ALTERRA CAPITAL HOLDINGS LTD – 10-K – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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The following is a discussion and analysis of our results of operations for the year endedDecember 31, 2011 compared to the year endedDecember 31, 2010 and for the year endedDecember 31, 2010 compared to the year endedDecember 31, 2009 , and also a discussion of our financial condition as ofDecember 31, 2011 . This discussion and analysis should be read in conjunction with the audited consolidated financial statements and related notes that are included in this Annual Report on Form 10-K. Key Performance Indicators The financial measures that we believe are most meaningful in analyzing our performance and assessing whether we are achieving our objectives are growth in book value per share, net operating income, combined ratio, return on average shareholders' equity and net operating return on average shareholders' equity. The table below shows the key performance indicators as ofDecember 31, 2011 and 2010 and for the years endedDecember 31, 2011 , 2010 and 2009. As of As of December 31, December 31, 2011 2010 Book value per share (1) $ 27.51 $ 26.30 Diluted book value per share (1) $ 26.91 $ 25.99 Year Ended December 31, 2011 2010 2009 (in millions of U.S. Dollars, except percentages) Net operating income (2) $ 96.6 $ 251.7 $ 208.9 Combined ratio (3) 98.2 % 85.7 % 88.1 % Return on average shareholders' equity (4) 2.3 % 12.3 % 17.6 % Net operating return on average shareholders' equity (2)(4) 3.4 % 10.2 % 14.9 %
(1) Book value per share is calculated as shareholders' equity divided by the
number of common shares outstanding. Diluted book value per share is
calculated as shareholders' equity divided by the number of diluted common
shares outstanding using the treasury stock method.
(2) Net operating income and net operating return on average shareholders' equity
are non-GAAP financial measures as defined by SEC Regulation G. See "Non-GAAP
financial measures" for reconciliation to the nearest U.S. GAAP financial
measure.
(3) Combined ratio is calculated by dividing the sum of net losses and loss
expenses, acquisition costs and general and administrative expenses by net
premiums earned for property and casualty business.
(4) Return on average shareholders' equity and net operating return on average
shareholders' equity are calculated by dividing net income and net operating
income, respectively, by average shareholders' equity (determined using the
average of the quarterly average shareholders' equity balances for the year).
We consider growth in book value per share to be the most important financial performance measure in assessing whether we are meeting our business objectives. During the year endedDecember 31, 2011 , our book value per share on a basic and diluted basis increased by 4.6% and 3.5%, respectively. We also distributed$0.52 per share in cash to our shareholders, which provided tangible value to shareholders and reduced our excess capital. We believe that a comparison of book value per share and diluted book value per share fromDecember 31, 2010 toDecember 31, 2011 should be adjusted for these distributions to fully reflect the return generated for shareholders. Adding back$0.52 per share to ourDecember 31, 2011 diluted book value per share of$26.91 would result in$27.43 per share, an increase of 5.5% overDecember 31, 2010 . The increase in diluted book value per share, as adjusted, was principally due to a combination of positive operating results, unrealized gains on our investment portfolio and share repurchases at a discount to diluted book value per share. Property catastrophe losses resulting from natural disasters inThailand in the fourth quarter, inthe United States in the second and third quarters, and inJapan ,New Zealand andAustralia in the first quarter, had a significant effect on our results of operations for the year endedDecember 31, 2011 . We incurred losses from these events of$253.4 million , net of reinsurance and reinstatement premiums, for the year endedDecember 31, 2011 . These events are currently estimated to have caused industry losses exceeding$100.0 billion dollars ; however, our strategy of diversified underwriting and a measured catastrophe risk appetite resulted in what we believe was a manageable level of property catastrophe losses and limited the capital impact to 8.7% of our shareholders' equity as ofDecember 31, 2010 . We seek to manage and monitor our exposure so that the estimated maximum impact of a catastrophic event in any geographic zone is less than 25% of our beginning of year shareholders' equity for a modeled 1 in 250 year event. As ofDecember 31, 2011 , our aggregate exposure was below this target. We continue to monitor the pricing environment and believe we have the capital and operational flexibility to adjust our aggregate exposure should market conditions change over the course of 2012. Despite the incurred losses from catastrophe events, our net operating income was$96.6 million for the year endedDecember 31, 2011 , with a combined ratio of 98.2%. The catastrophe losses principally affected our reinsurance and Alterra at Lloyd's segments. Our reinsurance segment still reported positive underwriting income for the year endedDecember 31, 2011 . Net favorable development on prior year loss reserves was$153.3 million for the year endedDecember 31, 2011 , reducing the combined ratio by 10.8 percentage points. The net favorable development was principally in our insurance and reinsurance segments. 36
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We continued to actively manage our capital during the year by taking advantage of select opportunities to purchase our common shares in the market. We spent$223.3 million to repurchase 10.3 million shares during the year at an average price of$21.67 per share, a 16.6% discount to ourDecember 31, 2010 diluted book value per share. As ofDecember 31, 2011 , our remaining share repurchase authorization was$104.4 million . Subsequently, onFebruary 8, 2012 , our board of directors increased our share repurchase authorization by$150.0 million . We expect to continue to consider share repurchases as an effective tool to manage capital in a soft cycle and to increase book value per share for our shareholders. We target a long-term net operating ROE of the risk free rate plus 10% over the cycle. For the year endedDecember 31, 2011 , our net operating ROE and return on average shareholders' equity fell short of our target primarily due to the significant property catastrophe event losses in the year and historically low fixed income investment yields. The markets in which we operate historically have been cyclical. During periods of excess underwriting capacity, competition can result in lower pricing and less favorable policy terms for insurers and reinsurers. During periods of reduced underwriting capacity, pricing and policy terms are generally more favorable for insurers and reinsurers. We believe that the industry has been in a period of excess underwriting capacity, and while 2011's property catastrophe events likely eroded some of that capacity, there was not sufficient pressure on the industry to improve pricing in 2011. The industry is also operating in a low interest rate environment, which makes it more difficult to generate significant investment income growth. Both of these factors generally result in lower net operating income, return on average shareholders' equity and net operating return on average shareholders' equity. Although there remains uncertainty regarding the timing, location and scale of a favorable turn in the market, we believe that the industry is showing signs of improvement for 2012. However, we intend to maintain our underwriting discipline while actively managing our expenses. We expect our gross written premiums for the year endingDecember 31, 2012 to be consistent with the year endedDecember 31, 2011 , and we expect to write more premiums in our short-tail lines of business than our long-tail casualty lines of business.
Drivers of Profitability
Revenues
We derive operating revenues from premiums from our insurance and reinsurance businesses. Additionally, we recognize returns from our investment portfolios.
Insurance and reinsurance premiums are a function of the amount and type of contracts written as well as prevailing market prices and conditions. Property and casualty premiums are earned over the terms of the underlying coverage. Life and annuity reinsurance premiums are generally earned when the premium is due from policyholders. Each of our insurance and reinsurance contracts contain different pricing, terms and conditions and expected profit margins. Therefore, the amount of premiums is not necessarily an accurate indicator of our anticipated profitability. Premium estimates are based upon information in underlying contracts, data received from clients and from premium audits. Changes in premium estimates are expected and may result in significant adjustments in any period. These estimates change over time as additional information regarding the underlying business volume of our clients is obtained. There is often a delay in the receipt of updated premium information from clients due to the time lag in preparing and reporting the data to us. After review by our underwriters and finance staff, we increase or decrease premium estimates as updated information from our clients is received. Our net investment income is a function of the average invested assets and the average yield that we earn on those invested assets. The investment yield on our fixed maturities investments is a function of market interest rates as well as the credit quality and duration of our fixed maturities portfolio. Our net realized and unrealized gains or losses on investments includes realized gains and losses on our fixed maturity securities and changes in fair value of our trading securities and other investments. We recognize the realized gains and losses at the time of sale, and they, along with the changes in fair value of our trading securities, reflect the results of changing market values and conditions, including changes in market interest rates and changes in the market's perception of the credit quality of our fixed maturities holdings. The change in fair value of other investments is principally a function of the success of the funds in which we are invested, which depends on, among other things, the underlying strategies of the funds, the ability of the fund managers to execute the fund strategies and general economic and investment market conditions.
Expenses
Our principal expenses are losses and benefits, acquisition costs, interest expense and general and administrative expenses. Losses and benefits are based on the amount and type of insurance and reinsurance contracts written by us during the current reporting
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period and information received during the current reporting period from clients pertaining to contracts written in prior years. We record losses and benefits based on actuarial estimates of the expected losses and benefits to be incurred on each contract written. The ultimate losses and benefits depend on the actual costs to settle these liabilities. We increase or decrease losses and benefits estimates as actual claim reports are received. Our ability to make reasonable estimates of losses and benefits at the time of pricing our contracts is a critical factor in determining profitability. Acquisition costs consist principally of ceding commissions paid to ceding clients and brokerage expenses. These typically represent a negotiated percentage of the premiums on insurance and reinsurance contracts written. Acquisition costs are stated net of ceding commissions associated with premiums ceded to our quota share partners on our insurance and reinsurance business. These ceding commissions are designed to compensate us for the costs of producing the portfolio of risks ceded to our reinsurers. We defer and amortize these costs over the period in which the related premiums are earned. Interest expense principally reflects interest on any bank loans and interest on our senior notes. Interest expense also includes the net interest charge on funds withheld from reinsurers under reinsurance and retrocessional contracts. Interest expense on funds withheld from other reinsurers under reinsurance and retrocessional contracts will vary principally due to changes in the balance of funds withheld. In addition, interest expense also includes interest on deposit contracts. General and administrative expenses are principally employee salaries, incentive compensation and related personnel costs, office rent, amortization of leasehold improvements, information technology expenditures and other operating costs. These costs generally do not vary with the amount of premiums written.
Critical Accounting Policies
Our consolidated financial statements are prepared in accordance with U.S. GAAP, which require management to make estimates and assumptions. We believe that the following accounting policies affect the significant judgments and estimates used in the preparation of our consolidated financial statements.
Reserve for property and casualty losses
The liability for property and casualty losses is the largest and most complex estimate in our consolidated balance sheet. The liability for losses, including loss adjustment expenses, represents estimates of the ultimate cost of all losses incurred but not paid as of the balance sheet date. The reserves are estimated on an undiscounted basis. We utilize a variety of standard actuarial methods to estimate our reserves. Although these actuarial methods have been developed over time, assumptions about anticipated size of loss and loss emergence patterns are subject to fluctuations. We review our estimate of reserves on a quarterly basis and consider all significant facts and circumstances then known. Newly reported loss information from clients or insureds is the principal contributor to adjustments to our loss reserve estimates. These adjustments are recognized in the period in which they are determined, and therefore can impact that period's results either favorably (when reserve estimates established in prior periods prove to be redundant) or adversely (when reserve estimates established in prior periods prove to be deficient).
We categorize our loss reserves into two types: case reserves and incurred but not reported reserves, or IBNR.
The table below shows our reserves as ofDecember 31, 2011 and 2010 by type and by segment. As of December 31, 2011 As of December 31, 2010 Case IBNR Total Case IBNR Total In millions of U.S. Dollars Insurance Casualty $ 316.7 $ 870.4 $ 1,187.1 $ 279.9 $ 914.5 $ 1,194.4 Property 104.6 43.7 148.3 70.5 70.8 141.3 421.3 914.1 1,335.4 350.4 985.3 1,335.7 Reinsurance Casualty 523.8 1,132.7 1,656.5 481.3 1,216.3 1,697.6 Property 255.4 193.4 448.8 165.9 177.5 343.4 779.2 1,326.1 2,105.3 647.2 1,393.8 2,041.0 U.S. Specialty Casualty 56.7 124.6 181.3 39.1 97.0 136.1 38
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Property 70.1 56.1 126.2 26.1 69.8 95.9 126.8 180.7 307.5 65.2 166.8 232.0
Alterra at Lloyd's
Casualty 43.2 169.6 212.8 87.3 122.0 209.3 Property 120.8 134.8 255.6 26.7 61.4 88.1 164.0 304.4 468.4 114.0 183.4 297.4 Total $ 1,491.3 $ 2,725.3 $ 4,216.6 $ 1,176.8 $ 2,729.3 $ 3,906.1 Casualty $ 940.4 $ 2,297.3 $ 3,237.7 $ 887.6 $ 2,349.8 $ 3,237.4 Property 550.9 428.0 978.9 289.2 379.5 668.7 Total $ 1,491.3 $ 2,725.3 $ 4,216.6 $ 1,176.8 $ 2,729.3 $ 3,906.1 Case Reserves. Case reserves are established for individual claims that have been reported to us or, in the case of reinsurance, have been reported by our cedants. For our insurance operations, we are generally notified of insured losses by our insureds and/or their brokers. Based on this information, we establish case reserves by estimating the expected ultimate losses from the claim (including any administrative costs associated with settling the claim). Our claims personnel use their knowledge of the specific claim along with internal and external experts, including underwriters, actuaries and legal counsel, to estimate the expected ultimate losses. For our reinsurance operations, case reserves are generally established based on reports received from ceding companies and/or their brokers. For excess of loss contracts, we are typically notified of insurance losses on specific contracts and record a case reserve for the estimated expected ultimate losses from the claim. For proportional contracts, we typically receive aggregated claims information and record a case reserve based on that information. As with insurance business, we evaluate this information and estimate the expected ultimate losses. IBNR. IBNR reserves are reserves that are statistically estimated for losses that have occurred but not yet been reported to us. Consistent with industry practice, we utilize a variety of standard actuarial methods together with management judgment to estimate IBNR. The loss reserve selection from these methods is based on the loss development characteristics of the specific line of business and contracts, which take into consideration coverage terms, type of business, maturity of loss data, reported claims and paid claims. We do not necessarily utilize the same actuarial method or group of actuarial methods for all contracts within a line of business or segment as variations between contracts result in a number of different methods or groups of methods being appropriate. There is normally a time lag between when a loss event occurs and when it is actually reported to us. These actuarial methods that we use to estimate losses have been designed to address the lag in loss reporting as well as the delay in obtaining information that would allow us to more accurately estimate future payments. There is also often a time lag between reinsurance clients establishing case reserves and re-estimating their reserves, and notifying us of the new or revised case reserves. As a result, reporting lag is more pronounced in our reinsurance contracts than in our insurance contracts due to the reliance on insurers to report their claims to us. On reinsurance transactions, the reporting lag will generally be 60 to 90 days after the end of a reporting period, but can be longer in some cases. Based on the experience of our actuaries and management, we select loss development factors and trending techniques to mitigate the problems caused by reporting lags. We regularly evaluate and update our loss development and trending factor selections using client specific and industry data.
The principal actuarial methods we use to perform our quarterly loss reserve analysis may include one or more of the following methods:
Initial 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 client data, frequency-severity and rate level forecasts and professional judgment. This method is often useful when there is limited historical data due to few losses being incurred. Paid Loss Development Method. This method estimates 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 rate consistent with the historical rate of payment. It provides an objective test of reported loss projections because paid losses contain no reserve estimates. For many lines of business, claim payments are made slowly and it may take many years for claims to be fully reported and settled. 39
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Reported Loss Development Method. This method estimates ultimate losses by using 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 paid loss methods. 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 case loss reserve estimates established. Bornhuetter-Ferguson Paid and Reported Loss Methods. These methods are a weighted average of the initial expected loss ratio and the relevant development factor method. The weighting between the two methods depends on the maturity of the business. This means that for the more recent years a greater weight is placed on the initial expected loss ratio, while for the more mature years a greater weight is placed on the development factor methods. These methods avoid some of the distortions that could result from a large development factor being applied to a small base of paid or reported losses to calculate ultimate losses. This method will react slowly if actual paid or reported loss experience develops differently than historical paid or reported loss experience because of major changes in rate levels, retentions or deductibles, the forms and conditions of coverage, the types of risks covered or a variety of other factors. Outstanding to IBNR Ratio Method. This method is used in selected cases typically for very mature years that still have open claims. This method assumes that the estimated future loss development is indicated by the current level of case reserves. Frequency-Severity Method. This method is based on assumptions about the number of claims that will impact a contract and the average ultimate size of those claims. On excess of loss contracts, reported claims in lower layers provide insight to the expected number of claims that will likely impact the upper layers. The selection of appropriate actuarial methods to establish reserves may change over time as the underlying loss information becomes more seasoned. Our actuarial projections are based upon an assessment of known facts and circumstances, historical data, estimates of future trends in claims severity and frequency, changes in social attitudes, political and economic conditions, including the effects of inflation, and judicial theories of liability factors, including the actions of third parties, which are beyond our control. We rely on data reported by clients when calculating reserves. The quality of the data varies from client to client. Our actuarial and claims management teams periodically analyze our clients' loss data to ascertain its quality and credibility. This process may involve comparisons with submission data and industry loss data, claims audits and inquiries about the methods of establishing case reserves associated with large industry events. Our reserving methodologies use a loss reserving model that calculates a point estimate for our ultimate losses. Although we believe that our assumptions and methodologies are reasonable, we cannot be certain that our ultimate payments will not vary, potentially materially, from the estimates we have made. We believe that the provision for outstanding losses and benefits is adequate to cover the ultimate net cost of losses incurred to the balance sheet date, but the provision is necessarily an estimate and could potentially be settled for a significantly greater or lesser amount. These estimates are reviewed regularly and any adjustments to the estimates are recorded in the period they are determined. See Item 1A-Risk Factors-Our losses and loss adjustment expenses and benefits may exceed our loss and benefit reserves, which could significantly increase our liabilities and reduce our net income and could have a significant and negative effect on our financial condition and results of operations. Our development of prior period loss reserves, net of reinsurance, has been less than 6.0% in each of the three years endingDecember 31, 2011 , 2010 and 2009 and an average of 3.9% over the past ten years. Based on this experience, we currently believe that it is reasonably likely that net loss reserves could change 4.0% from currently reported amounts. This change could be higher or lower depending on client reported data and changes in our assessment of known facts and circumstances. As ofDecember 31, 2011 , a 4.0% change in net loss reserves would impact our net income and shareholders' equity by$127.3 million . The uncertainty and degree of judgment used in our estimate of loss reserves varies depending on the nature of the contract and the line of business. For the purposes of the following discussion, we consider the losses for the following lines of business to be included within property losses: agriculture, aviation, marine & energy, property and other. We consider losses for the accident & health, auto, credit, excess liability, financial institutions, general casualty, international casualty, medical malpractice, professional liability, surety, whole account and workers compensation lines of business to be classified as casualty losses. 40
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Casualty losses are generally long-tailed, which means that there can be a significant delay between the occurrence of a loss and the time it is settled by the insurer. These losses are also more susceptible to litigation and can be significantly affected by changing contract interpretations and a changing legal environment. In addition, the casualty business generally has a longer reporting lag and payment pattern than property business. Due to these factors, the estimation of loss reserves for casualty business generally involves a higher degree of judgment than for short-tailed business. Property losses are generally short-tailed and are usually known and paid within a relatively short period of time after the underlying loss event has occurred. Our estimates for losses resulting from catastrophic events are based upon a combination of internal and external catastrophe models, as well as client- and location-specific assessments and reports, where available. These estimates are developed immediately after the loss event, and the loss estimates are subsequently refined based on broker advices and client notifications.
Losses and benefits recoverable from reinsurers
We reinsure or retrocede portions of certain risks for which we have accepted liability. In these transactions, we cede to a counterparty reinsurer or retrocessionaire all or part of the risk we have assumed. This purchase of reinsurance does not legally discharge our liability with respect to the obligations that we have insured or reinsured.
The determination of the amount of losses and benefits recoverable from reinsurers requires an estimate of the amount of loss reserves to be ceded to our reinsurers. This consists of recoverable amounts related to both our case and IBNR reserves. The reinsurance recoveries are estimated on a contract by contract basis by applying the terms of any applicable reinsurance coverage to our reserve estimates.
We evaluate and monitor the financial strength of each of our counterparties. Some reinsurance and retrocessional agreements give us the right to receive additional collateral or to terminate the agreement in the event of deterioration in the financial strength of the counterparty.
As ofDecember 31, 2011 , 85.9% of our losses recoverable were with reinsurers rated "A" or above byA.M. Best and 8.4% were rated "A-". The remaining 5.7% were with "NR-not rated" reinsurers.Grand Central Re Limited , or Grand Central Re, aBermuda domiciled reinsurance company in which we have a 7.5% equity investment, is our largest "NR-not rated" retrocessionaire and accounted for 3.3% of our losses recoverable as ofDecember 31, 2011 . As security for outstanding loss obligations, we retain funds from Grand Central Re amounting to 214.1% of its loss recoverable obligations. Of the remaining amount with "NR-not rated" retrocessionaires, we retain collateral equal to 84.0% of the losses and benefits recoverable. Our losses and benefits recoverable are not due for payment until the underlying loss has been paid. As ofDecember 31, 2011 , 95.6% of our losses and benefits recoverable were not due for payment.
Disputes
In connection with our ongoing analysis of our loss reserves, we review loss notifications and reports received from our clients to confirm that submitted claims are covered under the contract terms. Disputes with clients arise in the ordinary course of business due to coverage issues such as classes of business covered and interpretation of contract wording. We typically resolve any disputes through negotiations that could vary from a simple exchange of email correspondence to arbitration with a panel of experts. Our contracts generally provide for dispute resolution through arbitration. We are not currently involved in any coverage disputes that we believe would, individually or in the aggregate, have a material adverse effect upon our business or results of operations.
Property and casualty loss reserve development
The following table presents the development of balance sheet property and casualty loss reserves calculated in accordance with U.S. GAAP, as ofDecember 31, 2002 throughDecember 31, 2011 . This table does not present accident or policy year development data. The top line of the table shows the gross reserves at the balance sheet date for each of the indicated years and is reconciled to the net reserve by adjusting for reinsurance recoverables. This represents the estimated amount of net claims and claim expenses arising in the current year and all prior years that are unpaid at the balance sheet date, including IBNR reserves. The table also shows the re-estimated amount of the previously recorded reserves as adjusted for new information received as of the end of each succeeding year. 41
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The estimate changes as more information becomes known about the frequency and severity of claims for individual years. The "net cumulative redundancy (deficiency)" represents the aggregate change to date from the original estimate on the third line of the table "reserve for property and casualty losses, originally stated, net of reinsurance." The "gross cumulative redundancy (deficiency)" represents the aggregate change to date from the original gross estimate on the top line of the table. The table also shows the cumulative net paid amounts as of successive years with respect to the net reserve liability. In thousands of U.S. Dollars 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 (1) (3) (4)(5) (6) Gross reserve for property and casualty losses $ 617,404 $ 991,687
(80,407 ) (163,348 )
(293,512 ) (409,229 ) (496,173 ) (537,864 ) (810,113 ) (964,818 ) (921,032 ) (1,035,004 ) Reserve for property and casualty losses originally stated, net of reinsurance
536,997 828,339 1,161,587 1,596,803 1,838,936 1,796,013 2,128,058 2,213,276 2,985,102 3,181,534 Cumulative net paid losses, 1 year later 106,706 119,269 217,637 169,008 361,702 184,223 368,539 574,725 576,018 2 years later 165,539 257,182 321,533 501,837 504,462 385,859 828,767 937,445 - 3 years later 244,578 333,238 545,653 608,195 658,719 772,828 1,130,600 - - 4 years later 309,183 502,167 611,463 731,446 1,015,269 1,000,865 - - - 5 years later 420,454 553,107 693,893 1,069,689 1,192,441 - - - - 6 years later 458,930 597,605 980,718 1,206,724 - - - - - 7 years later 484,443 807,621 1,081,952 - - - - - - 8 years later 577,227 870,980 - - - - - - - 42
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Table of Contents 9 years later 614,752 - - - - - - - - Reserves re-estimated as of 1 year later 554,795 826,799 1,296,558 1,585,834 1,774,591 1,689,054 2,040,403 2,102,672 2,844,832 2 years later 563,469 975,441 1,277,712 1,533,584 1,679,434 1,628,832 1,986,002 1,995,973 - 3 years later 666,781 977,590 1,229,303 1,475,583 1,628,019 1,573,336 1,896,907 - - 4 years later 676,365 945,186 1,205,584 1,433,523 1,563,724 1,497,278 - - - 5 years later 655,532 932,423 1,184,617 1,380,775 1,486,714 - - - - 6 years later 652,881 924,962 1,158,483 1,337,031 - - - - - 7 years later 653,148 916,677 1,151,436 - - - - - - 8 years later 641,828 912,932 - - - - - - - 9 years later 634,817 - - - - - - - -
Net cumulative (deficiency) redundancy (97,820 ) (84,593 )
10,151 259,772 352,222 298,735 231,151
217,303 140,270 Gross cumulative (deficiency) redundancy (115,899 ) (98,842 ) 33,232 356,272 474,223 416,457 316,499 289,419 160,550
(1) Adjusted for reclassification of a contract to a deposit liability.
(2) The difference between the reinsurance recoverable included above and that
reflected in the reconciliation of losses and loss adjustment expenses in
Note 7 to the consolidated financial statements relates to net deferred
charges on retroactive reinsurance.
(3) Gross and net reserve for property and casualty losses includes, for the
first time, Alterra E&S, which we acquired in
(4) Gross and net reserve for property and casualty losses includes, for the
first time,
(5) Gross and net reserve for property and casualty losses includes, for the
first time, Alterra Capital
(6) Gross and net reserve for property and casualty losses includes, for the
first time,Harbor Point , which we acquired inMay 2010 . 43
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During 2011, our re-estimated balance sheet reserves for 2002 and each subsequent balance sheet decreased as a result of net favorable development on a large number of contracts from varied underwriting years and lines of business. The more significant development included:
• Net favorable development for the insurance segment of
which
on professional liability lines of business, primarily on the 2005 and
2006 years, and
lines of business from the 2010 and 2009 years; • Net favorable development for the reinsurance segment of$80.6 million ,
excluding the development associated with changes in reinsurance premium
estimates described below. We recorded net favorable development on long
tail lines of business, including
primarily on the 2001 year,
primarily on 2009 and prior years offset by unfavorable development of
recorded net favorable development on short tail lines of business,
including
$11.2 million on aviation primarily on the 2008 and 2007 years; • Net favorable development for our Alterra at Lloyd's segment of $17.3
million, principally recognized on the financial institutions and property
lines of business; • Net unfavorable development for our U.S. specialty segment of $11.5
million, including
development on the general casualty and property lines of business,
respectively, relating to our contract binding business, the renewal
rights for which we sold during the year;
• Net unfavorable development of
reinsurance premium estimates. Changes in premium estimates occur on prior
year contracts each year as we receive additional information on the underlying exposures insured and the associated loss is recorded, at the original loss ratio, concurrently with the premium adjustment. The unfavorable development was partially offset by an increase in earned premium net of acquisition costs of$12.9 million ; and
• Net favorable development of
premium estimates in our insurance segment.
Our balance sheet reserves for 2002 and each subsequent balance sheet date through 2004 in the above tables shows the effects of the development on two specific contracts recorded in 2005. The development on these two contracts in the years subsequent to 2004 has not been significant. The first contract increased 2002 reserves by$50.2 million , with the recording of such increased losses triggering additional premiums and interest on additional premiums of$49.3 million , which are not reflected in the table above. The second contract increased 2002 reserves by$49.6 million , 2003 reserves by$64.8 million and 2004 reserves by$15.3 million , for a total increase of$129.7 million . The adverse development triggered additional premiums and interest on such additional premiums of$105.3 million , which are not reflected in the table above. Changes in loss estimates principally arise from changes in underlying reported, incurred and paid claims data on contracts. Other assumptions used in our process, such as inflation, change infrequently in the reserving process and we do not perform a sensitivity analysis of changes in these assumptions. Given the variety of assumptions and judgments involved in establishing reserves for losses and benefits, we have not designed and maintained a system to capture and quantify the financial impact of changes in each of our underlying individual assumptions and judgments. For additional information on our reserves, including a reconciliation of losses and loss adjustment expense reserves for the years endedDecember 31, 2011 , 2010 and 2009, refer to Note 7 of our audited consolidated financial statements included herein.
Life and annuity benefit reserve process
Our life and annuity reinsurance benefit and claim reserves are compiled by our actuaries on a reinsurance contract-by-contract basis and are computed on a discounted basis using standard actuarial techniques and cash flow models. We establish and review our life and annuity reinsurance reserves regularly based upon cash flow projection models utilizing data provided by clients and actuarial models. We establish and maintain our life and annuity reinsurance reserves at a level that we estimate will, when taken together with future premium payments and investment income expected to be earned on associated premiums, be sufficient to support all future cash flow benefit obligations and third party servicing obligations as they become payable. Since the development of our life and annuity reinsurance reserves is based upon cash flow projection models, we make estimates and assumptions based on cedant experience and industry mortality tables, longevity, expense and investment experience, including a provision for adverse deviation. The assumptions used to determine policy benefit reserves are best estimate assumptions that are determined at the inception of the contracts and are locked-in throughout the life of the reinsurance contract unless a premium 44
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deficiency develops. The assumptions are reviewed no less than annually and are un-locked if they result in a material reserve change. We establish these estimates based upon transaction specific historical experience, information provided by the ceding company and industry experience studies. Actual results could differ materially from these estimates. As the experience on the contracts emerges, the assumptions are reviewed by management. We determine whether actual and anticipated experience indicates that existing policy reserves, together with the present value of future gross premiums, are sufficient to cover the present value of future benefits, settlement and maintenance costs and to recover unamortized acquisition costs. If such a review produces reserves in excess of those currently held then the lock-in assumptions are revised and an additional life and annuity benefit reserve is recognized at that time.
There have been no material reserve adjustments to our life and annuity reinsurance benefit reserves during the years ended
Because of the many assumptions and estimates used in establishing reserves and the long-term nature of reinsurance contracts, the reserving process, while based on actuarial science, is inherently uncertain.
Valuation of Investments
We invest in a trading portfolio of fixed maturities securities, an available for sale portfolio of fixed maturities securities and a held to maturity portfolio of fixed maturities securities. We record the trading and available for sale portfolios at fair value on our balance sheet. For our trading portfolio, the unrealized gain or loss associated with the difference between the fair value and the amortized cost of the investments is recorded in net income. For our available for sale portfolio, the unrealized gain or loss (absent credit losses) is recorded in accumulated other comprehensive income in the shareholders' equity section of our consolidated balance sheet. In an effort to match the expected cash flow requirements of our long term liabilities, we invest a portion of our fixed maturity investments in long duration securities. Because we intend to hold a number of these long duration securities to maturity, we classify those securities as held to maturity in our consolidated balance sheet and record these securities at amortized cost. As a result, we do not record changes in the fair value of this portfolio, which should reduce the impact on shareholders' equity of fluctuations in fair value of those investments. Our other investments comprise our investments in hedge funds, investments in structured deposits and various derivative instruments, all of which are recorded at fair value. Other investments also include private equity investments in which we have significant influence and are accounted for under the equity method. We measure fair value in accordance with Accounting Standards Codification, or ASC, 820, Fair Value Measurements. The guidance dictates a framework for measuring fair value and a fair value hierarchy based on the quality of inputs used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy are described below:
Level 1-Quoted prices for identical instruments in active markets.
Level 2-Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets.
Level 3-Model derived valuations in which one or more significant inputs or significant value drivers are unobservable.
When the inputs used to measure fair value fall within different levels of the hierarchy, the level within which the fair value measurement is categorized is based on the lowest level input that is significant to the fair value measurement in its entirety. Thus, a Level 3 fair value measurement may include inputs that are observable (Level 1 and 2) and unobservable (Level 3).
The use of valuation techniques may require a significant amount of judgment. During periods of market disruption, including periods of rapidly widening credit spreads or illiquidity, it may be difficult to value certain of our securities if trading becomes less frequent or market data becomes less observable.
Fixed Maturities
Fixed maturities are subject to fluctuations in fair value due to changes in interest rates, changes in issuer specific circumstances such as credit rating and changes in industry specific circumstances such as movements in credit spreads based on the market's perception of industry risks. As a result of these potential fluctuations, it is possible to have significant unrealized gains or losses on a security. Our strategy for our fixed maturities portfolio is to tailor the maturities of the portfolio to the timing of expected loss and benefit payments. At maturity, absent any credit loss, fixed maturities' amortized cost will equal their fair value and no realized gain 45
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or loss will be recognized in income. If, due to an unforeseen change in loss payment patterns, we need to sell any available for sale investments before maturity, we could realize significant gains or losses in any period, which could result in a meaningful effect on reported net income for such period.
We perform regular reviews of our available for sale and held to maturity fixed maturities portfolios and utilize a process that considers numerous indicators in order to identify investments that are showing signs of potential other than temporary impairments. These indicators include the length of time and extent of the unrealized loss, any specific adverse conditions, historic and implied volatility of the security, failure of the issuer of the security to make scheduled interest payments, expected cash flow analysis, significant rating changes and recoveries or additional declines in fair value subsequent to the balance sheet date. The consideration of these indicators and the estimation of credit losses involve significant management judgment. Any other-than-temporary impairment, or OTTI, related to a credit loss is recognized in earnings, and the amount of the OTTI related to other factors (e.g. interest rates, market conditions, etc.) is recorded as a component of other comprehensive income. If no credit loss exists but either we have the intent to sell the fixed maturity security or it is more likely than not that we will be required to sell the fixed maturity security before its anticipated recovery, then the entire unrealized loss is recognized in earnings. In periods after the recognition of an OTTI loss on fixed maturity securities, we account for such securities as if they had been purchased on the measurement date of the OTTI at an amortized cost basis equal to the previous amortized cost basis less the net impairment loss recognized in earnings. We recognized other than temporary impairment charges through earnings of$2.9 million ,$2.6 million and$3.1 during the years endedDecember 31, 2011 , 2010 and 2009, respectively. Fair value prices for all securities in our fixed maturities portfolio are independently provided by our investment custodians, investment accounting service provider and/or our investment managers, which each utilize internationally recognized independent pricing services. We record the unadjusted price provided by the investment custodian or the investment accounting service provider after an internal validation process. Our validation process includes, but is not limited to: (i) comparison of prices between two independent sources, with significant differences requiring additional price sources; (ii) quantitative analysis (e.g., comparing the quarterly return for each managed portfolio to its target benchmark with significant differences identified and investigated); (iii) evaluation of methodologies used by external parties to calculate fair value; and (iv) comparing the price to our knowledge of the current investment market. The independent pricing services used by our investment custodians, investment accounting service provider and investment managers obtain actual transaction prices for securities that have quoted prices in active markets. Each pricing service has its own proprietary method for determining the fair value of securities that are not actively traded. In general, these methods involve the use of "matrix pricing" in which the independent pricing service uses observable market inputs, including reported trades, benchmark yields, broker/dealer quotes, interest rates, prepayment speeds, default rates and such other inputs as are available from market sources to determine a reasonable fair value. In addition, pricing services use valuation models, such as an Option Adjusted Spread model, to develop prepayment and interest rate scenarios. The Option Adjusted Spread model is commonly used to estimate fair value for securities such as mortgage-backed and asset-backed securities. The ability to obtain quoted market prices is reduced in periods of decreasing liquidity, which generally increases the use of matrix pricing methods and generally increases the uncertainty surrounding the fair value estimates. This could result in the reclassification of a security between levels of the hierarchy.
Other Investments
Our hedge fund portfolio comprises a portfolio of limited partnership and stock investments in trading entities, or funds, which invest in a wide range of financial products. Investments in the funds are carried at fair value. The change in fair value is included in net realized and unrealized gains on investments and recognized in net income. The units of account that we fair value are our interests in the funds and not the underlying holdings of such funds. Thus, the inputs we use to value our investments in each of the funds may differ from the inputs used to value the underlying holdings of such funds. These funds are stated at fair value, which ordinarily will be the most recently reported net asset value as advised by the fund manager or administrator, where the fund's underlying holdings can be in various quoted and unquoted investments. We believe the reported net asset value represents the fair value market participants would apply to an interest in the fund. The fund managers value their underlying investments at fair value in accordance with policies established by each fund, as described in each of their financial statements and offering memoranda. Based upon information provided by the fund managers, as ofDecember 31, 2011 , we estimate that over 72% of the underlying assets in the funds are publicly traded securities or have broker quotes available. We have designed ongoing due diligence processes with respect to funds and their managers. These processes are designed to assist us in assessing the quality of information provided by, or on behalf of, each fund and in determining whether such information continues to be reliable or whether further review is necessary. Certain funds do not provide full transparency of their underlying holdings; however, we obtain the audited financial statements for every fund annually, and regularly review and discuss the fund performance with the fund managers to corroborate the reasonableness of the reported net asset values. While reported net asset value is the primary input to the review, when the net asset value is deemed not to be indicative of fair value, we may incorporate adjustments to the reported net asset value. Such adjustments may involve significant management judgment. 46
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As ofDecember 31, 2011 , certain of our funds had either imposed a gate on redemptions or segregated a portion of the underlying assets into a side-pocket (whereby the funds are assigned to a separate memorandum capital account or designated account). A gate refers to funds which provide for periodic redemptions, however, in accordance with the funds' governing documents, a fund with a gate has the ability to deny or delay a redemption request. Based on the review process applied by management on such funds, a reduction of$2.5 million was made to the net asset value reported by one fund manager as ofDecember 31, 2011 (2010-$3.2 million ) to adjust the carrying value of the fund to our best estimate of fair value.
Additional information about the fair values of our hedge fund portfolio can be found in Note 4 to our audited consolidated financial statements included herein.
Our structured deposit has a fair value that is based on a publicly quoted index. Our derivatives holdings comprise convertible bond equity call options, interest rate linked derivative instruments, credit derivatives and foreign currency forward contracts. The fair value of the equity call options is determined using an Option Adjusted Spread model, the significant inputs for which include equity prices, interest rates and benchmark yields. The other derivative instruments trade in the over-the-counter derivative market, or are priced based on broker/dealer quotes or quoted market prices for similar securities. Fair values of our catastrophe bonds are based on dealer quotes and, if available, trade prices. A review of fair value hierarchy classifications is conducted on a quarterly basis. Changes in the observability of valuation inputs may result in a reclassification for certain financial assets and liabilities. Reclassifications impacting Level 3 of the fair value hierarchy are reported as transfers in/out of the Level 3 category as of the beginning of the quarter in which the reclassifications occur.
Premium recognition
We follow ASC, 944 - Financial Services - Insurance in determining the accounting for our insurance and reinsurance products. Assessing whether or not the contracts we write meet the conditions for risk transfer requires judgment. The determination of risk transfer is based, in part, on the use of actuarial and pricing models and assumptions.
Insurance premium recognition
Our insurance premiums are recorded at the inception of each contract based upon contract terms. The amount of minimum and/or deposit premium is usually contractually documented at inception, and variances between deposit premium and final premium are generally small. An adjustment is made to the minimum and/or deposit premium if there are changes in underlying exposures insured based on information received from our clients. Premiums are earned on a pro rata basis over the coverage period.
Reinsurance premium recognition
Our reinsurance premiums are recorded at the inception of each contract based upon contract terms and information received from ceding clients and brokers. For excess of loss contracts, the amount of minimum and/or deposit premium is usually contractually documented at inception, and variances between this premium and final premium are generally small. An adjustment is made to the minimum and/or deposit premium, when notified, if there are changes in underlying exposures insured. For quota share or proportional reinsurance contracts, gross premiums written are normally estimated at inception based on information provided by cedants and/or brokers. We generally record such premiums using the client's initial estimates, and then adjust them as more current information becomes available, with such adjustments recorded as premiums written in the period they are determined. We believe that the ceding clients' estimate of the volume of business they expect to cede to us usually represents the best estimate of gross premium written at the beginning of the contract. As the contract progresses, we monitor actual premium received in conjunction with correspondence from the ceding client in order to refine our estimate. Variances from original premium estimates are normally greater for quota share contracts than excess of loss contracts. Premiums are earned on a pro rata basis over the coverage period. The pre-tax impact to net income may be mitigated by related acquisition costs and losses.
During the years ended
In millions of U.S. Dollars 2011 2010 2009 Quota share/proportional $ 538.7 $ 256.1 $ 258.4 Excess of loss 534.1 385.0 313.3 Total $ 1,072.8 $ 641.1 $ 571.7 47
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The net adjustments to gross premiums written as a result of changes in premium estimates were an increase of$37.3 million , for the year endedDecember 31, 2011 and decreases of$24.8 million and$10.9 million , for the years endedDecember 31, 2010 and 2009, respectively. Such adjustments are generally the result of changing market conditions experienced by our clients.
Additional premiums
Certain reinsurance contracts that we write are retrospectively rated and we are entitled to additional premium should losses exceed pre-determined, contractual thresholds. These additional premiums are based upon contractual terms and management judgment is involved with respect to the estimated amount of losses that we expect to be ceded to us. Additional premiums are recognized at the time loss thresholds specified in the contract are exceeded and are earned over the remaining coverage period, or are earned immediately if the period of risk coverage has passed. Changes in estimates of losses recorded on contracts with additional premium features will result in changes in additional premiums based on contractual terms. Additional premiums assumed and ceded, related net losses and the net impact on operating results for the years endedDecember 31, 2011 , 2010 and 2009 are as follows:
In million of U.S. Dollars 2011 2010
2009
(Decrease) increase in gross premiums written $ (0.3 ) $ (6.0 )
Decrease (increase) in premiums ceded - 0.9
(1.5 )
Decrease in net losses 7.4 10.8
-
Increase in income before tax $ 7.1 $ 5.7
For each of the years endedDecember 31, 2011 , 2010 and 2009, additional premiums relate to contracts where the coverage period had expired. Therefore, these additional premiums, representing revisions to our initial estimate of ultimate premiums as a result of changes in the estimate of loss reserves, were fully earned since the exposure period had ended. As ofDecember 31, 2011 , the majority of retrospectively rated contracts have been settled and, therefore, we expect such adjustments to have an immaterial impact on future periods.
Reinstatement premiums
Certain contracts we write, particularly property catastrophe reinsurance contracts, provide for reinstatements of coverage. Reinstatement premiums are the premiums for the restoration of the insurance or reinsurance limit of a contract to its full amount after a loss occurrence by the insured or reinsured. The purpose of optional and required reinstatements is to permit the insured / reinsured to reinstate the insurance coverage at a pre-determined price level once a loss event has penetrated the insured layer. In addition, required reinstatement premiums permit the insurer / reinsurer to obtain additional premiums to cover the additional loss limits provided. We accrue for reinstatement premiums resulting from losses recorded. Such accruals are based upon contractual terms and the only element of management judgment involved is with respect to the amount of losses recorded. Changes in estimates of losses recorded on contracts with reinstatement premium features will result in changes in reinstatement premiums based on contractual terms. Reinstatement premiums are recognized at the time we record losses and are earned on a pro-rata basis over the coverage period. Reinstatement premiums assumed and ceded for the year endedDecember 31, 2011 were$36.9 million and$6.3 million , respectively. Reinstatement premiums assumed and ceded were not material for the years endedDecember 31, 2010 and 2009.
Premiums receivable
For quota share, or proportional, contracts, we are entitled to receive premium as the ceding client collects the premium under contractual reporting and payment terms, which are usually quarterly. Premiums are usually collected over a two year period on our quota share or proportional contracts. For excess of loss contracts, premium is generally paid in contractually stipulated installments with payment terms ranging from payment at the inception of the contract to four quarterly payments. As a result of recognizing the estimated gross premium written at the inception of the policy and collecting that premium over an extended period, we include a premium receivable asset on our balance sheet. We actively monitor our premium receivable asset to consider whether we need an allowance for doubtful accounts. As part of this process, we consider the credit quality of our cedants and monitor premium receipts versus expectations. We also seek to include a right of offset in the contract terms. Since commencing our operations, premiums receivable written off have not been material and, currently, no material premiums receivable are significantly beyond their due dates or in dispute. 48
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Results of Operations
We monitor the performance of our underwriting operations in five segments:
• Insurance-We offer property and casualty excess of loss insurance from our
offices in
companies. Principal lines of business are aviation, excess liability,
professional lines and property.
• Reinsurance-We offer property and casualty quota share and excess of loss
reinsurance from our
business are agriculture, auto, aviation, credit/surety, general casualty,
marine & energy, medical malpractice, professional liability, property,
whole account and workers' compensation. • U.S. specialty-We offer property and casualty insurance coverage from
offices in
companies. Principal lines of business are general liability, marine,
professional liability and property.
• Alterra at Lloyd's-We offer property and casualty quota share and excess
of loss insurance and reinsurance from our
offices, primarily to medium- to large- sized international clients. We
also provide reinsurance to clients in
proportionate share of the underwriting results of the Syndicates, and the
results of our managing agent, Alterra at Lloyd's. The Syndicates
underwrite a diverse portfolio of specialty risks, including accident &
health, aviation, financial institutions, international casualty, marine,
professional liability, property and surety. • Life and annuity reinsurance-We previously offered reinsurance products
focusing on blocks of life and annuity business, which took the form of
co-insurance transactions whereby the risks are reinsured on the same
basis as the original policies. We have decided not to write any new life
and annuity contracts for the foreseeable future.
We also have a corporate function that includes our investment and financing activities and all other items not allocated to the segments, including interest expense and corporate general and administrative expenses. We manage our invested assets on an aggregated basis, and do not allocate investment income and realized and unrealized gains on investments to the property and casualty segments. Because of the longer duration of liabilities on life and annuity reinsurance business, investment returns are important in evaluating the profitability of this segment; accordingly, we allocate investment returns from the consolidated portfolio to this segment. The allocation is based on a notional allocation of invested assets from the consolidated portfolio using durations that are determined based on estimated cash flows for the life segment. The balance of investment returns from this consolidated portfolio is allocated to the corporate function for the purposes of segment reporting. We monitor the performance of all of our segments other than life and annuity reinsurance on the basis of underwriting income, loss ratio, acquisition ratio, general and administrative expense ratio and combined ratio. We monitor the performance of our life and annuity reinsurance business on the basis of income before taxes for the segment, which includes revenue from net premiums earned, allocated net investment income and realized and unrealized gains on investments, and expenses from claims and policy benefits, acquisition costs and general and administrative expenses. EffectiveJanuary 1, 2011 , we redefined two of our operating and reporting segments based on changes to our internal reporting structure. Insurance business written byAlterra Insurance USA , which was previously reported within the U.S. specialty segment, has been reclassified to the insurance segment.Alterra Insurance USA is a managing general underwriter for Alterra E&S andAlterra America , as well as various third party insurance companies, and is our principal insurance underwriting platform for retail distribution inthe United States . Segment disclosures for comparative periods have been revised to reflect this reclassification.
Net investment income and net realized and unrealized gains (losses) on investments are discussed within the investing activities section of this report and not within the segment sections of this report. See "Investing Activities."
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Consolidated Results of Operations - For the years ended
The following is a discussion and analysis of our consolidated results of operations for the years endedDecember 31, 2011 , 2010 and 2009, which are summarized below: 2011 % change 2010 % change 2009 (In millions of U.S. Dollars) Gross premiums written $ 1,904.1 35.0 % $ 1,410.7 2.6 % $ 1,375.0 Reinsurance premiums ceded (472.1 ) 27.2 % (371.1 ) (22.8 )% (480.5 ) Net premiums written $ 1,432.0 37.7 % $ 1,039.6 16.2 % $ 894.5 Net premiums earned $ 1,425.0 21.5 % $ 1,172.5 40.5 % $ 834.4 Net investment income 234.8 5.6 % 222.4 31.1 % 169.7 Net realized and unrealized (losses) gains on investments (38.3 ) (326.6 )% 16.9 (79.3 )% 81.8 Net impairment losses recognized in earnings (2.9 ) 11.5 % (2.6 ) (16.1 )% (3.1 ) Other income 5.3 10.4 % 4.8 60.0 % 3.0 Total revenues 1,623.9 14.8 % 1,414.0 30.2 % 1,085.8 Net losses and loss expenses 945.6 44.4 % 654.8 32.7 % 493.6 Claims and policy benefits 59.4 (8.9 )% 65.2 (35.5 )% 101.1 Acquisition costs 261.1 39.3 % 187.5 93.5 % 96.9 Interest expense 43.7 54.4 % 28.3 32.9 % 21.3 Net foreign exchange losses (gains) 1.3 N/A (0.1 ) (98.3 )% (5.8 ) Merger and acquisition expenses - (100.0 )% (48.8 ) 54.9 % (31.5 ) General and administrative expenses 257.0 16.5 % 220.6 43.2 % 154.0 Total losses and expenses 1,568.1 41.6 % 1,107.5 33.5 % 829.6 Income before taxes 55.8 (81.8 )% 306.5 19.6 % 256.2 Income tax (benefit) expense (9.5 ) (326.2 )% 4.2 (58.0 )% 10.0 Net income $ 65.3 (78.4 )% $ 302.3 22.8 % $ 246.2 Loss ratio (a) 66.5 % 56.1 % 62.4 % Acquisition cost ratio (b) 18.3 % 16.0 % 12.1 % General and administrative expense ratio (c) 13.4 % 13.6 % 13.6 % Combined ratio (d) 98.2 % 85.7 % 88.1 %
(a) The loss ratio is calculated by dividing net losses and loss expenses by net
premiums earned for the property and casualty business.
(b) The acquisition cost ratio is calculated by dividing acquisition costs by net
premiums earned for the property and casualty business.
(c) The general and administrative expense ratio is calculated by dividing
general and administrative expenses by net premiums earned for the property
and casualty business.
(d) The combined ratio is calculated by dividing the sum of net losses and loss
expenses, acquisition costs and general and administrative expenses by net
premiums earned for the property and casualty business.
Premiums. Gross premiums written for the year endedDecember 31, 2011 increased by 35.0% compared to the prior year. The principal reason for the increase was the additional reinsurance premiums written as a result of the Amalgamation, which were not included in the comparative period prior toMay 12, 2010 . In addition, favorable market conditions in the property and auto lines of business in the reinsurance segment resulted in increased premiums written in these lines. We also continued to expand our product offerings in Alterra at Lloyd's and our operations inLatin America generated increased levels of premiums written in the year endedDecember 31, 2011 . Our insurance and U.S specialty segments also had modest growth in premiums written during the year primarily due to pricing increases and new business in certain lines of business as well as increased product offerings. The growth in gross premiums written for the year endedDecember 31, 2011 was primarily in short-tail lines of business resulting in a change in mix of gross premiums written from 50.7% short-tail lines and 49.3% long-tail lines for the year endedDecember 31, 2010 to 56.4% short-tail lines and 43.6% long-tail lines. Gross premiums written for the year endedDecember 31, 2010 increased by 2.6% compared to the prior year. Our reinsurance segment was impacted in 2010 by the addition of premiums written by the formerHarbor Point companies. Gross premiums written also increased in our U.S. specialty and Alterra at Lloyd's segments as a result of our new product offerings, the addition of new underwriting teams, and our expansion intoLatin America . These increases, and those resulting from the Amalgamation, were principally offset by decreases in the level of premiums written in our insurance, reinsurance (excludingHarbor Point ) and life and 50
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annuity reinsurance segments. The lower premium volume in our insurance and reinsurance segments reflect expected reductions across several lines of business due to competitive market conditions, resulting in reduced writings because pricing did not meet our risk/return thresholds.
The decrease in our life and annuity segment was principally due to no new contracts being written in this segment during the years endedDecember 31, 2011 and 2010, compared to one contract written in the year endedDecember 31, 2009 . We made the decision in 2010 not to write any new life and annuity contracts for the foreseeable future. A discussion of pro forma reinsurance segment results includingHarbor Point in the 2010 and 2009 comparative figures is in the section entitled Reinsurance Segment on a pro forma basis. On a pro forma basis, gross premiums written and net premiums earned for the years endedDecember 31, 2010 and 2009 would have been as follows: 2011 % change 2010 (1) % change 2009 (1) (In millions of U.S. Dollars) Gross premiums written $ 1,904.1 6.1 % $ 1,794.1 (7.8 )% $ 1,946.4 Net premiums earned $ 1,425.0 2.4 % $ 1,391.4 0.6 % $ 1,382.8
(1) The above pro forma financial information for the years ended December 31,
2010 and 2009 is provided for informational purposes only and presents a
summary of the combined gross premiums written and net premiums earned of the
Company and the former
occurred on
On a pro forma comparative basis, gross premiums written for the year endedDecember 31, 2011 would have increased by 6.1%. The increase would have been principally due to growth in our Alterra at Lloyd's segment resulting from expansion of our platform, partially offset by decreases in several lines of business in our reinsurance segment due to challenging market conditions and increased competition. On a pro forma basis, the gross premiums written for the year endedDecember 31, 2010 would have decreased by 7.8%. This decrease would have principally been driven by lower premium volumes in our insurance and reinsurance segments, along with a decrease in our life and annuity reinsurance segment. The ratio of reinsurance premiums ceded to gross premiums written for the year endedDecember 31, 2011 was 24.8% compared to 26.3% for the year endedDecember 31, 2010 . The decrease in the percentage of reinsurance premiums ceded compared to the prior year was principally due to the Amalgamation and the reduction in the amount of business ceded by our reinsurance segment. This was partially offset due to the 100% retrocession of the business written through our contracted general agent distribution channel (our "contract binding" business) in our U.S. specialty segment starting fromAugust 1, 2011 (see section entitled U.S. Specialty), along with the impact of additional ceded reinstatement premiums in our Alterra at Lloyd's segment. We continually monitor our need for reinsurance based on aggregate risk exposures. The ratio of reinsurance premiums ceded to gross premiums written for the year endedDecember 31, 2010 was 26.3% compared to 34.9% for the year endedDecember 31, 2009 . The decrease was principally due to the inclusion of the formerHarbor Point business fromMay 12, 2010 at a lower ratio of ceded to written premiums, and the cancellation of a significant property quota share treaty in our U.S. specialty segment. The cancellation of the property quota share treaty in our U.S. specialty segment reduced reinsurance premiums ceded by$20.6 million . Net premiums earned is a function of the earning of gross premiums written and reinsurance premiums ceded over the last several quarters and, therefore, changes in net premiums earned generally lag quarterly increases and decreases in gross premiums written and reinsurance premiums ceded. As a result, net premiums earned tend to be less volatile than gross premiums written and reinsurance premiums ceded. The increase in net premiums earned for the year endedDecember 31, 2011 compared to the prior year was principally due to the incremental earnings as a result of the Amalgamation. In addition, organic growth in our Alterra at Lloyd's segment contributed to the increase in net premiums earned. The increase in net premiums earned for the year endedDecember 31, 2010 compared to the year endedDecember 31, 2009 was principally due to the incremental earnings as a result of the Amalgamation. Net investment income. Net investment income for the year endedDecember 31, 2011 increased by 5.6% compared to the prior year. The increase in net investment income was principally attributable to the increase in cash and invested assets as a result of the Amalgamation, with some additional benefit from shifting cash into higher yielding fixed maturity securities. Our average investment yield was 3.09% for the year endedDecember 31, 2011 compared to 3.39% and 3.56% for the years endedDecember 31, 2010 and 2009, respectively. The yields available in the current fixed maturity market generally are lower than the average yield on our existing portfolio. Due to the anticipated continuing low-yield market environment, we expect continued downwards pressure on our investment yield. 51
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Net realized and unrealized gains (losses) on investments. Net realized and unrealized gains and losses on investments may vary significantly from period to period. For the year endedDecember 31, 2011 , the principal component of the net loss was a$25.0 million loss on a catastrophe bond with exposure to theJapan earthquake and tsunami, compared to an increase in fair value of catastrophe bonds of$0.4 million in the prior year period. The year endedDecember 31, 2011 also included a decrease in fair value of our hedge funds of$11.8 million compared to an increase of$14.3 million in the prior year period, and a decrease in fair value of derivatives of$13.6 million compared to a decrease of$12.0 million in the prior year period. The principal components of the decrease in net realized and unrealized gains and losses on investments from the 2009 year to the 2010 year were hedge fund and derivative returns. The increase in fair value of hedge funds for the year endedDecember 31, 2010 was$14.3 million compared to an increase of$75.8 million for the year endedDecember 31, 2009 . Also contributing to the decrease year-over-year was a$10.4 million loss on an interest rate forward transaction entered into in the second quarter of 2010 in contemplation of a possible long term debt issuance. Other income. During the year endedDecember 31, 2011 , Alterra E&S sold the renewal rights to our contract binding business. We recognized a net gain on sale of$0.8 million , which included the derecognition of goodwill of$1.0 million . CommencingAugust 1, 2011 , until the earlier of the date the purchaser or Alterra E&S elects andFebruary 1, 2013 , the contract binding business will be written by Alterra E&S and we will cede 100% of the premiums and losses to the purchaser. Under the terms of the sale, we are entitled to additional contingent consideration should gross premiums written by the contract binding business exceed a specified threshold while the quota share reinsurance agreement is still in effect. Also included in other income in the year endedDecember 31, 2011 are fees earned for the management of New Point Re IV. Net losses and loss expenses. The loss ratio increased by 10.4 percentage points for the year endedDecember 31, 2011 compared to the year endedDecember 31, 2010 . Significant items impacting the 2011 loss ratio were:
• Net favorable loss development of prior year reserves, excluding the
effect of premium adjustments, for the year ended
2010; • Net favorable loss development for the year endedDecember 31, 2011 was
principally the result of net favorable development in our property,
workers compensation, general casualty, professional liability, aviation
and whole account lines of business, partially offset by net unfavorable
development in the medical malpractice line of business in our reinsurance
segment and in the general liability line in our U.S. specialty segment.
The unfavorable reserve development in our U.S. specialty segment principally related to the contract binding business, for which we sold the renewal rights for all renewals afterAugust 1, 2011 ;
• Excluding the net favorable loss development, the loss ratio was 77.3% for
the year endedDecember 31, 2011 compared to 65.1% for the year endedDecember 31, 2010 . The increase in the loss ratio for the year endedDecember 31, 2011 compared to the prior year was principally due to the increase in significant property catastrophe losses in 2011; and
• For the year ended
net of reinsurance of
significant property catastrophe events and significant per-risk losses.
The significant property catastrophe event net losses for the year ended
Cyclone Yasi, the
tsunami, tornadoes and flooding in
theThailand floods. For the year endedDecember 31, 2010 , our results included net losses of$54.9 million for property catastrophe events,
including losses resulting from the
Xynthia and
The loss ratio decreased by 6.3 percentage points for the year ended
• Net favorable loss development of prior year reserves, excluding the
effect of premium adjustments, for the year ended
2009; • Net favorable loss development for the year endedDecember 31, 2010 was
principally the result of net favorable development in our workers'
compensation, property, general casualty, professional liability and whole
account lines of business, partially offset by net unfavorable development
on marine & energy lines, compared to net favorable development on professional liability, property and general casualty lines offset by net unfavorable development on marine & energy lines in the year endedDecember 31, 2009 ;
• Excluding the net favorable loss development, the loss ratio was 65.1% for
the year ended
inclusion of net premiums earned from
significantly lower loss ratio, which reduced the average loss ratio
despite the increase in property catastrophe losses discussed below. The
loss ratio for the year ended
related to the
significant property catastrophe losses, other than from the
earthquake, as most of the significant property catastrophe loss events
occurred prior to the Amalgamation; 52
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• The loss ratio for the year ended
acquired
This fair value adjustment is being amortized over a weighted average
period of 4.0 years; and • The decrease in loss ratio described above was partially offset by an increase in net losses related to property catastrophe events and significant per-risk losses. For the year endedDecember 31, 2010 , our results included net losses of$54.9 million related to property catastrophe events and significant per-risk losses. For the year endedDecember 31, 2009 , our results included net losses of$8.9 million for such events. Our loss estimates for the property catastrophe losses are based on proprietary modeling analyses, industry assessments of exposure, claims information obtained from our clients and brokers to date, and a review of in-force contracts. Our actual losses from these events may vary materially from the estimates due to the inherent uncertainties in making such determinations resulting from several factors, including the preliminary nature of available information, the potential inaccuracies and inadequacies in the data provided by clients and brokers, the modeling techniques employed and the application of such techniques, the contingent nature of business interruption exposures, the effects of any resultant demand surge on claims activity, and the attendant coverage issues. Claims and policy benefits. We did not write any new life and annuity reinsurance contracts in the years endedDecember 31, 2011 and 2010. We wrote one new life and annuity reinsurance contract in the year endedDecember 31, 2009 . We do not intend to write any new life and annuity reinsurance contracts in our life and annuity reinsurance segment in the foreseeable future. Acquisition costs. Our acquisition cost ratio for the year endedDecember 31, 2011 increased by 2.3 percentage points compared to the prior year. The increase in the acquisition cost ratio was principally due to changes in the mix of business written. The insurance and reinsurance contracts we write have a wide range of acquisition cost ratios. Our relative mix of insurance and reinsurance business has moved towards more reinsurance, with 66.9% of net premiums earned being from reinsurance business for the year endedDecember 31, 2011 compared to 60.4% for the year endedDecember 31, 2010 . This resulted in an increase in the acquisition cost ratio as reinsurance business tends to have higher acquisition costs compared to insurance. A decrease in the level of reinsurance purchased across our segments also contributed to the increase in the ratio for the year endedDecember 31, 2011 . As we retain more business in our segments, we receive less ceding commission income to offset our brokerage and commission costs, which increases our acquisition cost ratio. Our acquisition cost ratio for the year endedDecember 31, 2010 increased by 3.9 percentage points compared to the year endedDecember 31, 2009 . The increase in the acquisition cost ratio was principally due to changes in the mix of business written, partially influenced by the additional net premiums earned from the formerHarbor Point companies.The Harbor Point portfolio of contracts contained a higher proportion of quota share contracts, which generally carry higher acquisition cost ratios than excess of loss contracts. A decrease in the level of reinsurance purchased across all of our segments, but in particular our U.S. specialty segment, also contributed to the increase in the ratio for the year endedDecember 31, 2010 . Interest expense. Interest expense includes interest on funds withheld from reinsurers, interest on our senior notes outstanding and accretion of deposit liability contracts. Interest expense for the year endedDecember 31, 2011 increased by$15.4 million compared to the year endedDecember 31, 2010 , and increased by$7.0 million for the year endedDecember 31, 2010 compared to the year endedDecember 31, 2009 . The increase in both periods was principally a result of the issuance of senior notes in September of 2010. In addition, an adjustment to the deposit liability on a certain contract based on new information received resulted in an increase in interest expense in 2011. For the year endedDecember 31, 2010 , an increase in funds withheld interest for one of our largest reinsurers contributed to the increase over the year endedDecember 31, 2009 . Merger and acquisition expenses. Merger and acquisition expenses for the year endedDecember 31, 2010 comprised advisory, legal and other professional fees, the acceleration of stock based compensation expense and other merger related expenses related to the Amalgamation. These expenses were offset by the negative goodwill gain of$95.8 million recognized from the Amalgamation. Merger and acquisition expenses for the year endedDecember 31, 2009 comprised advisory, legal and other professional fees related to the proposed transaction withIPC Holdings Limited andIPC Limited , which was terminated inJune 2009 , offset by a$50.0 million termination fee received. General and administrative expenses. General and administrative expenses for the year endedDecember 31, 2011 increased by$36.4 million compared to the year endedDecember 31, 2010 . The increase was principally due to the increased size of the Company following the Amalgamation. The year endedDecember 31, 2011 was the first full fiscal year of post-Amalgamation level expenses. Expansion of our underwriting teams, growth inLatin America and regulatory changes inEurope also contributed to the increase in general and administrative expenses in the period. These increases were partially offset by decreases in incentive based compensation. The increase in net earned premiums resulted in a small decrease in our general and administrative expense ratio for the year endedDecember 31, 2011 compared to the year endedDecember 31, 2010 . 53
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General and administrative expenses for the year endedDecember 31, 2010 increased by$66.6 million compared to the year endedDecember 31, 2009 . The increase was principally related to the additional general and administrative expenses of the formerHarbor Point companies. In addition, there was an increase in performance based compensation expense as a result of a larger cash component of the 2010 performance based compensation than in 2009. However, the corresponding increase in net earned premiums as a result of the Amalgamation resulted in no change in our general and administrative expense ratio for the year endedDecember 31, 2010 compared to the year endedDecember 31, 2009 . Income tax expense (benefit). Corporate income tax expense or benefit is generated through our foreign operations outside ofBermuda , principally inthe United States ,Europe andLatin America . The effective tax rate was negative 17.0% for the year endedDecember 31, 2011 compared with 1.4% in the year endedDecember 31, 2010 and 3.9% in the year endedDecember 31, 2009 . Our effective income tax rate, which we calculate as income tax expense or benefit divided by net income or loss before taxes, may fluctuate significantly from period to period depending on the geographic distribution of pre-tax net income or loss in any given period between different jurisdictions with different tax rates. The geographic distribution of pre-tax net income or loss can vary significantly between periods principally due to the mix of business written and earned during the period, the geographic location of investment income and realized and unrealized investment gains and losses and the geographic location of net losses and loss expenses incurred. Our effective tax rate changed significantly for the year endedDecember 31, 2011 due principally to two factors. Our results for the year endedDecember 31, 2011 contained a significant amount of property catastrophe losses and the distribution of these losses was heavily weighted towards jurisdictions with a higher tax rate. Further contributing to the change in effective tax rate was the release of a valuation allowance related to deferred tax assets in our U.S. subsidiaries, which had the effect of increasing the tax benefit for the year.
The Company's income before taxes, income tax expense (benefit) and effective income tax rate for the years ended
(In millions of U.S. Dollars) 2011 2010 2009 Income before taxes $ 55.8 $ 306.5 $ 256.2 Income tax (benefit) expense $ (9.5 ) $ 4.2 $ 10.0 Effective income tax rate (17.0 )% 1.4 % 3.9 % Insurance Segment December 31, 2011 % change December 31, 2010 % change December 31, 2009 (Expressed in millions of U.S. Dollars) Gross premiums written $ 410.3 2.7 % $ 399.6 (10.7 )% $
447.3
Reinsurance premiums ceded (200.1 ) 10.7 % (180.7 ) (17.3 )% (218.6 ) Net premiums written $ 210.2 (4.0 )% $ 218.9 (4.3 )% $ 228.7 Net premiums earned $ 210.8 (10.2 )% $ 234.7 7.9 % $ 217.5 Net losses and loss expenses (105.8 ) (24.5 )% (140.1 ) (0.2 )% (140.4 ) Acquisition costs (0.4 ) (89.2 )% (3.7 ) N/A 1.2 General and administrative expenses (37.7 ) 9.3 % (34.5 ) 23.7 % (27.9 ) Other income 1.0 (23.1 )% 1.3 (18.8 )% 1.6 Underwriting income $ 67.9 17.7 % $ 57.7 11.0 % $ 52.0 Loss ratio (a) 50.2 % 59.7 % 64.6 % Acquisition cost ratio (b) 0.2 % 1.6 % (0.6 )% General and administrative expense ratio (c) 17.9 % 14.7 % 12.8 % Combined ratio (d) 68.2 % 76.0 % 76.9 % 54
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(a) The loss ratio is calculated by dividing net losses and loss expenses by net
premiums earned.
(b) The acquisition cost ratio is calculated by dividing acquisition costs by net
premiums earned.
(c) The general and administrative expense ratio is calculated by dividing
general and administrative expenses by net premiums earned.
(d) The combined ratio is calculated by dividing the sum of net losses and loss
expenses, acquisition costs and general and administrative expenses by net premiums earned. % of % of % of Premium Premium Premium 2011 Written % Ceded 2010 Written % Ceded 2009 Written % Ceded (Expressed in millions of U.S. Dollars) Gross Premiums Written by Type of Risk: Aviation $ 32.4 7.9 % 31.3 % $ 39.9 10.0 % 50.0 % $ 69.8 15.6 % 48.3 % Excess liability 116.6 28.4 % 47.0 % 113.6 28.4 % 44.9 % 133.3 29.8 % 49.2 % Professional liability 184.4 45.0 % 51.6 % 183.0 45.8 % 47.4 % 179.9 40.2 % 51.3 % Property 76.9 18.7 % 52.1 % 63.1 15.8 % 36.5 % 64.3 14.4 % 42.0 % $ 410.3 100.0 % 48.8 % $ 399.6 100.0 % 45.2 % $ 447.3 100.0 % 48.9 % Short tail lines (a) $ 109.3 26.6 % $ 103.0 25.8 % $ 134.1 30.0 % Long tail lines (b) 301.0 73.4 % 296.6 74.2 % 313.2 70.0 % $ 410.3 100.0 % $ 399.6 100.0 % $ 447.3 100.0 %
(a) Short tail includes aviation and property lines of business.
(b) Long tail includes excess liability and professional liability lines of
business.
Premiums. Gross premiums written for the year endedDecember 31, 2011 increased by 2.7% compared to the prior year. Significant factors affecting 2011 gross premiums written were: • An increase in property gross premiums written, principally due to improved pricing conditions; and
• Competitive pricing conditions in professional liability, excess liability
and aviation resulted in flat or decreased levels of business written. Our
objective is to continue to be selective in our renewals and new business
writings, focusing on business that we believe meet our rate of return requirements. Gross premiums written decreased in the year endedDecember 31, 2010 by 10.7% compared to the year endedDecember 31, 2009 . Significant factors affecting 2010 gross premiums written were:
• A decrease in gross premiums written in the aviation line for the year
ended
in aviation business written in our Alterra at Lloyd's segment as many of
the policies previously written in our insurance segment were renewed by
Alterra at Lloyd's; and
• A decrease in gross premiums written in our excess liability line for the
year ended
The ratio of reinsurance premiums ceded to gross premiums written for the year endedDecember 31, 2011 was 48.8%, compared to 45.2% and 48.9%, respectively, in the years endedDecember 31, 2010 andDecember 31, 2009 . The amount of reinsurance that we purchase can vary significantly by line of business. The increase in the percentage of reinsurance premiums ceded is principally due to changes in the mix of business and an increase in the percentage of quota share reinsurance purchased on our property line of business to manage our aggregate exposures. A contributing factor to the decrease in 2010 was the reduction in property reinsurance premiums ceded toHarbor Point , which became fully eliminated intercompany transactions after the Amalgamation. We replaced those reinsurance premiums ceded with third parties over the course of the normal renewal periods. Net premiums earned is a function of the earning of gross premiums written and reinsurance premiums ceded over the last several quarters and, therefore, changes in net premiums earned generally lag quarterly increases and decreases in gross premiums written and reinsurance premiums ceded. As a result, net premiums earned tend to be less volatile than gross premiums written and reinsurance premiums ceded. 55
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Net losses and loss expenses. The loss ratio for the year endedDecember 31, 2011 decreased by 9.5 percentage points compared to the year endedDecember 31, 2010 . The net favorable and (unfavorable) development of prior year reserves in the years endedDecember 31, 2011 , 2010 and 2009 by line of business was as follows: 2011 2010 2009 (In millions of U.S. Dollars) Aviation $ 8.9 $ 8.3 $ 7.7 Excess liability 21.0 8.3 7.0 Professional liability 15.7 22.1 21.0 Property 21.3 6.5 5.6 66.9 45.2 41.3 Loss development resulting from premium adjustments 1.2 (2.8 ) (2.4 ) $ 68.1 $ 42.4 $ 38.9
Significant items impacting the 2011 loss ratio were:
• Net favorable loss development of prior year reserves, excluding the effect of premium adjustments, in the year endedDecember 31, 2011 of$66.9 million compared to$45.2 million in the year endedDecember 31, 2010 ;
• Net favorable loss development in the year ended
reflected better than expected loss emergence across all lines of
business, most significantly in the property, excess liability and
professional liability lines. Favorable loss development principally
emerged on the 2009 and 2010 years for the property line of business and
on the 2005 and 2006 years for excess liability and professional liability
lines of business; • Excluding the net favorable loss development, the loss ratio was 81.9% for
the year endedDecember 31, 2011 compared to 79.0% for the year endedDecember 31, 2010 . The increase was principally due to higher losses
related to property catastrophe and significant per-risk losses during the
year ended
and • For the year endedDecember 31, 2011 , our results included net losses of
per-risk losses compared to
2010. A portion of these losses fall within our attritional loss ratio, as
we expect a certain level of property losses in each period. Large events
during the year ended
earthquake and tsunami, tornadoes and flooding in
Hurricane Irene.
The loss ratio for the year endedDecember 31, 2010 decreased by 4.9 percentage points compared to the year endedDecember 31, 2009 . Significant items impacting the 2010 loss ratio were: • Net favorable loss development of prior year reserves, excluding the effect of premium adjustments, in the year endedDecember 31, 2010 of$45.2 million compared to$41.3 million in the year endedDecember 31, 2009 ;
• Net favorable loss development in the year ended
reflected better than expected loss emergence across all lines of
business, most significantly in the professional liability line. Favorable
loss development principally emerged on the 2009 year for aviation, 2004
year for excess liability, 2004, 2005 and 2006 years for professional
liability, and on the 2008 and 2009 years for the property line of business;
• Excluding the net favorable loss development, the loss ratio was 79.0% for
the year ended
loss experience in our aviation line of business during the year endedDecember 31, 2010 ; and
• For the year ended
per-risk losses. Large events during the year ended
included the
contained within our annual loss expectations for the property line of business. There were no significant property catastrophe events and
significant per-risk losses occurring in the year ended
Changes in premium estimates for contracts that incepted before 2011 resulted in a decrease in prior year loss reserves of$1.2 million in 2011 and an increase in prior year loss reserves of$2.8 million in 2010 and$2.4 million in 2009. Acquisition costs. Acquisition costs are presented net of ceding commission income associated with reinsurance premiums ceded. These ceding commissions are designed to compensate us for the costs of producing the portfolio of risks ceded to our reinsurers. Acquisition costs generally fluctuate based on shifts in business mix year over year. General and administrative expenses. General and administrative expenses for the year endedDecember 31, 2011 increased$3.2 million compared to the year endedDecember 31, 2010 . The increase was principally due to increased headcount and expenses associated with expanding our underwriting infrastructure withinAlterra Insurance USA . These increases, together with the decrease in net premiums earned, resulted in a higher general and administrative expense ratio for the year endedDecember 31, 2011 compared to the prior year. 56
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General and administrative expenses for the year endedDecember 31, 2010 increased$6.6 million compared to the year endedDecember 31, 2009 . The increase was principally due to increased performance based compensation expense resulting from improved underwriting results compared to the prior year, and a shift to a larger cash component and fewer stock-based awards.
Reinsurance Segment
The underwriting results of the formerHarbor Point companies have been included within the reinsurance segment for the period fromMay 12, 2010 . As a result, a comparison of 2011 results with 2010 and 2009 results is not meaningful. For this reason, we have included certain financial information for the reinsurance segment on a combined pro forma basis for informational purposes only as if the Amalgamation had occurred onJanuary 1, 2009 . See the section entitled Reinsurance Segment on a pro forma basis for a presentation of the combined pro forma information. 2011 % change 2010 % change 2009 (Expressed in millions of U.S. Dollars) Gross premiums written $ 869.7 70.9 % $ 509.0 4.1 % $ 489.0 Reinsurance premiums ceded (83.1 ) 29.6 % (64.1 ) (19.9 )% (80.0 ) Net premiums written $ 786.6 76.8 % $ 444.9 8.8 % $ 409.0 Net premiums earned $ 824.0 31.3 % $ 627.6 61.8 % $ 387.9 Net losses and loss expenses (528.0 ) 51.8 % (347.8 ) 36.7 % (254.5 ) Acquisition costs (182.3 ) 39.1 % (131.1 ) 84.4 % (71.1 ) General and administrative expenses (79.3 ) 20.2 % (66.0 ) 107.5 % (31.8 ) Other income 1.2 N/A - N/A - Underwriting income (loss) 35.6 (57.0 )% 82.7 171.1 % 30.5 Loss ratio (a) 64.1 % 55.4 % 65.6 % Acquisition cost ratio (b) 22.1 % 20.9 % 18.3 % General and administrative expense ratio (c) 9.6 % 10.5 % 8.2 % Combined ratio (d) 95.8 % 86.8 % 92.1 %
(a) The loss ratio is calculated by dividing net losses and loss expenses by net
premiums earned.
(b) The acquisition cost ratio is calculated by dividing acquisition costs by net
premiums earned.
(c) The general and administrative expense ratio is calculated by dividing
general and administrative expenses by net premiums earned.
(d) The combined ratio is calculated by dividing the sum of net losses and loss
expenses, acquisition costs and general and administrative expenses by net
premiums earned. 57
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Table of Contents % of % of % of Premium Premium Premium 2011 written % Ceded 2010 written % Ceded 2009 written % Ceded (Expressed in millions of U.S Dollars) Gross Premiums Written by Type of Risk: Agriculture $ 30.7 3.5 % 0.4 % $ 29.2 5.7 % 2.4 % $ 89.6 18.3 % 2.5 % Auto 99.8 11.5 % - % 32.9 6.5 % - % - - % - % Aviation 16.0 1.8 % 18.6 % 31.3 6.1 % 6.7 % 34.7 7.1 % 13.5 % Credit/surety 34.9 4.0 % - % 2.2 0.4 % - % - - % - % General casualty 73.8 8.5 % 1.9 % 48.4 9.5 % 1.0 % 29.2 6.0 % 7.9 % Marine & energy 24.0 2.8 % 0.5 % 16.4 3.2 % 0.2 % 18.3 3.7 % 0.3 % Medical malpractice 37.4 4.3 % 1.0 % 51.4 10.1 % 7.4 % 67.5 13.8 % 4.1 % Other 3.1 0.4 % 0.2 % 2.8 0.6 % - % 2.3 0.5 % 0.3 % Professional liability 159.5 18.3 % - % 110.4 21.7 % - % 71.5 14.6 % - % Property 319.7 36.8 % 24.3 % 148.1 29.1 % 40.0 % 87.0 17.8 % 54.1 % Whole account 35.8 4.1 % 0.1 % 5.1 1.0 % 16.4 % 11.4 2.3 % 13.1 % Workers' compensation 35.0 4.0 % 0.6 % 30.8 6.1 % (10.3 )% 77.5 15.9 % 25.0 % $ 869.7 100.0 % 9.6 % $ 509.0 100.0 % 12.6 % $ 489.0 100.0 % 16.4 % Short tail (a) $ 546.1 62.8 % $ 265.5 52.2 % $ 237.6 48.6 % Long tail (b) 323.6 37.2 % 243.5 47.8 % 251.4 51.4 % $ 869.7 100.0 % $ 509.0 100.0 % $ 489.0 100.0 %
(a) Short tail includes agriculture, auto, aviation, credit/surety, marine &
energy, other, property and whole account lines of business.
(b) Long tail includes general casualty, medical malpractice, professional
liability, whole account and workers' compensation lines of business.
Premiums. Gross premiums written for the year ended
• Gross premiums written across all lines of business increased due to the
inclusion of premiums written by the former
full year in 2011 compared to only fromMay 12 in 2010; • Gross premiums written in our property line increased due to new business
and increases in participations due to improved pricing and market
conditions. This growth included an increase in property gross premiums
written related to our
year endedDecember 31, 2010 to$36.6 million for the year endedDecember 31, 2011 ;
• The property line of business was impacted by reinstatement premiums
primarily on catastrophe exposed contracts. The reinstatement premiums
were
million for the year endedDecember 31, 2010 ;
• An increase in agriculture premiums resulting from the Amalgamation was
partially offset by the non-renewal of a
from the client retaining more business; • An increase in medical malpractice premiums resulting from the
Amalgamation and the impact of positive premium adjustments of $8.4
million in the year ended
adjustments of$2.5 million in the year endedDecember 31, 2010 , was offset by the non-renewal of two contracts that accounted for$23.1 million due to competitive pricing; and
• An increase in gross premiums written in our aviation, general casualty,
marine & energy and professional liability lines of business resulting
from the Amalgamation was offset by contracts not being renewed or reductions in our participation due to a more competitive pricing environment. Gross premiums written for the year endedDecember 31, 2010 increased by 4.1% compared to the year endedDecember 31, 2009 . Significant factors affecting 2010 gross premiums written were:
• Gross premiums written increased in the auto, general casualty,
professional liability and property lines of business principally due to
the inclusion of premiums written by the former
fromMay 12, 2010 ; • Gross premiums written decreased in our agriculture line of business
principally due to the non-renewal of a contract as a result of a client merger in 2010;
• Medical malpractice premiums decreased principally due to reduction in
line sizes, increase in client retentions and reduced estimates of assumed
premiums on some quota share policies; • Workers' compensation premiums decreased principally due to the
non-renewal of a significant contract written in the prior year, resulting
in a decrease of
adjustment of
downwards revision to losses on the contract; and
• Across our lines of business, we continued to experience a competitive
price environment. We have been selective in our renewals and business
writings, focusing on business that meets our rate of return requirements.
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The ratio of reinsurance premiums ceded to gross premiums written for the year endedDecember 31, 2011 was 9.6% compared to 12.6% in the prior year. The decrease was principally due to the Amalgamation, which resulted in an increase in gross premiums written with a smaller percentage increase in ceded premiums written. In addition, there was an increase in auto business, which is not reinsured, and property business, which had a lower retrocession rate than the prior year. We monitor our need for reinsurance based on aggregate exposures. The ratio of reinsurance premiums ceded to gross premiums written for the year endedDecember 31, 2010 was 12.6% compared to 16.4% for the year endedDecember 31, 2009 . The decrease in the percentage was principally due to the inclusion ofHarbor Point business fromMay 12, 2010 at a lower ratio of reinsurance premiums ceded to gross premiums written. Net premiums earned is a function of the earning of gross premiums written and reinsurance premiums ceded over the last several quarters and, therefore, changes in net premiums earned generally lag quarterly increases and decreases in gross premiums written and reinsurance premiums ceded. As a result, net premiums earned tend to be less volatile than gross premiums written and reinsurance premiums ceded. The increase in net premiums earned for the year endedDecember 31, 2011 compared to the prior year was principally due to the incremental earnings of theHarbor Point portfolio of contracts, which are included within the entire 2011 period but are only included for a portion of the comparable 2010 period. The increase in net premiums earned for the year endedDecember 31, 2010 compared to the year endedDecember 31, 2009 was also principally due to the incremental earnings of theHarbor Point portfolio of contracts written before the Amalgamation, which are included in the 2010 year but have no equivalent in the comparable 2009 year. Net losses and loss expenses. The loss ratio increased 8.7 percentage points for the year endedDecember 31, 2011 compared to the year endedDecember 31, 2010 . The net favorable and (unfavorable) development of prior year reserves in the years endedDecember 31, 2011 , 2010 and 2009 by line of business was as follows: 2011 2010 2009 (Expressed in millions of U.S. Dollars) Agriculture $ 4.2 $ 2.3 $ 3.1 Auto (3.4 ) - - Aviation 11.2 (7.0 ) 2.6 Credit/surety 4.9 - - General casualty 4.5 16.8 10.5 Marine & energy 1.7 (9.5 ) (24.3 ) Medical malpractice (7.9 ) 2.7 7.9 Other 5.0 - - Professional liability 8.2 (12.2 ) 8.6 Property 27.1 24.9 20.3 Whole account 13.5 10.7 2.3 Workers' compensation 11.6 15.9 1.0 80.6 44.6 32.0 Loss development resulting from premium adjustments (14.3 ) 7.8 11.4 $ 66.3 $ 52.4 $ 43.4
Significant items impacting the 2011 loss ratio were:
• Net favorable loss development of prior year reserves in the year ended
endedDecember 31, 2010 ; • The net favorable development in the year endedDecember 31, 2011
reflected better than expected loss emergence. Favorable loss development
principally emerged on the 2010 and prior years for the property line of business, on the 2001 year for workers' compensation relating to the favorable settlement of a contract, on the 2008 and 2007 years for
aviation and on the 2009 and prior years for the professional liability
line of business. This favorable loss development was partially offset by
unfavorable development principally on the 2010 and 2009 years for the medical malpractice line of business. 59
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• Excluding net favorable loss development, the loss ratio was 73.9% for the
year ended
(61.6% after adding back a
for a workers' compensation contract discussed below). The increase in the
loss ratio for the year ended
2010 was due principally to the increase in property catastrophe and significant per-risk losses; and
• The year ended
property catastrophe-related losses compared to
ended
catastrophe losses included losses resulting from the
Cyclone Yasi, the
tsunami, tornadoes and flooding in
the
catastrophe losses included losses for the Deepwater Horizon oil spill,
Europe Windstorm Xynthia,
and floods in
The loss ratio decreased by 10.2 percentage points for the year ended
• Net favorable loss development of prior year reserves in the year ended
million compared to
Included in the net favorable development for the year ended December 31,
2010 was an
prior year workers' compensation contract for which there was an
offsetting reduction to net premiums earned of
the net favorable loss development on this workers' compensation contract
had a modest negative impact on net income; • The net favorable development in the year endedDecember 31, 2010
reflected better than expected loss emergence. Favorable loss development
principally emerged on the 2008 and 2009 years for the property line of business, on the 2002 - 2009 years for the general casualty line of
business and on the 2005 and prior years for the workers' compensation
lines of business. This favorable loss development was partially offset by unfavorable development principally on the 2004 and 2008-2009 years for the professional liability line of business, the 2005 - 2009 years
for the marine & energy line of business and the 2007 and 2009 years for
the aviation line of business; • Excluding the net favorable loss development (and after adding back the
compensation contract discussed above), the loss ratio was 61.6% for the
year ended
the prior year was principally due to the inclusion of net premiums earned
from the former
significantly lower loss ratio, which reduced the average loss ratio.
Despite the increase in property catastrophe losses discussed below, the
2010 loss ratio on the net premiums earned related to the former Harbor
Point portfolio of contracts does not include any significant property
catastrophe losses other than from the
the year's property catastrophe loss events occurred prior to the Amalgamation;
• The loss ratio for the year ended
acquired
This fair value adjustment is being amortized over a weighted average
period of 4.0 years, and • Partially offsetting the decrease described above was the increased
property catastrophe-related and significant per-risk losses. The year endedDecember 31, 2010 included$27.8 million in property catastrophe-related and significant per-risk losses, principally as a
result of the Deepwater Horizon oil spill, Europe Windstorm Xynthia,
The year ended
catastrophe-related and significant per-risk losses.
Increases in net earned premiums, net of acquisition costs of$12.9 million , resulted in a increase in prior year loss reserves of$14.3 million for the year endedDecember 31, 2011 . Decreases in net earned premiums, net of acquisition costs of$8.5 million and$11.7 million for the years endedDecember 31, 2010 and 2009, respectively, resulted in a decrease in prior year loss reserves of$7.8 million and$11.4 million for the years endedDecember 31, 2010 and 2009, respectively. Changes in premium estimates occur on prior year contracts each year as we receive additional information on the underlying exposures insured and the associated loss is recorded, at the original loss ratio, concurrently with the premium adjustment. Acquisition costs. The ratio of acquisition costs to net premiums earned for the year endedDecember 31, 2011 increased 1.2 percentage points compared to the year endedDecember 31, 2010 . The reinsurance contracts that we write have a wide range of acquisition cost ratios and the variance is the result of shifts in the mix of business written and earned. For the year endedDecember 31, 2011 , a higher proportion of net earned premiums were from our auto, whole account and credit/surety lines of business, which generally have higher acquisition cost ratios compared to other lines of business. The ratio of acquisition costs to net premiums earned for the year endedDecember 31, 2010 increased 2.6 percentage points compared to the year endedDecember 31, 2009 . The increase in the acquisition cost ratio was principally due to changes in the mix of business written, partially influenced by the additional net premiums earned from the formerHarbor Point companies. The formerHarbor Point business contains a higher proportion of quota share contracts, which generally have higher acquisition cost ratios than excess of loss contracts. 60
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General and administrative expenses. General and administrative expenses for the year endedDecember 31, 2011 increased by$13.3 million compared to the year endedDecember 31, 2010 . This increase was principally due to 2011 being the first full fiscal year following the Amalgamation. In addition, an increase in the number of retirement eligible employees, whose stock-based compensation awards are fully expensed when granted, and the transfer of some corporate function employees and expenses to the reinsurance segment as part of the Amalgamation integration also contributed to the increase. This impact was partially offset by a decrease in performance based compensation expense. Growth in net premiums earned exceeded the increase in general and administrative expenses, resulting in a decrease of 0.9 percentage points in the general and administrative loss ratio. General and administrative expenses for the year endedDecember 31, 2010 increased$34.2 million compared to the year endedDecember 31, 2009 . The increase was principally due to the inclusion ofHarbor Point's expenses for the period fromMay 12, 2010 . In addition, there was an increase in performance based compensation expense as a result of improved underwriting results compared to the prior year, and a shift to a larger cash component and fewer stock-based awards, compared to 2009.
Reinsurance Segment-on a pro forma basis
The following table presents certain financial information for the reinsurance segment on an actual reported basis for the year endedDecember 31, 2011 and on a combined pro forma basis (after the elimination of intercompany transactions and the amortization of certain acquisition accounting adjustments) for the years endedDecember 31, 2010 and 2009, for informational purposes only, as if the Amalgamation had occurred onJanuary 1, 2010 andJanuary 1, 2009 , respectively. The pro forma data does not necessarily represent results that would have occurred if the Amalgamation had taken place at the beginning of each period presented, nor is it indicative of future results. 2011 % change 2010 % change 2009 (Expressed in millions of U.S. Dollars) Gross premiums written $ 869.7 (2.5 )% $ 892.4 (15.8 )% $ 1,060.4 Net premiums earned 824.0 (1.1 )% 833.5 (8.5 )% 910.7 Net losses and loss expenses (528.0 ) 9.7 % (481.2 ) 5.3 % (456.9 ) Acquisition costs (182.3 ) 5.2 % (173.3 ) (5.1 )% (182.7 ) General and administrative expenses (79.3 ) 4.9 % (75.6 ) (6.8 )% (81.1 ) Loss ratio(a) 64.1 % 57.7 % 50.2 % Acquisition cost ratio (b) 22.1 % 20.8 % 20.0 % General and administrative expense ratio (c) 9.6 % 9.1 % 8.9 % Combined ratio (d) 95.8 % 87.6 % 79.1 %
(a) The loss ratio is calculated by dividing net losses and loss expenses by net
premiums earned.
(b) The acquisition cost ratio is calculated by dividing acquisition costs by net
premiums earned.
(c) The general and administrative expense ratio is calculated by dividing
general and administrative expenses by net premiums earned.
(d) The combined ratio is calculated by dividing the sum of net losses and loss
expenses, acquisition costs and general and administrative expenses by net premiums earned. % of % of % of Premium Premium Premium 2011 Written 2010 Written 2009 Written (Expressed in millions of U.S. Dollars) Gross Premiums Written by Type of Risk: Agriculture $ 30.7 3.5 % $ 47.2 5.3 % $ 93.0 8.8 % Auto 99.8 11.5 % 65.3 7.3 % 58.8 5.5 % Aviation 16.0 1.8 % 32.7 3.7 % 42.8 4.0 % Credit/surety 34.9 4.0 % 28.8 3.2 % 20.7 2.0 % General casualty 73.8 8.5 % 85.3 9.6 % 93.9 8.9 % Marine & energy 24.0 2.8 % 33.6 3.8 % 46.7 4.4 % Medical 61
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malpractice 37.4 4.3 % 56.6 6.3 %
76.4 7.2 %
Other 3.1 0.4 % 7.7 0.9 %
3.6 0.3 %
Professional liability 159.5 18.3 % 173.9 19.5 %
202.1 19.1 % Property 319.7 36.8 % 276.9 31.0 % 297.2 28.0 % Whole account 35.8 4.1 % 50.4 5.6 % 35.0 3.3 %
Workers' compensation 35.0 4.0 % 34.0 3.8 %
90.2 8.5 % $ 869.7 100.0 % $ 892.4 100.0 % $ 1,060.4 100.0 % Short tail $ 546.1 62.8 % $ 517.4 58.0 % $ 580.3 54.7 % Long tail 323.6 37.2 % 375.0 42.0 % 480.1 45.3 % $ 869.7 100.0 % $ 892.4 100.0 % $ 1,060.4 100.0 %
(a) Short tail includes agriculture, auto, aviation, credit/surety, marine &
energy, other, property and whole account lines of business.
(b) Long tail includes general casualty, medical malpractice, professional
liability, whole account and workers' compensation lines of business.
Premiums. Gross premiums written for the year ended
• Gross premiums written in our agriculture line of business would have
decreased principally due the non-renewal of a
resulting from the client retaining more business partially offset by an
increase in gross premiums written due to two significant new contracts;
• Gross premiums written in our auto line of business increased principally
due to an increase in quota share contracts that renewed in the period due
to price and volume increases at the ceding companies as well as an
increased participation on one contract. In addition, the year ended
million related to 2010 quota share contracts also primarily due to price
and volume increases at the ceding companies; • Gross premiums written in our aviation, general casualty, marine & energy
and professional liability lines of business decreased principally due to contracts not being renewed or reductions in our participation due to a more competitive pricing environment;
• Gross premiums written in our medical malpractice line of business
decreased principally due to the non-renewal of two contracts that
accounted for
premium estimates of$8.4 million in the year endedDecember 31, 2011 compared to a decrease in premium estimates of$4.4 million in the year endedDecember 31, 2010 ;
• Gross premiums written in our property line of business increased
principally due to new business and increases in participations due to improved pricing and market conditions. In addition, the year endedDecember 31, 2011 included gross premiums written on property of$36.6 million compared to$14.5 million for the year endedDecember 31, 2010 related to ourLatin America operations; and
• Gross premiums written in our whole account line of business decreased due
to reductions in our participation on two quota share contracts.
Gross premiums written for the year ended
• Gross premiums written would have decreased in our agriculture line of
business principally due to the non-renewal of a contract as a result of a
client merger in 2010; • The increase in our credit/surety and whole account lines of business would have been principally due to new business written; • Marine & energy, medical malpractice and professional liability premiums
would have decreased principally due to reductions in line sizes, increase
in client retentions and reduced estimates of assumed premiums on certain
quota share policies; • The decrease in property premiums would have been principally due to
increased selectivity in our renewals, focusing on business that meets our
rate of return requirements; and
• Workers' compensation premiums would have decreased principally due to the
non-renewal of a contract written in the prior year period, resulting in a
decrease of
of
revision to losses on the contract. 62
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Net premiums earned is a function of the earning of gross premiums written and reinsurance premiums ceded over the last several quarters and, therefore, changes in net premiums earned generally lag quarterly increases and decreases in gross premiums written and reinsurance premiums ceded. As a result, net premiums earned tend to be less volatile than gross premiums written and reinsurance premiums ceded. Net losses and loss expenses. The loss ratio for the year endedDecember 31, 2011 would have increased by 6.4 percentage points compared to the year endedDecember 31, 2010 . Significant items impacting the 2011 loss ratio were:
• Net favorable loss development of prior year reserves in the year ended
endedDecember 31, 2010 ; • The net favorable development in the year endedDecember 31, 2011 was
principally due to favorable development on our property, workers
compensation, aviation and professional liability lines of business,
partially offset by unfavorable development on our medical malpractice
line of business. The favorable development in the year ended December 31,
2010 would have been principally on our property, general casualty and
workers' compensation lines of business, partially offset by unfavorable
development on our professional liability and marine & energy lines of
business; • Excluding the net favorable loss development, the loss ratio was 73.9% for
the year ended
for a
compensation contract) for the year ended
in the loss ratio for the year ended
principally due to the significant increase in property catastrophe
events; and
• The year ended
property catastrophe-related losses resulting from the
Cyclone Yasi, the
tsunami, tornadoes and flooding in
the
per-risk losses, principally as a result of the
the Deepwater Horizon oil spill, the
Xynthia and
The loss ratio for the year ended
• Net favorable loss development of prior year reserves in the year ended
in the year endedDecember 31, 2009 ;
• The favorable development in the year ended
been principally on our property, general casualty and workers
compensation lines of business, partially offset by unfavorable
development on our professional liability and marine & energy lines of
business. The favorable development in the year ended
would have been principally on our property and general casualty lines of
business, partially offset by unfavorable development recognized on our marine & energy line of business;
• Included in the net favorable development for the year ended December 31,
2010 would have been an
significant prior year workers' compensation contract for which there was
an offsetting reduction to net premiums earned of
result, the net favorable loss development on this workers' compensation
contract would have had a modest negative impact on net income;
• Excluding the net favorable loss development (and after adjusting for the
$9.5 million reduction to net premiums earned for the workers' compensation contract discussed above), the loss ratio would have been 65.7% for the year endedDecember 31, 2010 and 56.5% for the year endedDecember 31, 2009 . The increase in the loss ratio would have been
principally due to the significant increase in property catastrophe events
and significant per-risk losses; and
• The year ended
property catastrophe-related and significant per-risk losses, principally
as a result of the Deepwater Horizon oil spill, Europe Windstorm Xynthia,
the
related to Windstorm Klaus.
Acquisition costs. The ratio of acquisition costs to net premiums earned would have increased 1.3 percentage points for the year endedDecember 31, 2011 , compared to the prior year period. The ratio of acquisition costs to net premiums earned would have increased 0.8 percentage points for the year endedDecember 31, 2010 compared to the year endedDecember 31, 2009 . The reinsurance contracts that we write have a wide range of acquisition cost ratios. The increase in the acquisition cost ratio would have been due principally to changes in the mix of business earned. General and administrative expenses. General and administrative expenses for the year endedDecember 31, 2011 would have increased compared with the prior year period principally due to the transfer of some corporate function employees and expenses to 63
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the reinsurance segment as part of the Amalgamation integration and an increase in the number of retirement eligible employees whose stock-based compensation awards are fully expensed when granted. This impact would have been partially offset by a decrease in performance based compensation expense. General and administrative expenses for the year endedDecember 31, 2010 would have decreased compared with the year endedDecember 31, 2009 , principally due to the decrease in the amortization expense of renewal rights held byHarbor Point . The renewal rights were included in the assets ofChubb Re acquired byHarbor Point in 2005 and were fully amortized by the end of 2009. The general and administrative expense ratio would not have changed significantly from 2009 to 2010 as the 6.8% decrease in general and administrative expense would have been offset by an 8.5% decrease in net premiums earned. U.S. Specialty Segment 2011 % change 2010 % change 2009 (Expressed in millions of U.S. Dollars) Gross premiums written $ 330.2 12.1 % $ 294.5 10.8 % $ 265.9 Reinsurance premiums ceded (123.9 ) 40.0 % (88.5 ) (40.4 )% (148.5 ) Net premiums written $ 206.3 0.1 % $ 206.0 75.5 % $ 117.4 Net premiums earned $ 201.3 18.0 % $ 170.6 88.3 % $ 90.6 Net losses and loss expenses (139.6 ) 30.3 % (107.1 ) 95.4 % (54.8 ) Acquisition costs (35.5 ) 26.3 % (28.1 ) 274.7 % (7.5 ) General and administrative expenses (35.8 ) 18.9 % (30.1 ) 7.9 % (27.9 ) Other income - - % - (100.0 )% (0.1 ) Underwriting (loss) income $ (9.6 ) (281.1 )% $ 5.3 N/A $ 0.3 Loss ratio (a) 69.3 % 62.7 % 60.4 % Acquisition cost ratio (b) 17.6 % 16.5 % 8.2 % General and administrative expense ratio (c) 17.8 % 17.7 % 30.8 % Combined ratio (d) 104.8 % 96.9 % 99.4 %
(a) The loss ratio is calculated by dividing net losses and loss expenses by net
premiums earned.
(b) The acquisition cost ratio is calculated by dividing acquisition costs by net
premiums earned.
(c) The general and administrative expense ratio is calculated by dividing
general and administrative expenses by net premiums earned.
(d) The combined ratio is calculated by dividing the sum of net losses and loss
expenses, acquisition costs and general and administrative expenses by net premiums earned. % of % of % of Premium Premium Premium 2011 Written % Ceded 2010 Written % Ceded 2009 Written % Ceded (Expressed in millions of U.S. Dollars) Gross Premiums Written by Type of Risk: General Liability $ 86.6 26.2 % 47.4 % $ 81.1 27.5 % 27.4 % $ 68.2 25.7 % 34.5 % Marine 88.5 26.8 % 34.6 % 67.5 22.9 % 45.5 % 61.4 23.1 % 58.8 % Professional Liability 17.7 5.4 % 13.8 % 6.6 2.3 % (18.2 )% 0.6 0.2 % 10.6 % Property 137.4 41.6 % 36.2 % 139.3 47.3 % 26.4 % 135.7 51.0 % 65.4 % $ 330.2 100.0 % 37.5 % $ 294.5 100.0 % 30.1 % $ 265.9 100.0 % 55.9 % Short tail (a) $ 225.9 68.4 % $ 206.8 70.2 % $ 197.1 74.1 % Long tail (b) 104.3 31.6 % 87.7 29.8 % 68.8 25.9 % $ 330.2 100.0 % $ 294.5 100.0 % $ 265.9 100.0 %
(a) Short tail includes marine and property lines of business.
(b) Long tail includes general liability and professional liability lines of
business. 64
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During the year endedDecember 31, 2011 , Alterra E&S sold the renewal rights to our contract binding business. CommencingAugust 1, 2011 , until the earlier of the date the purchaser or Alterra E&S elects andFebruary 1, 2013 , the contract binding business will be written by Alterra E&S and we will cede 100% of the premiums and losses to the purchaser. As a result, our volume of gross premiums written with respect to the contract binding business is expected to continue for the foreseeable future. The 100% quota share reinsurance of this business means that we will not retain any written and earned premium or net losses, but we will earn a ceding commission, on new and renewal policies incepting afterAugust 1, 2011 . Premiums. Gross premiums written for the year endedDecember 31, 2011 increased 12.1% compared to the prior year period. The increase in 2011 gross premiums written was principally due to:
• Organic growth in business written in our marine and professional
liability lines; and
• Growth in our general liability line of business due to the addition of
excess casualty business to our product offerings in this line.
Gross premiums written for the year ended
• The addition of professional liability to our product line in the fourth
quarter of 2009; • Focused growth of our general liability line written through the brokerage
distribution channel; and
• Moderate growth of 3% to 10% in our marine and property lines of business.
The ratio of reinsurance premiums ceded to gross premiums written for the year endedDecember 31, 2011 was 37.5% compared to 30.1% in the prior year period. The increase in the percentage of premiums ceded in the year endedDecember 31, 2011 was principally due to the 100% cession of our contract binding business starting fromAugust 1, 2011 . Excluding this additional amount of premiums ceded, the percentage of premiums ceded for the year endedDecember 31, 2011 was 30.4%. The prior year period was impacted by the cancellation of a property quota share treaty that resulted in$20.6 million of returned ceded premium. Excluding this treaty, the ratio of reinsurance premiums ceded to gross premiums written for the year endedDecember 31, 2010 was 37.0%. The decrease from 37.0% to 30.4% was consistent with our planned increase in risk retention during the year. The ratio of reinsurance premiums ceded to gross premiums written for the year endedDecember 31, 2010 decreased from 55.9% in the year endedDecember 31, 2009 . This decrease was principally due to the cancellation of a property quota share treaty that was replaced with a surplus share treaty under which we retain more risk. Net premiums earned is a function of the earning of gross premiums written and reinsurance premiums ceded over the last several quarters and, therefore, changes in net premiums earned generally lag quarterly increases and decreases in gross premiums written and reinsurance premiums ceded. As a result, net premiums earned tend to be less volatile than gross premiums written and reinsurance premiums ceded. Net losses and loss expenses. The loss ratio for the year endedDecember 31, 2011 increased 6.6 percentage points compared to the year endedDecember 31, 2010 . The net favorable and (unfavorable) development of prior year reserves in the years endedDecember 31, 2011 , 2010 and 2009 by line of business was as follows: 2011 2010 2009 (In millions of U.S. Dollars) General Liability $ (6.8 ) $ (0.2 ) $ (0.6 ) Marine (0.5 ) (2.0 ) (2.2 ) Property (4.2 ) 3.1 1.7 $ (11.5 ) $ 0.9 $ (1.1 )
Significant items impacting the 2011 loss ratio were:
• Net unfavorable loss development of prior year reserves in the year ended
of
development in our general liability and property lines of business
related to business written by the contract binding business (2007-2010
years). As described above, this business was sold during 2011 and we did
not retain on our balance sheet any of the business written following the
sale. In addition, there was net unfavorable development in our marine
line of business relating to the 2010 year. The net favorable development
in the year endedDecember 31, 2010 principally was on our property line of business; 65
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• Excluding the net favorable loss development, the loss ratio was 63.6% for
the year endedDecember 31, 2011 compared to 63.2% for the year endedDecember 31, 2010 . The increase was principally due to changes in the mix
of business, particularly an increase in the marine and professional
liability lines of business. These lines of business have a higher average
loss ratio than property lines, which declined as a percentage of gross premiums written; and
• Our results for the year ended
the year ended
event net losses for the year ended
resulting from tornadoes and flooding in
Irene. The year endedDecember 31, 2010 included losses resulted fromTennessee flooding and northeastern U.S. storms. These losses fall within
our attritional loss ratio, as we expect a certain level of property
losses each period.
The loss ratio for the year endedDecember 31, 2010 increased 2.3 percentage points compared to the year endedDecember 31, 2009 . Significant items impacting the 2010 loss ratio were:
• Net favorable loss development of prior year reserves in the year ended
our property line of business in 2010 and 2009 represented better than expected loss emergence. Unfavorable development in our marine and general
liability lines of business were the result of increased loss estimates on
specific claim reserves; • Excluding the net favorable loss development, the loss ratio was 63.2% and
59.2% for the years endedDecember 31, 2010 andDecember 31, 2009 , respectively. The increase in the loss ratio was principally due to changes in the mix of business; and
• Our results for the year ended
losses. Large loss events in the year ended
flooding in
losses were contained within our annual loss expectations for the property
line of business. In the fourth quarter of 2010, we reduced our original
estimate of net losses associated with these events by
During the year ended
property catastrophe losses or significant per-risk losses.
Acquisition expenses. The acquisition cost ratio increased in each of the last two years as we reduced the amount of reinsurance purchased. As we retain more business, we receive less ceding commission income to offset our brokerage and commission costs, which increases our acquisition cost ratio. This effect should be tempered over the near term by the ceding commission income we expect to earn on the reinsurance of the contract binding business that we sold in August of 2011. General and administrative expenses. General and administrative expenses for the year endedDecember 31, 2011 increased$5.7 million compared to the prior year. The increase was principally due to additional costs associated with the sale of our contract binding business, costs associated with the establishment of our new excess casualty platform and an increase in expenses related to stock based compensation. Notwithstanding these factors, the general and administrative expense ratio for the year endedDecember 31, 2011 was consistent with the prior year, principally due to the gradual increase in net premiums earned compared to the prior year period.
General and administrative expenses increased in 2010 compared to 2009; however, our general and administrative expense ratio decreased. The decrease in the ratio was principally due to the increases in net premiums earned during 2010.
Alterra at Lloyd's Segment
Our Alterra at Lloyd's segment comprises all of our Lloyd's operating businesses. This includes the underwriting operations of the Syndicates for which we record our proportionate share.
2011 % change 2010 % change 2009 (Expressed in millions of U.S. Dollars) Gross premiums written $ 290.5 $ 43.4 % $ 202.6 57.1 % $ 129.0 Reinsurance premiums ceded (64.5 ) 72.5 % (37.4 ) 13.7 % (32.9 ) Net premiums written $ 226.0 $ 36.8 % $ 165.2 71.9 % $ 96.1 66
-------------------------------------------------------------------------------- Table of Contents Net premiums earned $ 185.9 37.7 % $ 135.0 42.0 % $ 95.1 Net losses and loss expenses (172.3 ) 187.6 % (59.9 ) 36.1 % (44.0 ) Acquisition costs (42.4 ) 75.2 % (24.2 ) 33.7 % (18.1 ) General and administrative expenses (37.0 ) 29.8 % (28.5 ) 42.5 % (20.0 ) Other income 1.2 (52.0 )%
2.5 257.1 % 0.7
Underwriting (loss) income $ (64.6 ) N/A $ 24.9 81.8 % $ 13.7 Loss ratio (a) 92.7 % 44.3 % 46.2 % Acquisition cost ratio (b) 22.8 % 17.9 % 19.1 % General and administrative expense ratio (c) 19.9 % 21.2 % 21.0 % Combined ratio (d) 135.4 % 83.4 % 86.3 %
(a) The loss ratio is calculated by dividing net losses and loss expenses by net
premiums earned.
(b) The acquisition cost ratio is calculated by dividing acquisition costs by net
premiums earned.
(c) The general and administrative expense ratio is calculated by dividing
general and administrative expenses by net premiums earned.
(d) The combined ratio is calculated by dividing the sum of net losses and loss
expenses, acquisition costs and general and administrative expenses by net premiums earned. % of % of % of Premium Premium Premium 2011 Written % Ceded 2010 Written % Ceded 2009 Written % Ceded (Expressed in millions of U.S. Dollars) Gross Premiums Written by Type of Risk: Accident & health $ 37.1 12.8 % 12.0 % $ 30.9 15.2 % 15.7 % $ 22.6 17.5 % 22.3 % Aviation 13.2 4.5 % 42.1 % 16.1 7.9 % 24.5 % 2.6 2.0 % - % Financial institutions 27.2 9.4 % 21.6 % 19.4 9.6 % 23.3 % 23.8 18.5 % 22.0 % International casualty 52.4 18.0 % 5.4 % 26.2 12.9 % 7.0 % - - % - % Marine 1.5 0.5 % 129.3 % - - % - % - - % - % Professional liability 20.7 7.1 % 21.7 % 19.6 9.7 % 13.0 % 19.9 15.4 % 20.5 % Property 132.1 45.5 % 29.3 % 85.6 42.3 % 23.0 % 60.1 46.6 % 30.9 % Surety 6.3 2.2 % 13.1 % 4.8 2.4 % - % - - % - % $ 290.5 100.0 % 22.2 % $ 202.6 100.0 % 18.5 % $ 129.0 100.0 % 25.5 % Short tail (a) $ 190.2 65.5 % $ 137.4 67.8 % $ 85.3 66.1 % Long tail (b) 100.3 34.5 % 65.2 32.2 % 43.7 33.9 % $ 290.5 100.0 % $ 202.6 100.0 % $ 129.0 100.0 %
(a) Short tail includes accident & health, aviation, marine, property and surety
lines of business.
(b) Long tail includes financial institutions, international casualty and
professional liability lines of business.
Premiums. Gross premiums written for the year endedDecember 31, 2011 increased 43.4% compared to the prior year. The increase in 2011 gross premiums written was primarily due to:
• An increase of
ended
this segment. OurLatin America operations generated$30.6 million of property gross premiums written in 2011 compared to$17.4 million in the prior year. The year endedDecember 31, 2011 also benefitted from the
addition of our direct and facultative property insurance underwriting
team and improved market conditions, as well as
reinstatement premiums principally related to property catastrophe events; • An increase of$26.2 million in our international casualty line of
business for the year ended
business in the quarter ended
expansion of our client base as well as favorable market conditions;
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• An increase of
the year endedDecember 31, 2011 principally due to the addition of our accident & health insurance team towards the end of 2010; and
• An increase of
for the year ended
the specie product line during the year.
For the year ended
Gross premiums written for the year ended
• The addition of aviation business to our Alterra at Lloyd's segment in the
fourth quarter of 2009, which largely represented a transfer of business
previously written within our insurance segment;
• The addition of international casualty product lines in the first quarter
of 2010, which generated$26.2 million of gross premiums written in the year endedDecember 31, 2010 ; and
• The commencement of underwriting in
million of gross premiums written for the year endedDecember 31, 2010 , primarily in the property line of business. The ratio of reinsurance premiums ceded to gross premiums written for the year endedDecember 31, 2011 was 22.2% compared to 18.5% for the prior year. For the year endedDecember 31, 2011 , the increase was impacted by reinstatement premiums ceded as a result of the catastrophe losses during the year. The ratio of reinsurance premiums ceded to gross premiums written for the year endedDecember 31, 2010 was 18.5% compared to 25.5% for the year endedDecember 31, 2009 . The volume of reinsurance premiums ceded did not increase at the same rate as the increase in gross premiums written because a significant proportion of our reinsurance program are excess of loss contracts rather than quota share (proportional) contracts. Net premiums earned is a function of the earning of gross premiums written and reinsurance premiums ceded over the last several quarters and, therefore, changes in net premiums earned generally lag quarterly increases and decreases in gross premiums written and reinsurance premiums ceded. As a result, net premiums earned tend to be less volatile than gross premiums written and reinsurance premiums ceded. Net losses and loss expense. The loss ratio for the year endedDecember 31, 2011 increased by 48.4 percentage points compared to the year endedDecember 31, 2010 . The net favorable and (unfavorable) development of prior year reserves in the years endedDecember 31, 2011 , 2010 and 2009 by line of business was as follows: 2011 2010 2009 (Expressed in millions of U.S. Dollars) Accident & health $ (2.7 ) $ - $ 0.6 Aviation 3.9 - - Financial institutions 11.6 4.9 0.9 International casualty (3.4 ) - - Professional liability 0.1 3.6 3.5 Property 7.8 6.4 1.1 $ 17.3 $ 14.9 $ 6.1
Significant items impacting the 2011 loss ratio were:
• Net favorable loss development of prior year reserves in the year ended
development of
favorable development in the year ended
on pre-2009 financial institutions business and on the property line of business related to pre-2008 years. The net favorable development in the
year ended
institutions and professional liability lines of business; • Excluding the net favorable loss development, the loss ratio was 102.0%
for the year ended
December 31, 2010 . The increase in the loss ratio was principally due to catastrophe-related and significant per-risk losses; and 68
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• Net losses and loss expense for the year ended
Property catastrophe losses for the year ended
losses resulting from the
earthquake, the
loss expense for the year ended
significant property catastrophe-related and significant per risk losses,
which included net losses from the
Horizon oil spill, theChile earthquake, Europe Windstorm Xynthia andAustralia hail storms and floods. A portion of these losses fall within
our attritional loss ratio, as we expect a certain level of property
losses each period.
The loss ratio for the year endedDecember 31, 2010 decreased by 1.9 percentage points compared to the year endedDecember 31, 2009 . Significant items impacting the 2010 loss ratio were:
• Net favorable loss development of prior year reserves in the year ended
of
development in the year endedDecember 31, 2010 was principally on our property, financial institutions and professional liability lines of
business. The net favorable development in the years ended December 31,
2010 and 2009 reflected better than expected loss emergence; • Excluding the net favorable loss development, the loss ratio was 55.4% for
the year endedDecember 31, 2010 compared to 52.7% for the year endedDecember 31, 2009 . The increase in the loss ratio was principally due to
changes in the mix of business, which included aviation and international
casualty lines of business, and an increase in catastrophe - related and
significant per risk losses. • Net losses and loss expense for the year endedDecember 31, 2010 included
included net losses from the
Losses and loss expense for the year ended
million in catastrophe-related and significant per risk losses.
Acquisition expenses. The acquisition cost ratio increased 4.9 percentage points for the year endedDecember 31, 2011 compared to the prior year. The year endedDecember 31, 2011 was impacted by the re-estimation of certain commission expenses based on updated information. The remaining increase was attributable to changes in the mix of business written. The acquisition cost ratio decreased 1.2 percentage points for the year endedDecember 31, 2010 compared to the year endedDecember 31, 2009 . The decrease in acquisition costs was principally attributable to the addition of international casualty business in the first quarter of 2010, which has a lower average acquisition cost ratio than other lines of business. General and administrative expenses. General and administrative expenses for the year endedDecember 31, 2011 increased$8.5 million compared to the prior year. Costs associated with expanding our underwriting teams, growth inBrazil and regulatory changes inEurope contributed to the absolute increase in general and administrative expenses. General and administrative expenses for the year endedDecember 31, 2010 increased$8.5 million compared to the year endedDecember 31, 2009 . However, the general and administrative expense ratio for the year endedDecember 31, 2010 remained consistent with the year endedDecember 31, 2009 as net premiums earned increased at almost the same rate. General and administrative expenses for this segment included profit commission income earned by Alterra at Lloyd's from the Syndicates that were not wholly owned by Alterra, which partially offset the costs of managing the Syndicates. Profit commission income in the year endedDecember 31, 2010 benefitted from a non-recurring gain of$4.9 million resulting from the closing of a year of account on one of these third-party Syndicates. Partially offsetting this profit commission income was an increase in information technology expenses, performance-based compensation, and expenses related to our new office inBrazil .
Life and Annuity Reinsurance Segment
2011 % change 2010 % change 2009 (Expressed in millions of U.S. Dollars) Net premiums earned $ 3.0 (33.3 )% $ 4.5 (89.6 )% $ 43.3 Net investment income 48.5 (2.6 )% 49.8 (2.4 )% 51.0 Net realized and unrealized (losses) gains on investments (10.4 ) (191.2 )% 11.4 (69.4 )% 37.3 Other income 0.4 33.3 % 0.3 N/A (0.1 ) Claims and policy benefits (59.4 ) (8.9 )% (65.2 ) (35.5 )% (101.1 ) Acquisition costs (0.6 ) 50.0 % (0.4 ) (71.4 )% (1.4 ) General and administrative expenses (0.6 ) (80.0 )% (3.0 ) 7.1 % (2.8 ) (Loss) income $ (19.1 ) N/A $ (2.6 ) (109.9 )% $ 26.2 69
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There were no new life and annuity contracts written during the years endedDecember 31, 2011 and 2010. One new reinsurance contract was written in the year endedDecember 31, 2009 , accounting for most of the premiums written for that year. Our life and annuity business was focused exclusively on acquiring policies with significant reserve balances, which allowed us to earn a profit by investing at a higher yield than the cost of funds of those reserves. We were able to execute this strategy successfully in prior years as our investment in hedge funds constituted a significant portion of our total investments and investment yields in general were more attractive. Our investment strategy is now focused primarily on holding high quality fixed maturity securities, which makes it difficult to grow our life and annuity business profitably. As a result, we have decided not to write any new life and annuity contracts for the foreseeable future. This decision does not affect our existing life and annuity reinsurance contracts and we continue to service our existing life and annuity customer base. The nature of life and annuity reinsurance transactions that we historically had written resulted in a limited number of transactions actually bound with potentially large variations in quarterly and annual premium volume. Consequently, components of our underwriting results, such as premiums written, premiums earned and claims and policy benefits can be volatile, and period-to-period comparisons are not necessarily representative of future trends. Our life and annuity benefit reserves are recorded on a discounted present value basis. This discount is amortized through income as a claims and policy benefits expense over the term of the underlying policies. As a result, income is driven by the spread between the actual rate of return on our investments and the interest discount on our reserves, together with differences between estimated and actual claims, premiums, expenses and persistency of the underlying policies. Losses for the years endedDecember 31, 2011 and 2010 were principally due to low rates of return on our hedge fund investments. Net realized and unrealized gains and losses on investments for this segment consist entirely of net gains or losses on hedge fund investments. If hedge fund investments provide a positive rate of return over the long term, we expect that the combination of net investment income from fixed maturities and net gains from hedge funds would exceed the discount rate on our reserves and, therefore, provide positive income for this segment. Gross premiums written, reinsurance premiums ceded, net premiums earned, acquisition costs and general and administrative expenses represent ongoing premium receipts or adjustments and related administration expenses on existing contracts. Claims and policy benefits in each period represent reinsured policy claims payments net of the change in policy and claim liabilities.
Net investment income and net realized and unrealized gains (losses) on investments are discussed within the investing activities section as we manage investments for this segment on a consolidated basis with our other segments.
Investing Activities
The results of investing activities discussed below include net investment income, net realized and unrealized gains (losses) on investments and net impairment losses recognized in earnings for the consolidated group, including amounts that are allocated to the life and annuity segment.
Year Ended Year Ended Year Ended December 31, 2011 % change December 31, 2010 % change December 31, 2009 (Expressed in millions of U.S. Dollars) Net investment income $ 234.8 5.6 % $ 222.4 $ 31.1 % $
169.7
Net realized and unrealized (losses) gains on investments $ (38.3 ) (326.6 )% $ 16.9 (79.3 )% $ 81.8 Net impairment losses recognized in earnings $ (2.9 ) 11.5 % $ (2.6 ) (16.1 )% $ (3.1 ) Average yield on cash and fixed maturities 3.09 % 3.39 % 3.56 % 70
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Net investment income. The increase in net investment income for each of the years since 2009 was attributable principally to the increase in cash and invested assets as a result of the Amalgamation onMay 12, 2010 . Partially offsetting the increased investment base were declining investment yields each year. The yields available in the current fixed maturity market are generally lower than the average yield on our existing portfolio. As a result, we expect continuing downwards pressure on our investment yield for the foreseeable future. Net realized and unrealized (losses) gains on investments include the following: Year Ended Year Ended Year Ended December 31, 2011 December 31, 2010 December 31, 2009 (Expressed in millions of U.S. Dollars) (Decrease) increase in fair value of hedge funds (a) $ (11.8 ) $ 14.3 $ 75.8 (Decrease) increase in fair value of derivatives (13.6 ) (12.0 ) 0.8 (Decrease) increase in fair value of catastrophe bonds (25.6 ) 0.4 - (Decrease) increase in fair value of structured deposit (2.3 ) 2.6 - Income from equity method investments 1.5 0.6 0.7 (Decrease) increase in fair value of other investments (51.8 ) 5.9 77.3 Net realized gains on available for sale securities 11.5 15.5 1.9 Net realized and unrealized gains (losses) on trading securities 2.0 (4.5 ) 2.6 Net realized and unrealized (losses) gains on investments $ (38.3 ) $ 16.9 $ 81.8
(a) An increase in fair value of derivatives of
hedge fund is included in the increase (decrease) in fair value of hedge
funds for the year ended
Change in fair value of other investments. Our investment in hedge funds comprises the majority of other investments. The decrease in fair value of the hedge fund portfolio was$11.8 million , or a negative 3.57% rate of return, for the year endedDecember 31, 2011 , compared to an increase of$14.3 million , or a 4.27% rate of return, for the year endedDecember 31, 2010 . The rate of return of negative 3.57% for the year endedDecember 31, 2011 compares to theHFRI Fund of Funds Composite Index returning negative 5.64% over the same period, which we believe is our most relevant benchmark.
The increase in fair value of the hedge fund portfolio was
Six of the nine hedge fund strategies we employed experienced negative returns during the year endedDecember 31, 2011 . The largest contributors by investment strategy to the decrease in fair value for the year endedDecember 31, 2011 were the event-driven arbitrage and diversified arbitrage strategies. As ofDecember 31, 2011 , 8.5% and 7.0% of our hedge fund portfolio was allocated to the event-driven arbitrage and diversified arbitrage strategies, respectively. The largest increase in fair value offsetting the overall decrease for year was contributed by the global macro strategy. As ofDecember 31, 2011 , 19.6% of our hedge fund portfolio was allocated to this strategy. Eight of the ten hedge fund strategies we employed experienced positive returns during the year endedDecember 31, 2010 . The largest contributors by investment strategy to the increase in fair value for the year endedDecember 31, 2010 were the global macro and the diversified arbitrage strategies. As ofDecember 31, 2010 , 16.9% and 9.5% of our hedge fund portfolio was allocated to the global macro and diversified arbitrage strategies, respectively. The largest decrease in fair value offsetting the overall increase for the year was contributed by the event driven arbitrage strategy. As ofDecember 31, 2010 , 10.2% of our hedge fund portfolio was allocated to this strategy. Eight of the nine hedge fund strategies we employed experienced positive returns during the year endedDecember 31, 2009 . The largest contributors by investment strategy to the net gain for the year endedDecember 31, 2009 were the distressed securities and the event driven arbitrage strategies. As ofDecember 31, 2009 , 20.0% and 13.3% of our hedge fund portfolio was allocated to the distressed securities and the event driven arbitrage strategies, respectively. The allocation of invested assets to our hedge fund portfolio as ofDecember 31, 2011 was 3.2%, which is consistent with our expected ongoing allocation. The objective of our hedge fund portfolio is to achieve a market neutral/absolute return strategy, with diversification by strategy and underlying fund. A market neutral strategy strives to generate consistent returns in both up and down markets by selecting long and short positions with a total net exposure of zero. Returns are derived from the long/short spread, or the amount by which long positions outperform short positions. The objective of an absolute return strategy is to provide stable performance regardless of market conditions, with minimal correlation to market benchmarks. 71
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The fair value of derivatives decreased by$13.6 million for the year endedDecember 31, 2011 compared to a decrease of$12.0 million for the year endedDecember 31, 2010 . We hold various derivative instruments, including convertible bond equity call options, interest rate linked derivative instruments and foreign currency forward contracts. The majority of the loss for the year endedDecember 31, 2011 came from interest rate swap positions taken as part of a total return strategy followed by a portion of our investment portfolio. The fair value of derivatives decreased by$12.0 million for the year endedDecember 31, 2010 compared to an increase of$0.8 million for the year endedDecember 31, 2009 . During the second quarter of 2010, we considered replacing our revolving bank loan with longer term debt. In contemplation of this plan, we entered into two interest rate forward contracts indexed to the U.S. treasury rate. Due to market volatility at that time, we elected not to replace our revolving bank loan and the forward contracts were settled for a loss of$10.4 million in the second quarter, which resulted in the majority of the loss for the year endedDecember 31, 2010 . Nearly all of the decrease in fair value of the catastrophe bonds for the year endedDecember 31, 2011 was due to a$25.0 million loss on one catastrophe bond with exposure to the earthquake and tsunami inJapan . During the second quarter of 2011, we disposed of all remaining catastrophe bond holdings. AtDecember 31, 2010 , we had$47.2 million invested in catastrophe bonds, with a par value of$45.3 million . The increase in fair value of the catastrophe bonds was$0.4 million during the year endedDecember 31, 2010 .
As of
Net realized and unrealized gains and losses on available for sale and trading securities. Our total fixed maturities portfolio is split into three portfolios:
• an available for sale portfolio; • a held to maturity portfolio; and • a trading portfolio. Our available for sale portfolio is recorded at fair value with unrealized gains and losses recorded in other comprehensive income as part of total shareholders' equity. Our available for sale fixed maturities investment strategy is not intended to generate significant realized gains and losses as more fully discussed below in the Financial Condition section. Our held to maturity portfolio includes securities for which we have the ability and intent to hold to maturity or redemption, and is recorded at amortized cost. There should be no realized gains or losses related to this portfolio unless there is an other than temporary impairment loss. Our trading portfolio is recorded at fair value with unrealized gains and losses recorded in net income. Net realized and unrealized gains on our fixed maturities portfolios for the years endedDecember 31, 2011 , 2010 and 2009 were$13.5 million ,$11.0 million and$4.5 million , respectively. Net impairment losses recognized in earnings. As a result of our quarterly review of securities in an unrealized loss position, we recorded OTTI losses through earnings for the years endedDecember 31, 2011 , 2010 and 2009 of$2.9 million ,$2.6 million and$3.1 million , respectively. These impairment losses are presented separately from all other net realized and unrealized gains and losses on investments. A discussion of our process for estimating OTTI is included in Note 3 of our audited consolidated financial statements included herein. Financial Condition Cash and invested assets. Aggregate invested assets, comprising cash and cash equivalents, fixed maturities and other investments, were$7,814.7 million as ofDecember 31, 2011 compared to$7,861.4 million as ofDecember 31, 2010 , a decrease of 0.6%. The modest decrease in cash and invested assets resulted principally from the combination of the timing of the settlement of premiums and losses, growth in our available for sale portfolio, partially offset by smaller held to maturity and other investment portfolios, foreign exchange losses on the held to maturity portfolio, and payments for share repurchases and dividends. We hold an available for sale portfolio, a trading portfolio and a held to maturity portfolio of fixed maturities securities. In an effort to match the expected cash flow requirements of our long-term liabilities, we invest a portion of our fixed maturity investments in long duration securities. Because we intend to hold a number of these long duration securities to maturity, we classify these securities as held to maturity in our consolidated balance sheet. This held to maturity portfolio is recorded at amortized cost. As a result, we do not record changes in the fair value of this portfolio, which should reduce the impact on shareholders' equity of fluctuations in fair value of those investments. 72
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Fixed maturities are subject to fluctuations in fair value due to changes in interest rates, changes in issuer specific circumstances, such as credit rating changes, and changes in industry specific circumstances, such as movements in credit spreads based on the market's perception of industry risks. As a result of these fluctuations, it is possible to have significant unrealized gains or losses on a security. Our strategy for our fixed maturities portfolios is to tailor the maturities of the portfolios to the timing of expected loss and benefit payments. At maturity, absent any credit loss, a fixed maturity's amortized cost will equal its fair value and no realized gain or loss will be recognized in income. If, due to an unforeseen change in loss payment patterns, we need to sell available for sale fixed maturity securities before maturity, we could realize significant gains or losses in any period, which could result in a meaningful effect on reported net income for such period. In order to reduce the likelihood of needing to sell investments before maturity, especially given the unpredictable and potentially significant cash flow requirements of our property catastrophe business, we maintain significant cash and cash equivalent balances. We believe it is more likely than not that we will not be required to sell those fixed maturities securities in an unrealized loss position until such time as they reach maturity or the fair value increases. We perform regular reviews of our fixed maturities portfolio and utilize a process that considers numerous indicators in order to identify investments that show signs of potential other than temporary impairments. The indicators include the issuer's financial condition and ability to make future scheduled interest and principal payments, benchmark yield spreads, the nature of collateral or other credit support and significant economic events that have occurred that affect the industry in which the issuer participates. Our fixed maturity portfolio comprises high quality, liquid securities. As ofDecember 31, 2011 , our fixed maturities investments had a dollar-weighted average credit rating of Aa2/AA. Under our fixed maturities investment guidelines, a minimum weighted average credit rating of Aa3/AA-, or its equivalent, must be maintained for our fixed maturities investment portfolio as a whole. Our fixed maturities investment guidelines also provide that we cannot leverage our fixed maturities investments. Further details of the credit ratings on our fixed maturities investments are included in Note 3 of our audited consolidated financial statements included herein. Our portfolio of fixed maturities includes mortgage-backed and asset-backed securities and collateralized mortgage obligations. These types of securities have cash flows that are backed by the principal and interest payments of a group of underlying mortgages or other receivables. As a result of the increasing default rates of borrowers, there currently is a greater risk of defaults on mortgage-backed and asset-backed securities and collateralized mortgage obligations than historically existed, especially those that are non-investment grade. These factors make estimating the fair value of these securities more uncertain. We obtain fair value estimates from multiple independent pricing sources in an effort to mitigate some of the uncertainty surrounding the fair value estimates. If we need to liquidate these securities within a short period of time, the actual realized proceeds may be significantly different from the fair values estimated as ofDecember 31, 2011 . We performed a review of securities in an unrealized loss position as ofDecember 31, 2011 for OTTI, which included the consideration of relevant factors, including prepayment rates, subordination levels, default rates, credit ratings, weighted average life and cash flow testing. Together with our investment managers, we continue to monitor our potential exposure to mortgage-backed and asset-backed securities, and we will make adjustments to the investment portfolio, if and when we deem necessary. As a result of this process, we recognized an other than temporary impairment charge through net income of$2.9 million during the year endedDecember 31, 2011 . We continue to monitor the ongoing uncertainty over the financial health of certain European governments and European financial institutions and our exposure to the credit risk of these investments. As ofDecember 31, 2011 , we hold European government securities with a fair value of$727.1 million , distributed as follows: As of December 31, 2011 Fair Value % of Total (in millions of U.S. Dollars) France $ 263.8 36.3 % Germany 247.5 34.0 % Netherlands 147.8 20.3 % Ireland 23.8 3.3 % Belgium 19.8 2.7 % United Kingdom 11.4 1.6 % Denmark 5.8 0.8 %
All other European countries 7.2
1.0 %
European government holdings $ 727.1 100.0 % 73
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We hold no securities issued by the governments of
As of
As of December 31, 2011 Fair Value % of Total (in millions of U.S. Dollars) European Investment Bank $ 66.5 14.1 % KFW 49.2 10.5 % Credit Suisse Group 35.5 7.5 % Lloyds Banking Group plc 31.3 6.6 % UBS AG 30.3 6.4 % BNP Paribas SA 26.6 5.7 % HSBC Holdings plc 23.5 5.0 % Barclays plc 22.4 4.8 % All other 185.7 39.4 % European financial institution holdings $ 471.0
100.0 %
All of our European government and financial institutions holdings are included within our review procedures for other-than-temporary impairments. A discussion of our process for estimating OTTI is included in Note 3 of our audited consolidated financial statements included herein. Potential risks associated with sovereign debt ofEuropean Union member states and Euro denominated investments are discussed in "Item 1A - Risk Factors - The Financial crisis inEurope , including the threat of default on European sovereign debt, the devaluation of the Euro and the dissolution of theEuropean Union , could adversely affect our results of operations, liquidity and financial condition." As described in Note 4 of our audited consolidated financial statements, our available for sale and trading fixed maturities investments and the majority of our other investments are carried at fair value. Fair value prices for all securities in our fixed maturities portfolio are independently provided by our investment custodians, our investment accounting service provider and our investment managers, with each utilizing internationally recognized independent pricing services. We record the unadjusted price provided by the investment custodian, investment accounting service provider or investment manager after validating the prices. Our validation process includes: (i) comparison of prices between two independent sources, with significant differences requiring additional price sources; (ii) quantitative analysis (e.g., comparing the quarterly return for each managed portfolio to its target benchmark, with significant differences identified and investigated); (iii) evaluation of methodologies used by external parties to calculate fair value, including a review of the inputs used for pricing; and (iv) comparing the price to our knowledge of the current investment market. The independent pricing services used by our investment custodians, investment accounting service provider and investment managers obtain actual transaction prices for securities that have quoted prices in active markets. Each pricing service has its own proprietary method for determining the fair value of securities that are not actively traded. In general, these methods involve the use of "matrix pricing" in which the independent pricing service uses observable market inputs including, but not limited to, reported trades, benchmark yields, broker/dealer quotes, interest rates, prepayment speeds, default rates and such other inputs as are available from market sources to determine a reasonable fair value. In addition, pricing services use valuation models, such as an Option Adjusted Spread model, to develop prepayment and interest rate scenarios. The Option Adjusted Spread model is commonly used to estimate fair value for securities such as mortgage-backed and asset-backed securities. The ability to obtain quoted market prices is reduced in periods of decreasing liquidity, which generally increases the use of matrix pricing methods and the uncertainty surrounding the fair value estimates. Investments in hedge funds comprise a portfolio of limited partnerships and stock investments in trading entities, or funds, which invest in a wide range of financial products. The units of account that we value are our interests in the funds and not the underlying holdings of such funds. As a result, the inputs we use to value our investments in each of the funds may differ from the inputs used to value the underlying holdings of such funds. These funds are stated at fair value, which ordinarily will be the most recently reported net asset value as advised by the fund manager or administrator, where the fund's underlying holdings can be in various quoted and unquoted investments. We believe the reported net asset value represents the fair value market participants would apply to an interest in the fund. The fund managers value their underlying investments at fair value in accordance with policies established by each fund, as described in each of their financial statements and offering memoranda. 74
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We have designed ongoing due diligence processes with respect to funds in which we invest and their managers. These processes are designed to assist us in assessing the quality of information provided by, or on behalf of, each fund and in determining whether such information continues to be reliable or whether further review is necessary. While reported net asset value is the primary input to the review, when the net asset value is deemed not to be indicative of fair value, we may incorporate adjustments to the reported net asset value. These adjustments may involve significant judgment. We obtain the audited financial statements for every fund annually and regularly review and discuss the fund performance with the fund managers to corroborate the reasonableness of the reported net asset values.
We are able to redeem the hedge fund portfolio on the same terms that the underlying funds can be liquidated. In general, the funds in which we are invested require at least 30 days notice of redemption, and may be redeemed on a monthly, quarterly, semi-annual, annual or longer basis, depending on the fund.
Certain funds in which we invest have a lock-up period. A lock-up period refers to the initial amount of time an investor is contractually required to invest before having the ability to redeem. Funds that provide for periodic redemptions may, depending on the funds' governing documents, have the ability to deny or delay a redemption request, called a gate. The fund may implement this restriction because the aggregate amount of redemption requests as of a particular date exceeds a specified level, generally ranging from 15% to 25% of the fund's net assets. The gate is a method for executing an orderly redemption process, which allows for redemption requests to be executed in a timely manner to reduce the possibility of adversely affecting the remaining investors in the fund. The majority of our hedge fund portfolio is redeemable within one year, and the imposition of gates by certain funds is not expected to significantly impact our cash flow needs. Based upon information provided by the fund managers, as ofDecember 31, 2011 , we estimate that over 72.0% of the underlying assets held by our hedge fund portfolio are traded securities or have broker quotes available. Typically, the imposition of a gate delays a portion of the requested redemption, with the remaining portion settled in cash shortly after the redemption date. Of ourDecember 31, 2011 outstanding redemptions receivable of$23.8 million , none of which are gated,$21.1 million was received in cash prior toFebruary 23, 2012 . The fair value of our holdings in funds with gates imposed as ofDecember 31, 2011 was$19.1 million . Certain funds may be allowed to invest a portion of their assets in illiquid securities, such as private equity and convertible debt. In such cases, a common mechanism used is a side-pocket, whereby the illiquid security is assigned to a separate memorandum capital account or designated account. Typically, the investor loses its redemption rights to the designated account. Only when the illiquid security is sold, or otherwise deemed liquid by the fund, may investors redeem their interest. As ofDecember 31, 2011 , the fair value of our hedge funds held in side-pockets was$37.4 million . Due to the uncertainty surrounding the timing of the redemption of the underlying assets within funds with gates and side-pockets, we have included these funds in the greater than 365 days category in the table below. If we requested full redemptions for all of our holdings in the funds, the table below indicates our best estimate of the earliest date fromDecember 31, 2011 on which such redemptions might be received. This estimate is based on available information from the funds and is subject to significant change. As of December 31, 2011 % of Hedge fund Fair Value portfolio (in millions of U.S. Dollars) Liquidity: Within 90 days $ 54.2 21.7 % Between 91 to 180 days 50.8 20.3 % Between 181 to 365 days 42.1 16.8 % Greater than 365 days 102.9 41.2 % Total hedge funds $ 250.0 100.0 % Although we believe that our significant cash balances, fixed maturities investments and credit facilities provide sufficient liquidity to satisfy the claims of insureds and ceding clients, in the event that we were required to access assets invested in the hedge fund investment portfolio, our ability to do so may be limited by these liquidity constraints.
Additional information about the hedge fund portfolio can be found in Notes 3 and 4 to our audited consolidated financial statements included herein.
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We also hold an index-linked structured deposit. The deposit has a guaranteed minimum redemption value of$24.3 million and a scheduled redemption date ofDecember 18, 2013 . The interest earned on the deposit is a function of the performance of the reference index over the term of the deposit. Losses and benefits recoverable from reinsurers. Losses and benefits recoverable from reinsurers totaled$1,068.1 million as ofDecember 31, 2011 compared to$956.1 million as ofDecember 31, 2010 , an increase of 11.7%. This increase resulted principally from recoveries on losses for the significant catastrophes during the year and additional losses ceded under our reinsurance and retrocessional agreements resulting from net earned premiums during the year endedDecember 31, 2011 . Losses recoverable from reinsurers on property and casualty business were$1,034.9 million and$921.0 million as ofDecember 31, 2011 andDecember 31, 2010 , respectively. Benefits recoverable from reinsurers on life and annuity business were$33.2 million and$35.1 million as ofDecember 31, 2011 andDecember 31, 2010 , respectively. As ofDecember 31, 2011 , 85.9% of our losses and benefits recoverable were with reinsurers rated "A" or above byA.M. Best , 8.4% were rated "A-" and the remaining 5.7% were with "NR-not rated" reinsurers. Grand Central Re, aBermuda domiciled reinsurance company in which Alterra Bermuda has a 7.5% equity investment, is our largest "NR-not rated" retrocessionaire and accounted for 3.3% of our losses and benefits recoverable as ofDecember 31, 2011 . As security for outstanding loss obligations, we retain funds from Grand Central Re amounting to 214.1% of its loss recoverable obligations. Of the remaining amounts with "NR-not rated" retrocessionaires we retain collateral equal to 84.0% of the losses and benefits recoverable. Our losses and benefits recoverable are not due for payment until the underlying loss has been paid. As ofDecember 31, 2011 , 95.6% of our losses and benefits recoverable were not due for payment. Liabilities for property and casualty losses. Property and casualty losses totaled$4,216.5 million as ofDecember 31, 2011 compared to$3,906.1 million as ofDecember 31, 2010 , an increase of 7.9%. During the year endedDecember 31, 2011 , we incurred gross losses of$1,188.8 million , we paid$873.2 million in property and casualty losses and we recorded gross favorable development on prior year reserves of$160.5 million . Net of reinsurance, we paid$748.6 million in property and casualty losses during the year endedDecember 31, 2011 . Liabilities for life and annuity benefits. Life and annuity benefits totaled$1,190.7 million as ofDecember 31, 2011 compared to$1,275.6 million as ofDecember 31, 2010 . The decrease was principally attributable to movements in foreign exchange rates. We endeavor to match these liabilities with assets of similar currency and duration in order to limit the net impact to shareholders' equity of movements in foreign exchange rates. In addition, we paid$120.5 million of benefit payments during the year endedDecember 31, 2011 . Senior notes. OnSeptember 27, 2010 ,Alterra Finance , a wholly-owned indirect subsidiary of Alterra, issued$350.0 million principal amount of 6.25% senior notes dueSeptember 30, 2020 with interest payable onMarch 30 andSeptember 30 of each year. The 6.25% senior notes areAlterra Finance's senior unsecured obligations and rank equally in right of payment with all ofAlterra Finance's future unsecured and unsubordinated indebtedness and rank senior to all ofAlterra Finance's future subordinated indebtedness. The 6.25% senior notes are fully and unconditionally guaranteed by Alterra on a senior unsecured basis. The guarantee ranks equally with all of Alterra's existing and future unsecured and unsubordinated indebtedness and ranks senior to all of Alterra's future subordinated indebtedness. The effective interest rate related to the 6.25% senior notes, based on the net proceeds received, was 6.37%. The proceeds, net of all issuance costs, from the sale of the 6.25% senior notes were$346.9 million and were used to repay a$200.0 million revolving bank loan outstanding under a credit facility, that was subsequently replaced in December of 2011, with the remainder to be used for general corporate purposes. OnApril 16, 2007 ,Alterra USA privately issued$100.0 million principal amount of 7.20% senior notes dueApril 14, 2017 with interest payable onApril 16 andOctober 16 of each year. The senior notes areAlterra USA's senior unsecured obligations and rank equally in right of payment with all existing and future senior unsecured indebtedness ofAlterra USA . The 7.20% senior notes are fully and unconditionally guaranteed by Alterra. Following repurchases of$8.5 million and$0.9 million principal amount inDecember 2008 andDecember 2009 , respectively, the principal amount of the senior notes outstanding as ofDecember 31, 2011 was$90.6 million . The net proceeds for the sale of the 7.20% senior notes were used to repay a bank loan used to acquire Alterra E&S. Shareholders' equity. Our shareholders' equity decreased to$2,809.2 million as ofDecember 31, 2011 from$2,918.3 million as ofDecember 31, 2010 , a decrease of 3.7%, principally due to the repurchase of$225.1 million of common shares and the declaration of dividends of$54.5 million , partially offset by net income of$65.3 million in the year endedDecember 31, 2011 . In addition, we recorded an increase in accumulated other comprehensive income of$68.0 million , principally from an increase in net unrealized gains on investments. Liquidity. We generated$235.6 million of cash from operations during the year endedDecember 31, 2011 compared to$308.3 million for the year endedDecember 31, 2010 . The two principal factors that impact our operating cash flow are premium collections and timing of loss and benefit payments. 76
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Our casualty business generally has a long claim-tail. As a result, we expect that we will generate significant operating cash flow as we accumulate property and casualty loss reserves on our balance sheet. Our property business generally has a short claim-tail. Consequently, we expect volatility in our operating cash flow levels as losses are incurred. We believe that our property and casualty loss reserves and life and annuity benefit reserves currently have an average duration of approximately 4.9 years. We expect increases in the amount of expected loss payments in future periods with a resulting decrease in operating cash flow; however, we do not expect loss payments to exceed the premiums generated. Actual premiums written and collected and losses and loss expenses paid in any period could vary materially from our expectations and could have a significant and adverse effect on operating cash flow. While we tailor our fixed maturities portfolios in an effort to match the duration of expected loss and benefit payments, increased loss amounts or settlement of losses and benefits earlier than anticipated can result in greater cash needs. We maintain a significant working cash balance and have generated positive cash flow from operations in each of our last eight years of operating history. We also have the ability to borrow an additional$250.0 million using our current credit facilities, subject to certain conditions. Our largest credit facility, a$1,100.0 million four-year secured facility, expires inDecember 2015 . Our cash and cash equivalents balance was$922.8 million as ofDecember 31, 2011 . We believe that we currently maintain sufficient liquidity to cover existing requirements and provide for contingent liquidity. Nonetheless, significant deviations in expected loss and benefit payments can occur, potentially requiring us to liquidate a portion of our fixed maturities portfolios. If we need to liquidate our fixed maturities securities within a short period of time, the actual realized proceeds may be significantly different from the fair values estimated as ofDecember 31, 2011 . We believe that our portfolio has sufficient liquidity to mitigate this risk, and we believe that we can continue to hold any potentially illiquid position until we can initiate an appropriately priced transaction. As a holding company, Alterra's principal asset is its investment in the common shares of its principal operating subsidiary, Alterra Bermuda. Alterra's principal source of funds is from interest income on cash balances and cash dividends from its subsidiaries, including Alterra Bermuda. The payment of dividends by Alterra Bermuda is limited underBermuda insurance laws. In particular, Alterra Bermuda may not declare or pay any dividends if it is in breach of its minimum solvency or liquidity levels underBermuda law or if the declaration or payment of the dividends would cause it to fail to meet the minimum solvency or liquidity levels underBermuda law. As ofDecember 31, 2011 , Alterra Bermuda met all minimum solvency and liquidity requirements. AlterraBermuda returned$450.0 million of capital and surplus to Alterra during the year endedDecember 31, 2011 through dividends and distribution of additional paid-in capital.Alterra Re USA may not pay dividends without the consent of the Connecticut Insurance Commissioner untilMay 12, 2012 . In the ordinary course of business, we are required to provide letters of credit or other regulatory approved security to certain of our clients to meet contractual and regulatory requirements. During the year endedDecember 31, 2011 we replaced our$850.0 million five-year credit facility and our$600.0 million five-year credit facility with a$1,100.0 million four-year credit facility. As ofDecember 31, 2011 , we hadtwo U.S. dollar denominated letter of credit facilities totaling$1,175.0 million with an additional$500.0 million available, subject to certain conditions. On that date, we had$604.0 million in letters of credit outstanding under these facilities. We had a British pound sterling, or GBP, denominated letter of credit facility ofGBP 30.0 million ($46.6 million ) to support ourLondon branch ofAlterra Europe , of whichGBP 16.8 million ($26.1 million ) was utilized as ofDecember 31, 2011 . We also had a GBP denominated letter of credit facility ofGBP 60.0 million ($93.3 million ) which was used to support our Funds at Lloyd's commitments but is no longer being used for this purpose and is scheduled to expire inJune 2012 . Each of our credit facilities requires that we comply with certain financial covenants, which may include covenants related to maximum debt to capital ratio, minimum consolidated tangible net worth, minimum insurer financial strength rating and restrictions on the payment of dividends. We were in compliance with all of the financial covenants of each of our credit facilities as ofDecember 31, 2011 . As ofDecember 31, 2011 , we provided$209.5 million in Funds at Lloyd's. These amounts are not available for distribution for the payment of dividends. Our Funds at Lloyd's commitments are met using cash and fixed maturity securities. Our corporate members may also be required to maintain funds under the control of Lloyd's in excess of their capital requirements and such funds also may not be available for distribution or the payment of dividends. Capital resources. As ofDecember 31, 2011 , total shareholders' equity was$2,809.2 million compared to$2,918.3 million as ofDecember 31, 2010 , a decrease of 3.7%. OnMay 21, 2010 , we filed a shelf registration statement on Form S-3 (File No. 333-167035) with theSEC that permits us to periodically issue debt securities, common shares, preferred shares, depository shares, warrants, share-purchase contracts and share purchase units. The shelf registration statement also covers debt securities ofAlterra Finance and trust preferred securities of Alterra Capital Trust I. In September of 2010,Alterra Finance issued$350.0 million principal amount of 6.25% senior notes dueSeptember 30, 2020 with interest payable onMarch 30 andSeptember 30 of each year pursuant to the shelf registration statement. The senior notes are guaranteed by Alterra. InApril 2007 ,Alterra USA issued$100.0 million aggregate principal amount of 7.20% senior notes dueApril 14, 2017 , of which$90.6 million principal amount was outstanding as ofDecember 31, 2011 . The senior notes are guaranteed by Alterra.
We believe that we have sufficient capital to meet our foreseeable financial obligations.
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We may repurchase our shares from time to time through the open market, privately negotiated transactions or Rule 10b5-1 stock trading plans. During the year endedDecember 31, 2011 , we repurchased 10,389,707 common shares for$225.1 million . As ofDecember 31, 2011 , the aggregate amount available under our Board approved share repurchase plan was$104.4 million . OnFebruary 8, 2012 , our Board of Directors authorized an additional$150.0 million in repurchases.
Off-balance sheet arrangements
We do not participate in transactions that generate relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or variable interest entities, that have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.
Contractual Obligations
Less than 1 More than Contractual Obligations Total year 1-3 years 3-5 years 5 years (Expressed in millions of U.S. dollars) Senior notes $ 667.9 $ 28.4 $ 56.8 $ 56.8 $ 525.9 Operating lease obligations 26.2 7.4 8.3 4.5 6.0 Property and casualty losses 4,216.5 617.3 1,421.4 963.4 1,214.4 Life and annuity benefits 2,248.0 109.7 207.2 193.8 1,737.3 Deposit liabilities 167.6 41.0 68.4 9.4 48.8 Total $ 7,326.2 $ 803.8 $ 1,762.1 $ 1,227.9 $ 3,532.4 The reserves for losses and benefits together with deposit liabilities represent management's estimate of the ultimate cost of settling losses, benefits and deposit liabilities. As more fully discussed in "- Critical Accounting Policies-Reserve for property and casualty losses and life and annuity reinsurance benefit reserves" above, the estimation of losses and benefits is based on various complex and subjective judgments. Actual losses and benefits paid may differ, perhaps significantly, from the reserve estimates reflected in our financial statements. Similarly, the timing of payment of our estimated losses and benefits is not fixed and there may be significant changes in actual payment activity. The assumptions used in estimating the likely payments due by period are based on our historical claims payment experience and industry payment patterns, but due to the inherent uncertainty in the process of estimating the timing of such payments, there is a risk that the amounts paid in any such period can be significantly different from the amounts disclosed above. The amounts in the above table represent our gross estimates of known liabilities as ofDecember 31, 2011 and do not include any allowance for claims for future events within the time period specified. Accordingly, it is highly likely that the total amounts paid out in the time periods shown will be greater than those indicated in the table. Furthermore, life and annuity benefits and deposit liabilities recorded in the audited consolidated financial statements as ofDecember 31, 2011 are computed on a net present value basis, whereas the expected payments by period in the table above are the estimated payments at a future time and do not reflect a discount of the amount payable. 78
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Non-GAAP Financial Measures
In this Annual Report on Form 10-K, we have presented net operating income and net operating return on average shareholders' equity, which are "non-GAAP financial measures" as defined in Regulation G. We believe that these non-GAAP financial measures, which may be defined differently by other companies, allow for a more complete understanding of the performance of our business. These measures, however, should not be viewed as a substitute for those determined in accordance with U.S. GAAP. A reconciliation of the non-GAAP financial measures to their respective most directly comparable U.S. GAAP financial measures is as follows: Year Ended Year Ended Year Ended December 31, 2011 December 31, 2010 December 31, 2009 (Expressed in millions of U.S. Dollars, except share and per share amounts) Net income $ 65.3 $ 302.3 $ 246.2 Net realized and unrealized losses (gains) on non-hedge fund investments, net of tax (a) 30.4 (0.9 ) (1.4 ) Net foreign exchange (gains) losses, net of tax 0.9 0.4 (4.3 ) Merger and acquisition expenses, net of tax - (50.1 ) (31.6 ) Net operating income $ 96.6 $ 251.7 $ 208.9 Net income per diluted share $ 0.61 $ 3.17 $ 4.26 Net realized and unrealized losses (gains) on (a) non-hedge fund investments, net of tax 0.29 (0.01 ) (0.02 ) Net foreign exchange losses, net of tax 0.01 0.01 (0.07 ) Merger and acquisition expenses, net of tax - (0.53 ) (0.55 ) Net operating income per diluted share $ 0.91 $ 2.64 $ 3.62 Weighted average common shares outstanding - basic 105,249,683 94,682,279 57,006,908 Weighted average common shares outstanding - diluted 106,502,893 95,459,375 57,767,137 Average shareholders' equity (b) $ 2,806.2 $ 2,467.4 $ 1,398.9 Return on average shareholders' equity 2.3 % 12.3 % 17.6 % Net operating return on average shareholders' equity 3.4 % 10.2 % 14.9 %
Per share totals may not add due to rounding.
(a) Net realized and unrealized losses (gains) on non-hedge fund investments
includes realized and unrealized (gains) losses on trading securities,
realized (gains) losses on available for sale securities, net impairment
losses recognized in earnings, income from equity method investments and
change in fair value of investment derivatives, catastrophe bonds and
structured deposits.
(b) Average shareholders' equity is computed as the average of the quarterly
average shareholders' equity balances. The average for the year ended
2010, the date of the consummation of the Amalgamation.
We believe that net operating income provides a better indication of management performance than net income as realized and unrealized gains and losses on fixed maturities may fluctuate from period to period and foreign exchange gains and losses are typically outside the control of management. Merger and acquisition expenses are not indicative of expenses fundamental to the business and may fluctuate from period to period. We believe that net operating return on average shareholders' equity allows management to assess how the company has performed in terms of wealth generated for our shareholders.
New Accounting Pronouncements
ASU 2010-06, Fair Value Measurements and Disclosures (820) - Improving Disclosures about Fair Value Measurements
Accounting Standards Update, or ASU, 2010-06 requires additional disclosure, and clarifies existing disclosure requirements, about fair value measurements. The additional requirements include disclosure regarding the amounts and reasons for significant transfers in and out of Level 1 and 2 of the fair value hierarchy and also separate presentation of purchases, sales, issuances and settlements of items measured using significant unobservable inputs (i.e. Level 3). The guidance clarifies existing disclosure requirements regarding the inputs and valuation techniques used to measure fair value for measurements that fall in either Level 2 or Level 3 of the hierarchy. The requirements are effective for interim and annual reporting periods beginning afterDecember 15, 2009 , except for the disclosures about purchases, sales, issuances and settlements, which are effective for fiscal years beginning afterDecember 15, 2010 and for interim periods within those fiscal years. We have reflected the disclosure requirements effective for the current period in the consolidated financial statements and they did not have a material impact.
ASU 2010-20, Receivables (310) - Disclosures About the Credit Quality of Financing Receivables and the Allowance for Credit Losses
ASU 2010-20 requires additional disclosures about the credit quality of financing receivables and allowances for credit losses. The additional requirements include disclosure of the nature of credit risks inherent in financing receivables, how credit risk is analyzed and assessed when determining the allowance for credit losses, and the reasons for the change in the allowance for credit losses. The disclosures as of the end of a reporting period are effective for interim and annual reporting periods ending on or afterDecember 15, 2010 . The disclosures about activity that occurs during a reporting period are effective for interim and annual reporting periods beginning on or afterDecember 15, 2010 . We have reflected the disclosure requirements effective for the current period in the consolidated financial statements and they have not had a material impact. 79
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ASU 2010-26, Financial Services - Insurance (944) - Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts
ASU 2010-26 specifies how insurance companies should recognize costs that meet the definition of acquisition costs as defined by U.S.GAAP. ASU 2010-26 modifies the existing guidance to require that only costs that are associated with the successful acquisition of a new or renewal insurance contract should be capitalized as deferred acquisition costs. Costs that fall outside the proposed definition, such as indirect costs or salaries related to unsuccessful efforts, should be expensed as incurred. ASU 2010-26 is effective for fiscal periods beginning on or afterDecember 15, 2011 with prospective or retrospective application permitted. We do not expect this standard to have a material impact on our consolidated financial statements.
ASU 2011-05, Comprehensive Income (220)
ASU 2011-05 requires companies to present the components of net income and other comprehensive income in either a single continuous statement or two separate but consecutive statements. This eliminates the option to report other comprehensive income and its components in the statement of changes in shareholders' equity. Companies are also required to present reclassification adjustments from other comprehensive income to net income on the face of the financial statements. ASU 2011-05 is effective for fiscal periods beginning on or afterDecember 15, 2011 with early adoption permitted. The requirement to present reclassification adjustments on the face of the financial statements has been deferred and no effective date has been determined. We do not expect this standard to have a material impact on our consolidated financial statements.
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Craig Nordyke Appointed President and CEO of Dearborn National®
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