows from operations, return on our invested assets, property catastrophe
losses, timing of payments and other specific contractual obligations that
are coming due.
• For debt securities that are in an unrealized loss position that we do not
intend to sell, we assess whether a credit loss exists. The amount of the
credit loss is recognized in the income statement. The assessment involves
consideration of several factors including: (i) the significance of the
decline in value and the resulting unrealized loss position, (ii) the time
period for which there has been a significant decline in value and (iii) an
analysis of the issuer of the investment, including its liquidity, business
prospects and overall financial position.
Following the Company's review of the securities in the investment portfolio during the year endedDecember 31, 2011 , no securities were considered to be other-than-temporarily impaired due to the present value of the expected cash flows being lower than the amortized cost. During the year endedDecember 31, 2010 , we had one mortgage-backed security that was considered to be other-than-temporarily impaired due to the present value of the expected cash flows being lower than the amortized cost. The$0.2 million of OTTI was recognized through earnings due to credit related losses. For the mortgage-backed security for which OTTI was recognized due to credit loss, the significant inputs utilized to determine a credit loss were the estimated frequency and severity of losses of the underlying mortgages that comprise the mortgage-backed security. The frequency of losses was measured as the credit default rate, which includes such factors as loan-to-value ratios and credit scores of borrowers. The severity of losses includes such factors as trends in overall housing prices and house prices that are obtained at foreclosure. The frequency and severity inputs were used in projecting the future cash flows of the mortgage backed security. For the security in which we recognized an OTTI due to credit loss, the credit default rate was 10.3% and the severity rate was 49.0%. Prior toApril 1, 2009 , we reviewed the carrying value of our investments to determine if a decline in value was considered to be other than temporary. This review involved consideration of several factors including: (i) the significance of the decline in value and the resulting unrealized loss position; (ii) the time period for which there has been a significant decline in value; (iii) an analysis of the issuer of the investment, including its liquidity, business prospects and overall financial position; and (iv) our intent and ability to hold the investment for a sufficient period of time for the value to recover. For certain investments, our investment portfolio managers had the discretion to sell those investments at any time. As such, we recognized OTTI for those securities in an unrealized loss position each quarter as we could not assert that we had the intent to hold those investments until anticipated recovery. The identification of potentially impaired investments involves significant management judgment that included the determination of their fair value and the assessment of whether any decline in value was other than temporary. If the decline in value was determined to be other than temporary, then we recorded a realized loss in the statements of operations and comprehensive income in the period that it was determined, and the cost basis of that investment was reduced. Based on our review of the debt securities, for the year endedDecember 31, 2009 we recognized a total of$68.2 million in OTTI, of which$18.6 million was recognized in accumulated other comprehensive income in the consolidated balance sheets and$49.6 million was recognized in the income statement. Of the$49.6 million of OTTI recognized in the income statement,$7.7 million was due to credit related losses where the anticipated discounted cash flows of various debt securities were lower than the amortized cost, and$41.9 million in the first quarter of 2009 related to net impairment charges for those securities in an unrealized loss position where our investment managers had the discretion to sell. The$7.7 million of credit related OTTI recognized consisted of$6.0 million related to mortgage-backed securities and$1.7 million related to a corporate bond. We did not have securities with an unrealized loss as ofDecember 31, 2009 that we intended to sell or that we were required to sell. 83
--------------------------------------------------------------------------------
Table of Contents
Goodwill and Other Intangible Asset Impairment Valuation
We classify intangible assets into three categories: (1) intangible assets with finite lives subject to amortization; (2) intangible assets with indefinite lives not subject to amortization and (3) goodwill. Intangible assets, other than goodwill, consist of renewal rights, internally generated software, non-compete covenants and insurance licenses held by subsidiaries domiciled inthe United States . The following is a summary of our goodwill and other intangible assets as ofDecember 31, 2011 and 2010: Year Finite or Estimated Useful Carrying Value Carrying Value Source of Goodwill or Intangible Asset Acquired Indefinite Life December 31, 2011 December 31, 2010 (In millions) Insurance licenses(1) 2002 Indefinite N/A $ 3.9 $ 3.9 Insurance licenses(2) 2008 Indefinite N/A 12.0 12.0 Goodwill(2) 2008 Indefinite N/A 3.9 3.9 Distribution Network(3) 2008 Finite 15 years 30.0
32.5
Internally developed computer software(3) 2008 Finite 3 years 0.0 0.4 Insurance licenses(3) 2008 Indefinite N/A 8.0 8.0 Goodwill(3) 2008 Indefinite N/A 264.5 264.5 Total goodwill and other intangible assets $ 322.3 $ 325.2
(1) Related to the acquisition of
Allied World Assurance Company (U.S.) Inc.
(2) Related to the acquisition of
(3) Related to the acquisition of Darwin
For intangible assets with finite lives, the value is amortized over their useful lives. We also test intangible assets with finite lives for impairment if conditions exist that indicate the carrying value may not be recoverable. Such factors include, but are not limited to: • A significant decrease in the market price of the intangible asset; • A significant adverse change in the extent or manner in which the intangible asset is being used or in its physical condition;
• A significant adverse change in legal factors or in the business climate
that could affect the value of the intangible asset, including an adverse
action or assessment by a regulator;
• An accumulation of costs significantly in excess of the amount originally
expected for the acquisition or construction of the intangible asset;
• A current-period operating or cash flow loss combined with a history of
operating or cash flow losses or a projection or forecast that demonstrates
continuing losses associated with the use of the intangible asset; and
• A current expectation that, more likely than not, the intangible asset will
be sold or otherwise disposed of significantly before the end of its previously estimated useful life. As a result of our evaluation, we determined that there was no impairment to the carrying value of our intangible assets with finite lives for the year endedDecember 31, 2011 . For indefinite lived intangible assets we do not amortize the intangible asset but test these intangible assets for impairment by comparing the fair value of the assets to their carrying values on an annual basis or more frequently if circumstances warrant. The factors we consider to determine if an impairment exists are similar to factors noted above. As a result of our evaluation, we determined that there was no impairment to the carrying value of our indefinite lived intangible assets for the year endedDecember 31, 2011 . 84
--------------------------------------------------------------------------------
Table of Contents
Goodwill represents the excess of the cost of acquisitions over the fair value of net assets acquired and is not amortized. Goodwill is assigned at acquisition to the applicable reporting unit(s) based on the expected benefit to be received by the reporting unit(s) from the business combination. We determine the expected benefit based on several factors including the purpose of the business combination, the strategy of the company subsequent to the business combination and structure of the acquired company subsequent to the business combination. A reporting unit is a component of our business that has discrete financial information which is reviewed by management. In determining the reporting unit, we analyze the inputs, processes, outputs and overall operating performance of the reporting unit. During our annual goodwill impairment assessment for the year endedDecember 31, 2009 , we determined that for purposes of the goodwill recorded from the acquisition of Darwin that the Darwin reporting unit expected to receive the benefit of the business combination and as such we allocated all the goodwill to the Darwin reporting unit. For the annual goodwill impairment assessment for the year endedDecember 31, 2010 , we reassessed our reporting units and determined that the U.S. insurance segment is the reporting unit expected to receive the benefit of the business combination. The reason for the change in reporting units is due to the fact that since the acquisition of Darwin, we have integrated Darwin in several ways, which has made stand-alone Darwin company financial information no longer meaningful and not consistent with how we manage our business. Some of the integration efforts include, among others:
• The inclusion of Darwin senior management into the U.S. insurance segment
senior management.
• The inclusion of Darwin head product line managers into the U.S. insurance
segment product line managers. • We have moved a significant number of employees into and out of the
acquired Darwin legal entities. Former Darwin underwriters now underwrite
for historicalAllied World companies and vice versa.
• Any new business written, with a few limited exceptions, is recorded in one
underwriting system, which is the legacy Darwin underwriting system.
Based on the above, the lines have blurred to what cash flow streams are related to the acquisition and what are related to our legacy business. We believe this constitutes a reorganization of the reporting structure under U.S. GAAP. In applying the requirements, we have concluded all the goodwill that was originally allocated to the Darwin reporting unit should be allocated to the U.S. insurance segment reporting unit as the assets employed and the liabilities relate to the U.S. insurance operations. All the insurance operations of Darwin are included into the U.S. insurance segment. For goodwill, we perform a two-step impairment test on an annual basis or more frequently if circumstances warrant. The first step is to compare the fair value of the reporting unit with its carrying value, including goodwill. If the carrying amount of the reporting unit exceeds its fair value then the second step of the goodwill impairment test is performed. In determining the fair value of the reporting units discounted cash flow models and market multiple models are utilized. The discounted cash flow models apply a discount to projected cash flows including a terminal value calculation. The market multiple models apply earnings and book value multiples of similar publicly-traded companies to the reporting unit's projected earnings or book value. We select the weighting of the models utilized to determine the fair value of the reporting units based on judgment, considering such factors as the reliability of the cash flow projections and the entities included in the market multiples. The second step of the goodwill impairment test compares the implied fair value of the reporting unit's goodwill with the carrying amount of that goodwill in order to determine the amount of impairment to be recognized. The implied fair value of goodwill is determined by deducting the fair value of a reporting unit's identifiable assets and liabilities from the fair value of the reporting unit as a whole. The excess of the carrying value of goodwill above the implied goodwill, if any, would be recognized as an impairment charge in "amortization and impairment of intangible assets" in the consolidated income statements.
During 2011, we performed the first step of the goodwill impairment testing on the goodwill. We use both market based and non-market based valuations. Our market based valuations are based on market multiples of
85
--------------------------------------------------------------------------------
Table of Contents
book value and earnings. Our non-market based valuations are based on the present value of estimated future cash flows. Our overall point estimate is a weighted average of these valuations. Based on our analysis, the point estimate fair value of the U.S. insurance segment reporting unit was in excess of its carrying value by approximately 14%. As a result, we concluded there was no implied goodwill impairment, and therefore, no step two goodwill impairment testing was required. Results of Operations
The following table sets forth our selected consolidated statement of operations data for each of the periods indicated.
Year Ended December 31, 2011 2010 2009 ($ in millions) Gross premiums written $ 1,939.5 $ 1,758.4 $ 1,696.3 Net premiums written $ 1,533.8 $ 1,392.4 $ 1,321.1 Net premiums earned 1,457.0 1,359.5 1,316.9 Net investment income 195.9 244.1 300.7 Net realized investment gains 10.1 285.6 126.4 Net impairment charges recognized in earnings - (0.2 ) (49.6 ) Other income 101.7 0.9 1.5 $ 1,764.7 $ 1,889.9 $ 1,695.9 Net losses and loss expenses 959.2 707.9 604.1 Acquisition costs 167.3 159.5 148.9 General and administrative expenses 271.6 286.5 248.6 Amortization and impairment of intangibleassets 3.0 3.5 11.1 Interest expense 55.0 40.2 39.0 Foreign exchange loss 3.1 0.4 0.7 $ 1,459.2 $ 1,198.0 $ 1,052.4 Income before income taxes $ 305.5 $ 691.9 $ 643.5 Income tax expense 31.0 26.9 36.6 Net income $ 274.5 $ 665.0 $ 606.9 Ratios Loss and loss expense ratio 65.8 % 52.1 % 45.9 % Acquisition cost ratio 11.5 % 11.7 % 11.3 % General and administrative expense ratio 18.6 % 21.1 % 18.9 % Expense ratio 30.1 % 32.8 % 30.2 % Combined ratio 95.9 % 84.9 % 76.1 %
Comparison of Years Ended
Premiums
Gross premiums written increased by
• Gross premiums written in our U.S. insurance segment increased by
$109.3 million , or 15.0%. The increase in gross premiums written was primarily due to increased new business, including from new 86
--------------------------------------------------------------------------------
Table of Contents
products, for the year ended
business that did not meet our underwriting requirements (which included
inadequate pricing and/or terms and conditions) and increased competition.
• Gross premiums written in our international insurance segment increased by
and healthcare lines and new business including new products. This growth was partially offset by the
non-renewal of business that did not meet our underwriting requirements
(which included inadequate pricing and/or terms and conditions) and increased competition. • Gross premiums written in our reinsurance segment increased by$46.3 million , or 8.8%. The increase in gross premiums written was
primarily due to increased new business, including gross premiums written
by our new global marine and specialty division and the continued build-out
of our international platform, particularly inAsia . This growth was partially offset by the non-renewal of business that did not meet our underwriting requirements (which included inadequate pricing and/or terms and conditions).
The table below illustrates our gross premiums written by geographic location for the years ended
Year Ended December 31, Dollar Percentage 2011 2010 Change Change ($ in millions) United States $ 1,080.1 $ 993.5 $ 86.6 8.7 % Bermuda 565.8 545.6 20.2 3.7 Europe 210.4 193.0 17.4 9.0 Singapore 68.4 17.0 51.4 302.4 Hong Kong 14.8 9.3 5.5 59.1 $ 1,939.5 $ 1,758.4 $ 181.1 10.3 % Net premiums written increased by$141.4 million , or 10.2%, for the year endedDecember 31, 2011 compared to the year endedDecember 31, 2010 . The increase in net premiums written was primarily due to the increase in gross premiums written. During the twelve months endedDecember 31, 2011 , premiums ceded were reduced by$12.4 million due to the commutation of certain variable-rated reinsurance contracts that have swing-rated provisions. A "swing-rated" reinsurance contract links the ultimate amount of ceded premium to the ultimate loss ratio on the reinsured business. It enables the cedent to retain a greater portion of premium if the ultimate loss ratio develops at a level below the initial loss threshold set by the reinsurers, but requires a higher amount of ceded premium if the ultimate loss ratio develops above the initial threshold. In commuting these swing-rated reinsurance contracts, we reduced certain premiums previously ceded and also reduced ceded IBNR by$11.5 million in accordance with the terms of the contracts. During the twelve months endedDecember 31, 2010 , net premiums written included a$9.3 million reduction in premiums ceded for the commutation of certain variable-rated reinsurance contracts.
The difference between gross and net premiums written is the cost to us of purchasing reinsurance coverage, including the cost of property catastrophe reinsurance coverage. We ceded 20.9% of gross premiums written for the year ended
Net premiums earned increased by$97.5 million , or 7.2%, for the year endedDecember 31, 2011 compared to the year endedDecember 31, 2010 as a result of higher net premiums earned for the U.S. insurance and reinsurance segments. This is driven by increased net premiums written in the current and prior periods, as well as the impact of the commutation of the swing-rated reinsurance contracts, which are fully earned. 87
--------------------------------------------------------------------------------
Table of Contents
We evaluate our business by segment, distinguishing between U.S. insurance, international insurance and reinsurance. The following chart illustrates the mix of our business on both a gross premiums written and net premiums earned basis. Gross Premiums Net Premiums Written Earned Year Ended December 31, 2011 2010 2011 2010 U.S. insurance 43.2 % 41.5 % 40.1 % 38.1 % International insurance 27.4 % 28.7 % 21.8 % 24.9 % Reinsurance 29.4 % 29.8 % 38.1 % 37.0 % Total 100.0 % 100.0 % 100.0 % 100.0 % Net Investment Income Net investment income decreased by$48.2 million , or 19.7%, for the year endedDecember 31, 2011 compared to the year endedDecember 31, 2010 . The decrease was due to lower yields on our fixed maturity investments as well as an increased allocation to equity securities and other invested assets which contribute to our total return but carry little or no current yield. We increased our equity and other invested assets by$385.3 million betweenDecember 31, 2011 andDecember 31, 2010 . The annualized period book yield of the investment portfolio for the years endedDecember 31, 2011 and 2010 was 2.5% and 3.3%, respectively. Since we believe that there could be a rise in interest rates in 2012, there remains a risk of loss in the value of the company's fixed income portfolio. We have reduced our investment duration in 2011 to mitigate this risk. Investment management expenses of$14.2 million and$11.7 million were incurred during the years endedDecember 31, 2011 and 2010, respectively. The increase in investment management expenses was due to the increase in the size of our investment portfolio as well as expenses from higher expense asset classes (equities). As ofDecember 31, 2011 , approximately 92.6% of our fixed income investments consisted of investment grade securities. The average credit rating of our fixed income portfolio was AA- as rated by Standard & Poor's and Aa3 as rated by Moody's, with an average duration of approximately 1.9 years as ofDecember 31, 2011 . The average duration of the investment portfolio was 2.7 years as ofDecember 31, 2010 .
Realized Investment Gains/Losses and Net Impairment Charges Recognized in Earnings
During the year endedDecember 31, 2011 , we recognized$10.1 million in net realized investment gains compared to net realized investment gains of$285.6 million during the year endedDecember 31, 2010 . During the year endedDecember 31, 2011 , we did not recognize any net impairment charges compared to$0.2 million in net impairment charges recognized in earnings during the year endedDecember 31, 2010 . Net realized investment gains of$10.1 million for the year endedDecember 31, 2011 were comprised of the following:
• Net realized investment gains of
fixed maturity securities due to the rebalancing of our portfolio. • Net realized investment losses of$22.6 million primarily related to the
mark-to-market adjustments for our other invested assets, equity securities
and fixed maturity investments that are accounted for as trading securities. Mark-to-Market Adjustments for the Year EndedDecember 31, 2011 ($ in millions) Fixed maturity investments accounted for as trading securities $
8.1
Other invested assets and equity securities
4.5
Interest rate futures and foreign exchange forwards 5.9 Put options 4.1 Total $ 22.6 88
--------------------------------------------------------------------------------
Table of Contents
Net realized investment gains of
• Net realized investment gains of
• Net realized investment gains of$71.9 million related to the
mark-to-market adjustments of our other invested assets and fixed maturity
investments that are accounted for as trading securities. • Net realized investment loss of$0.4 million related to a U.S. Treasury
yield hedge transaction that terminated in
Other Income
The other income of
The other income of$0.9 million for the year endedDecember 31, 2010 represents fee income from our program administrator operations and wholesale brokerage operations. We sold these operations during the year endedDecember 31, 2010 .
Net Losses and Loss Expenses
Net losses and loss expenses increased by$251.3 million , or 35.5%, for the year endedDecember 31, 2011 compared to the year endedDecember 31, 2010 . The increase in net losses and loss expenses was due to lower prior year net favorable reserve development and higher catastrophe loss activity in the current period totaling$292.2 million , which included estimated net losses and loss expenses incurred of$96.5 million for the Tohoku earthquake and tsunami,$58.6 million for theNew Zealand earthquake,$53.7 million for the Midwestern U.S. storms,$43.0 million related to theThailand floods,$23.7 million for Hurricane Irene and$16.7 million for the Australian storms. During the year endedDecember 31, 2010 , we incurred$98.4 million of catastrophe-related losses, of which$66.8 million was from the Chilean earthquake,$17.0 million from theNew Zealand earthquake and$14.6 million from the Australian floods. We recorded net favorable reserve development related to prior years of$253.5 million and$313.3 million during the years endedDecember 31, 2011 and 2010, respectively. The following table shows the net favorable reserve development of$253.5 million by loss year for each of our segments for the year endedDecember 31, 2011 . In the table, a negative number represents net favorable reserve development and a positive number represents net unfavorable reserve development. Loss
For
the Year Ended
2002 2003 2004 2005
2006 2007 2008 2009 2010 Total
($ in millions) U.S. insurance $ (0.4 ) $ (2.9 ) $ (4.6 ) $ (20.5 )
(45.3 ) (40.5 ) (14.6 ) (10.1 ) 27.1 (118.5 ) Reinsurance (0.4 ) (2.5 ) (10.9 ) (35.6 ) (16.0 ) (20.7 ) (2.3 ) (10.8 ) (12.6 ) (111.8 ) $ - $ (1.3 ) $ (22.2 ) $ (89.4 ) $ (42.2 ) $ (68.8 ) $ (21.6 ) $ (28.1 ) $ 20.1 $ (253.5 ) The net favorable reserve development is a result of actual loss emergence being lower than anticipated. The unfavorable reserve development in our U.S. insurance segment for the 2006 loss year was primarily due to directors and officers claims within our professional liability line of business related to a class action suit filed against a number of private equity firms alleging collusion. The unfavorable reserve development in our international insurance segment for the 2010 loss year was primarily due to a casualty claim emanating from an oil field service risk. 89
--------------------------------------------------------------------------------
Table of Contents
The following table shows the favorable reserve development of$313.3 million by loss year for each of our segments for the year endedDecember 31, 2010 . In the table, a negative number represents net favorable reserve development and a positive number represents net unfavorable reserve development.
For the Year Ended
2002 2003 2004 2005 2006 2007 2008 2009 Total ($ in millions) U.S. insurance $ (1.6 ) $ (3.2 ) $ (25.6 ) $ (26.2 ) $ (5.3 ) $ (1.7 ) $ (2.5 ) $ (2.4 ) $ (68.5 ) International insurance 6.8 (6.7 ) (21.6 ) (87.5 ) (36.7 ) (19.3 ) (23.1 ) 7.5 (180.6 ) Reinsurance (0.9 ) (1.0 ) (9.8 ) (33.0 ) (12.4 ) (3.8 ) 3.0 (6.3 ) (64.2 ) $ 4.3 $ (10.9 ) $ (57.0 ) $ (146.7 ) $ (54.4 ) $ (24.8 ) $ (22.6 ) $ (1.2 ) $ (313.3 ) The loss and loss expense ratio for the year endedDecember 31, 2011 was 65.8% compared to 52.1% for the year endedDecember 31, 2010 . Net favorable reserve development recognized in the year endedDecember 31, 2011 and the impact of the commutation adjustment to ceded IBNR decreased the loss and loss expense ratio by 17.5 percentage points. Thus, the loss and loss expense ratio related to the current loss year was 83.3%. Net favorable reserve development recognized in the year endedDecember 31, 2010 and the impact of the commutation adjustment to ceded IBNR reduced the loss and loss expense ratio by 23.1 percentage points. Thus, the loss and loss expense ratio related to that loss year was 75.2%. The increase in the loss and loss expense ratio for the current loss year was primarily due to$292.2 million of losses from global catastrophes during the year endedDecember 31, 2011 , which contributed 20.1 points to the current loss year's loss and loss expense ratio. In comparison,$164.6 million of large individual losses, including catastrophes, contributed 12.1 points to the loss and loss expense ratio for the twelve months endedDecember 31, 2010 . The following table shows the components of the increase in net losses and loss expenses for the year endedDecember 31, 2011 compared to the year endedDecember 31, 2010 . Year Ended December 31, Dollar 2011 2010 Change ($ in millions) Net losses paid $ 684.8 $ 596.7 $ 88.1 Net change in reported case reserves 213.3 76.2 137.1 Net change in IBNR 61.1 35.0 26.1 Net losses and loss expenses $ 959.2 $ 707.9 $ 251.3 The increase in net losses paid for the year endedDecember 31, 2011 was due to higher paid losses in our U.S. insurance and reinsurance segments as a result of continued growth in these segments, combined with higher current period property catastrophe paid losses. The increase in reported case reserves was primarily due to higher case reserves in each of our operating segments. The increase in IBNR was due to higher IBNR in our international insurance segment as a result of lower net favorable reserve development. 90
--------------------------------------------------------------------------------
Table of Contents
The table below is a reconciliation of the beginning and ending reserves for losses and loss expenses. Losses incurred and paid are reflected net of reinsurance recoverables. Year EndedDecember 31, 2011 2010
Net reserves for losses and loss expenses,
Incurred related to:
Commutation of variable-rated reinsurance contracts 11.5
8.9
Current period non-catastrophe 909.0
913.9
Current period property catastrophe 292.2
98.4
Prior period non-catastrophe (239.2 )
(300.0 )
Prior period property catastrophe (14.3 ) (13.3 ) Total incurred $ 959.2 $ 707.9 Paid related to: Current period non-catastrophe 72.1
61.0
Current period property catastrophe 70.1
37.6
Prior period non-catastrophe 516.2
475.3
Prior period property catastrophe 26.4
22.8
Total paid $ 684.8 $
596.7
Foreign exchange revaluation (3.8 )
(1.4 )
Net reserve for losses and loss expenses,
Losses and loss expenses recoverable 1,002.9
927.6
Reserve for losses and loss expenses,
Acquisition Costs Acquisition costs increased by$7.8 million , or 4.9%, for the year endedDecember 31, 2011 compared to the year endedDecember 31, 2010 . The increase in acquisition costs was primarily due to the increase in net premiums earned in our U.S. insurance segment and reinsurance segment. Acquisition costs as a percentage of net premiums earned were 11.5% for the year endedDecember 31, 2011 compared to 11.7% for the same period in 2010.
General and Administrative Expenses
General and administrative expenses decreased by$14.9 million , or 5.2%, for the year endedDecember 31, 2011 compared to the same period in 2010. The decrease in general and administrative expenses was primarily due to the following:
• A decrease of
loss activity during the year endedDecember 31, 2011 . • A decrease of$7.0 million in stock related compensation due to a decrease
in overall awards granted during the year ended
addition to a one-time increase of
for our performance-based awards granted in 2009. • During the year endedDecember 31, 2010 we incurred a one-time 1% capital
stamp duty of
million from Allied World Bermuda to Allied World Switzerland.
Our general and administrative expense ratio was 18.6% for the year ended
91
--------------------------------------------------------------------------------
Table of Contents
Our expense ratio was 30.1% for the year endedDecember 31, 2011 compared to 32.8% for the year endedDecember 31, 2010 primarily due to a decrease in the general and administrative expense ratio.
Amortization and Impairment of Intangible Assets
The amortization and impairment of intangible assets decreased$0.5 million , or 14.3%, for the year endedDecember 31, 2011 compared to the year endedDecember 31, 2010 . The decrease was due to the non-compete covenants related to the acquisition of Darwin being fully amortized during 2010. No impairments were recognized during the year endedDecember 31, 2011 .
Interest Expense
Interest expense increased$14.8 million , or 36.8%, for the year endedDecember 31, 2011 compared to the year endedDecember 31, 2010 primarily as a result of additional interest expense on our 5.5% senior notes that were issued by Allied World Bermuda inNovember 2010 .
Income Tax Expense
Tax expense increased$4.1 million , or 15.2%, for the year endedDecember 31, 2011 compared to the year endedDecember 31, 2010 . The increase in tax expense is primarily due to higher taxable income for our Swiss holding company of approximately$90.6 million partially offset by lower taxable income for our U.S. operations of approximately$12.9 million . In addition, 2010 included a$5.0 million loss for tax purposes on the sale of our program administrator and wholesale brokerage operation which caused a reduction in tax expense in 2010 of$1.7 million . Our consolidated effective tax rates for the years endedDecember 31, 2011 and 2010 were 10.1% and 3.9%, respectively.
Net Income
Net income for the year endedDecember 31, 2011 was$274.5 million compared to$665.0 million for the year endedDecember 31, 2010 . The decrease was primarily the result of lower net realized investment gains, higher net loss and loss expenses, and lower net investment income. Net income for the year endedDecember 31, 2011 included a net foreign exchange loss of$3.1 million compared to$0.4 million for the year endedDecember 31, 2010 .
Comparison of Years Ended
Premiums
Gross premiums written increased by
• Gross premiums written in our U.S. insurance segment increased by$54.5 million , or 8.1%. The increase in gross premiums written was
primarily due to increased new business, including from new products, for
the year ended
2009. This increase was partially offset by the non-renewal of business
that did not meet our underwriting requirements (which included inadequate
pricing and/or terms and conditions) and increased competition.
• Gross premiums written in our international insurance segment decreased by
business that did not meet our underwriting requirements (which included
inadequate pricing and/or terms and conditions) and increased competition.
• Gross premiums written in our reinsurance segment increased by$58.6 million , or 12.6%. The increase in gross premiums written was
primarily due to increased participation on one property reinsurance treaty
for
general casualty reinsurance line of business for
new business from the build-out of our international platform. These
increases were partially offset by the non-renewal of business that did not
meet our underwriting requirements (which included inadequate pricing
and/or terms and conditions), increased competition and increased cedent
retention. 92
--------------------------------------------------------------------------------
Table of Contents
The table below illustrates our gross premiums written by geographic location for the years ended
Year Ended December 31, Dollar Percentage 2010 2009 Change Change ($ in millions) United States $ 993.5 $ 929.9 $ 63.6 6.8 % Bermuda 545.6 574.4 (28.8 ) (5.0 ) Europe 193.0 186.5 6.5 3.5 Hong Kong 9.3 5.5 3.8 69.1 Singapore 17.0 - 17.0 n/a * $ 1,758.4 $ 1,696.3 $ 62.1 3.7 % * n/a: not applicable Net premiums written increased by$71.3 million , or 5.4%, for the year endedDecember 31, 2010 compared to the year endedDecember 31, 2009 . The increase in net premiums written was primarily due to a reduction in premiums ceded. The difference between gross and net premiums written is the cost to us of purchasing reinsurance coverage, including the cost of property catastrophe reinsurance coverage. We ceded 20.8% of gross premiums written for the year endedDecember 31, 2010 compared to 22.1% for the year endedDecember 31, 2009 . The reduction in premiums ceded was due to lower premiums ceded under our property catastrophe reinsurance coverage, as well as the commutation and adjustment of$9.3 million of certain variable-rated reinsurance contracts that have swing-rated provisions. In commuting these swing-rated reinsurance contracts, we reduced certain premiums previously ceded and also reduced ceded losses by$8.9 million in accordance with the terms of the contracts. Net premiums earned increased by$42.6 million , or 3.2%, for the year endedDecember 31, 2010 compared to the year endedDecember 31, 2009 as a result of higher net premiums earned for the U.S. insurance and reinsurance segments. This is driven by increased net premiums written in the current and prior periods, as well as the impact of the commutation of the swing-rated reinsurance contracts which are fully earned. We evaluate our business by segment, distinguishing between U.S. insurance, international insurance and reinsurance. The following chart illustrates the mix of our business on both a gross premiums written and net premiums earned basis. Gross Premiums Net Premiums Written Earned Year Ended December 31, 2010 2009 2010 2009 U.S. insurance 41.5 % 39.8 % 38.1 % 34.0 % International insurance 28.7 % 32.8 % 24.9 % 31.4 % Reinsurance 29.8 % 27.4 % 37.0 % 34.6 % Total 100.0 % 100.0 % 100.0 % 100.0 % Net Investment Income Net investment income decreased by$56.6 million , or 18.8%, for the year endedDecember 31, 2010 compared to the year endedDecember 31, 2009 . The decrease was due to a combination of lower accretion of book value to par value for our fixed maturity investments, lower yields on our fixed maturity investments and an increased allocation to other invested assets, which contribute to our total return but carry no current yield. We increased our other invested assets by$162.9 million betweenDecember 31, 2010 andDecember 31, 2009 . In response to new OTTI guidance issued by the FASB inApril 2009 , we increased the book value of our fixed maturity investments for any non-credit OTTI previously recognized, which resulted in higher book values and 93
--------------------------------------------------------------------------------
Table of Contents
lower future accretions. Please see Note 2(e) of the notes to the consolidated financial statements regarding the change in OTTI policy. The annualized period book yield of the investment portfolio for the year endedDecember 31, 2010 and 2009 was 3.3% and 4.2%, respectively. The decrease in book yield was due to the overall market interest rate environment being at historically low levels during most of 2010. The decrease in the book yield was also due to increased investment turnover as a result of more active management of the investment portfolio given interest rate and spread volatility. The higher sales and purchases of investment securities resulted in us recognizing$217.7 million of net realized investment gains for the year endedDecember 31, 2010 and the proceeds being re-invested at lower yield levels. Investment management expenses of$11.7 million and$9.0 million were incurred during the year endedDecember 31, 2010 and 2009, respectively. The increase in investment management expenses was due to the increase in the size of our investment portfolio, the addition of a new portfolio manager and additional fees paid to investment advisors for higher cost investment strategies. As ofDecember 31, 2010 , approximately 96% of our fixed income investments consisted of investment grade securities. The average credit rating of our fixed income portfolio was AA as rated by Standard & Poor's and Aa2 as rated by Moody's, with an average duration of approximately 2.7 years as ofDecember 31, 2010 . The average duration of the investment portfolio was 3.0 years as ofDecember 31, 2009 .
Realized Investment Gains/Losses and Net Impairment Charges Recognized in Earnings
During the year endedDecember 31, 2010 , we recognized$285.6 million in net realized investment gains compared to net realized investment gains of$126.4 million during the year endedDecember 31, 2009 . During the year endedDecember 31, 2010 , we recognized$0.2 million in net impairment charges recognized in earnings compared to$49.6 million during the year endedDecember 31, 2009 . Net realized investment gains of$285.6 million for the year endedDecember 31, 2010 were comprised of the following:
• Net realized investment gains of
fixed maturity securities due to the rebalancing of our portfolio from
U.S. Treasury and agency securities into other asset classes and shortening
the overall duration of our investment portfolio as discussed above. The
realization of gains is not an explicit strategy of the company but a
by-product of actively managing the portfolio. During 2010 active
management consisted of managing the duration (increasing the duration to
3.5 years as of
remainder of the year) and sector exposures of the portfolio in
anticipation of potential interest rate movements and sector spread levels.
During 2010, we hired an additional fixed income manager. The transition
from the existing manager to our newest manager also contributed to the
higher turnover and level of realized investment gains. While we expect to
continue to actively manage the portfolio during 2011, we would expect
somewhat lower turnover. • Net realized investment gains of$71.9 million primarily related to the
mark-to-market adjustments for our other invested assets, equity securities
and fixed maturity investments that are accounted for as trading
securities. We expect the mark-to-market adjustments on our fixed maturity
investments that are accounted for as trading securities to increase as we
continue to increase the balance of these securities. From December 31,
2009 to
investments accounted for as trading by$3.3 billion , or 126.7%, from$2.5 billion as ofDecember 31, 2009 to$5.8 billion as ofDecember 31, 2010 . Contributing to the increase was the reclassification of all of our mortgage-backed and asset-backed securities from available for sale to trading onJuly 1, 2010 as part of the adoption of ASU 2010-11. Mark-to-Market Adjustments for the Year EndedDecember 31, 2010 ($ in
millions)
Fixed maturity investments accounted for as trading securities $
42.2
Other invested assets and equity securities 29.7 Total $ 71.9 94
--------------------------------------------------------------------------------
Table of Contents
• Net realized investment loss of
yield hedge transaction we purchased inMay 2010 and terminated inJune 2010 .
Net realized investment gains of
• Net realized investment gains of
primarily due to the sale of fixed maturity bonds partially offset by a
realized loss of
bond fund. • Net realized investment gains of$31.9 million related to the
mark-to-market adjustments of our other invested assets and fixed maturity
investments that are accounted for as trading securities.
During the year endedDecember 31, 2009 , we had$49.6 million of net impairment charges recognized in earnings,$7.7 million was due to credit related losses where the anticipated discounted cash flows of various debt securities were lower than the amortized cost, and$41.9 million was due to net impairment charges for those securities in an unrealized loss position where our investment managers had the discretion to sell.
Other Income
The other income of$0.9 million and$1.5 million for the years endedDecember 31, 2010 and 2009, respectively, represents fee income from the program administrator and wholesale brokerage operation. We sold these operations during the year endedDecember 31, 2010 for a gain of$1.9 million .
Net Losses and Loss Expenses
Net losses and loss expenses increased by$103.8 million , or 17.2%, for the year endedDecember 31, 2010 compared to the year endedDecember 31, 2009 . The increase in net losses and loss expenses was due to a number of individual losses totaling$164.6 million in the current year, with no comparable events having occurred during the year endedDecember 31, 2009 . We incurred$98.4 million of catastrophe related losses, of which$66.8 million was from the Chilean earthquake,$17.0 million from the New Zealand Earthquake and$14.6 million from the Australian floods. The increase due to higher loss activity was partially offset by higher net favorable prior year reserve development. We recorded net favorable reserve development related to prior years of$313.3 million and$248.0 million during the years endedDecember 31, 2010 and 2009, respectively. The following table shows the net favorable reserve development of$313.3 million by loss year for each of our segments for the year endedDecember 31, 2010 . In the table, a negative number represents net favorable reserve development and a positive number represents net unfavorable reserve development.
For the Year Ended
2002 2003 2004 2005 2006 2007 2008 2009 Total ($ in millions) U.S. insurance $ (1.6 ) $ (3.2 ) $ (25.6 ) $ (26.2 ) $ (5.3 ) $ (1.7 ) $ (2.5 ) $ (2.4 ) $ (68.5 ) International insurance 6.8 (6.7 ) (21.6 ) (87.5 ) (36.7 ) (19.3 ) (23.1 ) 7.5 (180.6 ) Reinsurance (0.9 ) (1.0 ) (9.8 ) (33.0 ) (12.4 ) (3.8 ) 3.0 (6.3 ) (64.2 ) $ 4.3 $ (10.9 ) $ (57.0 ) $ (146.7 ) $ (54.4 ) $ (24.8 ) $ (22.6 ) $ (1.2 ) $ (313.3 ) 95
--------------------------------------------------------------------------------
Table of Contents
The following table shows the favorable reserve development of$248.0 million by loss year for each of our segments for the year endedDecember 31, 2009 . In the table, a negative number represents net favorable reserve development and a positive number represents net unfavorable reserve development. Loss Reserve Development by Loss Year For the Year Ended December 31, 2009 2002 2003 2004 2005 2006 2007 2008 Total ($ in millions) U.S. insurance $ (6.7 ) $ (22.3 ) $ (36.3 ) $
(19.6 )
(5.8 ) (18.7 ) (61.1 ) (78.7 ) 11.3 (8.5 ) 22.0 (139.5 ) Reinsurance (4.0 ) (16.2 ) (20.7 ) (4.2 ) (1.1 ) 5.2 2.9 (38.1 ) Total $ (16.5 ) $ (57.2 ) $ (118.1 ) $ (102.5 ) $ 11.6 $ 2.5 $ 32.2 $ (248.0 ) The loss and loss expense ratio for the year endedDecember 31, 2010 was 52.1% compared to 45.9% for the year endedDecember 31, 2009 . Net favorable reserve development recognized in the year endedDecember 31, 2010 reduced the loss and loss expense ratio by 23.1 percentage points. Thus, the loss and loss expense ratio related to the current loss year was 75.2%. Net favorable reserve development recognized in the year endedDecember 31, 2009 reduced the loss and loss expense ratio by 18.8 percentage points. Thus, the loss and loss expense ratio related to that loss year was 64.7%. The increase in the loss and loss expense ratio for the current loss year was primarily due to a net increase in loss reserves of$164.6 million from a number of earthquakes, explosions and other weather related events during the year endedDecember 31, 2010 , which contributed 12.1 points to the current loss year's loss and loss expense ratio. The following table shows the components of the increase in net losses and loss expenses of$103.8 million for the year endedDecember 31, 2010 compared to the year endedDecember 31, 2009 . Year Ended December 31, Dollar 2010 2009 Change ($ in millions) Net losses paid $ 596.7 $ 458.2 $ 138.5 Net change in reported case reserves 76.2 76.0 0.2 Net change in IBNR 35.0 69.9 (34.9 ) Net losses and loss expenses $ 707.9 $ 604.1 $ 103.8 The increase in net losses paid for the year endedDecember 31, 2010 was due to higher paid losses in each of our operating segments. The decrease in reported case reserves was primarily due to lower case reserves in our international insurance segment due to the payment of claims partially offset by increased case reserves in our U.S. insurance and reinsurance segments. The decrease in IBNR was due to lower IBNR in our international insurance and reinsurance segments primarily due to net favorable reserve development partially offset by higher IBNR in our U.S. insurance segment due to the growth of U.S. operations. 96
--------------------------------------------------------------------------------
Table of Contents
The table below is a reconciliation of the beginning and ending reserves for losses and loss expenses. Losses incurred and paid are reflected net of reinsurance recoverables. Year EndedDecember 31, 2010 2009 ($ in millions)
Net reserves for losses and loss expenses,
Incurred related to:
Commutation of variable-rated reinsurance contracts 8.9
-
Current period non-catastrophe 913.9
852.1
Current period property catastrophe 98.4
-
Prior period non-catastrophe (300.0 )
(251.7 )
Prior period property catastrophe (13.3 ) 3.7 Total incurred $ 707.9 $ 604.1 Paid related to: Current period non-catastrophe 61.0
42.3
Current period property catastrophe 37.6
-
Prior period non-catastrophe 475.3
343.4
Prior period property catastrophe 22.8
72.5
Total paid $ 596.7 $
458.2
Foreign exchange revaluation (1.4 )
7.4
Net reserve for losses and loss expenses,
Losses and loss expenses recoverable 927.6
920.0
Reserve for losses and loss expenses,
Acquisition Costs Acquisition costs increased by$10.6 million , or 7.2%, for the year endedDecember 31, 2010 compared to the year endedDecember 31, 2009 . The increase in acquisition costs was primarily due to the increase in net premiums earned in our U.S. insurance segment and reinsurance segment, which typically have higher acquisition costs than our international insurance segment and represent a higher proportion of net premiums earned during the year endedDecember 31, 2010 compared to the same period in 2009. Acquisition costs as a percentage of net premiums earned were 11.7% for the year endedDecember 31, 2010 compared to 11.3% for the same period in 2009.
General and Administrative Expenses
General and administrative expenses increased by
• An overall increase in global headcount from 652 at
689 at
related costs of
• Increased stock-related compensation of
one-time increase of
under the Company's equity plans in 2009 to recognize expected performance
above the target level. For all performance-based awards, we initially
recognize the stock compensation expense at 100% of the fair market value
of our common shares on the date of grant and reassess, at least annually,
the projected growth in book value to determine whether an adjustment to
the initial estimate of the expense should be made. During the year endedDecember 31, 2010 , we have 97
--------------------------------------------------------------------------------
Table of Contents
accrued 150% of the fair market value of
shares awarded, as we believe it is probable that we will achieve the
maximum performance criteria when these performance-based awards vest at the
end of 2011. For additional information on our performance-based awards, see
Note 13 "Employee Benefit Plans" in our notes to the consolidated financial
statements. • A one-time increase of$12.5 million in professional fees during the year
ended
operation of Syndicate 2232 and our efforts to effect our redomestication
toSwitzerland . • Also related to our redomestication toSwitzerland , we incurred a 1%
capital stamp duty of
was a one-time expense.
• Decrease of
("Darwin LTIP"). We recognized an increase in the Darwin LTIP of $0.9 million during the year ended December 31, 2010 compared to an increase of $5.9 million during the year ended December 31, 2009 . The amount incurred for the Darwin LTIP is a result of pre-acquisition underwriting profitability, including any subsequent loss reserve development. The reduction in the Darwin LTIP during the year ended December 31, 2010 was due to lower favorable reserve development experienced during the year.
Our general and administrative expense ratio was 21.1% for the year ended
Our expense ratio was 32.8% for the year ended
Amortization and Impairment of Intangible Assets
The amortization and impairment of intangible assets decreased$7.6 million , or 68.5%, for the year endedDecember 31, 2010 compared to the year endedDecember 31, 2009 . The decrease is primarily the result of no longer amortizing the trademark intangible asset that was fully impaired for$6.9 million during the year endedDecember 31, 2009 . No impairments were recognized during the year endedDecember 31, 2010 . Interest Expense Interest expense increased$1.2 million , or 3.0%, for the year endedDecember 31, 2010 compared to the year endedDecember 31, 2009 primarily as a result of additional interest expense on our 5.5% senior notes that were issued inNovember 2010 . Income Tax Expense Tax expense decreased$9.7 million , or 26.5%, for the year endedDecember 31, 2010 compared to the year endedDecember 31, 2009 . Overall our tax expense is driven by our U.S. operations, which represents the largest taxable operation of the company. The decrease in tax expense is primarily due to lower taxable income for our U.S. operations of approximately$19.5 million , which resulted in approximately$6.9 million lower tax expense during the year endedDecember 31, 2010 compared to the year endedDecember 31, 2009 . The lower tax expense was also caused by a$5.0 million loss for tax purposes on the sale of our program administrator and wholesale brokerage operation during 2010 which caused a reduction of tax expense in 2010 of$1.7 million . Our consolidated effective tax rates for the years endedDecember 31, 2010 and 2009 were 3.9% and 5.7%, respectively. The decrease in the effective tax rate was due to the factors discussed above.
Net Income
Net income for the year endedDecember 31, 2010 was$665.0 million compared to$606.9 million for the year endedDecember 31, 2009 . The increase was primarily the result of higher net realized investment gains, higher net premiums earned and lower OTTI, partially offset by increased general and administrative expenses and higher current year catastrophe losses. Net income for the year endedDecember 31, 2010 included a net foreign exchange loss of$0.4 million compared to a net foreign exchange loss of$0.7 million for the year endedDecember 31, 2009 . 98
--------------------------------------------------------------------------------
Table of Contents
Underwriting Results by Operating Segments
Our company is organized into three operating segments:
U.S. Insurance Segment. The U.S. insurance segment includes our direct specialty insurance operations inthe United States . This segment provides both direct property and specialty casualty insurance primarily to non-Fortune 1000 North American domiciled accounts. International Insurance Segment. The international insurance segment includes our direct insurance operations inBermuda ,Europe ,Singapore andHong Kong . This segment provides both direct property and casualty insurance primarily to Fortune 1000 North American domiciled accounts and mid-sized to large non-North American domiciled accounts. Reinsurance Segment. Our reinsurance segment has operations inBermuda ,Europe ,Singapore andthe United States . This segment includes the reinsurance of property, general casualty, professional liability, specialty lines and property catastrophe coverages written by insurance companies. We presently write reinsurance on both a treaty and a facultative basis, targeting several niche reinsurance markets. U.S. Insurance Segment The following table summarizes the underwriting results and associated ratios for the U.S. insurance segment for the years endedDecember 31, 2011 , 2010 and 2009. Year Ended December 31, 2011 2010 2009 ($ in millions) Revenues Gross premiums written $ 838.6 $ 729.3 $ 674.8 Net premiums written 639.2 551.1 493.1 Net premiums earned 584.3 518.4 447.5 Other income - 0.9 1.5 Expenses
Net losses and loss expenses 387.1 297.5
211.4
Acquisition costs 75.0 67.8
58.1
General and administrative expenses 124.4 128.5
115.8
Underwriting (loss) income (2.2 ) 25.5
63.7
Ratios
Loss and loss expense ratio 66.2 % 57.4 %
47.2 %
Acquisition cost ratio 12.8 % 13.1 %
13.0 %
General and administrative expense ratio 21.3 % 24.8 %
25.9 % Expense ratio 34.1 % 37.9 % 38.9 % Combined ratio 100.3 % 95.3 % 86.1 %
Comparison of Years Ended
Premiums. Gross premiums written increased by$109.3 million , or 15.0%, for the year ended <chron>December 31, 2011 compared to the same period in 2010. The increase in gross premiums written was primarily due to new business from existing products,$55.1 million in premiums from new products, specifically in our general casualty, environmental and inland marine lines of business and rate increases in our general property and general casualty lines of business. This growth was partially offset by the non-renewal of business that did not meet our underwriting requirements (which included inadequate pricing and/or terms and conditions), rate reductions in our other lines of business and increased competition. 99
--------------------------------------------------------------------------------
Table of Contents
The table below illustrates our gross premiums written by line of business for the periods indicated. Year Ended December 31, Dollar Percentage 2011 2010 Change Change ($ in millions)
Professional liability
11.5 % General casualty 205.3 145.7 59.6 40.9 Healthcare 201.7 179.8 21.9 12.2 Programs 87.1 105.6 (18.5 ) (17.5 ) General property 78.5 73.7 4.8 6.5 Other* 30.6 13.4 17.2 128.4 $ 838.6 $ 729.3 $ 109.3 15.0 %
* Includes our inland marine and environmental lines of business
Net premiums written increased by$88.1 million , or 16.0%, for the year endedDecember 31, 2011 compared to the year endedDecember 31, 2010 . The increase in net premiums written was primarily due to higher gross premiums written and the commutation of certain variable-rated reinsurance contracts that have swing-rated provisions, which reduced premiums ceded by$12.4 million . In commuting these swing-rated reinsurance contracts, we reduced certain premiums previously ceded and also reduced ceded losses by$11.5 million in accordance with the terms of the contracts. The net impact of the commutation was a net gain of$0.9 million . For the year endedDecember 31, 2010 , the commutation of certain variable-rated reinsurance contracts reduced premiums ceded by$9.3 million . Overall, we ceded 23.8% of gross premiums written for the year endedDecember 31, 2011 compared to 24.4% for the year endedDecember 31, 2010 . The decrease in the cession percentage was primarily due to the reduction of premiums ceded related to the commutation of the swing-rated reinsurance contracts. Excluding the impact of the commutation, we ceded 25.3% and 25.7% of gross premiums written during the years endedDecember 31, 2011 and 2010, respectively. Net premiums earned increased$65.9 million , or 12.7%, resulting from the growth of our U.S. insurance operations during 2010 and 2011. Additionally, the commutation of swing-rated reinsurance contracts during the year endedDecember 31, 2011 added$12.4 million to net premiums earned compared to$9.3 million during the year endedDecember 31, 2010 . Net losses and loss expenses. Net losses and loss expenses increased by$89.6 million , or 30.1%, for the year endedDecember 31, 2011 compared to the year endedDecember 31, 2010 . The increase in net losses and loss expenses was primarily due to the growth of the U.S. insurance operations, lower prior year net favorable reserve development and unfavorable prior year reserve development in the 2006 loss year related to directors and officers claims within our professional liability line of business concerning a class action suit filed against a number of private equity firms alleging collusion. We recognized estimated losses from catastrophes of$8.3 million , which included$3.8 million developing from the Midwestern U.S. storms earlier in the year and$4.5 million from Hurricane Irene during the year endedDecember 31, 2011 . 100
--------------------------------------------------------------------------------
Table of Contents
Overall, our U.S. insurance segment recorded net favorable reserve development of$23.2 million during the year endedDecember 31, 2011 compared to net favorable reserve development of$68.5 million for the year endedDecember 31, 2010 as shown in the tables below. The$23.2 million of net favorable reserve development excludes the impact of the commutation of the swing-rated reinsurance contracts of$11.5 million discussed above and the$68.5 million of net favorable reserve development for the year endedDecember 31, 2010 excludes the impact of the commutation of the swing-rated reinsurance contracts of$8.9 million . In the tables, a negative number represents net favorable reserve development and a positive number represents net unfavorable reserve development. Loss
For
the Year Ended
2002 2003 2004 2005 2006 2007 2008 2009 2010 Total ($ in millions) General casualty $ - $ (0.9 ) $ (1.5 ) $ (17.4 ) $ (2.9 ) $ 2.5 $ (1.9 ) $ (0.9 ) $ 0.5 $ (22.5 ) Healthcare (0.4 ) (1.8 ) (2.7 ) - (1.4 ) 0.1 (0.9 ) 0.3 (2.6 ) (9.4 ) General property - - (0.1 ) (0.4 ) 0.1 (1.1 ) (0.3 ) (1.0 ) (1.2 ) (4.0 ) Programs - - - (0.2 ) (0.1 ) (2.1 ) (0.8 ) 0.8 1.8 (0.6 ) Professional liability - (0.2 ) (0.3 ) (2.5 ) 23.4 (7.0 ) (0.8 ) (6.4 ) 7.1 13.3 $ (0.4 ) $ (2.9 ) $ (4.6 ) $ (20.5 ) $ 19.1 $ (7.6 ) $ (4.7 ) $ (7.2 ) $ 5.6 $ (23.2 ) Loss
for
the Year Ended
2002 2003 2004 2005 2006 2007 2008 2009 Total ($ in millions) General casualty $ (1.4 ) $ (1.4 ) $ (2.6 ) $ (6.6 ) $ (1.4 ) $ (1.7 ) $ (1.5 ) $ (3.2 ) $ (19.8 ) Healthcare (0.2 ) (1.6 ) (21.9 ) (7.3 ) - (0.6 ) 3.2 - (28.4 ) General property - - (0.8 ) (10.5 ) (3.6 ) (1.8 ) (1.9 ) 5.6 (13.0 ) Programs - - - (0.1 ) (0.1 ) 1.6 - (1.1 ) 0.3 Professional liability - (0.2 ) (0.3 ) (1.8 ) (0.2 ) 0.9 (2.3 ) (3.7 ) (7.6 ) $ (1.6 ) $ (3.2 ) $ (25.6 ) $ (26.3 ) $ (5.3 ) $ (1.6 ) $ (2.5 ) $ (2.4 ) $ (68.5 ) The loss and loss expense ratio for the year endedDecember 31, 2011 was 66.2% compared to 57.4% for the year endedDecember 31, 2010 . Net favorable reserve development recognized and the impact of the commutation adjustment to ceded IBNR in the year endedDecember 31, 2011 decreased the loss and loss expense ratio by 3.8 percentage points. Thus, the loss and loss expense ratio for the current loss year was 70.0%, which includes$8.3 million in losses from catastrophes. In comparison, net favorable reserve development recognized and the impact of the commutation adjustment to ceded IBNR in the year endedDecember 31, 2010 decreased the loss and loss expense ratio by 13.2 percentage points. Thus, the loss and loss expense ratio for that loss year was 70.6% which included a$12.0 million net loss on aConnecticut power plant explosion. 101
--------------------------------------------------------------------------------
Table of Contents
The table below is a reconciliation of the beginning and ending reserves for losses and loss expenses. Losses incurred and paid are reflected net of reinsurance recoverables. Year EndedDecember 31, 2011 2010
Net reserves for losses and loss expenses,
901.9
Incurred related to:
Commutation of variable-rated reinsurance contracts 11.5
8.9
Current period non-catastrophe 390.5
357.1
Current period catastrophe 8.3
-
Prior period non-catastrophe (22.0 ) (68.8 ) Prior period catastrophe (1.2 ) 0.3 Total incurred $ 387.1 $ 297.5 Paid related to: Current period non-catastrophe 37.3
22.2
Current period catastrophe 2.9
-
Prior period non-catastrophe 157.5 137.0 Prior period catastrophe 0.4 5.1 Total paid $ 198.1 $ 164.3
Net reserve for losses and loss expenses,
Losses and loss expenses recoverable 438.3
396.6
Reserve for losses and loss expenses,
Acquisition costs. Acquisition costs increased by$7.2 million or 10.6% for the year endedDecember 31, 2011 compared to the year endedDecember 31, 2010 . The increase was primarily caused by increased net premiums earned. The acquisition cost ratio decreased slightly to 12.8% for the year endedDecember 31, 2011 from 13.1% for the same period in 2010. General and administrative expenses. General and administrative expenses decreased by$4.1 million , or 3.2%, for the year endedDecember 31, 2011 compared to the year endedDecember 31, 2010 . The decrease in general and administrative expenses was primarily due to a decrease in performance based incentive compensation expenses. The decrease in the general and administrative expense ratio from 24.8% for the year endedDecember 31, 2010 to 21.3% for the same period in 2011 was primarily caused by increased net premiums earned and the decrease in expenses as discussed above.
Comparison of Years Ended
Premiums. Gross premiums written increased by$54.5 million , or 8.1%, for the year endedDecember 31, 2010 compared to the same period in 2009. The increase in gross premiums written was primarily due to increases to our underwriting staff and a higher volume of gross premiums written from new products in our general casualty and other lines of business where we believe attractive underwriting opportunities exist. In addition, we experienced rate increases within our general casualty and general property lines of business. These increases were partially offset by the non-renewal of business that did not meet our underwriting requirements (which included inadequate pricing and/or terms and conditions) and increased competition, particularly for public directors and officers liability products in our professional liability line of business. 102
--------------------------------------------------------------------------------
Table of Contents
The table below illustrates our gross premiums written by line of business for the periods indicated. Year Ended December 31, Dollar Percentage 2010 2009 Change Change ($ in millions) Professional liability $ 211.1 $ 202.0 $ 9.1 4.5 % Healthcare 179.8 177.7 2.1 1.2 General casualty 145.7 122.0 23.7 19.4 Programs 105.6 101.5 4.1 4.0 General property 73.7 71.5 2.2 3.1 Other 13.4 0.1 13.3 n/m * $ 729.3 $ 674.8 $ 54.5 8.1 % * n/m: not meaningful Net premiums written increased by$58.0 million , or 11.8%, for the year endedDecember 31, 2010 compared to the year endedDecember 31, 2009 . The increase in net premiums written was primarily due to higher gross premiums written, as well as a reduction of premiums ceded. The reduction in premiums ceded was primarily due to lower cessions in our general casualty and general property lines of business, as well as the commutation and adjustment of certain variable-rated reinsurance contracts that have swing-rated provisions of$9.3 million . Overall, we ceded 24.4% of gross premiums written for the year endedDecember 31, 2010 compared to 26.9% for the year endedDecember 31, 2009 . The decrease in the cession percentage was primarily due to the reduction of premiums ceded related to the commutation of the swing-rated reinsurance contracts. Excluding the impact of the commutation, we ceded 25.7% of gross premiums written during the year endedDecember 31, 2010 .
Net premiums earned increased
Net losses and loss expenses. Net losses and loss expenses increased by$86.1 million , or 40.7%, for the year endedDecember 31, 2010 compared to the year endedDecember 31, 2009 . The increase in net losses and loss expenses was primarily due to the continued growth of our U.S. operations, current year losses of$25.8 million primarily in our general property and programs lines of business, as well as the reduction of ceded IBNR for the commutation of the swing-rated reinsurance contracts of$8.9 million and lower net favorable reserve development recognized. Overall, our U.S. insurance segment recorded net favorable reserve development of$68.5 million during the year endedDecember 31, 2010 compared to net favorable reserve development of$70.4 million for the year endedDecember 31, 2009 as shown in the tables below. The$68.5 million of net favorable reserve development excludes the impact of the commutation of the swing-rated reinsurance contracts of$8.9 million discussed above. In the tables, a negative number represents net favorable reserve development and a positive number represents net unfavorable reserve development. Loss Reserve Development by Loss Year for the Year Ended December 31, 2010 2002 2003 2004 2005 2006 2007 2008 2009 Total ($ in millions) General casualty $ (1.4 ) $ (1.4 ) $ (2.6 ) $ (6.6 ) $ (1.4 ) $ (1.7 ) $ (1.5 ) $ (3.2 ) $ (19.8 ) Healthcare (0.2 ) (1.6 ) (21.9 ) (7.3 ) - (0.6 ) 3.2 - (28.4 ) General property - - (0.8 ) (10.5 ) (3.6 ) (1.8 ) (1.9 ) 5.6 (13.0 ) Programs - - - (0.1 ) (0.1 ) 1.6 - (1.1 ) 0.3
Professional liability - (0.2 ) (0.3 ) (1.8 )
(0.2 ) 0.9 (2.3 ) (3.7 ) (7.6 ) $ (1.6 ) $ (3.2 ) $ (25.6 ) $ (26.3 ) $ (5.3 ) $ (1.6 ) $ (2.5 ) $ (2.4 ) $ (68.5 ) 103
--------------------------------------------------------------------------------
Table of Contents Loss Reserve Development by Loss Year for the Year Ended December 31, 2009 2002 2003 2004 2005 2006 2007 2008 Total ($ in millions) General casualty $ (3.7 ) $ (19.7 ) $ (17.8 ) $ 1.2 $ 3.7 $ 1.2 $ 13.4 $ (21.7 ) Healthcare (1.4 ) (0.5 ) (10.5 ) (11.5 ) (6.0 ) (2.6 ) (8.1 ) (40.6 ) General property (1.6 ) (2.0 ) (3.6 ) (4.5 ) (1.5 ) (0.4 ) 7.0 (6.6 ) Programs - - -
(0.7 ) (2.5 ) (0.9 ) (6.5 ) (10.6 ) Professional liability
- (0.1 ) (4.4 ) (4.1 ) 7.8 8.4 1.5 9.1 $ (6.7 ) $ (22.3 ) $ (36.3 ) $ (19.6 ) $ 1.5 $ 5.7 $ 7.3 $ (70.4 ) The loss and loss expense ratio for the year endedDecember 31, 2010 was 57.4% compared to 47.2% for the year endedDecember 31, 2009 . Net favorable reserve development recognized and the impact of the commutation adjustment to ceded IBNR in the year endedDecember 31, 2010 decreased the loss and loss expense ratio by 13.2 percentage points. Thus, the loss and loss expense ratio for the current loss year was 70.6%. In comparison, net favorable reserve development recognized in the year endedDecember 31, 2009 decreased the loss and loss expense ratio by 15.7 percentage points. In addition, the$3.0 million decrease in premiums ceded for variable-rated reinsurance contracts of Darwin that have swing-rated provisions increased the loss and loss expense ratio by 0.4 percentage points. Thus, the loss and loss expense ratio for that loss year was 63.3%. The increase in the loss and loss expense ratio for the current loss year was primarily due to losses of$25.8 million noted above. These losses contributed 5.0 percentage points to the current loss year's loss and loss expense ratio, after adjusting for the$9.3 million impact to ceded earned premium of the commuted swing-rated reinsurance contracts previously discussed. The table below is a reconciliation of the beginning and ending reserves for losses and loss expenses. Losses incurred and paid are reflected net of reinsurance recoverables. Year Ended December 31, 2010 2009
Net reserves for losses and loss expenses,
819.4
Incurred related to:
Commutation of variable-rated reinsurance contracts 8.9 Current period non-catastrophe 357.1
281.8
Current period catastrophe -
-
Prior period non-catastrophe (68.8 ) (74.9 ) Prior period catastrophe 0.3 4.5 Total incurred $ 297.5 $ 211.4 Paid related to: Current period non-catastrophe 22.2
12.1
Current period catastrophe -
-
Prior period non-catastrophe 137.0 99.2 Prior period catastrophe 5.1 17.6 Total paid $ 164.3 $ 128.9
Net reserve for losses and loss expenses,
901.9
Losses and loss expenses recoverable 396.6
351.8
Reserve for losses and loss expenses,
104
--------------------------------------------------------------------------------
Table of Contents
Acquisition costs. Acquisition costs increased by$9.7 million for the year endedDecember 31, 2010 compared to the year endedDecember 31, 2009 . The increase was primarily caused by increased net premiums earned. The acquisition cost ratio increased slightly to 13.1% for the year endedDecember 31, 2010 from 13.0% for the same period in 2009. General and administrative expenses. General and administrative expenses increased by$12.7 million , or 11.0%, for the year endedDecember 31, 2010 compared to the year endedDecember 31, 2009 . The increase in general and administrative expenses was primarily due to higher salary and related costs from increased headcount offset by the reduction in the Darwin LTIP of$5.0 million . The decrease in the general and administrative expense ratio from 25.9% for the year endedDecember 31, 2009 to 24.8% for the same period in 2010 was the result of the increase in net premiums earned.
International Insurance Segment
The following table summarizes the underwriting results and associated ratios for the international insurance segment for the years endedDecember 31, 2011 , 2010 and 2009. Year Ended December 31, 2011 2010 2009 ($ in millions) Revenues Gross premiums written $ 530.4 $ 504.9 $ 555.9 Net premiums written 325.1 319.1 362.9 Net premiums earned 317.0 338.8 413.2 Expenses
Net losses and loss expenses 206.6 160.2
158.1
Acquisition costs (2.8 ) (0.5 )
2.7
General and administrative expenses 84.3 94.2
84.4
Underwriting income 28.9 84.9
168.0
Ratios
Loss and loss expense ratio 65.2 % 47.3 %
38.3 %
Acquisition cost ratio (0.9 )% (0.1 )%
0.7 %
General and administrative expense ratio 26.6 % 27.8 %
20.4 % Expense ratio 25.7 % 27.7 % 21.1 % Combined ratio 90.9 % 75.0 % 59.4 %
Comparison of Years Ended
Premiums. Gross premiums written increased by$25.5 million , or 5.1%, for the year endedDecember 31, 2011 compared to the same period in 2010. The increase in gross premiums written was primarily a result of new business, including$12.5 million from new products, specifically related to our trade credit line of business and small to mid-sized enterprise ("SME") insurance products. In addition, we increased premiums in our healthcare line of business and experienced rate increases within our general property line of business. This growth was partially offset by the continued trend of the non-renewal of business that did not meet our underwriting requirements (which included inadequate pricing and/or terms and conditions) including the non-renewal of one general property policy that was previously written during the year endedDecember 31, 2010 for$5.1 million and the non-renewal of several policies totaling$15.7 million in our general casualty line of business. 105
--------------------------------------------------------------------------------
Table of Contents
The table below illustrates our gross premiums written by line of business for the periods indicated. Year Ended December 31, Dollar Percentage 2011 2010 Change Change ($ in millions)
Professional liability*
2.3 % General property 159.4 150.7 8.7 5.8 General casualty 127.2 132.3 (5.1 ) (3.9 ) Healthcare 68.1 59.3 8.8 14.8 Other** 11.3 1.9 9.4 n/m $ 530.4 $ 504.9 $ 25.5 5.1 %
* Includes our SME line of business
** Includes our trade credit line of business
Net premiums written increased$6.0 million , or 1.9%, for the year endedDecember 31, 2011 compared to the year endedDecember 31, 2010 . Net premiums written increased at a lower percentage than gross premiums written due to an increase in ceded premiums written on our professional lines treaty as well as the establishment of a trade credit treaty. We ceded to reinsurers 38.7% of gross premiums written for the year endedDecember 31, 2011 compared to 36.8% for the year endedDecember 31, 2010 . The increase is primarily due to increased cessions on our general casualty and professional liability lines of business.
Net premiums earned decreased
Net losses and loss expenses. Net losses and loss expenses increased by$46.4 million , or 29.0%, for the year endedDecember 31, 2011 compared to the year endedDecember 31, 2010 . The increase in net losses and loss expenses was primarily due to higher loss activity in the current period and lower net favorable reserve development recognized. Catastrophe loss activity recognized during the year endedDecember 31, 2011 included net losses and loss expenses of$45.0 million related to the Tohoku earthquake and tsunami,$17.7 million related to the storms in the Midwestern United States,$12.7 million related to theNew Zealand earthquake,$22.8 million related to theThailand floods,$8.0 million related to Hurricane Irene and$1.4 million related to the Australian storms.
Overall, our international insurance segment recorded net favorable reserve development of
Loss
For
the Year Ended
2002 2003 2004 2005 2006 2007 2008 2009 2010 Total ($ in millions) General property $ - $ (0.1 ) $ (1.6 ) $ (2.7 ) $ (0.7 ) $ (1.1 ) $ (28.9 ) $ (17.5 ) $ 4.6 $ (48.0 ) General casualty (1.0 ) (4.2 ) 2.8 (16.0 ) (16.0 ) (14.1 ) (7.3 ) 7.2 22.5 (26.1 ) Healthcare (0.2 ) (0.1 ) (1.8 ) (2.0 ) (9.7 ) (10.5 ) - 0.2 - (24.1 ) Professional liability 2.0 8.5 (6.1 ) (12.6 ) (18.9 ) (14.8 ) 21.6 - - (20.3 ) $ 0.8 $ 4.1 $ (6.7 ) $ (33.3 ) $ (45.3 ) $ (40.5 ) $ (14.6 ) $ (10.1 ) $ 27.1 $ (118.5 )
The unfavorable reserve development in our professional liability segment for the 2008 loss year related primarily to a greater reliance on the Bornhuetter-Ferguson reported loss method than on the expected loss ratio
106
--------------------------------------------------------------------------------
Table of Contents
method. The unfavorable reserve development in our international insurance segment for the 2010 loss year was primarily due to a casualty claim emanating from an oil field service risk.
Loss
For the Year Ended December 31, 2010 2002 2003 2004 2005 2006 2007 2008 2009 Total ($ in millions) General property $ - $ (0.1 ) $ - $ (6.0 ) $ (6.4 ) $ (12.8 ) $ (34.4 ) $ (0.3 ) $ (60.0 ) General casualty 5.1 (2.3 ) (15.3 ) (29.8 ) (7.6 ) (6.5 ) 11.3 7.8 (37.3 ) Healthcare (0.3 ) (1.5 ) (2.2 ) (9.9 ) (22.5 ) - - - (36.4 ) Professional liability 2.0 (2.8 ) (4.1 ) (41.8 ) (0.2 ) - - - (46.9 ) $ 6.8 $ (6.7 ) $ (21.6 ) $ (87.5 ) $ (36.7 ) $ (19.3 ) $ (23.1 ) $ 7.5 $ (180.6 ) The loss and loss expense ratio for the year endedDecember 31, 2011 was 65.2%, compared to 47.3% for the year endedDecember 31, 2010 . The net favorable reserve development recognized during the year endedDecember 31, 2011 decreased the loss and loss expense ratio by 37.4 percentage points. Thus, the loss and loss expense ratio related to the current loss year was 102.6%. Comparatively, the net favorable reserve development recognized during the year endedDecember 31, 2010 decreased the loss and loss expense ratio by 53.3 percentage points. Thus, the loss and loss expense ratio related to that loss year was 100.6%. The increase in the loss and loss expense ratio for the current loss year was primarily due to net incurred catastrophe losses of$107.6 million which occurred during the year endedDecember 31, 2011 and contributed 33.9 percentage points to the current year's loss and loss expense ratio compared to$112.3 million of large individual losses during the year endedDecember 31, 2010 which contributed 33.1 percentage points to the prior year's loss and loss expense ratio. The table below is a reconciliation of the beginning and ending reserves for losses and loss expenses. Losses incurred and paid are reflected net of reinsurance recoverables. Year Ended December 31, 2011 2010
Net reserves for losses and loss expenses,
Incurred related to:
Current period non-catastrophe 217.5
276.7
Current period catastrophe 107.6
64.1
Prior period non-catastrophe (110.0 ) (168.5 ) Prior period catastrophe (8.5 ) (12.1 ) Total incurred $ 206.6 $ 160.2 Paid related to: Current period non-catastrophe 8.1
22.0
Current period catastrophe 18.0
36.5
Prior period non-catastrophe 173.4 181.7 Prior period catastrophe 14.3 13.0 Total paid $ 213.8 $ 253.2 Foreign exchange revaluation (3.8 )
(1.4 )
Net reserve for losses and loss expenses,
Losses and loss expenses recoverable 564.3
531.0
Reserve for losses and loss expenses,
107
--------------------------------------------------------------------------------
Table of Contents
Acquisition costs. Acquisition costs decreased$2.3 million for the year endedDecember 31, 2011 compared to the year endedDecember 31, 2010 . The negative cost represents ceding commissions received on ceded premiums in excess of the brokerage fees and commissions paid on gross premiums written. The acquisition cost ratio decreased from negative 0.1% for the year endedDecember 31, 2010 to negative 0.9% for the year endedDecember 31, 2011 . General and administrative expenses. General and administrative expenses decreased$9.9 million , or 10.5%, for the year endedDecember 31, 2011 compared to the year endedDecember 31, 2010 . The decrease in general and administrative expenses was primarily due to a decrease in incentive-based compensation due to higher loss activity as well as a decrease in staffing and related salaries and benefits. The year endedDecember 31, 2010 included one-time expenses in professional fees related to the establishment of Syndicate 2232 and our efforts to effect our redomestication toSwitzerland . These decreases were offset by an increase in fees for a full year of operating our Lloyd's Syndicate 2232 of$4.4 million in 2011 versus six months of operation in 2010. The general and administrative expense ratios for the years endedDecember 31, 2011 and 2010 were 26.6% and 27.8%, respectively, due to lower general and administrative expenses.
Comparison of Years Ended
Premiums. Gross premiums written decreased by$51.0 million , or 9.2%, for the year endedDecember 31, 2010 compared to the same period in 2009. The decrease in gross premiums written was due to the continued trend of the non-renewal of business that did not meet our underwriting requirements (which included inadequate pricing and/or terms and conditions) and increased competition in our international insurance segment. The table below illustrates our gross premiums written by line of business for the periods indicated. Year Ended December 31, Dollar Percentage 2010 2009 Change Change ($ in millions) Professional liability $ 160.7 $ 180.6 $ (19.9 ) (11.0 )% General property 150.7 171.7 (21.0 ) (12.2 ) General casualty 134.2 147.1 (12.9 ) (8.8 ) Healthcare 59.3 56.5 2.8 5.0 $ 504.9 $ 555.9 $ (51.0 ) (9.2 )% Net premiums written decreased$43.8 million , or 12.1%, for the year endedDecember 31, 2010 compared to the year endedDecember 31, 2009 . The decrease in net premiums written was primarily due to the decrease in gross premiums written partially offset by lower premiums ceded on our property catastrophe reinsurance coverage. We ceded to reinsurers 36.8% of gross premiums written for the year endedDecember 31, 2010 compared to 34.7% for the year endedDecember 31, 2009 . The increase is primarily due to increased cessions on our general casualty and professional liability lines of business. Net premiums earned decreased$74.4 million , or 18.0%, primarily due to lower net premiums written during 2009 and 2010. 108
--------------------------------------------------------------------------------
Table of Contents
Net losses and loss expenses. Net losses and loss expenses increased by$2.1 million , or 1.3%, for the year endedDecember 31, 2010 compared to the year endedDecember 31, 2009 . The increase in net losses and loss expenses was primarily due to higher loss activity in the current period partially offset by higher net favorable reserve development recognized. During the year endedDecember 31, 2010 , we experienced net losses and loss expenses of$112.3 million from a number of earthquakes, explosions and weather related events. Overall, our international insurance segment recorded net favorable reserve development of$180.6 million during the year endedDecember 31, 2010 compared to net favorable reserve development of$139.5 million for the year endedDecember 31, 2009 , as shown in the tables below. In the tables, a negative number represents net favorable reserve development and a positive number represents net unfavorable reserve development. Loss
For the
Year Ended
2002 2003 2004 2005
2006 2007 2008 2009 Total
($ in millions) General property $ - $ (0.1 ) $ - $ (6.0
) $ (6.4 ) $ (12.8 ) $ (34.4 ) $ (0.3 ) $ (60.0 ) General casualty
5.1 (2.3 ) (15.3 ) (29.8 ) (7.6 ) (6.5 ) 11.3 7.8 (37.3 ) Healthcare (0.3 ) (1.5 ) (2.2 ) (9.9 ) (22.5 ) - - - (36.4 ) Professional liability 2.0 (2.8 ) (4.1 ) (41.8 ) (0.2 ) - - - (46.9 ) $ 6.8 $ (6.7 ) $ (21.6 ) $ (87.5 ) $ (36.7 ) $ (19.3 ) $ (23.1 ) $ 7.5 $ (180.6 ) Loss Reserve
Development by Loss Year
For the Year
Ended
2002 2003 2004 2005
2006 2007 2008 Total
($ in millions) General property $ (0.3 ) $ (1.4 ) $ (3.9 ) $ (3.5 ) $ (7.4 ) $ (8.6 ) $ 14.2 $ (10.9 ) General casualty (5.0 ) (18.0 ) (30.1 ) (3.0 ) 18.7 0.1 7.6 (29.7 ) Healthcare (0.5 ) (1.0 ) (6.3 ) (21.7 ) - - - (29.5 ) Professional liability - 1.7 (20.8 ) (50.5 ) - - 0.2 (69.4 ) $ (5.8 ) $ (18.7 ) $ (61.1 ) $ (78.7 ) $ 11.3 $ (8.5 ) $ 22.0 $ (139.5 ) The loss and loss expense ratio for the year endedDecember 31, 2010 was 47.3%, compared to 38.3% for the year endedDecember 31, 2009 . The net favorable reserve development recognized during the year endedDecember 31, 2010 decreased the loss and loss expense ratio by 53.3 percentage points. Thus, the loss and loss expense ratio related to the current loss year was 100.6%. Comparatively, the net favorable reserve development recognized during the year endedDecember 31, 2009 decreased the loss and loss expense ratio by 33.8 percentage points. Thus, the loss and loss expense ratio related to that loss year was 72.1%. The increase in the loss and loss expense ratio for the current loss year was primarily due to net incurred losses of$112.3 million in the preceding paragraph, which occurred during the year endedDecember 31, 2010 and contributed 33.1 percentage points to the current year's loss and loss expense ratio. 109
--------------------------------------------------------------------------------
Table of Contents
The table below is a reconciliation of the beginning and ending reserves for losses and loss expenses. Losses incurred and paid are reflected net of reinsurance recoverables. Year EndedDecember 31, 2010 2009
Net reserves for losses and loss expenses,
Incurred related to:
Current period non-catastrophe 276.7
297.5
Current period catastrophe 64.1
-
Prior period non-catastrophe (168.5 ) (136.5 ) Prior period catastrophe (12.1 ) (2.9 ) Total incurred $ 160.2 $ 158.1 Paid related to: Current period non-catastrophe 22.0
16.1
Current period catastrophe 36.5
-
Prior period non-catastrophe 181.7 119.0 Prior period catastrophe 13.0 37.3 Total paid $ 253.2 $ 172.4 Foreign exchange revaluation (1.4 )
7.4
Net reserve for losses and loss expenses,
Losses and loss expenses recoverable 531.0
566.3
Reserve for losses and loss expenses, December 31 $ 2,226.7 $ 2,356.4 Acquisition costs. Acquisition costs decreased$3.2 million for the year endedDecember 31, 2010 compared to the year endedDecember 31, 2009 . The decrease in acquisition costs was due to lower net premiums earned. The acquisition cost ratio decreased from 0.7% for the year endedDecember 31, 2009 to a negative 0.1% for the year endedDecember 31, 2010 . General and administrative expenses. General and administrative expenses increased$9.8 million , or 11.6%, for the year endedDecember 31, 2010 compared to the year endedDecember 31, 2009 . The increase in general and administrative expenses was primarily due to an increase in salary and related costs, including stock-based compensation. The general and administrative expense ratios for the years endedDecember 31, 2010 and 2009 were 27.8% and 20.4%, respectively, due to higher general and administrative expenses and lower net premiums earned. 110
--------------------------------------------------------------------------------
Table of Contents
Reinsurance Segment
The following table summarizes the underwriting results and associated ratios for the reinsurance segment for the years endedDecember 31, 2011 , 2010 and 2009. Year Ended December 31, 2011 2010 2009 ($ in millions) Revenues Gross premiums written $ 570.5 $ 524.2 $ 465.6 Net premiums written 569.5 522.3 465.2 Net premiums earned 555.7 502.3 456.2 Expenses
Net losses and loss expenses 365.5 250.2
234.6
Acquisition costs 95.1 92.1
88.0
General and administrative expenses 62.9 63.8
48.4
Underwriting income 32.2 96.2
85.2
Ratios
Loss and loss expense ratio 65.8 % 49.8 %
51.4 %
Acquisition cost ratio 17.1 % 18.3 %
19.3 %
General and administrative expense ratio 11.3 % 12.7 %
10.6 % Expense ratio 28.4 % 31.0 % 29.9 % Combined ratio 94.2 % 80.8 % 81.3 %
Comparison of Years Ended
Premiums. Gross premiums written increased by$46.3 million , or 8.8%, for the year endedDecember 31, 2011 compared to the same period in 2010. The increase in gross premiums written was primarily due to increased writings in our international reinsurance lines of business with the continuing build out of ourLondon andSingapore offices, including business written through Syndicate 2232, as well as$25.4 million of new business from our new global marine and specialty division. This growth was partially offset by the non-renewal of business that did not meet our underwriting requirements (which included inadequate pricing and/or terms and conditions). In addition, the increase in gross premiums written was partially offset by a two year treaty we wrote in our general casualty reinsurance line of business for$31.4 million in the year endedDecember 31, 2010 .
The table below illustrates our gross premiums written by geographic location for our reinsurance operations.
Year Ended December 31, Dollar Percentage 2011 2010 Change Change ($ in millions) Bermuda $ 204.7 $ 210.1 $ (5.4 ) (2.6 )% United States 241.6 264.2 (22.6 ) (8.6 ) Singapore 66.6 16.6 50.0 301.2 Europe 57.6 33.3 24.3 73.0 $ 570.5 $ 524.2 $ 46.3 8.8 % 111
--------------------------------------------------------------------------------
Table of Contents
The table below illustrates our gross premiums written by line of business for each of the periods indicated.
Year Ended December 31, Dollar Percentage 2011 2010 Change Change ($ in millions) International reinsurance $ 153.2 $ 109.0 $ 44.2 40.6 % Property reinsurance 153.1 133.8 19.3 14.4
General casualty reinsurance* 142.8 174.6 (31.8 )
Specialty reinsurance** 64.2 28.8 35.4
122.9
Professional liability reinsurance 57.2 78.0 (20.8 )
(26.7 ) $ 570.5 $ 524.2 $ 46.3 8.8 %
* Includes our facultative reinsurance line of business
** Includes our workers compensation catastrophe reinsurance and accident and
health reinsurance
Net premiums written increased by$47.2 million , or 9.0%, consistent with the increase in gross premiums written. Net premiums earned increased$53.4 million , or 10.6%. Premiums related to our reinsurance business generally earn at a slower rate than those related to our direct insurance business. Direct insurance premiums typically earn ratably over the term of a policy. Reinsurance premiums under a quota share reinsurance contract are typically earned over the same period as the underlying policies, or risks, covered by the contract. As a result, the earning pattern of a quota share reinsurance contract may extend up to 24 months, reflecting the inception dates of the underlying policies. Property catastrophe premiums and premiums for other treaties written on a losses occurring basis earn ratably over the term of the reinsurance contract. Net losses and loss expenses. Net losses and loss expenses increased by$115.3 million , or 46.1%, for the year endedDecember 31, 2011 compared to the year endedDecember 31, 2010 . The increase in net losses and loss expenses was due to loss activity incurred from the Tohoku earthquake and tsunami of$51.5 million ,$45.9 million from theNew Zealand earthquake,$32.2 million related to the Midwestern U.S. storms,$20.2 million related to theThailand floods,$11.2 million related to Hurricane Irene and$15.3 million related to the Australian storms compared to$26.6 million from a number of earthquakes and other weather related events during the year endedDecember 31, 2010 . The increase in losses and loss expenses from catastrophe losses was partially offset by greater net favorable reserve development during the year endedDecember 31, 2011 . Overall, our reinsurance segment recorded net favorable reserve development of$111.8 million and$64.2 million during the years endedDecember 31, 2011 and 2010, respectively, as shown in the tables below. In the tables, a negative number represents net favorable reserve development and a positive number represents net unfavorable reserve development. Loss Reserve Development by Loss Year For the Year Ended December 31, 2011 2002 2003 2004 2005 2006 2007 2008 2009 2010 Total ($ in millions)
Professional liability reinsurance $ (0.1 ) $ (0.8 ) $ (3.6 ) $
(9.7 ) $ (12.9 ) $ (7.1 ) $ (1.2 ) $ (0.2 ) $ - $ (35.6 ) International reinsurance - (0.2 ) (4.2 ) (10.9 ) (0.2 ) (2.8 ) (0.3 ) (3.5 ) (10.8 ) (32.9 ) General casualty reinsurance (0.1 ) (0.9 ) (1.8 ) (12.4 ) (1.5 ) (7.9 ) (0.6 ) - 2.9 (22.3 ) Specialty reinsurance - - (0.2 ) - - (0.8 ) (0.2 ) (5.7 ) (4.1 ) (11.0 ) Property reinsurance (0.2 ) (0.6 ) (1.1 ) (2.6 ) (1.4 ) (2.1 ) - (1.4 ) (0.6 ) (10.0 ) $ (0.4 ) $ (2.5 ) $ (10.9 ) $ (35.6 ) $ (16.0 ) $ (20.7 ) $ (2.3 ) $ (10.8 ) $ (12.6 ) $ (111.8 ) 112
--------------------------------------------------------------------------------
Table of Contents Loss
For
the Year Ended
2002 2003 2004
2005 2006 2007 2008 2009 Total
($ in millions) Professional liability reinsurance $ (0.3 ) $ (0.5 ) $ (5.4 ) $ (10.3 ) $ (9.0 ) $ (1.3 ) $ (0.7 ) $ - $ (27.5 ) International reinsurance
(0.1 ) (0.3 ) (0.7 )
(1.5 ) (0.4 ) 0.2 5.7 1.2 4.1 General casualty reinsurance
(0.1 ) 0.4 (2.3 ) (17.7 ) (2.6 ) (1.5 ) (0.3 ) - (24.1 ) Specialty reinsurance - - (0.6 ) (0.1 ) - (1.2 ) (2.7 ) - (4.6 ) Property reinsurance (0.3 ) (0.7 ) (0.9 ) (3.4 ) (0.4 ) - 1.1 (7.5 ) (12.1 ) $ (0.8 ) $ (1.1 ) $ (9.9 ) $ (33.0 ) $ (12.4 ) $ (3.8 ) $ 3.1 $ (6.3 ) $ (64.2 ) The loss and loss expense ratio for the year endedDecember 31, 2011 was 65.8%, compared to 49.8% for the year endedDecember 31, 2010 . Net favorable reserve development recognized during the year endedDecember 31, 2010 reduced the loss and loss expense ratio by 20.1 percentage points. Thus, the loss and loss expense ratio related to the current loss year was 85.9%. In comparison, net favorable reserve development recognized in the year endedDecember 31, 2010 reduced the loss and loss expense ratio by 12.8 percentage points. Thus, the loss and loss expense ratio related to that loss year was 62.6%. The increase in the loss and loss expense ratio for the current loss year was primarily due to the$176.3 million of global catastrophe losses discussed above, which contributed 31.7 percentage points to the loss and loss expense ratio for the year endedDecember 31, 2011 . Earthquakes and other weather related events discussed above during the year endedDecember 31, 2010 contributed$26.6 million or 5.3 percentage points to the prior year's loss and loss expense ratio. The table below is a reconciliation of the beginning and ending reserves for losses and loss expenses. Losses incurred and paid are reflected net of reinsurance recoverables. Year Ended December 31, 2011 2010
Net reserves for losses and loss expenses,
Incurred related to:
Current period non-catastrophe 301.0
280.1
Current period property catastrophe 176.3
34.3
Prior period non-catastrophe (107.2 )
(62.7 )
Prior period property catastrophe (4.6 ) (1.5 ) Total incurred $ 365.5 $ 250.2 Paid related to: Current period non-catastrophe 26.7
16.8
Current period property catastrophe 49.2
1.0
Prior period non-catastrophe 185.3
156.7
Prior period property catastrophe 11.7 4.7 Total paid $ 272.9 $ 179.2
Net reserve for losses and loss expenses,
Losses and loss expenses recoverable 0.3
-
Reserve for losses and loss expenses, December 31 $ 1,313.7 $ 1,220.8 Acquisition costs. Acquisition costs increased by$3.0 million , or 3.3%, for the year endedDecember 31, 2011 compared to the year endedDecember 31, 2010 . The increase was primarily a result of higher net premiums earned partially offset by a decrease in profit commissions due to loss activity. The acquisition cost 113
--------------------------------------------------------------------------------
Table of Contents
ratio was 17.1% for the year endedDecember 31, 2011 , slightly lower than the 18.3% for the year endedDecember 31, 2010 . The decrease in the acquisition cost ratio is due to more business written on an excess-of-loss basis, which typically carries a lower acquisition cost ratio than quota share business. General and administrative expenses. General and administrative expenses decreased$0.9 million , or 1.4%, for the year endedDecember 31, 2011 compared to the year endedDecember 31, 2010 . The decrease in general and administrative expenses was primarily due to a decrease in performance based incentive compensation expenses partially offset by additional professional fees related to the operation of the Lloyd's Syndicate which was operational for only six months in the prior year. The general and administrative expense ratios for the years endedDecember 31, 2011 and 2010 were 11.3% and 12.7%, respectively, due to lower general and administrative expenses and higher net premiums earned.
Comparison of Years Ended
Premiums. Gross premiums written increased by$58.6 million , or 12.6%, for the year endedDecember 31, 2010 compared to the same period in 2009. The increase in gross premiums written was primarily due to increased writings in our property and international reinsurance lines of business with the build out of ourLondon andSingapore offices, including business written through Syndicate 2232. We increased our participation on one property reinsurance treaty for$23.6 million in 2010 from$9.0 million in 2009, and we wrote one new treaty in our general casualty reinsurance line of business for$31.4 million . These increases were partially offset by the non-renewal of business that did not meet our underwriting requirements (which included inadequate pricing and/or terms and conditions), increased competition and increased cedent retention.
The table below illustrates our gross premiums written by geographic location for our reinsurance operations.
Year Ended December 31, Dollar Percentage 2010 2009 Change Change ($ in millions) Bermuda $ 210.1 $ 192.3 $ 17.8 9.3 % United States 264.2 255.1 9.1 3.6 Europe 33.3 18.2 15.1 83.0 % Singapore 16.6 - 16.6 n/a $ 524.2 $ 465.6 $ 58.6 12.6 % The table below illustrates our gross premiums written by line of business for the periods indicated. Year Ended December 31, Dollar Percentage 2010 2009 Change Change ($ in millions) General casualty reinsurance $ 160.2 $ 138.5 $ 21.7 15.7 % Property reinsurance 133.8 100.5 33.3 33.1 International reinsurance 109.0 84.2 24.8 29.5 Professional liability reinsurance 78.0 102.8 (24.8 ) (24.1 ) Specialty reinsurance 28.8 23.5 5.3 22.6 Facultative reinsurance 14.4 16.1 (1.7 ) (10.6 ) 524.2 465.6 58.6 12.6 %
The specialty reinsurance line of business includes the workers compensation catastrophe reinsurance and accident and health reinsurance.
114
--------------------------------------------------------------------------------
Table of Contents
Net premiums written increased by
Net losses and loss expenses. Net losses and loss expenses increased by$15.6 million , or 6.6%, for the year endedDecember 31, 2010 compared to the year endedDecember 31, 2009 . The increase in net losses and loss expenses was primarily due to the growth of the reinsurance operations and higher loss activity of$26.6 million from a number of earthquakes and other weather related events, partially offset by higher net favorable prior year reserve development. Overall, our reinsurance segment recorded net favorable reserve development of$64.2 million and$38.1 million during the years endedDecember 31, 2010 and 2009, respectively, as shown in the tables below. In the tables, a negative number represents net favorable reserve development and a positive number represents net unfavorable reserve development. Loss
For
the Year Ended
2002 2003 2004
2005 2006 2007 2008 2009 Total
($ in millions) Professional liability reinsurance $ (0.3 ) $ (0.5 ) $ (5.4 ) $ (10.3 ) $ (9.0 ) $ (1.3 ) $ (0.7 ) $ - $ (27.5 ) International reinsurance
(0.1 ) (0.3 ) (0.7 )
(1.5 ) (0.4 ) 0.2 5.7 1.2 4.1 General casualty reinsurance
(0.1 ) 0.4 (2.3 )
(17.7 ) (2.6 ) (1.5 ) (0.3 ) - (24.1 ) Specialty reinsurance
- - (0.6 )
(0.1 ) - (1.2 ) (2.7 ) - 4.6 ) Property reinsurance
(0.3 ) (0.7 ) (0.9 ) (3.4 ) (0.4 ) - 1.1 (7.5 ) (12.1 ) $ (0.8 ) $ (1.1 ) $ (9.9 ) $ (33.0 ) $ (12.4 ) $ (3.8 ) $ 3.1 $ (6.3 ) $ (64.2 ) Loss
For the Year Ended December 31, 2009 2002 2003 2004 2005 2006 2007 2008 Total
($ in millions) Professional liability reinsurance $ (3.1 ) $ (6.8 ) $ (13.2 ) $ (1.5 ) $ (0.1 )
(0.2 ) (0.6 ) 1.1
(0.1 ) - 4.6 3.2 8.0 General casualty reinsurance
(0.6 ) (9.1 ) (7.7 ) (7.1 ) (0.9 ) - - (25.4 ) Specialty reinsurance - - (0.9 ) 1.2 - - - 0.3 Property reinsurance (0.1 ) 0.2 - 3.3 - (7.6 ) (3.7 ) (7.9 ) $ (4.0 ) $ (16.3 ) $ (20.7 ) $ (4.2 ) $ (1.0 ) $ 5.1 $ 3.0 $ (38.1 ) The loss and loss expense ratio for the year endedDecember 31, 2010 was 49.8%, compared to 51.4% for the year endedDecember 31, 2009 . Net favorable reserve development recognized during the year endedDecember 31, 2010 reduced the loss and loss expense ratio by 12.8 percentage points. Thus, the loss and loss expense ratio related to the current loss year was 62.6%. In comparison, net favorable reserve development recognized in the year endedDecember 31, 2009 reduced the loss and loss expense ratio by 8.4 percentage points. Thus, the loss and loss expense ratio related to that loss year was 59.8%. The increase in the loss and loss expense ratio for the current loss year was primarily due to net incurred losses of$26.6 million noted above, which contributed 5.3 percentage points to the current loss year's loss and loss expense ratio. 115
--------------------------------------------------------------------------------
Table of Contents
The table below is a reconciliation of the beginning and ending reserves for losses and loss expenses. Losses incurred and paid are reflected net of reinsurance recoverables. Year EndedDecember 31, 2010 2009
Net reserves for losses and loss expenses,
Incurred related to:
Current period non-catastrophe 280.1
272.7
Current period property catastrophe 34.3
-
Prior period non-catastrophe (62.7 )
(40.2 )
Prior period property catastrophe (1.5 ) 2.1 Total incurred $ 250.2 $ 234.6 Paid related to: Current period non-catastrophe 16.8
14.1
Current period property catastrophe 1.0
-
Prior period non-catastrophe 156.7
125.2
Prior period property catastrophe 4.7 17.6 Total paid $ 179.2 $ 156.9
Net reserve for losses and loss expenses,
Losses and loss expenses recoverable -
1.9
Reserve for losses and loss expenses, December 31 $ 1,220.8 $ 1,151.7 Acquisition costs. Acquisition costs increased by$4.1 million , or 4.7%, for the year endedDecember 31, 2010 compared to the year endedDecember 31, 2009 primarily as a result of higher net premiums earned. The acquisition cost ratio was 18.3% for the year endedDecember 31, 2010 , slightly lower than the 19.3% for the year endedDecember 31, 2009 . The decrease in the acquisition cost ratio is due to more business written on an excess-of-loss basis, which typically carries a lower acquisition cost ratio than quota share business. General and administrative expenses. General and administrative expenses increased$15.4 million , or 31.8%, for the year endedDecember 31, 2010 compared to the year endedDecember 31, 2009 . The increase in general and administrative expenses was primarily due to an increase in salary and related costs included stock-based compensation. The 2.1 percentage point increase in the general and administrative expense ratio from 10.6% for the year endedDecember 31, 2009 to 12.7% for the year endedDecember 31, 2010 was due to higher general and administrative expense partially offset by higher net premiums earned. Liquidity and Capital Resources
General
Our operating subsidiaries depend upon cash inflows from premium receipts, net of commissions, investment income, and proceeds from sales and redemptions of investments. Cash outflows are in the form of claims payments, reinsurance premium payments, purchase of investments, operating expenses, income tax payments, intercompany payments as well as dividend payments to the holding company. Historically, our operating subsidiaries have generated sufficient cash flows to meet all of their obligations. Because of the inherent volatility of our business, the seasonality in the timing of payments by insureds and cedents, the irregular timing of loss payments, the impact of a change in interest rates and credit spreads on the investment income as well as seasonality in coupon payment dates for fixed income securities, cash flows from operating activities may vary between periods. We expect that annual positive cash flows from operating activities will be sufficient to cover claims payments. In the unlikely event that paid losses exceed operating cash flows in any given period, we would use our cash balances available, or liquidate a portion of our high quality 116
--------------------------------------------------------------------------------
Table of Contents
and liquid investment portfolio in order to meet our short term liquidity needs. As discussed in Item 1 "Business," our total investments and cash totaled$8.1 billion atDecember 31, 2011 , the main components of which were investment grade fixed income securities and cash and cash equivalents.
As of
OnNovember 26, 2010 , we received approval from theSupreme Court of Bermuda to change the place of incorporation of our ultimate parent company fromBermuda toSwitzerland , and onDecember 1, 2010 we completed our redomestication toSwitzerland . Our ultimate parent company is now Holdings andAllied World Bermuda is a wholly owned subsidiary of Holdings. Holdings is a holding company and transacts no business of its own. Cash flows to Holdings may comprise dividends, advances and loans from its subsidiary companies. Holdings is therefore reliant on receiving dividends and other permitted distributions from its subsidiaries to make dividend payments on its common shares. Under Swiss law, distributions to shareholders may be paid out only if the company has sufficient distributable profits from previous fiscal years, or if the company has freely distributable reserves, each as presented on the audited annual stand-alone statutory balance sheet. Distributions to shareholders out of the share and participation capital may be made by way of a capital reduction in the form of a reduction in the par value of the common shares to achieve a similar result as the payment of a dividend. Allied World Bermuda is a holding company and transacts no business of its own. Cash flows to Allied World Bermuda may comprise dividends, advances and loans from its subsidiary companies. Allied World Bermuda is therefore reliant on receiving dividends and other permitted distributions from its subsidiaries to make principal and interest payments on its senior notes.
Capital Activities
InMay 2010 , the company established a share repurchase program in order to repurchase Holdings' common shares. Repurchases under the authorization may be effected from time to time through open market purchases, privately negotiated transactions, and tender offers or otherwise. The timing, form and amount of the share repurchases under the program will depend on a variety of factors, including market conditions, the company's capital position, legal requirements and other factors. During the year endedDecember 31, 2011 , we repurchased through open market purchases 1,419,163 shares at a total cost of$86.7 million , for an average price of$61.09 per share. We have classified the repurchased shares as "treasury shares, at cost" on the consolidated balance sheets. InNovember 2010 , Allied World Bermuda issued$300 million senior notes due in 2020. The senior notes bear interest at an annual rate of 5.50% per year and were priced to yield 5.56%. Interest on the senior notes is payable semi-annually onMay 15 andNovember 15 of each year commencing onMay 15, 2011 . The net proceeds from the offering of the senior notes were and will be used for general corporate purposes, including the repurchase of the company's outstanding common shares. The senior notes are the company's unsecured and unsubordinated obligations and rank equally in right of payment with all existing and future unsecured and unsubordinated indebtedness. We may redeem the senior notes at any time or from time to time in whole or in part at a redemption price equal to the greater of the principal amount of the senior notes to be redeemed or a make-whole price, plus accrued and unpaid interest. The senior notes include covenants and events of default that are usual and customary, but do not contain any financial covenants. In addition, these senior notes as well as the 7.50% senior notes issued in 2006 have been unconditionally and irrevocably guaranteed for the payment of the principal and interest by Holdings. InFebruary 2011 , we repurchased a warrant owned by American International Group, Inc. ("AIG") in a privately negotiated transaction. The warrant entitled AIG to purchase 2,000,000 of our common shares for$34.20 per share. We repurchased the warrant for an aggregate purchase price of$53.6 million . The repurchase of the warrant was recognized as a reduction in "additional paid-in capital" in the consolidated balance sheets. The repurchase was executed separately from the company's share repurchase program. We believe our company's capital position continues to remain well within the range needed for our business requirements and we have sufficient liquidity to fund our ongoing operations. 117
--------------------------------------------------------------------------------
Table of Contents
Restrictions and Specific Requirements
The jurisdictions in which our operating subsidiaries are licensed to write business impose regulations requiring companies to maintain or meet various defined statutory ratios, including solvency and liquidity requirements. Some jurisdictions also place restrictions on the declaration and payment of dividends and other distributions.
The payment of dividends from Holdings'Bermuda domiciled operating subsidiary is, under certain circumstances, limited underBermuda law, which requires ourBermuda operating subsidiary to maintain certain measures of solvency and liquidity. Holdings' U.S. domiciled operating subsidiaries are subject to significant regulatory restrictions limiting their ability to declare and pay dividends. In particular, payments of dividends byAllied World Assurance Company (U.S.) Inc. ,Allied World National Assurance Company ,Allied World Reinsurance Company ,Darwin National Assurance Company ,Darwin Select Insurance Company and Vantapro Specialty Insurance Company are subject to restrictions on statutory surplus pursuant to the respective states in which these insurance companies are domiciled. Each state requires prior regulatory approval of any payment of extraordinary dividends. In addition,Allied World Assurance Company, AG is subject to Swiss financial and regulatory restrictions limiting its ability to declare and pay dividends andAllied World Assurance Company (Europe) Limited andAllied World Assurance Company (Reinsurance) Limited are subject to regulatory restrictions limiting their ability to declare and pay any dividends without the consent of theCentral Bank of Ireland . We also have branch operations inCanada ,Hong Kong andSingapore , which have regulatory restrictions limiting the ability to declare and pay dividends. We also have insurance subsidiaries that are the parent company for other insurance subsidiaries, which means that dividends and other distributions will be subject to multiple layers of regulations in order to dividend funds to Holdings. The inability of the subsidiaries of Holdings to pay dividends and other permitted distributions could have a material adverse effect on Holdings' cash requirements and our ability to make principal, interest and dividend payments on the senior notes and common shares. Holdings' operating subsidiary inBermuda ,Allied World Assurance Company, Ltd , is neither licensed nor admitted as an insurer, nor is it accredited as a reinsurer, in any jurisdiction inthe United States . As a result, it is generally required to post collateral security with respect to any reinsurance liabilities it assumes from ceding insurers domiciled inthe United States in order for U.S. ceding companies to obtain credit on their U.S. statutory financial statements with respect to insurance liabilities ceded to them. Under applicable statutory provisions, the security arrangements may be in the form of letters of credit, reinsurance trusts maintained by trustees or funds-withheld arrangements where assets are held by the ceding company.Allied World Assurance Company, Ltd uses trust accounts primarily to meet security requirements for inter-company and certain reinsurance transactions. We also have cash and cash equivalents and investments on deposit with various state or government insurance departments or pledged in favor of ceding companies in order to comply with relevant insurance regulations. In addition,Allied World Assurance Company, Ltd currently has access to up to$1.7 billion in letters of credit under two letter of credit facilities,$900 million withCitibank Europe plc and$800 million with a syndication of lenders described below. These facilities are used to provide security to reinsureds and are collateralized by us, at least to the extent of letters of credit outstanding at any given time. The letters of credit issued under the credit facility withCitibank Europe plc are deemed to be automatically extended without amendment for twelve months from the expiry date, or any future expiration date unless at least 30 days prior to any expiration dateCitibank Europe plc notifies us that they elect not to consider the letters of credit renewed for any such additional period. IfCitibank Europe plc no longer provides capacity under the credit facility it may limit our ability to meet our security requirements and would require us to obtain other sources of security at terms that may not be favorable to us. We entered into an$800 million five-year senior credit facility (the "Credit Facility") with a syndication of lenders that will terminate onNovember 27, 2012 . The Credit Facility consists of a$400 million secured letter of credit facility for the issuance of standby letters of credit (the "Secured Facility") and a$400 million unsecured facility for the making of revolving loans and for the issuance of standby letters of credit (the "Unsecured Facility"). Both the Secured Facility and the Unsecured Facility have options to increase the aggregate commitments by up to$200 million , subject to approval of the lenders. The Credit Facility will be used for 118
--------------------------------------------------------------------------------
Table of Contents
general corporate purposes and to issue standby letters of credit. The Credit Facility contains representations, warranties and covenants customary for similar bank loan facilities, including a covenant to maintain a ratio of consolidated indebtedness to total capitalization as of the last day of each fiscal quarter or fiscal year of not greater than 0.35 to 1.0 and a covenant under the Unsecured Facility to maintain a certain consolidated net worth. In addition, each material insurance subsidiary must maintain a financial strength rating fromA.M. Best Company of at least A- under the Unsecured Facility and of at least B++ under the Secured Facility. As ofDecember 31, 2011 we had a consolidated indebtedness to total capitalization of 0.21 to 1.0 and all of our subsidiaries had a financial strength rating fromA.M. Best of A. The Unsecured Facility required a minimum net worth as ofDecember 31, 2011 of$1.4 billion and our net worth as calculated according to the Unsecured Facility was$3.1 billion as ofDecember 31, 2011 . Based on the results of these financial calculations, we were in compliance with all covenants under the Credit Facility as ofDecember 31, 2011 . InMay 2010 ,Allied World Capital (Europe) Limited established an irrevocable standby letter of credit in order to satisfy funding requirements of our Lloyd's Syndicate 2232. As ofDecember 31, 2011 , the amount of the letter of credit was £59.0 million ($90.9 million ). Security arrangements with ceding insurers may subject our assets to security interests or require that a portion of our assets be pledged to, or otherwise held by, third parties. Both of our letter of credit facilities are fully collateralized by assets held in custodial accounts at the Bank of New York Mellon held for the benefit of the banks. Although the investment income derived from our assets while held in trust accrues to our benefit, the investment of these assets is governed by the terms of the letter of credit facilities or the investment regulations of the state or territory of domicile of the ceding insurer, which may be more restrictive than the investment regulations applicable to us underBermuda law. The restrictions may result in lower investment yields on these assets, which may adversely affect our profitability. The following shows our trust accounts on deposit, as well as outstanding and remaining letter of credit facilities and the collateral committed to support the letter of credit facilities: As of As of December 31, December 31, 2011 2010 ($ in millions) Total trust accounts on deposit $ 2,029.1 $ 1,657.4 Total letter of credit facilities: Citibank Europe plc 900.0 900.0 Credit Facility 800.0 800.0 Total letters of credit facilities 1,700.0
1,700.0
Total letter of credit facilities outstanding: Citibank Europe plc 675.6 689.8 Credit Facility 141.4 159.0 Total letter of credit facilities outstanding 817.0
848.8
Total letter of credit facilities remaining: Citibank Europe plc 224.4 210.2 Credit Facility(1) 658.6 641.0 Total letter of credit facilities remaining 883.0
851.2
Collateral committed to support the letter of credit facilities $ 1,044.2 $ 1,121.3
(1) Net of any borrowing or repayments under the Unsecured Facility.
As ofDecember 31, 2011 , we had a combined unused letters of credit capacity of$883.0 million from theCredit Facility andCitibank Europe plc. We believe that this remaining capacity is sufficient to meet our future letter of credit needs. 119
--------------------------------------------------------------------------------
Table of Contents
We do not currently anticipate that the restrictions on liquidity resulting from restrictions on the payment of dividends by our subsidiary companies or from assets committed in trust accounts or to collateralize the letter of credit facilities will have a material impact on our ability to carry out our normal business activities, including interest and dividend payments, respectively, on our senior notes and common shares.
Sources and Uses of Funds
Our sources of funds primarily consist of premium receipts net of commissions, investment income, net proceeds from capital raising activities that may include the issuance of common shares, senior notes and other debt or equity issuances, and proceeds from sales and redemption of investments. Cash is used primarily to pay losses and loss expenses, purchase reinsurance, pay general and administrative expenses and taxes, and pay dividends and interest, with the remainder made available to our investment portfolio managers for investment in accordance with our investment policy. Cash flows from operations for the year endedDecember 31, 2011 were$548.1 million compared to$451.3 million for the year endedDecember 31, 2010 and$668.2 million for the year endedDecember 31, 2009 . The increase in cash flows from operations was impacted by increased premium writings in the year endedDecember 31, 2011 compared to the year endedDecember 31, 2010 . The decrease in cash flows from operations for the year endedDecember 31, 2010 compared to the year endedDecember 31, 2009 was primarily due to an increase in net paid losses of$138.5 million and an increase in insurance balances receivable primarily related to a funds held balance of$73.9 million for a property catastrophe reinsurance treaty entered into in 2010. The funds held balance can be used by the cedent to pay claims, if any. Any balance remaining after the expiry of the reinsurance treaty is returned to us. Cash flows from investing activities consist primarily of proceeds on the sale of investments and payments for investments acquired. We had cash flows used in investing activities of$509.1 million for the year endedDecember 31, 2011 ,$500.1 million of cash flows provided by investing activities for the year endedDecember 31, 2010 and$582.6 million of cash flows used in investing activities of for the year endedDecember 31, 2009 . The increase in cash flows used in investing activities for the year endedDecember 31, 2011 reflects additional investment of our operating cash flow. The cash flows provided by investing activities for the year endedDecember 31, 2010 compared to net cash used in investment activities for the year endedDecember 31, 2009 was primarily due to the turnover of the investment portfolio during 2010 in order to manage the overall market interest rate exposure and moving securities to our new portfolio manager. Cash flows from financing activities consist primarily of capital raising activities, which include the issuance or repurchase of common shares or debt and the payment of dividends or the repayment of debt. Cash flows used in financing activities were$162.1 million for the year endedDecember 31, 2011 compared to net cash used in financing activities of$486.1 million and$450.0 million for the year endedDecember 31, 2010 and 2009, respectively. During the year endedDecember 31, 2011 we paid dividends of$28.6 million , repurchased$86.7 million of our common shares and repurchased$53.6 million in warrants. During the year endedDecember 31, 2010 , we paid dividends of$47.7 million , repurchased$674.7 million of our common shares, which included the repurchase of all the common shares owned by Goldman Sachs, and repurchased$70.0 million in warrants to purchase our common shares from Chubb and Goldman Sachs. The reduction in share repurchases was impacted by the previously pending merger agreement with Transatlantic. During 2010, we issued 5.50% Senior Notes for net proceeds of$298.6 million , which we used for share repurchases and other general corporate purposes. In addition to our quarterly dividends declared and paid during 2010, the Board of Directors declared a special dividend of$0.25 per common share related to the redomestication. Under Swiss law, we were not able to pay a dividend until two months after our annual meeting. This special dividend provided a dividend to shareholders for the interim period. This special dividend was paid onNovember 26, 2010 to shareholders of record onNovember 15, 2010 . Our funds are primarily invested in liquid, high-grade fixed income securities. As ofDecember 31, 2011 and 2010, 92.6% and 96.2%, respectively, of our fixed income portfolio consisted of investment grade securities. As ofDecember 31, 2011 andDecember 31, 2010 , net accumulated unrealized gains on our available for sale fixed 120
--------------------------------------------------------------------------------
Table of Contents
maturity investments were$14.5 million and$57.1 million , respectively. The decrease in net unrealized gains resulted from the sale of certain available for sale securities during the year endedDecember 31, 2011 and reinvesting the proceeds in fixed maturity investments where mark-to-market changes are reflected in the consolidated income statement. The maturity distribution of our fixed income portfolio (on a fair value basis) as ofDecember 31, 2011 andDecember 31, 2010 was as follows: As of As of December 31, December 31, 2011 2010 ($ in millions) Due in one year or less $ 661.6 $ 249.3 Due after one year through five years 2,686.1
3,119.9
Due after five years through ten years 725.5
867.9 Due after ten years 94.2 122.9 Mortgage-backed 1,818.1 1,751.9 Asset-backed 513.2 549.0 Total $ 6,498.7 $ 6,660.9 We have investments in various other invested assets, the market value of which was$540.4 million as ofDecember 31, 2011 . Each of these funds has redemption notice requirements. For each of our funds, liquidity is allowed after certain defined periods based on the terms of each fund. See Note 4(d) "Investments - Other Invested Assets" to our consolidated financial statements for additional details on our other invested assets. We do not believe that inflation has had a material effect on our consolidated results of operations. The potential exists, after a catastrophe loss, for the development of inflationary pressures in a local economy. The effects of inflation are considered implicitly in pricing. Loss reserves are established to recognize likely loss settlements at the date payment is made. Those reserves inherently recognize the effects of inflation. The actual effects of inflation on our results cannot be accurately known, however, until claims are ultimately resolved. Financial Strength Ratings Financial strength ratings and senior unsecured debt ratings represent the opinions of rating agencies on our capacity to meet our obligations. The rating agencies consider a number of quantitative and qualitative factors in determining an insurance company's financial strength and credit ratings. Quantitative considerations of an insurance company include the evaluation of financial statements, historical operating results and, through the use of proprietary capital models, the measure of investment and insurance risks relative to capital. Among the qualitative considerations are management strength, business profile, market conditions and established risk management practices used, among other things, to manage risk exposures and limit capital volatility. Some of our reinsurance treaties contain special funding and termination clauses that are triggered in the event that we or one of our subsidiaries is downgraded by one of the major rating agencies to levels specified in the treaties, or our capital is significantly reduced. If such an event were to happen, we would be required, in certain instances, to post collateral in the form of letters of credit and/or trust accounts against existing outstanding losses, if any, related to the treaty. In a limited number of instances, the subject treaties could be cancelled retroactively or commuted by the cedent and might affect our ability to write business.
For additional information on our financial strength ratings refer to Our Financial Strength Ratings in Item 1 "Business".
In 2010, we established Syndicate 2232 and commenced underwriting activities through the Lloyd's market. All Lloyd's syndicates benefit from Lloyd's central resources, including Lloyd's brand, its network of global licenses and the central fund. As all of Lloyd's policies are ultimately backed by this common security, a single market rating can be applied. A. M. Best has assigned Lloyd's a financial strength rating of "A" (Excellent) and Standard & Poor's and Fitch Ratings have assigned Lloyd's a financial strength rating of "A+" (Strong).
We believe that the quantitative and qualitative factors that influence our ratings are supportive of our ratings.
121
--------------------------------------------------------------------------------
Table of Contents
Long-Term Debt
InJuly 2006 , Allied World Bermuda issued$500.0 million aggregate principal amount of 7.50% senior notes dueAugust 1, 2016 , with interest payableAugust 1 andFebruary 1 each year, commencingFebruary 1, 2007 . Allied World Bermuda can redeem the senior notes prior to maturity, subject to payment of a "make-whole" premium; however, Allied World Bermuda currently has no intention of redeeming the notes. InNovember 2010 , Allied World Bermuda issued$300.0 million aggregate principal amount of 5.50% senior notes dueNovember 1, 2020 , with interest payableMay 15 andNovember 15 each year, commencingMay 15, 2011 . Allied World Bermuda can redeem the senior notes prior to maturity, subject to payment of a "make-whole" premium; however, Allied World Bermuda currently has no intention of redeeming the notes.
The senior notes issued in 2006 and 2010 have been unconditionally and irrevocably guaranteed for the payment of the principal and interest by Holdings.
Aggregate Contractual Obligations
The following table shows our aggregate contractual obligations by time period remaining until due date as of
Payment Due by Period Less Than More Than Total 1 Year 1-3 Years 3-5 Years 5 Years ($ in millions) Contractual Obligations Senior notes (including interest) $ 1,136.0 $ 54.0 $ 108.0 $ 608.0 $ 366.0 Operating lease obligations 94.0 12.9 24.2 19.2 37.7 Investment commitments outstanding 245.9 - 27.0 42.5 176.4 Darwin LTIP 3.4 3.4 - - - Gross reserve for losses and loss expenses* 5,225.1 1,098.1 1,343.3 793.2 1,990.5 Total $ 6,704.4 $ 1,168.4 $ 1,502.5 $ 1,462.9 $ 2,570.6
* Our unpaid losses and loss expenses represent our best estimate of the cost to
settle the ultimate liabilities based on information available as of
commitments. The timing and amounts of actual loss payments related to these
reserves might vary significantly from our current estimate of the expected
timing and amounts of loss payments based on many factors, including large
individual losses as well as general market conditions.
The investment commitments outstanding represent unfunded commitments related to our other invested assets.
As part of the acquisition of Darwin, we assumed the Darwin LTIP that Darwin had implemented for certain of its key employees. Initially, the Darwin LTIP allocated 20% of the underwriting profit for each year (premiums net of losses and expenses) plus 20% of the investment income based on average net assets outstanding in each year (at a deemed interest rate equal to the 10 year U.S. Treasury note rate) to the Darwin LTIP participants, based on their assigned percentage interests. EffectiveJanuary 1, 2006 , the Darwin LTIP was modified to reflect changes in the calculation of the underwriting profitability allocated to the participants of the Darwin LTIP. For 2006 and later years, the amount allocated to the participants is calculated as an amount equal to 20% of the underwriting profit less an amount equal to 5% of net premiums earned. In addition, imputed investment income will no longer be credited to the pool participants. Interests in these profit pools vest over a four-year period. The payments due are made in increments over the fourth, fifth and sixth years. This plan is in run-off. The amounts included for reserve for losses and loss expenses reflect the estimated timing of expected loss payments on known claims and anticipated future claims as ofDecember 31, 2011 and do not take reinsurance recoverables into account. Both the amount and timing of cash flows are uncertain and do not have contractual payout terms. For a discussion of these uncertainties, refer to " - Critical Accounting Policies - Reserve for Losses and Loss Expenses." Due to the inherent uncertainty in the process of estimating the timing of these 122
--------------------------------------------------------------------------------
Table of Contents
payments, there is a risk that the amounts paid in any period will differ significantly from those disclosed. Total estimated obligations will be funded by existing cash and investments.
Off-Balance Sheet Arrangements
As of
| Wordcount: | 32219 |
Advisor News
- Equitable launches 403(b) pooled employer plan to support nonprofits
- Financial FOMO is quietly straining relationships
- GDP growth to rebound in 2027-2029; markets to see more volatility in 2026
- Health-related costs are the greatest threat to retirement security
- Social Security literacy is crucial for advisors
More Advisor NewsAnnuity News
- MetLife to Announce First Quarter 2026 Results
- CT commissioner: 70% of policyholders covered in PHL liquidation plan
- ‘I get confused:’ Regulators ponder increasing illustration complexities
- Three ways the Corebridge/Equitable merger could shake up the annuity market
- Corebridge, Equitable merge to create potential new annuity sales king
More Annuity NewsHealth/Employee Benefits News
- Latino: The truth about ACA subsidies after the "One Big Beautiful Bill"
- Virginia insurance regulators order rate cuts for several Aflac policies
- State legislators continue to question HPH-HMSA deal
- Shares of Health Insurers Rally After CMS Bumps Up 2027 Rates
- Virginia insurance regulators order Aflac rate cuts
More Health/Employee Benefits NewsLife Insurance News
- WoodmenLife 2025 annual report celebrates family, community and country
- Overcoming price objections by reframing costs
- Virginia insurance regulators order rate cuts for several Aflac policies
- AM Best Maintains Under Review With Positive Implications Status for The Fortegra Group, Inc.’s Insurance Subsidiaries
- Life insurance application activity sees record-breaking Q1
More Life Insurance News