RENAISSANCERE 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 2012, compared to 2011, and 2011, compared to 2010, respectively. The following also includes a discussion of our liquidity and capital resources atDecember 31, 2012 . This discussion and analysis should be read in conjunction with the audited consolidated financial statements and notes thereto included in this filing. This filing contains forward-looking statements that involve risks and uncertainties. Actual results may differ materially from the results described or implied by these forward-looking statements. See "Note on Forward-Looking Statements." OVERVIEWRenaissanceRe was established inBermuda in 1993 to write principally property catastrophe reinsurance and today is a leading global provider of reinsurance and insurance coverages and related services. Our aspiration is to be the world's best underwriter of high-severity, low frequency risks. Through our operating subsidiaries, we seek to produce superior returns for our shareholders by being a trusted, long-term partner to our customers, for assessing and managing risk, delivering responsive solutions, and keeping our promises. We accomplish this by leveraging our core capabilities of risk assessment and information management, and by investing in our capabilities to serve our customers across the cycles that have historically characterized our markets. Overall, our strategy focuses on superior risk selection, superior customer relationships and superior capital management. We provide value to our customers and joint venture partners in the form of financial security, innovative products, and responsive service. We are known as a leader in paying valid reinsurance claims promptly. We principally measure our financial success through long-term growth in tangible book value per common share plus the change in accumulated dividends, which we believe is the most appropriate measure of our Company's financial performance, and believe we have delivered superior performance in respect of this measure over time. Since a substantial portion of the reinsurance and insurance we write provides protection from damages relating to natural and man-made catastrophes, our results depend to a large extent on the frequency and severity of such catastrophic events, and the coverages we offer to customers affected by these events. We are exposed to significant losses from these catastrophic events and other exposures that we cover. Accordingly, we expect a significant degree of volatility in our financial results and our financial results may vary significantly from quarter-to-quarter or from year-to-year, based on the level of insured catastrophic losses occurring around the world. Our revenues are principally derived from three sources: 1) net premiums earned from the reinsurance and insurance policies we sell; 2) net investment income and realized and unrealized gains from the investment of our capital funds and the investment of the cash we receive on the policies which we sell; and 3) other income received from our joint ventures, advisory services, weather and energy risk management operations and various other items. Our expenses primarily consist of: 1) net claims and claim expenses incurred on the policies of reinsurance and insurance we sell; 2) acquisition costs which typically represent a percentage of the premiums we write; 3) operating expenses which primarily consist of personnel expenses, rent and other operating expenses; 4) corporate expenses which include certain executive, legal and consulting expenses, costs for research and development, and other miscellaneous costs, including those associated with operating as a publicly traded company; 5) redeemable noncontrolling interest - DaVinciRe, which represents the interest of third parties with respect to the net income (loss) of DaVinciRe; and 6) interest and dividend costs related to our debt and preference shares. We are also subject to taxes in certain jurisdictions in which we operate; however, since the majority of our income is currently earned inBermuda , a non-taxable jurisdiction, the tax impact to our operations has historically been minimal. The operating results, also known as the underwriting results, of an insurance or reinsurance company are discussed frequently by reference to its net claims and claim expense ratio, underwriting expense ratio, and combined ratio. The net claims and claim expense ratio is calculated by dividing net claims and claim expenses incurred by net premiums earned. The underwriting expense ratio is calculated by dividing underwriting expenses (acquisition expenses and operational expenses) by net premiums earned. The combined ratio is the sum of the net claims and claim expense ratio and the underwriting expense ratio. A combined ratio below 100% generally indicates profitable underwriting prior to the consideration of 62 -------------------------------------------------------------------------------- investment income. A combined ratio over 100% generally indicates unprofitable underwriting prior to the consideration of investment income. We also discuss our net claims and claim expense ratio on an accident year basis. This ratio is calculated by taking net claims and claim expenses, excluding development on net claims and claim expenses from events that took place in prior fiscal years, divided by net premiums earned. As described in more detail below under "Segments", our reportable segments include: (1) Reinsurance, which includes catastrophe reinsurance, specialty reinsurance and certain property catastrophe and specialty joint ventures and (2) Lloyd's, which includes reinsurance and insurance business written through Syndicate 1458. In addition, our Other category primarily reflects our: strategic investments; weather and energy risk management operations; investments unit; corporate expenses, capital servicing costs and noncontrolling interests; results of our discontinued operations and the remnants of ourBermuda -based insurance operations not sold pursuant to the Stock Purchase Agreement with QBE. Segments Our reportable segments include: (1) Reinsurance and (2) Lloyd's. As ofDecember 31, 2012 , we undertook a review of our reportable segments and concluded that our former Insurance segment no longer met the quantitative thresholds defined in FASB ASC Topic Segment Reporting. These operations are not actively involved in pursuing business opportunities and are in run-off; therefore we determined they no longer require, nor warrant, separate disclosure as a reportable segment. As such, the results of operations for the former Insurance segment have been included in our Other category as noted above, and all prior periods presented herein have been reclassified to conform with the current year presentation. Reinsurance Our Reinsurance segment has two main units: (1) Property catastrophe reinsurance, principally written for our own account,
and for DaVinci, is our traditional core business. We believe we are one of
the world's leading providers of this coverage, based on catastrophe gross
premiums written. This coverage protects against large natural catastrophes,
such as earthquakes, hurricanes and tsunamis, as well as claims arising from
other natural and man-made catastrophes such as winter storms, freezes,
floods, fires, wind storms, tornadoes, explosions and acts of terrorism. We
offer this coverage to insurance companies and other reinsurers primarily on
an excess of loss basis. This means that we begin paying when our customers'
claims from a catastrophe exceed a certain retained amount.
(2) Specialty reinsurance, also principally written for our own account, and for
DaVinci, covering certain targeted classes of business where we believe we
have a sound basis for underwriting and pricing the risk that we assume. Our
portfolio includes various classes of business, such as catastrophe exposed
workers' compensation, surety, terrorism, energy, aviation, crop, political
risk, trade credit, financial, mortgage guarantee, catastrophe-exposed personal lines property, casualty clash, certain other casualty lines and other specialty lines of reinsurance that we collectively refer to as specialty reinsurance. We believe that we are seen as a market leader in
certain of these classes of business. We are seeking to expand our specialty
reinsurance operations over time, although we cannot assure you that we will
do so, particularly in light of current and forecasted market conditions.
Our specialty reinsurance business is typically significantly impacted by a
comparably small number of relatively large transactions.
Lloyd's
Our Lloyd's segment includes insurance and reinsurance business written for our own account through Syndicate 1458. Syndicate 1458 commenced business by writing certain lines of insurance and reinsurance business incepting on or afterJune 1, 2009 . The syndicate was established to enhance our underwriting platform by providing access to Lloyd's extensive distribution network and worldwide licenses. RenaissanceRe CCL, an indirect wholly owned subsidiary of the Company, is the sole corporate member of Syndicate 1458. RSML, a wholly owned subsidiary ofRenaissanceRe , is the managing agent for Syndicate 63 -------------------------------------------------------------------------------- 1458. We anticipate that Syndicate 1458's absolute and relative contributions to our consolidated results of operations may have a meaningful impact over time. Other Our Other category primarily includes the results of: (1) our share of strategic investments in certain markets we believe offer attractive risk-adjusted returns or where we believe our investment adds value, and where, rather than assuming exclusive management responsibilities ourselves, we partner with other market participants; (2) our weather and energy risk management operations primarily through Renaissance Trading and REAL; (3) our investment unit which manages and invests the funds generated by our consolidated operations; (4) corporate expenses, capital services costs and noncontrolling interests; (5) the results of our discontinued operations; and (6) as described in more details above, the remnants of ourBermuda -based insurance operations not sold pursuant to the Stock Purchase Agreement with QBE. New Business From time to time we consider diversification into new ventures, either through organic growth, the formation of new joint ventures, or the acquisition of or the investment in other companies or books of business of other companies. This potential diversification includes opportunities to write targeted, additional classes of risk-exposed business, both directly for our own account and through possible new joint venture opportunities. We also regularly evaluate potential strategic opportunities that we believe might utilize our skills, capabilities, proprietary technology and relationships to support possible expansion into further risk-related coverages, services and products. Generally, we focus on underwriting or trading risks where reasonably sufficient data may be available, and where our analytical abilities may provide us a competitive advantage, in order for us to seek to model estimated probabilities of losses and returns in accordance with our approach in respect of our then current portfolio of risks. We regularly review potential strategic transactions that might improve our portfolio of business, enhance or focus our strategies, expand our distribution or capabilities, or to seek other benefits. In evaluating potential new ventures or investments, we generally seek an attractive estimated return on equity, the ability to develop or capitalize on a competitive advantage, and opportunities which we believe will not detract from our core operations. While we regularly review potential strategic transactions and periodically engage in discussions regarding possible transactions, there can be no assurance that we will complete any such transactions or that any such transaction would be successful or materially enhance our results of operations or financial condition. We believe that our ability to potentially attract investment and operational opportunities is supported by our strong reputation and financial resources, and by the capabilities and track record of our ventures unit. Risk Management We seek to develop and effectively utilize sophisticated computer models and other analytical tools to assess and manage the risks that we underwrite and attempt to optimize our portfolio of reinsurance and insurance contracts and other financial risks. Our policies, procedures, tools and resources to monitor and assess our operational risks companywide, as well as our global enterprise-wide risk management practices, are overseen by our Chief Risk Officer, who reports directly to our Chief Financial Officer. With respect to our Reinsurance operations, since 1993 we have developed and continuously seek to improve our proprietary, computer-based pricing and exposure management system, REMS©. We believe that REMS©, as updated from time to time, is a more robust underwriting and risk management system than is currently commercially available elsewhere in the reinsurance industry and offers us a significant competitive advantage. REMS© was originally developed to analyze catastrophe risks, though we continuously seek ways to enhance the program in order to analyze other classes of risk. For information related to Risk Management, refer to "Item 1. Business, Underwriting and Enterprise Risk Management". Discontinued Operations During the fourth quarter of 2010, we made the strategic decision to divest substantially all of our U.S.-based insurance operations in order to focus on the business encompassed within our Reinsurance and Lloyd's segments and our other businesses. Except as explicitly described as held for sale or as discontinued operations, and unless otherwise noted, all discussions and amounts presented herein relate 64 -------------------------------------------------------------------------------- to our continuing operations. Prior years presented have been reclassified to conform to this new presentation. OnNovember 18, 2010 , we entered into a Stock Purchase Agreement with QBE to sell substantially all of our U.S.-based insurance operations, including our U.S. property and casualty business underwritten through managing general agents, our crop insurance business underwritten throughAgro National Inc. ("Agro National"), our commercial property insurance operations and our claims operations. We have classified the assets and liabilities associated with this transaction as held for sale. The financial results for these operations have been presented as discontinued operations in our Consolidated Statements of Operations. Consideration for the transaction was book value atDecember 31, 2010 , for the aforementioned businesses, payable in cash at closing and subject to adjustment for certain tax and other items. The transaction closed onMarch 4, 2011 and we received net consideration of$269.5 million . Pursuant to the Stock Purchase Agreement,RenaissanceRe was subject to a post-closing review followingDecember 31, 2011 of the net reserve for claims and claim expenses for loss events occurring on or prior toDecember 31, 2010 (the "Reserve Collar"). Subsequent to the post-closing review,RenaissanceRe was liable to pay, or otherwise reimburse QBE amounts up to$10.0 million for net adverse development on prior accident years net claims and claim expenses. Conversely, if prior accident years net claims and claim expenses experienced net favorable development, QBE was liable to pay, or otherwise reimburseRenaissanceRe amounts up to$10.0 million . During 2011,RenaissanceRe recognized a$10.0 million liability and corresponding expense in liabilities of discontinued operations held for sale and income (loss) from discontinued operations, respectively, due to purported net adverse development on prior accident years net claims and claim expenses associated with the Reserve Collar. EffectiveMay 23, 2012 ,RenaissanceRe and QBE reached an agreement in respect of the Reserve Collar, andRenaissanceRe paid QBE the sum of$9.0 million onJune 1, 2012 , representing full and final settlement of the Reserve Collar and recorded a gain of$1.0 million in income from discontinued operations during the second quarter of 2012. See "Note 3. Discontinued Operations in our Notes to Consolidated Financial Statements" for additional information. SUMMARY OF CRITICAL ACCOUNTING ESTIMATES Claims and Claim Expense Reserves General Description We believe the most significant accounting judgment made by management is our estimate of claims and claim expense reserves. Claims and claim expense reserves represent estimates, including actuarial and statistical projections at a given point in time, of the ultimate settlement and administration costs for unpaid claims and claim expenses arising from the insurance and reinsurance contracts we sell. We establish our claims and claim expense reserves by taking claims reported to us by insureds and ceding companies, but which have not yet been paid ("case reserves"), adding the costs for additional case reserves ("additional case reserves") which represent our estimates for claims previously reported to us which we believe may not be adequately reserved as of that date, and adding estimates for the anticipated cost of IBNR. 65 --------------------------------------------------------------------------------
The following table summarizes our claims and claim expense reserves by line of business and split between case reserves, additional case reserves and IBNR:
Case Additional At December 31, 2012 Reserves Case Reserves IBNR Total (in thousands) Catastrophe $ 706,264 $ 222,208 $ 255,786 $ 1,184,258 Specialty 111,234 80,971 286,108 478,313 Total Reinsurance 817,498 303,179 541,894 1,662,571 Lloyd's 29,260 10,548 109,662 149,470 Other 17,016 8,522 41,798 67,336 Total $ 863,774 $ 322,249 $ 693,354 $ 1,879,377
At
(in thousands) Catastrophe $ 681,771 $ 271,990 $ 388,147 $ 1,341,908 Specialty 120,189 49,840 301,589 471,618 Total Reinsurance 801,960 321,830 689,736 1,813,526 Lloyd's 17,909 14,459 55,127 87,495 Other 32,944 3,515 54,874 91,333 Total $ 852,813 $ 339,804 $ 799,737 $ 1,992,354 Activity in the liability for unpaid claims and claim expenses is summarized as follows: Year ended December 31, 2012 2011 2010 Net reserves as of January 1 $ 1,588,325 $ 1,156,132 $ 1,260,334 Net incurred related to: Current year 483,180 993,168 431,476 Prior years (157,969 ) (131,989 ) (302,131 ) Total net incurred 325,211 861,179 129,345 Net paid related to: Current year 84,056 299,299 50,793 Prior years 142,615 129,687 182,754 Total net paid 226,671 428,986 233,547 Net reserves as of December 31 1,686,865 1,588,325
1,156,132
Reinsurance recoverable as of
101,711
Gross reserves as of
Our reserving methodology for each line of business uses a loss reserving process that calculates a point estimate for the Company's ultimate settlement and administration costs for claims and claim expenses. We do not calculate a range of estimates. We use this point estimate, along with paid claims and case reserves, to record our best estimate of additional case reserves and IBNR in our consolidated financial statements. Under GAAP, we are not permitted to establish estimates for catastrophe claims and claim expense reserves until an event occurs that gives rise to a loss. Reserving for our reinsurance claims involves other uncertainties, such as the dependence on information from ceding companies, which among other matters, includes the time lag inherent in reporting information from the primary insurer to us or to our ceding companies and differing reserving practices among ceding companies. The information received from ceding companies is typically in the form of bordereaux, broker notifications of loss and/or discussions with ceding companies or their brokers. This information can be received on a monthly, quarterly or transactional basis and normally includes estimates of paid claims and case reserves. We sometimes also receive an estimate or provision for IBNR. This information is often updated and adjusted from time to time during the loss settlement period as new data or facts in respect of 66 -------------------------------------------------------------------------------- initial claims, client accounts, industry or event trends may be reported or emerge in addition to changes in applicable statutory and case laws. Our estimates of losses from large events are based on factors including currently available information derived from the Company's claims information from certain customers and brokers, industry assessments of losses from the events, proprietary models, and the terms and conditions of our contracts. The uncertainty of our estimates for certain of these large events is additionally impacted by the preliminary nature of the information available, the magnitude and relative infrequency of the events, the expected duration of the respective claims development period, inadequacies in the data provided thus far by industry participants and the potential for further reporting lags or insufficiencies (particularly in respect of the Chilean, 2010New Zealand , 2011New Zealand and Tohoku earthquakes); and in the case of storm Sandy and theThailand flooding, significant uncertainty as to the form of the claims and legal issues, under the relevant terms of insurance contracts and reinsurance treaties. In addition, a significant portion of the net claims and claim expenses associated with storm Sandy and theNew Zealand and Tohoku earthquakes are concentrated with a few large clients and therefore the loss estimates for these events may vary significantly based on the claims experience of those clients. Loss reserve estimation in respect of our retrocessional contracts poses further challenges compared to directly assumed reinsurance. A significant portion of our reinsurance recoverable relates to theNew Zealand and Tohoku earthquakes. There is inherent uncertainty and complexity in evaluating loss reserve levels and reinsurance recoverable amounts, due to the nature of the losses relating to earthquake events, including that loss development time frames tend to take longer with respect to earthquake events. The contingent nature of business interruption and other exposures will also impact losses in a meaningful way, especially with regard to storm Sandy, the Tohoku earthquake andThailand flooding, which we believe may give rise to significant complexity in respect of claims handling, claims adjustment and other coverage issues, over time. Given the magnitude and relatively recent occurrence of these large events, meaningful uncertainty remains regarding total covered losses for the insurance industry and, accordingly, several of the key assumptions underlying our loss estimates. In addition, our actual net losses from these events may increase if our reinsurers or other obligors fail to meet their obligations. Because of the inherent uncertainties discussed above, we have developed a reserving philosophy which attempts to incorporate prudent assumptions and estimates, and we have generally experienced favorable net development on prior year reserves in the last several years. However, there is no assurance that this will occur in future periods. PriorYear Development of Reserve for Net Claims and Claim Expenses Our estimates of claims and claim expense reserves are not precise in that, among other matters, they are based on predictions of future developments and estimates of future trends and other variable factors. Some, but not all, of our reserves are further subject to the uncertainty inherent in actuarial methodologies and estimates. Because a reserve estimate is simply an insurer's estimate at a point in time of its ultimate liability, and because there are numerous factors which affect reserves and claims payments that cannot be determined with certainty in advance, our ultimate payments will vary, perhaps materially, from our estimates of reserves. If we determine in a subsequent period that adjustments to our previously established reserves are appropriate, such adjustments are recorded in the period in which they are identified. 67 -------------------------------------------------------------------------------- As detailed in the table and discussed in further detail below, changes to prior year estimated claims reserves increased our net income by$158.0 million during the year endedDecember 31, 2012 , (2011 - decreased our net loss by$132.0 million , 2010 - increased our net income by$302.1 million ), excluding the consideration of changes in reinstatement premium, profit commissions, redeemable noncontrolling interest - DaVinciRe, equity in net claims and claim expenses of Top Layer Re and income tax. Year ended December 31, 2012 2011 2010 Catastrophe $ 110,568 $ 59,137 $ 157,458 Specialty 34,146 77,761 128,561 Reinsurance 144,714 136,898 286,019 Lloyd's 16,202 (478 ) 197 Other (2,947 ) (4,431 ) 15,915 Total $ 157,969 $ 131,989 $ 302,131 Our reserving techniques, assumptions and processes differ between our property catastrophe reinsurance, specialty reinsurance and insurance businesses within our Reinsurance and Lloyd's segments. Following is a discussion of the risks we insure and reinsure, the reserving techniques, assumptions and processes we follow to estimate our claims and claim expense reserves, and our current estimates versus our initial estimates of our claims reserves, for each of these units. Reinsurance Segment Property Catastrophe Reinsurance Within our catastrophe unit, we principally write property catastrophe excess of loss reinsurance contracts to insure insurance and reinsurance companies against natural and man-made catastrophes. Under these contracts, we indemnify an insurer or reinsurer when its aggregate paid claims and claim expenses from a single occurrence of a covered peril exceed the attachment point specified in the contract, up to an amount per loss specified in the contract. Our most significant exposure is to losses from earthquakes and hurricanes and other windstorms, although we are also exposed to claims arising from other catastrophes, such as tsunamis, freezes, floods, fires, tornadoes, explosions and acts of terrorism. Our predominant exposure under such coverage is to property damage. However, other risks, including business interruption and other non-property losses, may also be covered under our property catastrophe reinsurance contracts when arising from a covered peril. Our coverages are offered on either a worldwide basis or are limited to selected geographic areas. Coverage can also vary from "all property" perils to limited coverage on selected perils, such as "earthquake only" coverage. We also enter into retrocessional contracts that provide property catastrophe coverage to other reinsurers or retrocedants. This coverage is generally in the form of excess of loss retrocessional contracts and may cover all perils and exposures on a worldwide basis or be limited in scope to selected geographic areas, perils and/or exposures. The exposures we assume from retrocessional business can change within a contract term as the underwriters of a retrocedant may alter their book of business after the retrocessional coverage has been bound. We also offer dual trigger reinsurance contracts which require us to pay claims based on claims incurred by insurers and reinsurers in addition to the estimate of insured industry losses as reported by referenced statistical reporting agencies. Our property catastrophe reinsurance business is generally characterized by loss events of low frequency and high severity. Initial reporting of paid and incurred claims in general, tends to be relatively prompt. We consider this business "short-tail" as compared to the reporting of claims for "long-tail" products, which tends to be slower. However, the timing of claims payment and reporting also varies depending on various factors, including: whether the claims arise under reinsurance of primary insurance companies or reinsurance of other reinsurance companies; the nature of the events (e.g., hurricanes, earthquakes or terrorism); the geographic area involved; post-event inflation which may cause the cost to repair damaged property to increase significantly from current estimates, or for property claims to remain open for a longer period of time, due to limitations on the supply of building materials, labor and other resources; complex policy coverage and other legal issues; and the quality of each client's claims management and reserving practices. Management's judgments regarding these factors are reflected in our claims reserve estimates. 68 -------------------------------------------------------------------------------- Reserving for most of our property catastrophe reinsurance business does not involve the use of traditional actuarial techniques. Rather, claims and claim expense reserves are estimated by management after a catastrophe occurs by completing an in-depth analysis of the individual contracts which may potentially be impacted by the catastrophic event. The in-depth analysis generally involves: 1) estimating the size of insured industry losses from the catastrophic event; 2) reviewing our portfolio of reinsurance contracts to identify those contracts which are exposed to the catastrophic event; 3) reviewing information reported by customers and brokers; 4) discussing the event with our customers and brokers; and 5) estimating the ultimate expected cost to settle all claims and administrative costs arising from the catastrophic event on a contract-by-contract basis and in aggregate for the event. Once an event has occurred, during the then current reporting period we record our best estimate of the ultimate expected cost to settle all claims arising from the event. Our estimate of claims and claim expense reserves is then determined by deducting cumulative paid losses from our estimate of the ultimate expected loss for an event and our estimate of IBNR is determined by deducting cumulative paid losses, case reserves and additional case reserves from our estimate of the ultimate expected loss for an event. Once we receive a notice of loss or payment request under a catastrophe reinsurance contract, we are generally able to process and pay such claims promptly. Because the events from which claims arise under policies written by our property catastrophe reinsurance business are typically prominent, public occurrences such as hurricanes and earthquakes, we are often able to use independent reports as part of our loss reserve estimation process. We also review catastrophe bulletins published by various statistical reporting agencies to assist us in determining the size of the industry loss, although these reports may not be available for some time after an event. In addition to the loss information and estimates communicated by cedants and brokers, we also use industry information which we gather and retain in our REMS© modeling system. The information stored in our REMS© modeling system enables us to analyze each of our policies in relation to a loss and compare our estimate of the loss with those reported by our policyholders. The REMS© modeling system also allows us to compare and analyze individual losses reported by policyholders affected by the same loss event. Although the REMS© modeling system assists with the analysis of the underlying loss and provides us with the information and ability to perform increased analysis, the estimation of claims resulting from catastrophic events is inherently difficult because of the variability and uncertainty associated with property catastrophe claims and the unique characteristics of each loss. For smaller events including localized severe weather events such as windstorms, hail, ice, snow, flooding, freezing and tornadoes, which are not necessarily prominent, public occurrences, we initially place greater reliance on catastrophe bulletins published by statistical reporting agencies to assist us in determining what events occurred during the reporting period than we do for large events. This includes reviewing catastrophe bulletins published by Property Claim Services for U.S. catastrophes. We set our initial estimates of reserves for claims and claim expenses for these smaller events based on a combination of our historical market share for these types of losses and the estimate of the total insured industry property losses as reported by statistical reporting agencies, although we generally make significant adjustments based on our current exposure to the geographic region involved as well as the size of the loss and the peril involved. This approach supplements our approach for estimating losses for larger catastrophes, which as discussed above, includes discussions with brokers and ceding companies, reviewing individual contracts impacted by the event, and modeling the loss in our REMS© system. Approximately one year from the date of loss for these small events, we estimate IBNR for these events by using an actuarial technique. The actuarial technique used to estimate IBNR is the paid Bornhuetter-Ferguson actuarial method. The paid Bornhuetter-Ferguson actuarial method loss development factors are selected based on a review of our historical experience and these factors are reviewed at least annually. There were no changes to the paid loss development factors over the last three years. In general, our property catastrophe reinsurance reserves for our more recent reinsured catastrophic events are subject to greater uncertainty and, therefore, greater potential variability, and are likely to experience material changes from one period to the next. This is due to the uncertainty as to the size of the industry losses from the event, uncertainty as to which contracts have been exposed to the catastrophic event, uncertainty due to complex legal and coverage issues that can arise out of large or complex catastrophic events such as the events ofSeptember 11, 2001 , hurricaneKatrina and storm Sandy, and uncertainty as to the magnitude of claims incurred by our customers. As our property catastrophe reinsurance claims age, 69 -------------------------------------------------------------------------------- more information becomes available and we believe our estimates become more certain, although there is no assurance this trend will continue in the future. PriorYear Development of Reserve for Net Claims and Claim Expenses Within our property catastrophe reinsurance business, we seek to review substantially all of our claims and claim expense reserves quarterly. Our quarterly review procedures include identifying events that have occurred up to the latest balance sheet date, determining our best estimate of the ultimate expected cost to settle all claims and administrative costs associated with those new events which have arisen during the reporting period, reviewing the ultimate expected cost to settle claims and administrative costs associated with those events which occurred during previous periods, and considering new estimation techniques, such as additional actuarial methods or other statistical techniques, that can assist us in developing a best estimate. This process is judgmental in that it involves reviewing changes in paid and reported losses each period and adjusting our estimates of the ultimate expected losses for each event if there are developments that are different from our previous expectations. If we determine that adjustments to an earlier estimate are appropriate, such adjustments are recorded in the period in which they are identified. As noted above, the level of our claims and claim expenses associated with certain catastrophes can be very large. As a result, small percentage changes in the estimated ultimate claims and large catastrophe events can significantly impact our reserves for claims and claim expenses in subsequent periods. The following table details the development of our liability for unpaid claims and claim expenses for the catastrophe reinsurance unit for the year endedDecember 31, 2012 :
Catastrophe
Year endedDecember 31, 2012
Reinsurance Unit
Catastrophe claims and claim expenses Large catastrophe events Chile Earthquake (2010) $ 24,575 Hurricanes Gustav & Ike (2008) 17,541 U.K. Floods (2007) 17,271 Hurricanes Katrina, Rita and Wilma (2005) 6,420 Hurricane Irene (2011) 4,630 Thailand Floods (2011) 3,933 Tohoku Earthquake and Tsunami (2011) 3,896 Windstorm Kyrill (2007) 3,417 New Zealand Earthquake (2010) (3,570 ) New Zealand Earthquake (2011) (17,912 ) Other 2,542 Total large catastrophe events 62,743 Small catastrophe events Danish Floods (2011) 5,000 U.S. PCS 63 Winter Storm (2011) 5,000 U.S. PCS 42 Winter Storm (2011) 2,560 U.S. PCS 53 Winter Storm (2011) 2,558 Other 32,707 Total small catastrophe events 47,825 Total favorable development of prior accident years claims and claim expenses $ 110,568 70
-------------------------------------------------------------------------------- The favorable development of prior accident years claims and claim expenses within the Company's catastrophe reinsurance unit in the year endedDecember 31, 2012 of$110.6 million was primarily due to reductions in estimated ultimate losses on the 2010 Chilean earthquake of$24.6 million , the 2008 hurricanes of$17.5 million , theU.K. floods of$17.3 million , the 2005 hurricanes of$6.4 million , hurricane Irene of$4.6 million , the Tohoku earthquake of$3.9 million and a number of other catastrophes totaling$57.7 million , and partially offset by adverse development related to the 2010 and 2011 New Zealand earthquakes of$21.5 million primarily due to increase in estimated ultimate losses. The following table details the development of our liability for unpaid claims and claim expenses for the catastrophe reinsurance unit for the year endedDecember 31, 2011 :
Catastrophe
Year endedDecember 31, 2011
Reinsurance Unit
(in thousands) Catastrophe claims and claim expenses Large catastrophe events Tropical Cyclone Tasha (2010) $ 13,922 Hurricanes Katrina, Rita and Wilma (2005) 10,008 Chilean Earthquake (2010) 8,455 World Trade Center (2001) 4,701 Hurricanes Charley, Francis, Ivan and Jeanne (2004) 4,076 U.K. Floods (2007) 3,635 Windstorm Kyrill (2007) 2,494 New Zealand Earthquake (2010) (15,179 ) Total large catastrophe events 32,112 Small catastrophe events U.S. PCS 21 Wildland Fire (2007) 4,554 U.S. PCS 33 Great Midwest Storm (2010) 3,125 U.S. PCS 31 Wind and Thunderstorm (2010) 3,039 U.S. PCS 96 Wind and Thunderstorm (2010) 2,288 Other 14,019 Total small catastrophe events 27,025 Total favorable development of prior accident years claims and claim expenses $ 59,137 The favorable development on prior year reserves in 2011 within the Company's catastrophe reinsurance unit of$59.1 million was due to$27.0 million related to reductions in the estimated ultimate losses of smaller catastrophe events,$32.1 million related to net reductions arising from the estimated ultimate losses of large catastrophe events, including$13.9 million ,$10.0 million ,$8.5 million and$4.7 million related to tropical cyclone Tasha, the 2005 hurricanes, the Chilean earthquake and theWorld Trade Center , and partially offset by$15.2 million of adverse development related to the 2010New Zealand earthquake. 71 --------------------------------------------------------------------------------
The following table details the development of our liability for unpaid claims and claim expenses for the catastrophe reinsurance unit for the year ended
Catastrophe
Year endedDecember 31, 2010
Reinsurance Unit
(in thousands) Catastrophe claims and claim expenses Large catastrophe events Mature, large catastrophe events European Windstorm Erwin (2005) $ 10,593 World Trade Center (2001) 9,914 Hurricanes Martin and Floyd (1999) 4,822 European Floods (2002) 4,361 U.S. PCS 88 Wind and Thunderstorm (2003) 2,873 Hurricane Isabel (2003) 1,995 U.S. PCS 97 Wildland Fire (2003) 1,231 Windstorm Anatol (1999) 971 Northridge Earthquake (1993) 1,094 Total mature, large catastrophe events 37,854 Buncefield Oil Depot (2005) 27,418 Hurricanes Katrina, Rita and Wilma (2005) 25,482 Hurricanes Gustav and Ike (2008) 10,878 Hurricanes Charley, Francis, Ivan and Jeanne (2004) 8,149 European Windstorm Klaus (2009) 8,000 Total large catastrophe events 117,781 Small catastrophe events U.S. PCS 78 Wind and Thunderstorm (2009) 3,215 U.S. PCS 66 Wind and Thunderstorm (2009) 3,149 U.S. Winter Storm (2009) 3,000 Hurricane Bill (2009) 2,500 U.S. PCS 82 Wind and Thunderstorm (2009) 2,429 Austrian Floods (2009) 2,356 Other 23,028 Total small catastrophe events 39,677 Total favorable development of prior accident years claims and claim expenses $ 157,458 The favorable development of prior accident years claims and claim expenses within the Company's catastrophe reinsurance unit in 2010 of$157.5 million was due in part to reductions of$37.9 million to the estimated ultimate claims of mature, large catastrophe events, such as the 2001World Trade Center , European windstorm Erwin and the large European windstorms of 1999, for which the claims are principally paid and the amount of additional reported claims had slowed considerably and therefore the ultimate claims were reduced. In addition, the 2005 Buncefield Oil Depot claim was reduced by$27.4 million in 2010, principally due to the underlying insured subrogating its liability and subsequently reimbursing the Company for claims the Company had previously paid to the insured. The ultimate claims associated with the 2005 hurricanes,Katrina , Rita and Wilma, and the 2004 hurricanes, Charley, Frances, Ivan and Jeanne, were reduced by$25.5 million and$8.1 million , respectively, as reported claims came in better than expected in 2010. As discussed below, the Company adopted a new actuarial technique in 2009 to reserve for these hurricanes and the level of reported claims in 2010 was less than the actuarial technique would have indicated, resulting in formulaic decreases to the ultimate claims for these large hurricanes. The 72 -------------------------------------------------------------------------------- ultimate claims associated with the 2008 hurricanes, Gustav and Ike, were reduced by$10.9 million and the 2009 European windstorm Klaus were reduced by$8.0 million in 2010, due to better than expected reported claims activity. The remainder of the favorable development of prior accident years claims and claim expenses was due to a reduction in ultimate claims on a large number of relatively small catastrophes, all principally the result of reported claims coming in less than expected, resulting in formulaic decreases to the ultimate claims for these events. Actual Results vs. Initial Estimates The table below summarizes our initial assumptions and changes in those assumptions for claims and claim expense reserves within our catastrophe unit. As discussed above, the key assumption in estimating reserves for our catastrophe unit is our estimate of ultimate claims and claim expenses. The table shows our initial estimates of ultimate claims and claim expenses for each accident year and how these initial estimates have developed over time. The initial estimate of accident year claims and claim expenses represents our estimate of the ultimate settlement and administration costs for claims incurred from catastrophic events occurring during a particular accident year, and as reported as ofDecember 31 of that year. The re-estimated ultimate claims and claim expenses as ofDecember 31, 2010 , 2011 and 2012, represent our revised estimates as reported as of those dates. The cumulative favorable (adverse) development shows how our most recent estimates as reported atDecember 31, 2012 differ from our initial accident year estimates. Favorable development implies that our current estimates are lower than our initial estimates while adverse development implies that our current estimates are higher than our original estimates. Total reserves as ofDecember 31, 2012 reflect the unpaid portion of our estimates of ultimate claims and claim expenses. The table is presented on a gross basis and therefore does not include the benefit of reinsurance recoveries. It also does not consider the impact of loss related premium or redeemable noncontrolling interest - DaVinciRe. Actual vs. Initial Estimated Property Catastrophe Reinsurance Claims and Claim Expense Reserve Analysis Re-estimated Claims and (in thousands, Claim Expenses except percentages) as of December 31, Initial Estimate of Claims and % of Claims Accident Cumulative Claim and Claim Year Claims Favorable % Decrease Expense Expenses Accident and Claim (Adverse) (Increase) from Reserves as of
Unpaid as of
Year Expenses 2010 2011
2012 Development Initial Ultimate
1994 $ 100,816
310 0.2 % 1995 72,561 61,348 61,345 61,345 11,216 15.5 % 48
0.1 %
1996 67,671 45,214 45,209 45,219 22,452 33.2 % 14 - % 1997 43,050 9,046 9,040 9,041 34,009 79.0 % 5
0.1 %
1998 129,171 151,755 151,951 152,038 (22,867 ) (17.7 )% 564 0.4 % 1999 267,981 199,097 198,257 197,849 70,132 26.2 % 304 0.2 % 2000 54,600 17,794 17,803 17,787 36,813 67.4 % 27
0.2 %
2001 257,285 212,678 205,078 201,140 56,145 21.8 % 8,756 4.4 % 2002 155,573 65,486 65,436 65,118 90,455 58.1 % 277
0.4 %
2003 126,312 68,892 69,057 67,608 58,704 46.5 % 218
0.3 %
2004 762,392 821,350 815,773 815,915 (53,523 ) (7.0 )% 2,267 0.3 % 2005 1,473,974 1,283,225 1,272,485 1,263,198 210,776 14.3 % 7,936 0.6 % 2006 121,754 60,413 60,313 58,392 63,362 52.0 % 1,028
1.8 %
2007 245,892 150,809 138,329 116,568 129,324 52.6 % 17,609
15.1 %
2008 599,481 480,907 481,878 455,909 143,572 23.9 % 41,903 9.2 % 2009 90,800 53,991 47,189 42,288 48,512 53.4 % 7,433
17.6 %
2010 385,207 385,207 355,564 321,522 63,685 16.5 % 175,570
54.6 %
2011 1,243,138 - 1,243,138 1,246,752 (3,614 ) (0.3 )% 641,316 51.4 % 2012 345,776 - - 345,776 - - % 278,673
80.6 %
$ 6,543,434 $ 4,204,347 $ 5,375,343 $ 5,620,595 $ 922,839 14.9 % $ 1,184,258 21.1 % 73
-------------------------------------------------------------------------------- As quantified in the table above, since the inception of the Company in 1993, while we have experienced adverse development from time to time, on a cumulative basis we have experienced$922.8 million of net favorable development on the run-off of our gross reserves within our catastrophe unit. This represents 14.9% of our initial estimated gross claims and claim expenses for accident years 2011 and prior of$6.2 billion and is calculated based on our estimates of claims and claim expense reserves as ofDecember 31, 2012 , compared to our initial estimates of ultimate claims and claim expenses, as of the end of each accident year. As described above, given the complexity in reserving for claims and claims expenses associated with catastrophe losses for property catastrophe excess of loss reinsurance contracts, we have experienced development, both favorable and unfavorable, in any given accident year. For example, our 2005 accident year developed favorably by$210.8 million , which is 14.3% better than our initial estimates of claims and claim expenses for the 2005 accident year as estimated as ofDecember 31, 2005 , while our 2004 accident year developed unfavorably by$53.5 million , or negative 7.0%. On a net basis our cumulative favorable or unfavorable development is generally reduced by offsetting changes in our reinsurance recoverables, as well as changes to loss related premiums such as reinstatement premiums, and redeemable noncontrolling interest for changes in claims and claim expenses that impact DaVinciRe, all of which generally move in the opposite direction to changes in our ultimate claims and claim expenses. The percentage of claims unpaid atDecember 31, 2012 for each accident year reflects both the speed at which claims and claim expenses for each accident year have been paid and our estimate of claims and claim expenses for that accident year. As seen above, claims and claim expenses for the 2006 and prior accident years have generally been paid, with 2001 having 4.4% remaining unpaid. This is driven in part by the mix of our business, which primarily included property catastrophe excess of loss reinsurance for personal lines property coverage, rather than commercial property coverage or retrocessional coverage, and the speed of the settlement and payment of claims by our underlying cedants. In contrast, our 2001 accident year, which includes losses from the events ofSeptember 11, 2001 , includes a higher mix of commercial business and retrocessional coverage where the underlying claims of our cedants tend to be settled and paid more slowly. In addition, our 2007 accident year has also paid out more slowly due to increased complexity surrounding claims of our underlying cedants as a result of the notable losses during 2007, including European windstorm Kyrill. As noted in the table above, the percentage of claims and claims expenses unpaid as ofDecember 31, 2012 related to more recent years, such as 2009 through 2012, range from 17.6% to 80.6%, which higher percentages are driven by the recency of these accident years, combined with the complexity surrounding claims of our underlying cedants and the nature of the events, such as the 2010 and 2011 New Zealand earthquakes, the Tohoku earthquake and storm Sandy. Sensitivity Analysis The table below shows the impact on our ultimate claims and claim expenses, net income and shareholders' equity as of and for the year endedDecember 31, 2012 of reasonably likely changes to our estimates of ultimate losses for claims and claim expenses incurred from catastrophic events within our property catastrophe reinsurance business unit. The reasonably likely changes are based on an historical analysis of the period-to-period variability of our ultimate costs to settle claims from catastrophic events, giving due consideration to changes in our reserving practices over time. In general, our claim reserves for our more recent catastrophic events are subject to greater uncertainty and, therefore, greater variability and are likely to experience material changes from one period to the next. This is due to the uncertainty as to the size of the industry losses from the event, uncertainty as to which contracts have been exposed to the catastrophic event, and uncertainty as to the magnitude of claims incurred by our clients. As our claims age, more information becomes available and we believe our estimates become more certain, although there is no assurance this trend will continue in the future. As a result, the sensitivity analysis below is based on the age of each accident year, our current estimated ultimate claims and claim expenses for the catastrophic events occurring in each accident year, and the reasonably likely variability of our current estimates of claims and claim expenses by accident year. The impact on net income and shareholders' equity assumes no increase or decrease in reinsurance recoveries, loss related premium or redeemable noncontrolling interest - DaVinciRe. 74 -------------------------------------------------------------------------------- Property Catastrophe Reinsurance Claims and Claim Expense Reserve Sensitivity Analysis $ Impact of % Impact of Change on Change Ultimate Claims on Reserve for % Impact of % Impact of Ultimate Claims and and Claim Claims Change on Net Change on Claim Expenses at Expenses and Claim Expenses Income for Shareholders'
(in thousands, except
Equity at percentages) 2012 2012 2012 December 31, 2012 December 31, 2012 Higher $ 6,205,941 $ 585,346 31.1 % (78.2 )% (16.7 )% Recorded 5,620,595 - - % - % - % Lower $ 5,035,249 $ (585,346 ) (31.1 )% 78.2 % 16.7 % We believe the changes we made to our estimated ultimate claims and claim expenses represent reasonably likely outcomes based on our experience to date and our future expectations. While we believe these are reasonably likely outcomes, we do not believe the reader should consider the above sensitivity analysis an actuarial reserve range. In addition, the sensitivity analysis only reflects reasonably likely changes in our underlying assumptions. It is possible that our estimated ultimate claims and claim expenses could be significantly higher or lower than the sensitivity analysis described above. For example, we could be liable for events for which we have not estimated claims and claim expenses or for exposures we do not currently believe are covered under our policies. These changes could result in significantly larger changes to our estimated ultimate claims and claim expenses, net income and shareholders' equity than those noted above. We also caution the reader that the above sensitivity analysis is not used by management in developing our reserve estimates and is also not used by management in managing the business. Specialty Reinsurance Within our specialty reinsurance business unit we write a number of reinsurance lines such as catastrophe exposed workers' compensation, surety, terrorism, energy, aviation, crop, political risk, trade credit, financial, mortgage guarantee, catastrophe-exposed personal lines property, casualty clash, certain other casualty lines and other specialty lines of reinsurance that we collectively refer to as specialty reinsurance. We offer our specialty reinsurance products principally on an excess of loss basis, as described above with respect to our property catastrophe reinsurance products, and we also provide some proportional coverage. In a proportional reinsurance arrangement (also referred to as quota share reinsurance or pro-rata reinsurance), the reinsurer shares a proportional part of the original premiums and losses of the reinsured. We offer our specialty reinsurance products to insurance companies and other reinsurance companies and provide coverage for specific geographic regions or on a worldwide basis. We expanded our specialty reinsurance business in 2002 and have increased our presence in the specialty reinsurance market since that time. Our specialty reinsurance business can generally be characterized as providing coverage for low frequency and high severity losses, similar to our property catastrophe reinsurance business. As with our property catastrophe reinsurance business, our specialty reinsurance contracts frequently provide coverage for relatively large limits or exposures. As a result of the foregoing, our specialty reinsurance business is subject to significant claims volatility. In periods of low claims frequency or severity, our results will generally be favorably impacted while in periods of high claims frequency or severity our results will generally be negatively impacted. Our processes and methodologies in respect of loss estimation for the coverages we offer through our specialty reinsurance operation differ from those used for our property catastrophe-oriented coverages. For example, our specialty reinsurance coverages are more likely to be impacted by factors such as long-term inflation and changes in the social and legal environment, which we believe gives rise to greater uncertainty in our claims reserves. Moreover, in reserving for our specialty reinsurance coverages we do not have the benefit of a significant amount of our own historical experience in certain of these lines and may have little or no related corporate reserving history in new lines. We believe this makes our specialty reinsurance reserving subject to greater uncertainty than our catastrophe unit. When initially developing our reserving techniques for our specialty reinsurance coverages, we considered estimating reserves utilizing several actuarial techniques such as paid and reported loss development 75 -------------------------------------------------------------------------------- methods. We elected to use the Bornhuetter-Ferguson actuarial method because this method is appropriate for lines of business, such as our specialty reinsurance business, where there is a lack of historical claims experience. This method allows for greater weight to be applied to expected results in periods where little or no actual experience is available, and, hence, is less susceptible to the potential pitfall of being excessively swayed by one year or one quarter of actual paid and/or reported loss data. This method uses initial expected loss ratio expectations to the extent that the expected paid or reported losses are zero, and it assumes that past experience is not fully representative of the future. As our reserves for claims and claim expenses age, and actual claims experience becomes available, this method places less weight on expected experience and places more weight on actual experience. This experience, which represents the difference between expected reported claims and actual reported claims is reflected in the respective reporting period as a change in estimate. We reevaluate our actuarial reserving techniques on a periodic basis. The utilization of the Bornhuetter-Ferguson actuarial method requires us to estimate an expected ultimate claims and claim expense ratio and select an expected loss reporting pattern. We select our estimates of the expected ultimate claims and claim expense ratios and expected loss reporting patterns by reviewing industry results for similar business and adjusting for the terms of the coverages we offer. The estimated expected claims and claim expense ratio may be modified to the extent that reported losses at a given point in time differ from what would be expected based on the selected loss reporting pattern. Our estimate of IBNR is the product of the premium we have earned, the initial expected ultimate claims and claim expense ratio and the percentage of estimated unreported losses. In addition, certain of our specialty reinsurance coverages may be impacted by natural and man-made catastrophes. We estimate claim reserves for these losses after the event giving rise to these losses occur, following a process that is similar to our catastrophe unit described above. PriorYear Development of Reserve for Net Claims and Claim Expenses Within our specialty reinsurance business, we seek to review substantially all of our claims and claim expense reserves quarterly. Typically, our quarterly review procedures include reviewing paid and reported claims in the most recent reporting period, reviewing the development of paid and reported claims from prior periods, and reviewing our overall experience by underwriting year and in the aggregate. We monitor our expected ultimate claims and claim expense ratios and expected loss reporting assumptions on a quarterly basis and compare them to our actual experience. These actuarial assumptions are generally reviewed annually, based on input from our actuaries, underwriters, claims personnel and finance professionals, although adjustments may be made more frequently if needed. Assumption changes are made to adjust for changes in the pricing and terms of coverage we provide, changes in industry results for similar business, as well as our actual experience, to the extent we have enough data to rely on our own experience. If we determine that adjustments to an earlier estimate are appropriate, such adjustments are recorded in the period in which they are identified. 76 --------------------------------------------------------------------------------
The following table details the development of our liability for unpaid claims and claim expenses for the specialty reinsurance unit for the year ended
Specialty
Year endedDecember 31, 2012
Reinsurance Unit
Catastrophe claims and claim expenses Large catastrophe events Hurricanes Katrina, Rita and Wilma (2005) $ 3,000 Total catastrophe claims and claim expenses $ 3,000 Attritional claims and claim expenses Bornhuetter-Ferguson actuarial method - actual reported claims less than expected claims $ 16,747 Actuarial assumption changes 14,399 Total attritional claims and claim expenses $ 31,146 Total favorable development of prior accident years claims and claim expenses $ 34,146 The favorable development of prior accident years claims and claim expenses within our specialty reinsurance unit in the year endedDecember 31, 2012 of$34.1 million includes$14.4 million associated with actuarial assumption changes, principally in our casualty and medical malpractice lines of business, and primarily as a result of revised initial expected claims ratios and claim development factors due to actual experience coming in better than expected,$16.7 million related to actual reported loss activity coming in better than expected, as a result of the application of our formulaic actuarial reserving methodology, and$3.0 million due to a reduction in ultimate losses on the 2005 hurricanes. The following table details the development of our liability for unpaid claims and claim expenses for the specialty reinsurance unit for the year endedDecember 31, 2011 split between catastrophe claims and claim expenses and attritional claims and claim expenses:
Specialty
Year endedDecember 31, 2011
Reinsurance Unit
(in thousands) Catastrophe claims and claim expenses Hurricanes Katrina, Rita and Wilma (2005) $ 6,215 Chilean Earthquake (2010) 4,688 Tropical Cyclone Tasha (2010) 3,000 Total catastrophe claims and claim expenses $ 13,903 Attritional claims and claim expenses Bornhuetter-Ferguson actuarial method - actual reported claims less than expected claims $ 37,058 Actuarial assumption changes 26,800 Total attritional claims and claim expenses $ 63,858 Total favorable development of prior accident years claims and claim expenses $ 77,761 The favorable development on prior year reserves in 2011 within our specialty unit of$77.8 million includes:$26.8 million associated with actuarial assumption changes, principally in our workers' compensation quota share and risk, property risk and energy risk lines of business, and primarily as a result of revised initial expected claims ratios and claim development factors due to actual experience coming in better than expected;$13.9 million due to reductions in case reserves and additional case reserves for certain large catastrophe events; and the remainder of$37.1 million due to reported claims coming in better than expected in 2011 on prior accident years events, as a result of the application of our formulaic actuarial reserving methodology. 77 --------------------------------------------------------------------------------
The following table details the development of our liability for unpaid claims and claim expenses for the specialty reinsurance unit for the year ended
Specialty
Year endedDecember 31, 2010
Reinsurance Unit
(in thousands) Catastrophe claims and claim expenses Large catastrophe events Hurricanes Katrina, Rita and Wilma (2005) $ 5,350 Buncefield Oil Depot (2005) 2,073 Total catastrophe claims and claim expenses $ 7,423 Attritional claims and claim expenses Bornhuetter-Ferguson actuarial method - actual reported claims less than expected claims $ 71,261 Actuarial assumption changes 31,400 Reductions in specific events 18,477 Total attritional claims and claim expenses $ 121,138 Total favorable development of prior accident years claims and claim expenses $ 128,561 The favorable development of prior accident years claims and claim expenses within the Company's specialty reinsurance unit in 2010 of$128.6 million includes$31.4 million associated with actuarial assumption changes, principally in the Company's casualty clash and surety lines of business, and partially offset by an increase in reserves within the Company's workers compensation per risk line of business, principally as a result of revised initial expected claims ratios and claim development factors due to actual experience coming in better than expected;$18.5 million due to reductions in case reserves and additional case reserves, which are reserves established at the contract level for specific events;$7.4 million due to reductions in case reserves and additional case reserves for certain large catastrophe events; and the remainder of$71.3 million due to reported claims coming in better than expected in 2010 on prior accident years events, principally the 2005 through 2009 underwriting years, as a result of the application of the Company's formulaic actuarial reserving methodology. Actual Results vs. Initial Estimates The Actual vs. Initial Estimated Ultimate Claims and Claim Expense Ratio table below summarizes our key actuarial assumptions in reserving for our specialty reinsurance business. As noted above, the key actuarial assumptions include the estimated ultimate claims and claim expense ratios and the estimated loss reporting patterns. The table shows our initial estimates of the ultimate claims and claim expense ratio by underwriting year. The table shows how our initial estimates of these ratios have developed over time, with the re-estimated ratios reflecting a combination of the amount and timing of paid and reported losses compared to our initial estimates. The initial estimate is based on the actuarial assumptions that were in place at the end of that year. A decrease in the ultimate claims and claim expense ratio implies that our current estimates are lower than our initial estimates while an increase in the ultimate claims and claim expense ratio implies that our current estimates are higher than our initial estimates. The result would be a corresponding favorable impact on shareholders' equity and net income or a corresponding unfavorable impact on shareholders' equity and net income, respectively. The table also shows how our initial estimated ultimate claims and claim expense ratios have changed from one underwriting year to the next. The table below reflects a summary of the weighted average assumptions for all classes of business written within our specialty reinsurance unit. The table is presented on a gross loss basis and therefore does not include the benefit of reinsurance recoveries or loss related premium. 78 --------------------------------------------------------------------------------
Actual vs. Initial Estimated Specialty Reinsurance Claims and Claim Expense Reserve Analysis - Estimated Ultimate Claims and Claim Expense Ratio
Estimated Ultimate Claims and Claim Expenses Ratio Re-estimate at Underwriting Year Initial Estimate December 31, 2010 December 31, 2011 December 31, 2012 2002 77.2% 21.5% 20.5% 19.6% 2003 76.8% 28.1% 26.2% 25.3% 2004 78.2% 40.1% 36.9% 37.0% 2005 78.2% 31.6% 29.1% 28.1% 2006 76.6% 36.9% 31.7% 29.8% 2007 62.9% 55.5% 55.6% 56.1% 2008 57.9% 77.1% 74.9% 63.9% 2009 68.6% 50.9% 38.0% 35.8% 2010 57.7% 84.1% 67.1% 60.8% 2011 56.8% -% 73.0% 61.4% 2012 55.3% -% -% 88.1% The table above shows our initial estimated ultimate claims and claim expense ratios for attritional losses for each new underwriting year within our specialty reinsurance unit as of the end of each calendar year. Until 2007, our initial estimated ultimate remained relatively constant between 76.6% in 2006 and 78.2% in 2004 and 2005. This reflects the fact that management had not made significant changes to its initial estimates of expected ultimate claims and claim expense ratios from one underwriting year to the next. The principal reason for the modest changes from one underwriting year to the next is that the mix of business has changed. For example, the mix of business for the 2007 through 2012 underwriting years have a lower initial expected ultimate claims and claim expense ratio than in prior years as it is more heavily weighted to business that is expected to produce a lower level of losses. The decrease in the initial estimated ultimate claims and claim expense ratio from 2006 and prior, to 2007 through 2012, also reflects assumption changes made for certain classes of business where our experience, and the industry experience in general, has been better than expected and, as a result, we decreased our initial estimated ultimate claims and claim expense ratio for these classes of business. The decrease in the initial estimated ultimate claims and claim expense ratio for 2010 through 2012, compared to 2009, is principally due to assumption changes for modeled expected loss ratios and expected reporting patterns. The estimated ultimate net claims and claim expense ratio related to the 2011 underwriting year atDecember 31, 2012 of 61.4%, increased from the initial estimate of 56.8% primarily as a result of several relatively large claims incurred in 2011. The estimated ultimate net claims and claim expense ratio related to the 2012 underwriting year atDecember 31, 2012 of 88.1%, increased from the initial estimate of 55.3% primarily as a result of storm Sandy. As each underwriting year has developed, our re-estimated expected ultimate claims and claim expense ratios have changed. In particular, our re-estimated ultimate claims and claim expense ratios decreased significantly from the initial estimates for the 2002 through 2006 underwriting years. This was principally due to our 2005 reserve review. During our 2005 reserve review, we further segmented the specialty business with the aim of grouping risks into more homogeneous categories which respond to the evolution of actual exposures. This became possible as the volume of this business increased over the three preceding years. This further segmentation required the selection of loss reporting patterns to be applied to these new groups. We also updated our assumptions for our original loss reporting patterns based on a combination of new industry information and actual experience accumulated over the three preceding years. The assumptions for the new loss reporting patterns were applied to all prior underwriting years. In addition, we made explicit allowances for commuted contracts whereas previously these were considered in the overall reserving assumptions. We also reviewed substantially all of our case reserves and additional case reserves. The result of the foregoing was a decrease in our specialty reinsurance re-estimated ultimate claims and claim expense reserves in 2005. Subsequent to this reserve review, the results of our specialty book of business have been mixed. The 2006 underwriting year includes favorable development as actual paid and reported losses during 2006 have overall been less than expected, which has resulted in 79 -------------------------------------------------------------------------------- a reduction in our expected ultimate claims and claim expense ratio for this year. However, the 2008, 2010, 2011 and 2012 underwriting years have performed worse than expected and our current estimates are higher than our initial estimates. This is due in part to the losses in our casualty clash line of business in 2008, associated with exposure to the deterioration of the credit and capital markets in 2008 as well as the Madoff matter discovered in the fourth quarter of 2008. In comparison, our 2010 and 2011 underwriting years were impacted by a number of relatively large catastrophe events, including the 2010New Zealand and Chilean earthquakes in 2010, and in 2011, the 2011 New Zealand and Tohoku earthquakes, the large U.S. tornadoes, the Australian floods, losses arising from certain aggregate contracts, hurricane Irene and theThailand floods (collectively referred to as the "2011 Large Losses"). In addition, our 2012 underwriting year was impacted by storm Sandy. As noted above, our specialty reinsurance business is in general characterized by events of low frequency and high severity which results in actual experience that can be significantly better or worse than long-term trends or industry results for similar business may imply. As noted above, some of our specialty reinsurance contracts are exposed to net claims and claim expenses from large natural and man-made catastrophes. Net claims and claim expenses from these large catastrophes are reserved for after the events which gave rise to the claims in a manner which is consistent with our property catastrophe reinsurance reserving practices as discussed above. The large catastrophes occurring during the period from 2002 to 2012 impacting our specialty unit principally include hurricanesKatrina , Rita and Wilma, which occurred in 2005. Our estimate of ultimate net claims and claim expenses from hurricanesKatrina , Rita and Wilma, within our specialty reinsurance unit, net of reinsurance recoveries and assumed and ceded loss related premium, totaled$48.6 million atDecember 31, 2012 (2011 -$51.6 million , 2010 -$57.8 million ). Sensitivity Analysis The table below quantifies the impact on our reserves for claims and claim expenses, net income and shareholders' equity as of and for the year endedDecember 31, 2012 of reasonably likely changes to the actuarial assumptions used to estimate ourDecember 31, 2012 claims and claim expense reserves within our specialty reinsurance business unit. The table quantifies reasonably likely changes in our initial estimated ultimate claims and claim expense ratios and estimated loss reporting patterns. The changes to the initial estimated ultimate claims and claim expense ratios represent percentage increases or decreases to our current estimated ultimate claims and claim expense ratios. The change to the reporting patterns represent claims reporting that is both faster and slower than our current estimated claims reporting patterns. The impact on net income and shareholders' equity assumes no increase or decrease in reinsurance recoveries, loss related premium or redeemable noncontrolling interest - DaVinciRe. 80 --------------------------------------------------------------------------------
Specialty Reinsurance Claims and Claim Expense Reserve Sensitivity Analysis
$ Impact of % Impact of % Impact of Change Change Change on % Impact of on Reserves for on Reserve for Net Income Change on Estimated Claims and Claim Claims and Claim for the Year Shareholders' Loss Expenses at Expenses at Ended Equity at (in thousands,except Reporting December 31, December 31, December 31, December 31, percentages) Pattern 2012 2012 2012 2012 Increase expected claims and claim expense ratio Slower by 25% reporting $ 153,397 8.2 % (20.5 )% (4.4 )% Increase expected claims and claim expense ratio Expected by 25% reporting 71,455 3.8 % (9.5 )% (2.0 )% Increase expected claims and claim expense ratio Faster by 25% reporting 2,404 0.1 % (0.3 )% (0.1 )% Expected claims and Slower claim expense ratio reporting 65,554 3.5 % (8.8 )% (1.9 )% Expected claims and Expected claim expense ratio reporting - - % - % - % Expected claims and Faster claim expense ratio reporting (55,240 ) (2.9 )% 7.4 % 1.6 % Decrease expected claims and claim expense ratio Slower by 25% reporting (22,289 ) (1.2 )% 3.0 % 0.6 % Decrease expected claims and claim expense ratio Expected by 25% reporting (71,455 ) (3.8 )% 9.5 % 2.0 % Decrease expected claims and claim expense ratio Faster by 25% reporting (112,885 ) (6.0 )% 15.1 % 3.2 % We believe that ultimate claims and claim expense ratios 25.0 percentage points above or below our estimated assumptions constitute reasonably likely outcomes based on our experience to date and our future expectations. In addition, we believe that the adjustments that we made to speed up or slow down our estimated loss reporting patterns are reasonably likely changes. While we believe these are reasonably likely changes, we do not believe the reader should consider the above sensitivity analysis an actuarial reserve range. In addition, we caution the reader that the above sensitivity analysis only reflects reasonably likely changes. It is possible that our initial estimated claims and claim expense ratios and loss reporting patterns could be significantly different from the sensitivity analysis described above. For example, we could be liable for events which we have not estimated reserves for or for exposures we do not currently think are covered under our contracts. These changes could result in significantly larger changes to reserves for claims and claim expenses, net income and shareholders' equity than those noted above. We also caution the reader that the above sensitivity analysis is not used by management in developing our reserve estimates and is also not used by management in managing the business. Lloyd's Segment Within our Lloyd's segment, we write property catastrophe excess of loss reinsurance contracts to insure insurance and reinsurance companies against natural and man-made catastrophes, a number of specialty reinsurance lines and insurance policies and quota share reinsurance that involves understanding the characteristics of the underlying insurance policy. We use the Bornhuetter-Ferguson actuarial method to estimate claims and claim expenses within our Lloyd's segment for our specialty reinsurance and insurance lines of business. The comments discussed above relating to our reserving techniques and processes for our specialty reinsurance unit apply to the specialty reinsurance and insurance lines of business within our Lloyd's segment. In addition, certain of our coverages may be impacted by natural and man-made catastrophes. We estimate claim reserves for these losses after the event giving rise to these losses occurs, following a process that is similar to our catastrophe unit as noted above. 81 --------------------------------------------------------------------------------
Prior
Year ended December 31, 2012 2011
2010
Attritional claims and claim expenses $ 8,011 $ (478
)
Catastrophe events - property catastrophe reinsurance 5,726 -
-
Catastrophe events - other 3,750 -
-
Actuarial assumption changes (1,285 ) - - Total $ 16,202 $ (478 ) $ 197 The favorable development of prior accident years claims and claim expenses within our Lloyd's segment of$16.2 million during the year endedDecember 31, 2012 was principally due to decreases in estimated ultimate losses on certain specific events, including$9.5 million of catastrophe losses, principally related to theThailand floods and$2.5 million related to hurricane Irene, with the remainder due to reported claims coming in lower than expected on a number of prior accident years events, as a result of the application of our formulaic actuarial reserving methodology, partially offset by adverse development of$1.3 million due to assumption changes used in our formulaic actuarial reserving methodology. Actual Results vs. Initial Estimates The table below summarizes our initial assumptions and changes in those assumptions for catastrophe claims and claim expense reserves associated with our property catastrophe reinsurance business within our Lloyd's segment. Similar to our catastrophe unit included in our Reinsurance segment above, the key assumption in estimating reserves for property catastrophe reinsurance losses in our Lloyd's segment is our estimate of the ultimate claims and claim expenses. The table shows our initial estimates of ultimate claims and claim expenses for each accident year and how these initial estimates have developed over time. The initial estimate of accident year claims and claim expenses represents our estimate of the ultimate settlement and administration costs for claims incurred from catastrophic events occurring during a particular accident year, and as reported as ofDecember 31 of that year. The re-estimated ultimate claims and claim expenses as ofDecember 31, 2010 , 2011 and 2012, represent our revised estimates as reported as of those dates. The cumulative favorable (adverse) development shows how our most recent estimates as reported atDecember 31, 2012 differ from our initial accident year estimates. Favorable development implies that our current estimates are lower than our initial estimates while adverse development implies that our current estimates are higher than our original estimates. Total reserves as ofDecember 31, 2012 reflect the unpaid portion of our estimates of ultimate claims and claim expenses. The table is presented on a gross basis and therefore does not include the benefit of reinsurance recoveries or loss related premium such as reinstatement premium. Actual vs. Initial Estimated Lloyd's Segment Catastrophe Claims and Claim Expense Reserve Analysis for Property Catastrophe Reinsurance Business (in thousands, except percentages) Initial Claims % of Estimate and Claim Claims and Claim of Accident Re-estimated Claims and Cumulative % Decrease Expense Expenses Year Claim Expenses Favorable (Increase) Reserves at Unpaid at Claims and as of December 31, (Adverse) from Initial December 31, December 31, Accident Year Claim Expenses 2010 2011 2012 Development Ultimate 2012 2011 2010 $ 5,277 $ 5,277 $ 5,986 $ 6,310 $ (1,033 ) (19.6 )% $ 6,310 100.0 % 2011 30,121 - 30,121 24,037 6,084 20.2 % 8,256 34.3 % 2012 10,957 - - 10,957 - - % 9,355 85.4 % $ 46,355 $ 5,277 $ 36,107 $ 41,304 $ 5,051 14.3 % $ 23,921 57.9 % 82
-------------------------------------------------------------------------------- As quantified in the table above, since our Lloyd's segment commenced writing business in mid-2009, we have experienced$5.1 million of net favorable development on the run-off of our gross reserves related to catastrophe events for our property catastrophe reinsurance business within our Lloyd's segment. As described above and similar to our catastrophe unit, given the complexity in reserving for claims and claims expenses associated with catastrophe losses for property catastrophe reinsurance business, we have experienced development, both favorable and unfavorable, in any given accident year. For example, our 2011 accident year has developed favorably by$6.1 million , which is 20.2% better than our initial estimates of claims and claim expenses for the 2011 accident year as estimated as ofDecember 31, 2011 , while our 2010 accident year developed unfavorably by$1.0 million , or negative 19.6%. On a net basis our cumulative favorable or unfavorable development is generally reduced by offsetting changes in our reinsurance recoverables, as well as changes to loss related premiums such as reinstatement premiums, all of which generally move in the opposite direction to changes in our ultimate claims and claim expenses. The percentage of claims unpaid atDecember 31, 2012 for each accident year reflects both the speed at which claims and claim expenses for each accident year have been paid and our estimate of claims and claim expenses for that accident year. This is driven in part by the mix of our business and the speed of the settlement and payment of claims by our underlying cedants. Actual vs. Initial Estimated Lloyd's Segment Attritional Claims and Claim Expense Reserve Analysis - Estimated Ultimate Claims and Claim Expense Ratio The Actual vs. Initial Estimated Ultimate Claims and Claim Expense Ratio table below summarizes our key actuarial assumptions in reserving for attritional losses for our specialty reinsurance and insurance lines of business in our Lloyd's segment. As noted above, the key actuarial assumptions include the estimated ultimate claims and claim expense ratios and the estimated loss reporting patterns. The table shows our initial estimates of the ultimate claims and claim expense ratio by underwriting year. The initial estimate is based on the actuarial assumptions that were in place at the end of that year. A decrease in the ultimate claims and claim expense ratio implies that our current estimates are lower than our initial estimates while an increase in the ultimate claims and claim expense ratio implies that our current estimates are higher than our initial estimates. The result would be a corresponding favorable impact on shareholders' equity and net income or a corresponding unfavorable impact on shareholders' equity and net income, respectively. The table below reflects a summary of the weighted average assumptions for all classes of specialty reinsurance and insurance business in our Lloyd's segment for which we reserve for attritional losses using the Bornhuetter-Ferguson actuarial method. The table is presented on a gross loss basis and therefore does not include the benefit of reinsurance recoveries or loss related premium such as reinstatement premium. Estimated Ultimate Claims and Claim Expenses Ratio Re-estimate at Underwriting Year Initial Estimate December 31, 2010 December 31, 2011 December 31, 2012 2010 63.3% 62.7% 56.5% 53.5 % 2011 66.0% -% 83.0% 60.6 % 2012 58.4% -% -% 87.4 % The table above shows our initial estimated ultimate claims and claim expense ratios for attritional losses for each new underwriting year within specialty insurance and reinsurance in our Lloyd's segment as of the end of each calendar year. The principal reason for changes from one underwriting year to the next is changes in the mix and relative volume of business. As each underwriting year has developed, our re-estimated expected ultimate claims and claim expense ratios have changed. In particular, our re-estimated ultimate claims and claim expense ratios decreased from the initial estimates for the 2010 and 2011 underwriting years. This was principally due to the application of our formulaic actuarial reserving methodology with the reductions being due to actual paid and reported claim activity being more favorable to date than what was originally anticipated when setting the initial reserves combined with reductions to estimated ultimate claims and claim expenses on certain large events. However, the 2012 underwriting year has performed worse than expected and our current estimates are higher than our initial estimates. This is due in part to experiencing claims and claim 83 -------------------------------------------------------------------------------- expenses related to large property losses in 2012 which added 15.4 percentage points to the 2012 underwriting year ultimate claims and claim expenses ratio. As noted above, our specialty reinsurance and insurance lines of business are in general characterized by events of low frequency and high severity which results in actual experience that can be significantly better or worse than long-term trends or industry results for similar business may imply. Sensitivity Analysis The table below shows the impact on our ultimate claims and claim expenses, net income and shareholders' equity as of and for the year endedDecember 31, 2012 of reasonably likely changes to our estimates of ultimate losses for claims and claim expenses incurred from catastrophic events associated with property catastrophe reinsurance business within our Lloyd's segment. The reasonably likely changes are based on a historical analysis of the period-to-period variability of our ultimate costs to settle claims from catastrophic events, giving due consideration to changes in our reserving practices over time. In general, our claim reserves for our more recent catastrophic events are subject to greater uncertainty and, therefore, greater variability and are likely to experience material changes from one period to the next. This is due to the uncertainty as to the size of the industry losses from the event, uncertainty as to which contracts have been exposed to the catastrophic event, and uncertainty as to the magnitude of claims incurred by our clients. As our claims age, more information becomes available and we believe our estimates become more certain, although there is no assurance this trend will continue in the future. As a result, the sensitivity analysis below is based on the age of each accident year, our current estimated ultimate claims and claim expenses for the catastrophic events occurring in each accident year, and the reasonably likely variability of our current estimates of claims and claim expenses by accident year. Lloyd's Segment Property Catastrophe Reinsurance Claims and Claim Expense Reserve Sensitivity Analysis $ Impact of Change on Ultimate % Impact of % Impact of % Impact of Ultimate Claims Change Change Change Claims and and Claim on
Reserve for Claims on Net Income for on Shareholders'
Claim Expenses at Expenses and
Claim Expenses the Year Ended Equity at
(in thousands,
except percentages) 2012 2012 2012 2012 2012 Higher $ 51,608 $ 10,304 0.5 % (1.4 )% (0.3 )% Recorded 41,304 - - % - % - % Lower $ 31,000 $ (10,304 ) (0.5 )% 1.4 % 0.3 % We believe the changes we made to our estimated ultimate claims and claim expenses represent reasonably likely outcomes based on our experience to date and our future expectations. While we believe these are reasonably likely outcomes, we do not believe the reader should consider the above sensitivity analysis an actuarial reserve range. In addition, the sensitivity analysis only reflects reasonably likely changes in our underlying assumptions. It is possible that our estimated ultimate claims and claim expenses could be significantly higher or lower than the sensitivity analysis described above. For example, we could be liable for events for which we have not estimated claims and claim expenses or for exposures we do not currently believe are covered under our policies. These changes could result in significantly larger changes to our estimated ultimate claims and claim expenses, net income and shareholders' equity than those noted above. We also caution the reader that the above sensitivity analysis is not used by management in developing our reserve estimates and is also not used by management in managing the business. 84 -------------------------------------------------------------------------------- Lloyd's Segment Attritional Claims and Claim Expense Reserve Sensitivity Analysis $ Impact of % Impact of % Impact of Change Change Change on % Impact of on Reserves for on Reserves for Net Income Change on Estimated Claims and Claim Claims and Claim for the Year Shareholders' Loss Expenses at Expenses at Ended Equity at (in thousands,except Reporting December 31, December 31, December 31, December 31, percentages) Pattern 2012 2012 2012 2012 Increase expected claims and claim Slower expense ratio by 25% reporting $ 45,302 2.4 % (6.0 )% (1.3 )% Increase expected claims and claim Expected expense ratio by 25% reporting 22,761 1.2 % (3.0 )% (0.6 )% Increase expected claims and claim Faster expense ratio by 25% reporting (7,138 ) (0.4 )% 1.0 % 0.2 % Expected claims and Slower claim expense ratio reporting 18,033 1.0 % (2.4 )% (0.5 )% Expected claims and Expected claim expense ratio reporting - - % - % - % Expected claims and Faster claim expense ratio reporting (23,919 ) (1.3 )% 3.2 % 0.7 % Decrease expected claims and claim Slower expense ratio by 25% reporting (9,236 ) (0.5 )% 1.2 % 0.3 % Decrease expected claims and claim Expected expense ratio by 25% reporting (22,761 ) (1.2 )% 3.0 % 0.6 % Decrease expected claims and claim Faster expense ratio by 25% reporting (40,700 ) (2.2 )% 5.4 % 1.2 % We believe that ultimate claims and claim expense ratios 25.0 percentage points above or below our estimated assumptions constitute reasonably likely outcomes based on our experience to date and our future expectations. In addition, we believe that the adjustments that we made to speed up or slow down our estimated loss reporting patterns are reasonably likely changes. While we believe these are reasonably likely changes, we do not believe the reader should consider the above sensitivity analysis an actuarial reserve range. In addition, we caution the reader that the above sensitivity analysis only reflects reasonably likely changes. It is possible that our initial estimated claims and claim expense ratios and loss reporting patterns could be significantly different from the sensitivity analysis described above. For example, we could be liable for events which we have not estimated reserves for or for exposures we do not currently think are covered under our contracts. These changes could result in significantly larger changes to reserves for claims and claim expenses, net income and shareholders' equity than those noted above. We also caution the reader that the above sensitivity analysis is not used by management in developing our reserve estimates and is also not used by management in managing the business. Other Included in the Other category are the remnants of ourBermuda -based insurance operations not sold pursuant to the Stock Purchase Agreement with QBE. These operations are in run-off and no new business is being underwritten. Our outstanding claims and claim expense reserves for these operations include insurance policies and quota share reinsurance with respect to risks including: 1) commercial property, which principally included catastrophe-exposed commercial property products; 2) commercial multi-line, which included commercial property and liability coverage, such as general liability, automobile liability and physical damage, building and contents, professional liability and various specialty products; and 3) personal lines property, which principally included homeowners personal lines property coverage and catastrophe exposed personal lines property coverage. 85 -------------------------------------------------------------------------------- We use the Bornhuetter-Ferguson actuarial method to estimate claims and claim expenses within the Other category for our property and casualty insurance and quota share reinsurance business. The comments discussed above relating to our reserving techniques and processes for our specialty reinsurance unit within our Reinsurance segment also apply to our Other category. In addition, certain of our coverages may be impacted by natural and man-made catastrophes. We estimate claim reserves for these losses after the event giving rise to these losses occurs, following a process that is similar to our catastrophe unit. Development of Prior Year Liability for Unpaid Claims and Claim Expenses The following table details the development of our liability for unpaid claims and claim expenses for our Other category split between large catastrophe events and attritional claims and claim expenses: 2012 2011 2010 Catastrophe events $ 1,171 $ 4,243 $ 300 Attritional claims and claim expenses 3,265 1,389 15,615 Loss portfolio transfer (7,383 ) - - Actuarial assumption changes - (10,063 ) - Total $ (2,947 ) $ (4,431 ) $ 15,915 The adverse development on prior accident years of$2.9 million for the year endedDecember 31, 2012 within our Other category was principally the result of a loss portfolio transfer entered into by the Company onOctober 1, 2012 , in respect of its contractor's liability book of business within Glencoe, whereby the Company paid consideration of$36.5 million to transfer net liabilities of$29.1 million , resulting in a loss of$7.4 million which is recorded above as prior accident years attritional claims and claims expenses in the Company's Other category, partially offset by reductions in reported losses on certain attritional loss contracts and favorable development related to catastrophe events, primarily the 2008 hurricanes. The adverse development on prior accident years of$4.4 million in 2011 within the Company's Other category was principally due to the construction defect book of business, which experienced higher than expected reported losses, and was subsequently subject to a comprehensive actuarial review during the fourth quarter of 2011, which review resulted in an increase of$10.1 million to the estimated ultimate claims and claim expenses related to this book of business due to changes in the actuarial assumptions. The total gross reserve for claims and claim expenses for the construction defect book of business atDecember 31, 2011 is$58.8 million . Partially offsetting the adverse development on prior accident years within the construction defect book of business, noted above, was favorable development of$4.2 million related to large catastrophe events, of which$4.6 million related to the 2005 hurricanes, and$1.4 million related to the application of our formulaic actuarial reserving methodology with the reductions being due to actual paid and reported claim activity being more favorable to date than what was originally anticipated when setting the initial reserves. The favorable development of$15.9 million in 2010 on prior accident year claims and claim expenses within the Company's Other category was principally driven by the application of the Company's formulaic actuarial reserving methodology for this business with the reductions being due to actual paid and reported claim activity being more favorable to date than what was originally anticipated when setting the initial reserves. There were no significant changes made to the actuarial assumptions in 2010 or to the ultimate claims associated with the large catastrophe events. Actual Results vs. Initial Estimates The Actual vs. Initial Estimated Ultimate Claims and Claim Expense Ratio table below summarizes our key actuarial assumptions in reserving for our Other category. As noted above, the key actuarial assumptions include the estimated ultimate claims and claim expense ratios and the estimated loss reporting patterns. The table shows our initial estimates of the ultimate claims and claim expense ratios by accident year. The table shows how our initial estimates of these ratios have developed over time with the re-estimated ratios reflecting a combination of the amount and timing of paid and reported losses compared to our initial estimates. The initial estimate is based on the actuarial assumptions that were in place at the end of that year. A decrease in the ultimate claims and claim expense ratio implies that our current estimates are lower than our initial estimates while an increase in the ultimate claims and claim expense ratio implies that our 86 -------------------------------------------------------------------------------- current estimates are higher than our initial estimates. The result would be a corresponding favorable impact on shareholders' equity and net income or a corresponding unfavorable impact on shareholders' equity and net income, respectively. The table also shows how our initial estimated ultimate claims and claim expense ratios have changed from one accident year to the next. The table below reflects a summary of the weighted average assumptions for all classes of business written within our Other category. The table is presented on a gross loss basis and therefore does not include the benefit of reinsurance recoveries or loss related premium. Actual vs. Initial Estimated Other Category Claims and Claim Expense Reserve Analysis - Estimated Ultimate Claims and Claim Expense Ratio Estimated Ultimate Claims and Claim
Expenses Ratio
Re-estimate
at
Underwriting Year Initial Estimate December 31, 2010 December 31, 2011 December 31, 2012 2003 55.3% 30.6% 32.6% 32.8% 2004 50.2% 45.1% 45.6% 46.3% 2005 45.0% 46.5% 46.5% 45.8% 2006 47.4% 36.6% 40.6% 40.6% 2007 45.7% 24.3% 24.7% 24.8% 2008 46.0% 68.0% 64.4% 63.2% 2009 53.0% 66.7% 61.5% 63.1% 2010 57.9% 129.5% 68.9% 64.8% 2011 -% -% -% -% 2012 -% -% -% -% The table above shows our initial estimated ultimate claims and claim expense ratios for attritional losses for each new underwriting year within our Other category as of the end of each calendar year. Our initial estimated ultimate remained relatively constant between 2005 and 2008. This reflects the fact that management has not made significant changes to its estimated initial expected ultimate claims and claim expense ratio from one period to the next during that period. The principal reason for the changes from one year to the next, for example, the 2009 through 2010 underwriting years, is that the mix of business has changed. As each underwriting year has developed, our re-estimated ultimate claims and claim expense ratios have generally been reduced until recently. This reflects the impact of actual experience where actual paid and reported losses to date for attritional losses are less than originally expected. For the years 2008 through 2010, our re-estimated ultimate claims and claim expense ratios increased from the initial estimate due to reported losses exceeding our initial estimate within our Other category's commercial property line of business, combined with a relatively low level of net premiums earned during those periods for our commercial property line of business. As described above, under the Bornhuetter-Ferguson actuarial method less weight is placed on initial estimates and more weight is placed on actual experience as our claims and claim expense reserves age. 87 -------------------------------------------------------------------------------- As noted above, some of the contracts were exposed to claims and claim expenses from large natural and man-made catastrophes. Claims and claim expenses from these large catastrophes are reserved for after the event which gave rise to the claims in a manner which is consistent with our property catastrophe reinsurance reserving practices as discussed above. The large catastrophes occurring during the period from 2004 to 2008 principally include hurricanes Charley, Frances, Ivan and Jeanne in 2004, hurricanesKatrina , Rita and Wilma in 2005, and hurricanes Gustav and Ike in 2008. Our ultimate claims and claim expenses from these events within our Other category are shown in the table below.
(in thousands, except
percentages) Re-estimated Claims and Claim Expenses at Initial % Claims and % of Claims Estimate Decrease Claim and Claim of Accident Cumulative (Increase) Expense Expenses Year Claims Favorable from Reserves at Unpaid at Events and Claim December December
December (Adverse) Initial
(Accident Year) Expenses 31, 2010 31, 2011 31, 2012 Development Estimate 2012 2012 Charley, Frances, Ivan and Jeanne (2004) $ 210,323 $ 249,949 $ 249,456 $ 249,500 $ (39,177 ) (18.6 )% $ 585 0.2 % Katrina, Rita and Wilma (2005) 311,312 297,596 293,477 296,801 14,511 4.7 % 5,278 1.8 % Gustav and Ike (2008) 19,258 19,849 18,500 18,500 758 3.9 % 5,949 32.2 % $ 540,893 $ 567,394 $ 561,433 $ 564,801 $ (23,908 ) (4.4 )% $ 11,812 2.1 % Sensitivity Analysis The table below quantifies the impact on our reserves for claims and claim expenses, net income and shareholders' equity as of and for the year endedDecember 31, 2012 of reasonably likely changes to the actuarial assumptions used to estimate ourDecember 31, 2012 claims and claim expense reserves within our Other category. The table quantifies reasonably likely changes in our initial estimated ultimate claims and claim expense ratios and estimated loss reporting patterns. The changes to the initial estimated ultimate claims and claim expense ratios represent percentage increases or decreases to our current estimated ultimate claims and claim expense ratios. The change to the reporting patterns represent claims reporting that is both faster and slower than our current estimated reporting patterns. The impact on net income and shareholders' equity assumes no increase or decrease in reinsurance recoveries or loss related premium and is before tax. 88 --------------------------------------------------------------------------------
Other Category Claims and Claim Expense Reserve Sensitivity Analysis
$ Impact of % Impact of % Impact of Change Change Change on % Impact of on Reserves for on Reserves for Net Income Change on Estimated Claims and Claim Claims and Claim for the Year Shareholders' Loss Expenses at Expenses at Ended Equity at (in thousands,except Reporting December 31, December 31, December 31, December 31, percentages) Pattern 2012 2012 2012 2012 Increase expected claims and claim Slower expense ratio by 25% reporting $ 27,914 1.5 % (3.7 )% (0.8 )% Increase expected claims and claim Expected expense ratio by 25% reporting 10,450 0.6 % (1.4 )% (0.3 )% Increase expected claims and claim Faster expense ratio by 25% reporting (1,541 ) (0.1 )% 0.2 % - % Expected claims and Slower claim expense ratio reporting 13,971 0.7 % (1.9 )% (0.4 )% Expected claims and Expected claim expense ratio reporting - - % - % - % Expected claims and Faster claim expense ratio reporting (9,592 ) (0.5 )% 1.3 % 0.3 % Decrease expected claims and claim Slower expense ratio by 25% reporting 29 - % - % - % Decrease expected claims and claim Expected expense ratio by 25% reporting (10,450 ) (0.6 )% 1.4 % 0.3 % Decrease expected claims and claim Faster expense ratio by 25% reporting (17,644 ) (0.9 )% 2.4 % 0.5 % We believe that ultimate claims and claim expense ratios 25.0 percentage points above or below our estimated assumptions constitute reasonably likely outcomes based on our experience to date and our future expectations. In addition, we believe that the adjustments that we made to speed up or slow down our estimated loss reporting patterns are reasonably likely changes. While we believe these are reasonably likely changes, we do not believe the reader should consider the above sensitivity analysis an actuarial reserve range. In addition, we caution the reader that the above sensitivity analysis only reflects reasonably likely changes. It is possible that our initial estimated claims and claim expense ratios and loss reporting patterns could be significantly different from the sensitivity analysis described above. For example, we could be liable for events which we have not estimated reserves for or for exposures we do not currently think are covered under our contracts. These changes could result in significantly larger changes to our reserves for claims and claim expenses, net income and shareholders' equity than those noted above. We also caution the reader that the above sensitivity analysis is not used by management in developing our reserve estimates and is also not used by management in managing the business. Reinsurance Recoverable We enter into reinsurance agreements in order to help reduce our exposure to large losses and to help manage our risk portfolio. Amounts recoverable from reinsurers are estimated in a manner consistent with the claims and claim expense reserves associated with the related assumed reinsurance. For multi-year retrospectively rated contracts, we accrue amounts (either assets or liabilities) that are due to or from assuming companies based on estimated contract experience. If we determine that adjustments to earlier estimates are appropriate, such adjustments are recorded in the period in which they are determined. The estimate of reinsurance recoverable can be more subjective than estimating the underlying claims and claim expense reserves as discussed under the heading "Claims and Claim Expense Reserves" above. In particular, reinsurance recoverable may be affected by deemed inuring reinsurance, industry losses reported by various statistical reporting services, and other factors. Reinsurance recoverable on dual trigger reinsurance contracts require us to estimate our ultimate losses applicable to these contracts as well as estimate the ultimate amount of insured losses for the industry as a whole that will be reported by the applicable statistical reporting agency, as per the contract terms. In addition, the level of our additional case 89 -------------------------------------------------------------------------------- reserves and IBNR reserves has a significant impact on reinsurance recoverable. These factors can impact the amount and timing of the reinsurance recoverable to be recorded. The majority of the balance we have accrued as recoverable will not be due for collection until some point in the future. The amounts recoverable ultimately collected are open to uncertainty due to the ultimate ability and willingness of reinsurers to pay our claims, for reasons including insolvency and elective run-off, contractual dispute and various other reasons. In addition, because the majority of the balances recoverable will not be collected for some time, economic conditions as well as the financial and operational performance of a particular reinsurer may change, and these changes may affect the reinsurer's willingness and ability to meet their contractual obligations to us. To reflect these uncertainties, we estimate and record a valuation allowance for potential uncollectible reinsurance recoverable which reduces reinsurance recoverable and net earnings. We estimate our valuation allowance by applying specific percentages against each recovery based on our counterparty's credit rating. The percentages applied are based on historical industry default statistics developed by major rating agencies and are then adjusted by us based on industry knowledge and our judgment and estimates. We also apply case-specific valuation allowances against certain recoveries that we deem unlikely to be collected in full. We then evaluate the overall adequacy of the valuation allowance based on other qualitative and judgmental factors. The valuation allowance recorded against reinsurance recoverable was$4.5 million atDecember 31, 2012 (2011 -$7.3 million ). The reinsurers with the three largest balances accounted for 14.3%, 14.3% and 12.6%, respectively, of our reinsurance recoverable balance atDecember 31, 2012 (2011 - 27.3%, 14.9% and 12.4%, respectively). The three largest company-specific components of the valuation allowance represented 44.1%, 26.7% and 6.1%, respectively, of our total valuation allowance atDecember 31, 2012 (2011 - 34.2%, 27.3% and 12.0%, respectively). Fair Value Measurements and Impairments Fair Value The use of fair value to measure certain assets and liabilities with resulting unrealized gains or losses is pervasive within our financial statements. Fair value is defined under accounting guidance currently applicable to us to be the price that would be received upon the sale of an asset or paid to transfer a liability in an orderly transaction between open market participants at the measurement date. We recognize the change in unrealized gains and losses arising from changes in fair value in our consolidated statements of operations, with the exception of changes in unrealized gains and losses on our fixed maturity investments available for sale, which are recognized as a component of accumulated other comprehensive income in shareholders' equity. FASB ASC Topic Fair Value Measurements and Disclosures prescribes a fair value hierarchy that prioritizes the inputs to the respective valuation techniques 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) and the lowest priority to valuation techniques that use at least one significant input that is unobservable (Level 3). The three levels of the fair value hierarchy are described below: • Fair values determined by Level 1 inputs utilize unadjusted quoted prices
obtained from active markets for identical assets or liabilities for which
we have access. The fair value is determined by multiplying the quoted price
by the quantity held by us;
• Fair values determined by Level 2 inputs utilize inputs other than quoted
prices included in Level 1 that are observable for the asset or liability,
either directly or indirectly. Level 2 inputs include quoted prices for
similar assets and liabilities in active markets, and inputs other than
quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals, broker quotes and certain pricing indices; and
• Level 3 inputs are based all or in part on significant unobservable inputs
for the asset or liability, and include situations where there is little, if
any, market activity for the asset or liability. In these cases, significant
management assumptions can be used to establish management's best estimate
of the assumptions used by other market participants in determining the fair
value of the asset or liability. 90
-------------------------------------------------------------------------------- In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls has been determined based on the lowest level input that is significant to the fair value measurement of the asset or liability. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and we consider factors specific to the asset or liability. In order to determine if a market is active or inactive for a security, we consider a number of factors, including, but not limited to, the spread between what a seller is asking for a security and what a buyer is bidding for the same security, the volume of trading activity for the security in question, the price of the security compared to its par value (for fixed maturity investments), and other factors that may be indicative of market activity. There have been no material changes in our valuation techniques, nor have there been any transfers between Level 1 and Level 2, during the period represented by these consolidated financial statements. Below is a summary of the assets and liabilities that are measured at fair value on a recurring basis and also represents the carrying amount of such assets and liabilities on our consolidated balance sheet: Quoted Prices in Active Significant Markets for Other Significant Identical Observable Unobservable Assets Inputs Inputs At December 31, 2012 Total (Level 1)
(Level 2) (Level 3)
Fixed maturity investments
U.S. treasuries $ 1,259,800 $ 1,259,800 $ - $ - Agencies 315,154 - 315,154 -
Non-U.S. government (Sovereign
debt) 133,198 - 133,198 - Non-U.S. government-backed corporate 349,514 - 349,514 - Corporate 1,615,207 - 1,587,415 27,792 Agency mortgage-backed 408,531 - 408,531 - Non-agency mortgage-backed 248,339 - 248,339 - Commercial mortgage-backed 406,166 - 406,166 - Asset-backed 12,954 - 12,954 - Total fixed maturity investments 4,748,863 1,259,800 3,461,271 27,792 Short term investments 821,163 - 821,163 - Equity investments trading 58,186 58,186 - - Other investments Private equity partnerships 344,669 - - 344,669 Senior secured bank loan funds 202,929 - 172,334 30,595 Catastrophe bonds 91,310 - 91,310 - Hedge funds 5,803 - - 5,803 Total other investments 644,711 - 263,644 381,067
Other assets and (liabilities)
Assumed and ceded (re)insurance
contracts 2,647 - - 2,647 Derivatives (1) 19,123 (125 ) 14,821 4,427 Other 7,315 - (11,551 ) 18,866
Total other assets and
(liabilities) 29,085 (125 ) 3,270 25,940 $ 6,302,008 $ 1,317,861 $ 4,549,348 $ 434,799
(1) See "Note 19. Derivative Instruments in our Notes to Consolidated Financial
Statements" for additional information related to the fair value by type of
contract, of derivatives entered into by us. 91
-------------------------------------------------------------------------------- As atDecember 31, 2012 , we classified$449.3 million and$14.5 million of assets and liabilities, respectively, at fair value on a recurring basis using Level 3 inputs. This represented 5.7% and 0.4% of our total assets and liabilities, respectively. Level 3 fair value measurements are based on valuation techniques that use at least one significant input that is unobservable. These measurements are made under circumstances in which there is little, if any, market activity for the asset or liability. We use valuation models or other pricing techniques that require a variety of inputs including contractual terms, market prices and rates, yield curves, credit curves, measures of volatility, prepayment rates and correlations of such inputs, some of which may be unobservable, to value these Level 3 assets and liabilities. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment. In making the assessment, we considered factors specific to the asset or liability. In certain cases, the inputs used to measure fair value of an asset or a liability may fall into different levels of the fair value hierarchy. In such cases, the level in the fair value hierarchy within which the fair value measurement in its entirety is classified is determined based on the lowest level input that is significant to the fair value measurement of the asset or liability. See to "Note 6. Fair Value Measurements in our Notes to Consolidated Financial Statements" for additional information about fair value measurements. Impairments The amount and timing of asset impairment is subject to significant estimation techniques and asset impairment is a critical accounting estimate for us. The more significant impairment reviews we complete are for our fixed maturity investments available for sale, equity method investments and goodwill and other intangible assets as described in more detail below. Fixed Maturity Investments Available For Sale Our quarterly process for assessing whether declines in the fair value of our fixed maturity investments available for sale represent impairments that are other-than-temporary includes reviewing each fixed maturity investment available for sale that is impaired and determining: (i) if we have the intent to sell the debt security or (ii) if it is more likely than not that we will be required to sell the debt security before its anticipated recovery; and (iii) whether a credit loss exists, that is, where we expect that the present value of the cash flows expected to be collected from the security are less than the amortized cost basis of the security. In assessing our intent to sell securities, our procedures may include actions such as discussing planned sales with our third party investment managers, reviewing sales that have occurred shortly after the balance sheet date, and consideration of other qualitative factors that may be indicative of our intent to sell or hold the relevant securities. We recognized a total of $Nil of other-than-temporary impairments due to our intent to sell these securities during the year endedDecember 31, 2012 (2011 - $Nil, 2010 - $Nil). In assessing whether it is more likely than not that we will be required to sell a security before its anticipated recovery, we consider various factors including our future cash flow forecasts and requirements, legal and regulatory requirements, the level of our cash, cash equivalents, short term investments, fixed maturity investments trading and fixed maturity investments available for sale in an unrealized gain position, and other relevant factors. For the year endedDecember 31, 2012 , we recognized $Nil of other-than-temporary impairments due to required sales (2011 - $Nil, 2010 - $Nil). In evaluating credit losses, we consider a variety of factors in the assessment of a security including: (i) the time period during which there has been a significant decline below cost; (ii) the extent of the decline below cost and par; (iii) the potential for the security to recover in value; (iv) an analysis of the financial condition of the issuer; (v) the rating of the issuer; (vi) the implied rating of the issuer based on an analysis of option adjusted spreads; (vii) the absolute level of the option adjusted spread for the issuer; and (viii) an analysis of the collateral structure and credit support of the security, if applicable. Once we determine that it is possible that a credit loss may exist for a security, we perform a detailed review of the cash flows expected to be collected from the issuer. We estimate expected cash flows by applying estimated default probabilities and recovery rates to the contractual cash flows of the issuer, with such default and recovery rates reflecting long-term historical averages adjusted to reflect current credit, economic and market conditions, giving due consideration to collateral and credit support, if applicable, and 92 -------------------------------------------------------------------------------- discounting the expected cash flows at the purchase yield on the security. In instances in which a determination is made that an impairment exists but we do not intend to sell the security and it is not more likely than not that we will be required to sell the security before the anticipated recovery of its remaining amortized cost basis, the impairment is separated into: (i) the amount of the total other-than-temporary impairment related to the credit loss; and (ii) the amount of the total other-than-temporary impairment related to all other factors. The amount of the other-than-temporary impairment related to the credit loss is recognized in earnings. The amount of the other-than-temporary impairment related to all other factors is recognized in other comprehensive income. For the year endedDecember 31, 2012 , we recognized$0.3 million and$0.1 million of credit related other-than-temporary impairments which were recognized in earnings and other than-temporary impairments related to other factors which were recognized in other comprehensive income, respectively (2011 -$0.6 million and$0.1 million , respectively, 2010 -$0.8 million and$2 thousand , respectively). AtDecember 31, 2012 , our gross unrealized losses on fixed maturity investments available for sale totaled$0.1 million . Investments inOther Ventures , Under Equity Method Investments in which we have significant influence over the operating and financial policies of the investee are classified as investments in other ventures, under equity method, and are accounted for under the equity method of accounting. Under this method, we record our proportionate share of income or loss from such investments in our results for the period. Any decline in the value of investments in other ventures, under equity method, including goodwill and other intangible assets arising upon acquisition of the investee, considered by management to be other-than-temporary, is impaired and is reflected in our consolidated statements of operations in the period in which it is determined. As ofDecember 31, 2012 , we had$87.7 million (2011 -$70.7 million ) in investments in other ventures, under equity method on our consolidated balance sheets, including$10.8 million of goodwill and$19.6 million of other intangible assets (2011 -$9.0 million and$24.5 million ). In determining whether an equity method investment is impaired, we look at a variety of factors including the operating and financial performance of the investee, the investee's future business plans and projections, recent transactions and market valuations of publicly traded companies where available, discussions with the investee's management, and our intent and ability to hold the investment until it recovers in value. In doing this, we make assumptions and estimates in assessing whether an impairment has occurred and if, in the future, our assumptions and estimates made in assessing the fair value of these investments change, this could result in a material decrease in the carrying value of these investments. This would cause us to write-down the carrying value of these investments and could have a material adverse effect on our results of operations in the period the impairment charge is taken. During the year endedDecember 31, 2012 , we recorded $Nil (2011 - $Nil, 2010 -$0.8 million ) other-than-temporary impairment charges related to investments in other ventures, under the equity method. Goodwill and Other Intangible Assets Goodwill and other intangible assets acquired are initially recorded at fair value. Subsequent to initial recognition, finite lived other intangible assets are amortized over their estimated useful life, subject to impairment, and goodwill and indefinite lived other intangible assets are carried at the lower of cost or fair value. If goodwill or other intangible assets are impaired, they are written down to their estimated fair values with a corresponding expense reflected in our consolidated statements of operations. We test goodwill and other intangible assets for impairment in the fourth quarter of each year, or more frequently if events or changes in circumstances indicate that the carrying amount may not be recoverable. For purposes of the annual impairment evaluation, goodwill is assigned to the applicable reporting unit of the acquired entities giving rise to the goodwill and other intangible assets and is tested based on the cash flows they produce. There are generally many assumptions and estimates underlying the fair value calculation. Principally, we identify the reporting unit or business entity that the goodwill or other intangible asset is attributed to, and review historical and forecasted operating and financial performance and other underlying factors affecting such analysis, including market conditions. Other assumptions used could produce significantly different results which may result in a change in the value of goodwill or our other intangible assets and related charge in our consolidated statements of operations. An impairment charge could be recognized in the event of a significant decline in the implied fair value of those operations where the goodwill or other intangible assets are applicable. As atDecember 31, 2012 , excluding the amounts 93 -------------------------------------------------------------------------------- recorded in investments in other ventures, under equity method, as noted above, our consolidated balance sheets include$5.9 million of goodwill (2011 -$5.9 million ) and$2.6 million of other intangible assets (2011 -$3.0 million ). Impairment charges were $Nil during the year endedDecember 31, 2012 (2011 -$5.2 million , 2010 - $Nil). Income Taxes Income taxes have been provided in accordance with the provisions of FASB ASC Topic Income Taxes. Deferred tax assets and liabilities result from temporary differences between the amounts recorded in our consolidated financial statements and the tax basis of the Company's assets and liabilities. Such temporary differences are primarily due to net operating loss carryforwards and GAAP versus tax basis accounting differences related to interest expense, underwriting results, accrued expenses and investments. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance against deferred tax assets is recorded if it is more likely than not that all, or some portion, of the benefits related to deferred tax assets will not be realized. AtDecember 31, 2012 , our net deferred tax asset (prior to our valuation allowance) and valuation allowance were$48.0 million (2011 -$34.6 million ) and$48.2 million (2011 -$35.0 million ), respectively (see "Note 15. Taxation in our Notes to Consolidated Financial Statements" for additional information). At each balance sheet date, we assess the need to establish a valuation allowance that reduces the net deferred tax asset when it is more likely than not that all, or some portion, of the deferred tax assets will not be realized. The valuation allowance is based on all available information including projections of future GAAP taxable income from each tax-paying component in each tax jurisdiction. Losses incurred within our U.S. tax-paying subsidiaries in the fourth quarter of 2011 were significant enough to result in a cumulative GAAP taxable loss at the U.S. tax-paying subsidiaries for the three year period endedDecember 31, 2011 . We reassess our valuation allowance on a quarterly basis and commencing with our reassessment effectiveDecember 31, 2011 , we determined that it is more likely than not that we would not be able to recover our U.S. net deferred tax asset and as a result, recognized a full valuation allowance in the fourth quarter of 2011. AtDecember 31, 2012 , our U.S. tax-paying subsidiaries had a net deferred tax asset of$37.7 million (2011 -$26.4 million ), for which a full valuation allowance has been provided as we continued to remain in a cumulative three year GAAP taxable loss position at our U.S. tax-paying subsidiaries throughout 2012, among other facts. OurIreland andU.K. operations have produced GAAP taxable losses and we currently do not believe it is more likely than not that we will be able to recover our net deferred tax assets from these operations. The Company has unrecognized tax benefits of $Nil as ofDecember 31, 2012 (2011 -$3.3 million ). Interest and penalties related to unrecognized tax benefits, would be recognized in income tax expense. AtDecember 31, 2012 , interest and penalties accrued on unrecognized tax benefits was $Nil (2011 - $Nil). Income tax returns filed for tax years 2009 through 2011, 2008 through 2011 and 2011, are open for examination by theInternal Revenue Service , Irish tax authorities andU.K. tax authorities, respectively. The Company does not expect the resolution of these open years to have a significant impact on its consolidated statements of operations and financial condition. 94 --------------------------------------------------------------------------------
SUMMARY OF RESULTS OF OPERATIONS
Year ended December 31, 2012 2011 2010 (in thousands, except per share amounts and percentages) Statements of operations highlights Gross premiums written $ 1,551,591 $ 1,434,976 $ 1,165,295 Net premiums written 1,102,657 1,012,773 848,965 Net premiums earned 1,069,355 951,049 864,921 Net claims and claim expenses incurred 325,211
861,179 129,345
Underwriting income (loss) 451,301
(177,172 ) 474,573
Net investment income 167,375
118,000 203,955
Net realized and unrealized gains on
investments 163,991
70,668 144,444
Income (loss) from continuing operations 746,662 (74,502 ) 798,482
Income (loss) from discontinued operations 2,287 (15,890 ) 62,670
Net income (loss) 748,949
(90,392 ) 861,152
Net income (loss) available (attributable) to
RenaissanceRe common shareholders 566,014
(92,235 ) 702,613
Income (loss) from continuing operations
available (attributable) to
common shareholders per common share -
diluted $ 11.18 $
(1.53 )
Income (loss) from discontinued operations
per common share - diluted 0.05 (0.31 ) 1.13
Net income (loss) available (attributable) to
share - diluted $ 11.23 $ (1.84 ) $ 12.31 Dividends per common share $ 1.08 $ 1.04 $ 1.00 Key ratios
Net claims and claim expense ratio - current
accident year 45.2 %
104.4 % 49.9 %
Net claims and claim expense ratio - prior
accident years (14.8 )%
(13.8 )% (34.9 )%
Net claims and claim expense ratio - calendar
year 30.4 % 90.6 % 15.0 % Underwriting expense ratio 27.4 % 28.0 % 30.1 % Combined ratio 57.8 % 118.6 % 45.1 % Return on average common equity 17.7 % (3.0 )% 21.7 % December 31, December 31, December 31, Book value 2012 2011 2010 Book value per common share $ 68.14 $ 59.27 $ 62.58 Accumulated dividends per common share 12.00 10.92 9.88
Book value per common share plus accumulated
dividends $ 80.14 $
70.19
Change in book value per common share plus
change in accumulated dividends 16.8 % (3.6 )% 23.0 % December 31, December 31, December 31, Balance sheet highlights 2012 2011 2010 Total assets $ 7,928,628 $ 7,744,912 $ 8,138,278
Total shareholders' equity attributable to
RenaissanceRe $ 3,503,065 $ 3,605,193 $ 3,936,325 95
-------------------------------------------------------------------------------- Below is a discussion of the results of operations for the year endedDecember 31, 2012 compared to the year endedDecember 31, 2011 . Net income available toRenaissanceRe common shareholders was$566.0 million in 2012, compared to a net loss attributable toRenaissanceRe common shareholders of$92.2 million in 2011, an improvement of$658.2 million . As a result of our net income available toRenaissanceRe common shareholders in 2012, we generated an annualized return on average common equity of 17.7% and our book value per common share increased from$59.27 atDecember 31, 2011 to$68.14 atDecember 31, 2012 , a 16.8% increase, after considering the change in accumulated dividends paid to our common shareholders. The most significant events affecting our financial performance during 2012, on a comparative basis to 2011, include: • Increased Gross Premiums Written - gross premiums written increased $116.6
million, or 8.1%, to
and
2012 and 2011, respectively, gross premiums written increased
or 20.1% for the year, due to a combination of improved pricing during the
2012 renewals within our core markets, and continued growth across most lines
of business within our specialty unit and Lloyd's segment;
• Significantly Improved Underwriting Results - underwriting income of $451.3
million and a combined ratio of 57.8% in 2012, compared to an underwriting
loss of
impacted by the increase in gross premiums written, noted above, and a
decrease in net claims and claim expenses of
significantly lower insured losses with respect of large events. Included in
underwriting income for 2012 was
underwriting losses related to storm Sandy and hurricane Isaac, respectively,
which added a total of 19.0 percentage points to our 2012 combined ratio. In
2011, a number of large losses, namely the 2011 New Zealand and Tohoku
earthquakes, the large U.S. tornadoes, the Australian floods, losses arising
from aggregate contracts, hurricane Irene and the
(collectively referred to as the "2011 Large Losses") resulted in $725.2
million of underwriting losses and added 85.4 percentage points to the
Company's combined ratio, as detailed in the table below;
• Higher Investment Results - our net investment income and net realized and
unrealized gains on investments increased
respectively, in 2012, compared to 2011, primarily due to higher total returns in our fixed maturity investments portfolio as a result of the significant tightening of credit spreads combined with higher average invested assets and improved valuations in our portfolio of other investments, specifically our senior secured bank loan funds;
• Equity in Earnings of
ventures improved to earnings of
equity investment in Top Layer Re which generated income of
2012, compared to a loss of
million, principally due to the absence of large losses during 2012, compared
to claims and claim expenses incurred in 2011 in Top Layer Re related to the
2011 New Zealand and Tohoku earthquakes; and partially offset by
• Other Loss - our other loss deteriorated
million in 2012, compared to a loss of
result of ceded reinsurance contracts accounted for at fair value which
incurred a loss of
in 2011, due to net recoverables on the Tohoku earthquake in the first
quarter of 2011 which did not reoccur in 2012 and partially offset by $20.8
million of trading losses within the Company's weather and energy risk
management operations, compared to trading losses of
and
• Net (Income) Loss Attributable to Redeemable Noncontrolling Interest -
DaVinciRe - our net income attributable to redeemable noncontrolling interest
- DaVinciRe was
redeemable noncontrolling interest - DaVinciRe of
change of
underwriting income as a result of the decrease in current accident year net
claims and claim expenses and higher investment results, as noted above,
which also impacted DaVinciRe, and together resulted in net income of $212.5
million for DaVinciRe in 2012, compared to net loss of
DaVinciRe in 2011. In addition, our ownership in DaVinciRe decreased from
42.8% atDecember 31, 2011 to 30.8% atDecember 31, 2012 , consequently increasing redeemable noncontrolling interest - DaVinciRe. 96
-------------------------------------------------------------------------------- Below is a discussion of the results of operations for the year endedDecember 31, 2011 compared to the year endedDecember 31, 2010 . Net loss attributable toRenaissanceRe common shareholders was$92.2 million in 2011, compared to$702.6 million of net income available toRenaissanceRe common shareholders in 2010, a decrease of$794.8 million . As a result of our net loss attributable toRenaissanceRe $62.58 atDecember 31, 2010 to$59.27 atDecember 31, 2011 , a 3.6% decrease, after considering the change in accumulated dividends paid to our common shareholders. In 2010, we generated returns on average common equity of 21.7%, and increased our book value per common share plus the change in accumulated dividends by 23.0%, respectively. The most significant events affecting our financial performance during 2011, on a comparative basis to 2010 include: • Significant Catastrophe Events and Corresponding Underwriting Losses - our
underwriting loss of
underwriting income of
million of underwriting losses as a result of a number of large losses,
namely the 2011 Large Losses, and resulted in
impact, compared to
losses of 2010, an increase of
•
favorable development on prior years claims and claim expenses decreased
and was comprised primarily of
segment, as detailed below;
• Lower Investment Results - net investment income and net realized and
unrealized gains on investments deteriorated
respectively, compared to 2010. The decrease in our investment results was
primarily due to lower total returns on the fixed maturity investments
portfolio, a decrease in the returns from our hedge fund and private equity
investments due to relatively weaker performance, and lower returns on
certain non-investment grade allocations included in other investments;
• Other (Loss) Income - our other (loss) income deteriorated
loss of
primarily the result of
weather and energy risk management operations due to the unusually warm
weather experienced in the
States during the fourth quarter of 2011, compared to trading income of $8.1
million in 2010, more than offsetting our ceded reinsurance contracts
accounted for at fair value which generated
compared to
from the Tohoku earthquake;
• Equity in Losses of
deteriorated to a loss of
million in 2010. The decrease is primarily due to our equity investment in
Top Layer Re which incurred a loss of
loss of
due to current accident year claims and claim expenses in Top Layer Re
related to the 2011 New Zealand earthquake and the Tohoku earthquake;
• Loss from Discontinued Operations - our loss from discontinued operations is
$15.9 million in 2011, compared to income from discontinued operations of$62.7 million in 2010, and is primarily due to certain tax related adjustments and the recognition of a$10.0 million expense related to a contractually agreed obligation to pay, or otherwise reimburse, QBE for
amounts up to
accident years net claims and claims expenses for reserves that were sold to
QBE. Income from discontinued operations in 2010 is primarily due to
underwriting income of
strong underwriting results for the 2010 crop year; and partially offset by
97 --------------------------------------------------------------------------------
• Net Loss Attributable to Redeemable Noncontrolling Interest - DaVinciRe - our
net loss attributable to redeemable noncontrolling interest - DaVinciRe was
noncontrolling interest - DaVinciRe of
underwriting income, due to the increase in current accident year net claims
and claim expenses, combined with lower investment results, as noted above,
which also impacted DaVinciRe and together resulted in a net loss for 2011,
compared to net income in 2010, and consequently decreased redeemable
noncontrolling interest - DaVinciRe.
Net Negative Impact of Hurricane Isaac and storm Sandy and the 2011 Large Losses Net negative impact of hurricane Isaac and storm Sandy and the 2011 Large Losses includes the sum of estimates of net claims and claim expenses incurred, earned reinstatement premiums assumed and ceded, lost profit commissions and redeemable noncontrolling interest -DaVinci Re . Net negative impact of the 2011 Large Losses also includes equity in the net claims and claim expenses of Top Layer Re, and other income in respect of ceded reinsurance contracts accounted for at fair value. Our estimates are based on a review of our potential exposures, preliminary discussions with certain counterparties and catastrophe modeling techniques. Given the magnitude and recent occurrence of these events, delays in receiving claims data, the contingent nature of business interruption and other exposures, potential uncertainties relating to reinsurance recoveries and other uncertainties inherent in loss estimation, meaningful uncertainty remains regarding losses from these events. In addition, a significant portion of the net claims and claim expenses associated with the 2011 New Zealand and Tohoku earthquakes and storm Sandy are concentrated with a few large clients and therefore the loss estimates for these events may vary significantly based on the claims experience of those clients. Accordingly, our actual net negative impact from the these events will vary from these preliminary estimates, perhaps materially so. Changes in these estimates will be recorded in the period in which they occur. See the financial data below for additional information detailing the net negative impact of hurricane Isaac and storm Sandy on our consolidated financial statements in 2012. Year ended December 31, 2012 Hurricane Isaac Storm
Sandy Total
(in thousands, except percentages)
Net claims and claim expenses incurred $ (33,185 ) $ (187,944 ) $ (221,129 )
Reinstatement premiums earned 8,863
37,437 46,300
Ceded reinstatement premiums earned -
(385 ) (385 )
Lost profit commissions (2,016 ) 1,771 (245 ) Net negative impact on underwriting result (26,338 )
(149,121 ) (175,459 )
Redeemable noncontrolling interest -
DaVinciRe 8,925
22,160 31,085
Net negative impact $ (17,413 ) $
(126,961 ) $ (144,374 )
Percentage point impact on consolidated
combined ratio 2.8 16.0 19.0
Net negative impact on Reinsurance segment
underwriting result $ (25,857 ) $
(132,061 ) $ (157,918 )
Net negative impact on Lloyd's segment
underwriting result (481 )
(17,060 ) (17,541 )
Net negative impact on underwriting result $ (26,338 ) $ (149,121 ) $ (175,459 )
98 --------------------------------------------------------------------------------
See the financial data below for additional information detailing the net negative impact of the 2011 Large Losses on our consolidated financial statements in 2011.
2011 Large Losses
Year ended
31, 2011 Earthquake Earthquake Floods Tornadoes Contracts Hurricane Irene Thailand Floods Total (in thousands, except percentages) Net claims and claim expenses incurred $ (273,596 ) $ (284,348 ) $ (12,273 ) $
(135,090 ) $ (33,080 ) $ (32,530 ) $ (76,437 ) $ (847,354 )
Assumed
reinstatement
premiums earned 49,878 60,914 1,694 23,273 1,524 5,874 17,144 160,301 Ceded reinstatement premiums earned (3,542 ) (26,004 ) - - - - - (29,546 ) Lost profit commissions (7,522 ) (331 ) (348 ) (151 ) - - (245 ) (8,597 ) Net negative impact on underwriting result (234,782 ) (249,769 ) (10,927 ) (111,968 ) (31,556 ) (26,656 ) (59,538 ) (725,196 ) Equity in net claims and claim expenses of Top Layer Re (23,757 ) (26,243 ) - - - - - (50,000 ) Recoveries from ceded reinsurance contracts accounted for at fair value - 45,000 - - - - - 45,000 Redeemable noncontrolling interest - DaVinciRe 55,748 53,669 1,182 32,941 4,944 7,698 14,474
170,656
Net negative impact $ (202,791 ) $ (177,343 ) $ (9,745 ) $ (79,027 ) $ (26,612 ) $ (18,958 ) $ (45,064 ) $ (559,540 ) Percentage point impact on consolidated combined ratio 25.0 26.5 1.1 11.6 3.3 2.7 6.0 85.4 Net negative impact on Reinsurance segment
underwriting result $ (228,756 ) $ (237,480 ) $ (10,927 ) $ (109,043 ) $ (31,556 )
(24,156 ) (53,538 )
(695,456 )
Net negative impact
on Lloyd's segment
underwriting result (6,026 ) (12,289 ) - (2,925 ) - (2,500 ) (6,000 )
(29,740 )
Net negative impact
on underwriting
result $ (234,782 ) $ (249,769 ) $ (10,927 ) $ (111,968 ) $ (31,556 ) $ (26,656 ) $ (59,538 ) $ (725,196 ) 99
-------------------------------------------------------------------------------- Underwriting Results by Segment Reinsurance Segment Below is a summary of the underwriting results and ratios for our Reinsurance segment followed by an analysis of our catastrophe unit and specialty reinsurance unit underwriting results and ratios:
Reinsurance segment overview
Year ended December 31, 2012 2011
2010
(in thousands, except percentages)
Gross premiums written (1) $ 1,392,094 $ 1,323,187 $ 1,123,619 Net premiums written $ 967,587 $ 913,499 $ 809,719 Net premiums earned $ 946,423 $ 873,088 $ 838,790
Net claims and claim expenses incurred 242,022 783,704
113,804 Acquisition expenses 90,491 82,978 77,954 Operational expenses 132,935 131,251 129,990 Underwriting income (loss) $ 480,975 $ (124,845 ) $ 517,042
Net claims and claim expenses incurred -
current accident year $ 386,736 $ 920,602
Net claims and claim expenses incurred -
prior accident years (144,714 ) (136,898
) (286,019 )
Net claims and claim expenses incurred -
total $ 242,022 $ 783,704
Net claims and claim expense ratio -
current accident year 40.9 % 105.4
% 47.7 %
Net claims and claim expense ratio - prior
accident years (15.3 )% (15.6
)% (34.1 )%
Net claims and claim expense ratio -
calendar year 25.6 % 89.8 % 13.6 % Underwriting expense ratio 23.6 % 24.5 % 24.8 % Combined ratio 49.2 % 114.3 % 38.4 %
(1) Includes gross premiums written of $Nil assumed from the Other category for
the year ended
Reinsurance Segment Gross Premiums Written - Gross premiums written in our Reinsurance segment were$1,392.1 million in 2012, an increase of$68.9 million , or 5.2%, compared to$1,323.2 million in 2011. Excluding the impact of$18.7 million and$159.8 million of net reinstatement premiums written from large losses in 2012 and 2011, respectively, gross premiums written increased$210.0 million or 18.1%, primarily due to the catastrophe unit experiencing improved market conditions on a risk-adjusted basis within its core lines of business during the 2012 renewals and due to the inception of several new contracts during 2012 which met our risk-adjusted return thresholds within our specialty unit. Included in net reinstatement premiums written of$18.7 million in 2012 is$36.0 million related to storm Sandy, partially offset by$16.3 million and$9.9 million of negative reinstatement premiums written related to the 2011 New Zealand earthquake and Tohoku, respectively. Gross premiums written in our Reinsurance segment increased by$199.6 million , or 17.8%, to$1,323.2 million in 2011, compared to$1,123.6 million in 2010, primarily due to an increase in gross premiums written in the catastrophe unit which was positively impacted by reinstatement premiums written on the 2011 Large Losses. Excluding the impact of$159.8 million and$28.0 million of reinstatement premiums written in 2011 and 2010, respectively, gross premiums written increased$67.8 million , or 6.2%, primarily due to improving market conditions in our core catastrophe markets during the June andJuly 2011 renewals, and partially offset by the softer market conditions in our core markets during theJanuary 2011 renewals. In addition, our specialty reinsurance gross premiums written increased$16.5 million , or 12.8%, to$145.9 million , compared to$129.4 million in 2010, primarily due to the inception of new contracts during 2011 which met our risk-adjusted return thresholds. 100 -------------------------------------------------------------------------------- Our Reinsurance segment premiums are prone to significant volatility due to the timing of contract inception and also due to the business being characterized by a relatively small number of relatively large transactions. In addition, our property catastrophe reinsurance gross premiums written continue to be characterized by a large percentage of U.S. andCaribbean premium as we have found business derived from exposures inEurope and the rest of the world to be, in general, less attractive on a risk-adjusted basis during recent periods. A significant amount of our U.S. andCaribbean premium provides coverage against windstorms, mainly U.S. Atlantic hurricanes, as well as earthquakes and other natural and man-made catastrophes. Ceded Premiums Written Year ended December 31, 2012 2011 2010 (in thousands)
Ceded premiums written - Reinsurance segment
Due to the potential volatility of the property catastrophe reinsurance contracts which we sell, we purchase reinsurance to reduce our exposure to large losses and to help manage our risk portfolio. We use our REMS© modeling system to evaluate how each purchase interacts with our portfolio of reinsurance contracts we write, and with the other ceded reinsurance contracts we purchase, to determine the appropriateness of the pricing of each contract and whether or not it helps us to balance our portfolio of risks. Ceded premiums written increased by$14.8 million in 2012, compared to 2011. Excluding the impact of$1.0 million and$28.0 million of reinstatement premiums related to recoveries on certain large losses in 2012 and 2011, respectively, ceded premiums written increased by$41.8 million or 10.9%, primarily due to ceded premiums written of$48.5 million related to our managed joint ventures, Upsilon andTim Re III. Ceded premiums written increased by$95.8 million in 2011, compared to 2010, principally due to our decision to purchase additional reinsurance protection, combined with$28.0 million of reinstatement premiums related to recoveries on certain programs impacted by the 2011 New Zealand and Tohoku earthquakes. To the extent that appropriately priced coverage is available, we anticipate continued use of reinsurance to reduce the impact of large losses on our financial results and to manage our portfolio of risk; however, the buying of ceded reinsurance in our Reinsurance segment is based on market opportunities and is not based on placing a specific reinsurance program each year. In addition, in future periods we may utilize the growing market for insurance-linked securities to expand our ceded reinsurance buying if we find the pricing and terms of such coverages attractive. Reinsurance Segment Underwriting Results - Our Reinsurance segment generated underwriting income of$481.0 million in 2012, compared to incurring an underwriting loss of$124.8 million in 2011, an improvement of$605.8 million . In 2012, our Reinsurance segment generated a net claims and claim expense ratio of 25.6%, an underwriting expense ratio of 23.6% and a combined ratio of 49.2%, compared to 89.8%, 24.5% and 114.3%, respectively, in 2011. The$605.8 million improvement in the Reinsurance segment's underwriting result and 65.1 percentage point decrease in the combined ratio was principally due to a decrease in current accident year claims and claim expenses in 2012, compared to 2011. During 2012, hurricane Isaac and storm Sandy had a net negative impact of$157.9 million , or 20.0 percentage points, on our Reinsurance segment's underwriting result and combined ratio, respectively, as detailed in the table below. In addition, current accident year net claims and claim expenses in 2012 included$16.0 million of estimated ultimate losses related to potential exposure to LIBOR related claims attributable to the current accident year. 101 --------------------------------------------------------------------------------
See the financial data below for additional information detailing the net negative impact of hurricane Isaac and storm Sandy on our Reinsurance segment in 2012.
Year ended December 31, 2012 Hurricane Isaac Storm
Sandy Total
(in thousands, except percentages)
Net claims and claim expenses incurred $ (32,685 ) $ (169,477 ) $ (202,162 )
Reinstatement premiums earned 8,844
36,030 44,874
Ceded reinstatement premiums earned -
(385 ) (385 )
Lost profit commissions (2,016 ) 1,771 (245 )
Net negative impact on Reinsurance segment
underwriting result (25,857 )
(132,061 ) (157,918 )
Percentage point impact on Reinsurance
segment combined ratio 3.3 16.5 20.0
Net negative impact on catastrophe unit
underwriting result $ (25,857 ) $
(121,061 ) $ (146,918 )
Net negative impact on specialty unit
underwriting result -
(11,000 ) (11,000 )
Net negative impact on Reinsurance segment
underwriting result $ (25,857 ) $ (132,061 ) $ (157,918 ) Our Reinsurance segment incurred an underwriting loss of$124.8 million in 2011, compared to$517.0 million of underwriting income in 2010, a decrease of$641.9 million . In 2011, our Reinsurance segment generated a net claims and claim expense ratio of 89.8%, an underwriting expense ratio of 24.5% and a combined ratio of 114.3%, compared to 13.6%, 24.8% and 38.4%, respectively, in 2010. The$641.9 million decrease in the Reinsurance segment's underwriting result and 75.9 percentage point increase in the combined ratio was principally due to a$520.8 million increase in current accident year losses and a$149.1 million decrease in favorable development on prior years reserves in 2011, compared to 2010. The increase in current accident year losses was primarily due to the 2011 Large Losses, which negatively impacted the Reinsurance segment's underwriting result and combined ratio by$695.5 million and 91.3 percentage points, respectively, after considering the impact of net reinstatement premiums earned and net lost profit commission related to these events, as detailed in the table below. 2011 Large Losses
Year ended 2011 New Zealand Tohoku Australian Large U.S. Aggregate
December 31, 2011 Earthquake Earthquake Floods Tornadoes Contracts Hurricane Irene Thailand Floods Total (in thousands, except percentages) Net claims and claim expenses incurred $ (267,570 ) $ (273,334 ) $ (12,273 ) $ (131,965 ) $ (33,080 ) $ (30,030 ) $ (70,437 ) $ (818,689 ) Assumed reinstatement premiums earned 49,878 60,603 1,694 23,073 1,524 5,874 17,144 159,790 Ceded reinstatement premiums earned (3,542 ) (24,418 ) - - - - - (27,960 ) Lost profit commissions (7,522 ) (331 ) (348 ) (151 ) - - (245 ) (8,597 ) Net negative impact on Reinsurance segment underwriting result $ (228,756 ) $ (237,480 ) $ (10,927 ) $ (109,043 ) $ (31,556 ) $ (24,156 ) $ (53,538 ) $ (695,456 ) Percentage point impact on Reinsurance segment combined ratio 26.9 27.8 1.2 12.4 3.6 2.7 6.0 91.3 Net negative impact on catastrophe unit underwriting result $ (222,256 ) $ (229,980 ) $ (4,927 ) $ (109,043 ) $ (31,556 ) $ (24,156 ) $ (47,538 ) $ (669,456 ) Net negative impact on specialty unit underwriting result (6,500 ) (7,500 ) (6,000 ) - - - (6,000 ) (26,000 ) Net negative impact on Reinsurance segment underwriting result $ (228,756 ) $ (237,480 ) $ (10,927 ) $ (109,043 ) $ (31,556 ) $ (24,156 ) $ (53,538 ) $ (695,456 ) 102
-------------------------------------------------------------------------------- Losses from our property catastrophe reinsurance and specialty reinsurance policies can be infrequent, but severe, as demonstrated by our 2011 results. Although 2012 is generally considered to be the third most costly year for insured property catastrophe losses, behind only 2011 and 2005, we incurred a relatively low level of net claims and claim expenses. During periods with relatively low levels of property catastrophe loss activity, we have the potential to produce a low level of losses and a related increase in underwriting income. As described above, we believe there is likely to be an increase in the severity, and possibly the frequency, of weather related natural disasters and catastrophes relative to the historical experience over the past 100 years, including the frequency and severity of hurricanes that have the potential to make landfall in the U.S., potentially as a result of decadal ocean water temperature cyclical trends, changes in expected sea levels and a longer-term trend towards global warming. Our Reinsurance segment prior year reserves experienced$144.7 million of net favorable development in 2012. The favorable development on prior year reserves in 2012 included$110.6 million related to our catastrophe reinsurance unit and$34.1 million related to our specialty reinsurance unit. Favorable development within the catastrophe unit is primarily due to reductions in estimated ultimate losses on the 2010 Chilean earthquake of$24.6 million , the 2008 hurricanes of$17.5 million , theJune 2007 U.K. floods of$17.3 million , the 2005 hurricanes of$6.4 million , hurricane Irene of$4.6 million , the Tohoku earthquake of$3.9 million and a number of other catastrophes totaling$57.7 million , and partially offset by adverse development related to the 2010 and 2011 New Zealand earthquakes of$21.5 million primarily due to an increase in estimated ultimate losses. Favorable development within the specialty unit included$14.4 million associated with actuarial assumption changes, principally in our casualty and medical malpractice lines of business, and primarily as a result of revised initial expected claims ratios and claim development factors due to actual experience coming in better than expected and$19.7 million related to actual reported loss activity coming in better than expected. Our Reinsurance segment prior year reserves experienced$136.9 million of net favorable development in 2011. The favorable development on prior year reserves in 2011 included$59.1 million related to our catastrophe reinsurance unit and$77.8 million related to our specialty reinsurance unit. The favorable development on prior year reserves in 2011 within the catastrophe reinsurance unit of$59.1 million was due to$27.0 million related to reductions in the estimated ultimate losses of smaller catastrophe events,$32.1 million arising from net reductions to the estimated ultimate losses of large catastrophe events, including$13.9 million ,$10.0 million ,$8.5 million and$4.7 million related to tropical cyclone Tasha, the 2005 hurricanes, the Chilean earthquake and theWorld Trade Center , respectively, and partially offset by$15.2 million of adverse development related to the 2010New Zealand earthquake. The favorable development within the specialty reinsurance unit included$37.1 million due to reported losses developing more favorably than expected during 2011 on prior accident years events,$26.8 million associated with actuarial assumption changes, principally in our workers' compensation quota share and risk, property risk and energy risk lines of business, and primarily as a result of revised initial expected claims ratios and claim development factors due to actual experience coming in better than expected, and$13.9 million related to a decrease in case reserves and additional case reserves, which are established at the contract level for specific loss or large events. Our underwriting expenses consist of acquisition expenses and operational expenses. Acquisition expenses consist of the costs to acquire premiums and are principally comprised of broker commissions and excise taxes. Acquisition expenses are driven by contract terms and are normally a set percentage of premiums and, accordingly, these costs will normally move in line with the fluctuation in gross premiums earned. Our acquisition expense ratio has remained relatively constant at 9.6%, 9.5% and 9.3% in 2012, 2011 and 2010, respectively. Operating expenses consist primarily of salaries and other general and administrative expenses and have remained relatively constant at$132.9 million ,$131.3 million and$130.0 million in 2012, 2011 and 2010, respectively. Our operating expense ratio may increase over time, as a result of factors including the absolute and comparative growth of our operating expenses, further refinements to internal expense allocations, market trends and market dynamics. We have entered into joint ventures and specialized quota share cessions of our book of business. In accordance with the joint venture and quota share agreements, we are entitled to certain profit commissions and fee income. We record these profit commissions and fees as a reduction in acquisition and operating expenses and, accordingly, these fees have reduced our underwriting expense ratios. These fees totaled 103 --------------------------------------------------------------------------------$65.4 million ,$58.3 million and$56.5 million in 2012, 2011 and 2010, respectively, and resulted in a corresponding decrease to the Reinsurance segment underwriting expense ratio of 6.9%, 6.7% and 6.7%, respectively. In addition, we are entitled to certain fee income and profit commissions from DaVinci. Because the results of DaVinci, and its parent DaVinciRe, are consolidated in our results of operations, these fees and profit commissions are eliminated in our consolidated financial statements and are principally reflected in redeemable noncontrolling interest - DaVinciRe. The net impact of all fees and profit commissions related to these joint ventures and specialized quota share cessions within our Reinsurance segment was$120.0 million ,$64.6 million and$91.6 million in 2012, 2011 and 2010, respectively. Catastrophe Below is a summary of the underwriting results and ratios for our catastrophe unit: Catastrophe unit overview Year ended December 31, 2012 2011 2010
(in thousands, except percentages)
Property catastrophe gross premiums written
Renaissance $ 733,963 $ 742,236
DaVinci 448,244 435,060
364,153
Total property catastrophe gross premiums
written (1) $ 1,182,207 $ 1,177,296 $ 994,233 Net premiums written $ 766,035 $ 773,560 $ 685,393 Net premiums earned $ 781,738 $ 737,545 $ 721,419
Net claims and claim expenses incurred 165,209 770,350
153,290 Acquisition expenses 66,665 62,882 63,889 Operational expenses 103,811 100,932 104,535 Underwriting income (loss) $ 446,053 $ (196,619 ) $ 399,705
Net claims and claim expenses incurred -
current accident year $ 275,777 $ 829,487
Net claims and claim expenses incurred -
prior accident years (110,568 ) (59,137
) (157,458 )
Net claims and claim expenses incurred -
total $ 165,209 $ 770,350
Net claims and claim expense ratio -
current accident year 35.3 % 112.5
% 43.1 %
Net claims and claim expense ratio - prior
accident years (14.2 )% (8.1
)% (21.9 )%
Net claims and claim expense ratio -
calendar year 21.1 % 104.4 % 21.2 % Underwriting expense ratio 21.8 % 22.3 % 23.4 % Combined ratio 42.9 % 126.7 % 44.6 %
(1) Includes gross premiums written of $Nil assumed from the Other category for
the year ended
Catastrophe Reinsurance Gross Premiums Written - In 2012, our catastrophe reinsurance gross premiums written increased by$4.9 million , or 0.4%, to$1,182.2 million , compared to$1,177.3 million in 2011. Excluding the impact of$17.1 million and$159.8 million of net reinstatement premiums written in 2012 and 2011, our catastrophe unit gross premiums written increased$147.6 million , or 14.5%, in 2012, primarily due to improved market conditions on a risk-adjusted basis within our core lines of business during the key January andJune 2012 renewals, and inclusive of$37.4 million and$37.7 million of gross premiums written on behalf of our recent fully-collateralized joint ventures, Upsilon Re andTim Re III. In 2011, our catastrophe reinsurance gross premiums written increased by$183.1 million , or 18.4%, to$1,177.3 million , compared to$994.2 million in 2010. The increase is due in part to reinstatement premiums written on 2011 Large Losses, and the improving market conditions in our core markets during the June andJuly 2011 renewals, partially offset by the then softer market conditions in our core markets during theJanuary 2011 renewals. Excluding the impact of$159.8 million and$28.0 million of 104 -------------------------------------------------------------------------------- reinstatement premiums written in 2011 and 2010, respectively, our catastrophe unit gross premiums written increased$51.3 million , or 5.3%, in 2011. Our property catastrophe reinsurance gross premiums written continue to be characterized by a large percentage of U.S. andCaribbean premium, as we have found business derived from exposures inEurope or the rest of the world to be, in general, less attractive on a risk-adjusted basis during recent periods. A significant amount of our U.S. andCaribbean premium provides coverage against windstorms, mainly U.S. Atlantic hurricanes, as well as earthquakes and other natural and man-made catastrophes. Catastrophe Reinsurance Underwriting Results - Our catastrophe unit generated underwriting income of$446.1 million in 2012, compared to incurring an underwriting loss of$196.6 million in 2011, an improvement of$642.7 million . The improvement in underwriting income was driven by an increase in net premiums earned of$44.2 million principally due to the increase in gross premiums written noted above and a$553.7 million decrease in current accident year claims and claim expenses as a result of the relatively low level of insured catastrophe losses during 2012 which included$191.2 million of net claims and claim expenses related to hurricane Isaac and storm Sandy, compared to 2011 which was negatively impacted by net claims and claim expenses related to the 2011 Large Losses of$792.7 million . In addition, favorable development on prior accident years claims and claim expenses within our catastrophe unit was$110.6 million in 2012, compared to$59.1 million in 2011, an increase of$51.4 million , as discussed below. In 2012, our catastrophe unit generated a net claims and claim expense ratio of 21.1%, an underwriting expense ratio of 21.8% and a combined ratio of 42.9%, compared to 104.4%, 22.3% and 126.7%, respectively, in 2011. Current accident year net claims and claim expenses of$275.8 million includes$158.5 million related to storm Sandy,$35.0 million related to the tornado outbreaks across the Midwestern region of the U.S. during late February and early March (PCS 66 and 67, respectively),$32.7 million related to hurricane Isaac and$8.2 million related to theJune 29, 2012 derecho (PCS 83) which impacted the Midwest to Mid-Atlantic coast of the U.S., with the remainder due primarily to a number of other relatively small events throughout the U.S. During 2012, hurricane Isaac and storm Sandy had a net negative impact of$146.9 million , or 23.3 percentage points, on our catastrophe unit's underwriting result and combined ratio, respectively, as detailed in the table below. Operating expenses of$103.8 million in 2012 remained relatively flat compared to$100.9 million in 2011. See the financial data below for additional information detailing the net negative impact of hurricane Isaac and storm Sandy on our catastrophe unit in 2012. Year ended December 31, 2012 Hurricane Isaac Storm
Sandy Total
(in thousands, except percentages)
Net claims and claim expenses incurred $ (32,685 ) $ (158,477 ) $ (191,162 )
Reinstatement premiums earned 8,844
36,030 44,874
Ceded reinstatement premiums earned -
(385 ) (385 )
Lost profit commissions (2,016 ) 1,771 (245 )
Net negative impact on catastrophe unit
underwriting result $ (25,857 ) $
(121,061 ) $ (146,918 )
Percentage point impact on catastrophe unit
combined ratio 4.8 21.0 23.3 In comparison, our catastrophe unit incurred an underwriting loss of$196.6 million in 2011, compared to underwriting income of$399.7 million in 2010, a decrease of$596.3 million . The decrease in underwriting income was primarily due to a$518.7 million increase in current accident year claims and claim expenses as a result of the 2011 Large Losses and a decrease of$98.3 million in favorable development on prior accident years claims and claim expenses, and partially offset by a$16.1 million increase in net premiums earned due to the reinstatement premiums written and earned, noted above. In 2011, our catastrophe unit generated a net claims and claim expense ratio of 104.4%, an underwriting expense ratio of 22.3% and a combined ratio of 126.7%, compared to 21.2%, 23.4% and 44.6%, respectively, in 2010. The decrease in the underwriting expense ratio to 22.3% in 2011, from 23.4% in 2010, was driven in part by an increase in net premiums earned as a result of the reinstatement premiums 105 -------------------------------------------------------------------------------- written and earned, which do not incur additional acquisition expenses, as well as a$3.6 million reduction in operating expenses. The increase in current accident year losses was primarily due to the 2011 Large Losses, which negatively impacted the catastrophe unit's underwriting results and combined ratio by$669.5 million and 104.8 percentage points, respectively, after considering the impact of net reinstatement premiums earned and lost profit commissions related to these events, as detailed in the table below. 2011 Large Losses Year ended December 2011 New Zealand Tohoku Large U.S. Aggregate 31, 2011 Earthquake Earthquake Tornadoes Australian Floods Contracts Hurricane Irene Thailand Floods Total (in thousands, except percentages) Net claims and claim expenses incurred $ (261,070 ) $ (265,834 ) $ (131,965 ) $ (6,273 ) $ (33,080 ) $ (30,030 ) $ (64,437 ) $ (792,689 ) Assumed reinstatement premiums earned 49,878 60,603 23,073 1,694 1,524 5,874 17,144 159,790 Ceded reinstatement premiums earned (3,542 ) (24,418 ) - - - - - (27,960 ) Lost profit commissions (7,522 ) (331 ) (151 ) (348 ) - - (245 ) (8,597 ) Net negative impact on catastrophe unit underwriting result $ (222,256 ) $ (229,980 ) $ (109,043 ) $
(4,927 ) $ (31,556 ) $ (24,156 ) $ (47,538 ) $ (669,456 ) Percentage point impact on catastrophe unit combined ratio 30.4 31.5 14.4 0.6 4.3 3.1 6.0 104.8 During 2012, we experienced$110.6 million of favorable development on prior year reserves, compared to$59.1 million of favorable development on prior years reserves in 2011. The favorable development on prior year reserves in 2012 was primarily due to reductions in estimated ultimate losses on the 2010 Chilean earthquake of$24.6 million , the 2008 hurricanes of$17.5 million , the <chron>June 2007U.K. floods of$17.3 million , the 2005 hurricanes of$6.4 million , hurricane Irene of$4.6 million , the Tohoku earthquake of$3.9 million and a number of other catastrophes totaling$57.7 million , and partially offset by adverse development related to the 2010 and 2011 New Zealand earthquakes of$21.5 million primarily due to increase in estimated ultimate losses. During 2011, we experienced$59.1 million of favorable development on prior year reserves, compared to$157.5 million of favorable development on prior years reserves in 2010. The favorable development on prior year reserves in 2011 within the catastrophe reinsurance unit of$59.1 million was due to$27.0 million related to reductions in the estimated ultimate losses of smaller catastrophe events,$32.1 million arising from net reductions to the estimated ultimate losses of large catastrophe events, including$13.9 million ,$10.0 million ,$8.5 million and$4.7 million related to tropical cyclone Tasha, the 2005 hurricanes, the Chilean earthquake and theWorld Trade Center , respectively, and partially offset by$15.2 million of adverse development related to the 2010New Zealand earthquake. See "Item 7. Summary of Critical Accounting Estimates, Claims and Claim Expense Reserves" for additional discussion of our reserving techniques and prior year development of net claims and claim expenses. 106 --------------------------------------------------------------------------------
Specialty
Below is a summary of the underwriting results and ratios for our specialty reinsurance unit: Specialty unit overview Year ended December 31, 2012 2011 2010
(in thousands, except percentages)
Specialty gross premiums written
Renaissance $ 207,387 $ 144,192
DaVinci 2,500 1,699
2,538
Total specialty gross premiums written
$ 129,386 Net premiums written $ 201,552 $ 139,939 $ 124,326 Net premiums earned $ 164,685 $ 135,543 $ 117,371 Net claims and claim expenses incurred 76,813 13,354 (39,486 ) Acquisition expenses 23,826 20,096 14,065 Operational expenses 29,124 30,319 25,455 Underwriting income $ 34,922 $ 71,774 $ 117,337
Net claims and claim expenses incurred -
current accident year $ 110,959 $ 91,115
Net claims and claim expenses incurred -
prior accident years (34,146 ) (77,761
) (128,561 )
Net claims and claim expenses incurred -
total $ 76,813 $ 13,354
$ (39,486 )
Net claims and claim expense ratio -
current accident year 67.4 % 67.2
% 75.9 %
Net claims and claim expense ratio - prior
accident years (20.8 )% (57.3
)% (109.5 )%
Net claims and claim expense ratio -
calendar year 46.6 % 9.9 % (33.6 )% Underwriting expense ratio 32.2 % 37.1 % 33.6 % Combined ratio 78.8 % 47.0 % - % Specialty Reinsurance Gross Premiums Written - In 2012, our specialty reinsurance gross premiums written increased$64.0 million , or 43.9%, to$209.9 million , compared to$145.9 million in 2011, primarily due to the inception of a number of new contracts during 2012 which met our risk-adjusted return thresholds. During 2012, we experienced growth in a number of our specialty lines of business within Glencoe and will continue to seek to expand our specialty reinsurance operations through this platform, although we cannot assure you that we will do so. Our specialty reinsurance premiums are prone to significant volatility as this business is characterized by a relatively small number of comparably large transactions. In 2011, our specialty reinsurance gross premiums written increased$16.5 million , or 12.8%, to$145.9 million , compared to$129.4 million in 2010, primarily due to the inception of new contracts during 2011 which met our risk-adjusted return thresholds. Specialty Reinsurance Underwriting Results - Our specialty unit generated$34.9 million of underwriting income in 2012, compared to$71.8 million in 2011, a decrease of$36.9 million , principally due to a$63.5 million increase in net claims and claim expenses, partially offset by a$29.1 million increase in net premiums earned due to the increase in gross premiums written noted above. The$63.5 million increase in net claims and claim expenses is driven by a$43.6 million decrease in favorable development on prior accident year net claims and claim expenses and a$19.8 million increase in current accident year net claims and claim expenses, both as discussed below. 107 -------------------------------------------------------------------------------- In 2012, our specialty unit generated a net claims and claim expense ratio of 46.6%, an underwriting expense ratio of 32.2% and a combined ratio of 78.8%, compared to 9.9%, 37.1% and 47.0%, respectively, in 2011. The 4.9 percentage point decrease in the underwriting expense ratio was principally driven by a$29.1 million increase in net premiums earned and partially offset by a$3.7 million increase in acquisition expenses, both as a result of the increase in gross premiums written noted above. Operating expenses of$29.1 million in 2012 remained relatively flat compared to$30.3 million in 2011. Current accident year net claims and claim expenses of$111.0 million in 2012 includes$16.0 million related to estimated ultimate losses related to potential exposure to LIBOR related claims attributable to the current accident year,$11.0 million related to storm Sandy and$5.0 million related to the grounding of the Costa Concordia cruise ship, with the remainder principally due to reported attritional losses and the application of our formulaic reserving methodologies for establishing incurred but not reported reserves for net claims and claim expenses. In comparison, 2011 experienced$91.1 million of current accident year net claims and claim expenses including estimated losses associated with the Tohoku earthquake, 2011 New Zealand earthquake, the Australian flooding and theThailand flooding of$7.5 million ,$6.5 million ,$6.0 million and$6.0 million , respectively. Our specialty unit generated$71.8 million of underwriting income in 2011, compared to$117.3 million in 2010, a decrease of$45.6 million , principally due to a$52.8 million increase in net claims and claim expenses. The$52.8 million increase in net claims and claim expenses is primarily driven by a$50.8 million decrease in favorable development on prior accident year net claims and claim expenses, as discussed below. Included in current accident year net claims and claim expenses of$91.1 million are estimated losses associated with several large events including the Tohoku earthquake of$7.5 million , the 2011 New Zealand earthquake of$6.5 million , the Australian floods of$6.0 million and theThailand floods of$6.0 million . In 2011, our specialty unit generated a net claims and claim expense ratio of 9.9%, an underwriting expense ratio of 37.1% and a combined ratio of 47.0%, compared to negative 33.6%, 33.6% and 0.0%, respectively, in 2010. The 3.5 percentage point increase in the underwriting expense ratio was principally driven by an increase in operational expenses due to higher allocated operating expenses and a relative increase in contracts with higher acquisition expense ratios during 2011. The favorable development of$34.1 million within our specialty reinsurance unit in 2012 included$14.4 million associated with actuarial assumption changes, principally in our casualty and medical malpractice lines of business, and primarily as a result of revised initial expected claims ratios and claim development factors due to actual experience coming in better than expected,$3.0 million of favorable development on the 2005 hurricanes and$16.7 million of reported losses developing more favorably than expected during 2012 on prior accident years events. The favorable development of$77.8 million within our specialty reinsurance unit in 2011 included$37.1 million due to reported losses developing more favorably than expected during 2011 on prior accident years events,$26.8 million associated with actuarial assumption changes, principally in our workers' compensation quota share and risk, property risk and energy risk lines of business, and primarily as a result of revised initial expected claims ratios and claim development factors due to actual experience coming in better than expected, and$13.9 million related to a decrease in case reserves and additional case reserves, which are established at the contract level for specific loss or large events. See "Item 7. Summary of Critical Accounting Estimates, Claims and Claim Expense Reserves" for additional discussion of our reserving techniques and prior year development of net claims and claim expenses. 108 -------------------------------------------------------------------------------- Lloyd's Segment Below is a summary of the underwriting results and ratios for our Lloyd's segment: Lloyd's segment overview Year ended December 31, 2012 2011 2010
(in thousands, except percentages)
Lloyd's gross premiums written
Specialty $ 123,099 $ 83,641 $ 34,065 Catastrophe 36,888 27,943 14,724 Insurance - - 17,420
Total Lloyd's gross premiums written (1)
$ 66,209 Net premiums written $ 135,131 $ 98,617 $ 61,189 Net premiums earned $ 122,968 $ 76,386 $ 50,204 Net claims and claim expenses incurred 80,242 73,259 25,676 Acquisition expenses 22,864 14,031 10,784 Operational expenses 45,680 36,732 24,837 Underwriting loss $ (25,818 ) $ (47,636 ) $ (11,093 )
Net claims and claim expenses incurred -
current accident year $ 96,444 $ 72,781
Net claims and claim expenses incurred -
prior accident years (16,202 ) 478
(197 )
Net claims and claim expenses incurred -
total $ 80,242 $ 73,259
Net claims and claim expense ratio -
current accident year 78.4 % 95.3
% 51.5 %
Net claims and claim expense ratio - prior
accident years (13.1 )% 0.6
% (0.4 )%
Net claims and claim expense ratio -
calendar year 65.3 % 95.9 % 51.1 % Underwriting expense ratio 55.7 % 66.5 % 71.0 % Combined ratio 121.0 % 162.4 % 122.1 %
(1) Includes gross premiums written of $Nil and
Other category and Reinsurance segment, respectively, for the year ended
Lloyd's Gross Premiums Written - Gross premiums written in our Lloyd's segment increased by$48.4 million , or 43.4% to$160.0 million in 2012, compared to$111.6 million in 2011, primarily due to Syndicate 1458 growing its book of business across the majority of its lines of business and the impact of rate increases, most notably in its casualty lines of business. Gross premiums written in our Lloyd's segment increased by$45.4 million , or 68.5% to$111.6 million in 2011, compared to$66.2 million in 2010. Excluding the impact of an intercompany quota share agreement in the second quarter of 2010, gross premiums written in the Lloyd's segment increased$63.0 million , or 129.7%, primarily due to Syndicate 1458 growing its book of business across the majority of its lines of business, most notably its casualty lines of business. Lloyd's Underwriting Results - Our Lloyd's segment incurred an underwriting loss of$25.8 million and a combined ratio of 121.0% in 2012, compared to$47.6 million and a combined ratio of 162.4% in 2011. Current accident year net claims and claim expenses increased$23.7 million , while favorable development of prior accident years net claims and claim expenses increased$16.7 million , during 2012, compared to 2011, resulting in net claims and claims expenses increasing to$80.2 million in 2012, compared to$73.3 million in 2011. Included in current accident year net claims and claim expenses during 2012 is$18.5 million related to storm Sandy,$4.5 million due to the U.S. drought impacting the 2012 crop season and 109 -------------------------------------------------------------------------------- estimated ultimate losses of$2.5 million associated with potential exposure to LIBOR related claims attributable to the current accident year, with the remainder due to reported attritional losses and the application of our formulaic reserving methodologies for establishing incurred but not reported reserves for net claims and claim expenses. Operational expenses increased$8.9 million , to$45.7 million in 2012, compared to 2011, principally driven by an increase in compensation and related operating expenses as a result of growth in headcount as Syndicate 1458 continues to expand its operations. The decrease in the underwriting expense ratio to 55.7% in 2012, from 66.5% in 2011, was primarily driven by the increase in net premiums earned. Our Lloyd's segment incurred an underwriting loss of$47.6 million and a combined ratio of 162.4% in 2011, compared to an underwriting loss of$11.1 million and a combined ratio of 122.1% in 2010. Our Lloyd's segment was negatively impacted by the 2011 Large Losses which resulted in$29.7 million of underwriting losses and increased the combined ratio by 39.3 percentage points, as detailed in the table below. Operational expenses increased$11.9 million , to$36.7 million in 2011, compared to 2010, and principally include compensation and related operating expenses. The decrease in the underwriting expense ratio to 66.5% in 2011, from 71.0% in 2010, was primarily driven by the increase in net premiums earned. 2011 Large Losses 2011 New Zealand Tohoku Large U.S. Hurricane Thailand
Year ended
(in thousands, except
percentages)
Net claims and claim expenses
incurred $ (6,026 ) $ (11,014 ) $
(3,125 ) $ (2,500 ) $ (6,000 ) $ (28,665 )
Assumed reinstatement premiums
earned - 311 200 - - 511
Ceded reinstatement premiums
earned - (1,586 ) - - - (1,586 )
Net negative impact on Lloyd's
segment underwriting result $ (6,026 ) $ (12,289 ) $ (2,925 ) $ (2,500 ) $ (6,000 ) $ (29,740 )
Percentage point impact on
Lloyd's segment combined ratio 7.9 16.9 3.7 3.3 7.9 39.3 The favorable development of$16.2 million within our Lloyd's segment in 2012 included$5.5 million related to the 2011 Thailand floods,$2.5 million related to hurricane Irene and$1.3 million related to actuarial assumption changes, with the remainder primarily due to reported claims coming in lower than expected on a number of prior accident years events, as a result of the application of our formulaic actuarial reserving methodology. See "Item 7. Summary of Critical Accounting Estimates, Claims and Claim Expense Reserves" for additional discussion of our reserving techniques and prior year development of net claims and claim expenses. Other Underwriting Loss Year ended December 31, 2012 2011 2010 (in thousands) Underwriting loss $ (3,856 ) $ (4,691 ) $ (31,376 ) Included in our Other category are the underwriting results related to the remnants of ourBermuda -based insurance operations not sold pursuant to the Stock Purchase Agreement with QBE. Included in our Other category was an underwriting loss of$3.9 million in 2012, primarily due to us entering into a loss portfolio transfer in respect of our contractor's liability book of business within Glencoe, whereby we transfered net liabilities of$29.1 million , resulting in a loss of$7.4 million which was recorded as prior accident years net claims and claims expenses, partially offset by favorable development related to the application of our formulaic actuarial reserving methodology with the reductions being due to actual paid and reported claim activity being more favorable to date than what was originally anticipated when setting the initial reserves. In 2011 our Other category experienced an underwriting loss of$4.7 million in 2011, compared to$31.4 million in 2010, due primarily to adverse development on prior accident years of$4.4 million . The adverse development in 2011 was principally due to the contractor's liability book of business, which experienced higher than expected reported losses of$11.5 million , and was subsequently subject to a comprehensive 110 -------------------------------------------------------------------------------- actuarial review during the fourth quarter of 2011, which review resulted in an increase of$10.1 million to the estimated ultimate claims and claim expenses related to this book of business due to changes in the actuarial assumptions. The total gross reserve for claims and claim expenses for the construction defect book of business atDecember 31, 2011 was$58.8 million and$40.8 million of net claims and claim expenses after reinsurance recoverables. Partially offsetting the adverse development on prior accident years within the construction defect book of business, noted above, was favorable development of$4.2 million related to large catastrophe events primarily related to the 2005 hurricanes, and$12.9 million related to the application of our formulaic actuarial reserving methodology with the reductions being due to actual paid and reported claim activity being more favorable to date than what was originally anticipated when setting the initial reserves. Net Investment Income Year ended December 31, 2012 2011 2010 (in thousands) Fixed maturity investments $ 102,476 $ 89,858 $ 108,195 Short term investments 1,007 1,666 2,318 Equity investments trading 1,086 471 - Other investments Hedge funds and private equity investments 36,635 27,541 64,419 Other 37,784 8,458 39,305 Cash and cash equivalents 194 163 277 179,182 128,157 214,514 Investment expenses (11,807 ) (10,157 ) (10,559 ) Net investment income $ 167,375 $ 118,000 $ 203,955 Net investment income was$167.4 million in 2012, compared to$118.0 million in 2011. The$49.4 million increase in net investment income in 2012 was driven by a$29.3 million increase in the returns from our allocation to senior secured bank loan funds and insurance-linked securities included in other in the table above, a$12.6 million increase from our fixed maturity investments portfolio where higher average invested assets benefited from the tightening credit spreads during 2012 and a$9.1 million increase in the returns from our portfolio of hedge funds and private equity investments, with the increase primarily from our private equity investments due to higher fund valuations. Historically low interest rates as compared to recent years have lowered the yields at which we invest our assets relative to historical levels. We expect these developments, combined with the current composition of our investment portfolio and other factors, to continue to put downward pressure on our net investment income for the near term. The hedge fund, private equity and other investment portfolios are accounted for at fair value with the change in fair value recorded in net investment income which included net unrealized gains of$38.2 million in 2012, compared to$12.7 million of net unrealized gains in 2011. Net investment income was$118.0 million in 2011, compared to$204.0 million in 2010. The$86.0 million decrease in net investment income was principally driven by a$36.9 million decrease in the returns from our hedge fund and private equity investments due to lower returns in 2011, a$30.8 million decrease in the returns on certain non-investment grade investments included in other investments, and an$18.3 million decrease in net investment income related to fixed maturity investments, which was driven by a widening in credit spreads during 2011, and included$26.7 million of losses on derivatives and futures used to hedge the interest rate exposure of credit sensitive fixed maturity investments. The hedge fund, private equity and other investment portfolios are accounted for at fair value with the change in fair value recorded in net investment income which included net unrealized gains of$12.7 million in 2011, compared to$57.5 million in 2010. Commencing in the first quarter of 2011, we established a portfolio of certain publicly traded equities which are reflected in our consolidated balance sheet as equity investments trading. This portfolio of equity investments is carried at fair value with dividend income included in net investment income, and realized and unrealized gains included in net realized and unrealized gains on investments, in our consolidated statements of operations and generated$1.1 million of net investment income in 2012, compared to$0.5 111 -------------------------------------------------------------------------------- million in 2011. We do not expect it to represent a material portion of our invested assets or our financial results for the reasonably foreseeable period. Net Realized and Unrealized Gains on Investments and Net Other-Than-Temporary Impairments Year ended December 31, 2012 2011 2010 (in thousands) Gross realized gains $ 97,787 $ 79,358 $ 138,814 Gross realized losses (16,705 ) (30,659 ) (19,147 ) Net realized gains on fixed maturity investments 81,082 48,699 119,667 Net unrealized gains on fixed maturity investments trading 75,283 19,404 24,777 Net unrealized gains on equity investments trading 7,626 2,565 - Net realized and unrealized gains on investments $ 163,991 $ 70,668 $ 144,444 Total other-than-temporary impairments (395 ) (630 ) (831 ) Portion recognized in other comprehensive income, before taxes 52 78 2 Net other-than-temporary impairments $ (343 ) $ (552 ) $ (829 ) Our investment portfolio is structured to preserve capital and provide us with a high level of liquidity. A large majority of our investments are invested in the fixed income markets and, therefore, our realized and unrealized holding gains and losses on investments are highly correlated to fluctuations in interest rates. Therefore, as interest rates decline, we will tend to have realized and unrealized gains from our investment portfolio, and as interest rates rise, we will tend to have realized and unrealized losses from our investment portfolio. We experienced net realized and unrealized gains on investments of$164.0 million during 2012, the majority of which were derived from our portfolio of fixed maturity investments. However, the trend towards historically low interest rates (as compared to recent years) may reverse, resulting in a rising interest rate environment which would tend to diminish our ability to generate net realized gains on our portfolio of fixed maturity investments, and may result in significant realized and unrealized losses on our investments in the future. Net realized and unrealized gains on investments were$164.0 million in 2012, compared to$70.7 million in 2011, an improvement of$93.3 million . In addition to increased turnover in our fixed maturity investments portfolio generating$81.1 million of net realized gains in 2012, unrealized gains on our fixed maturity investments trading of$75.3 million during 2012 increased$55.9 million , compared to$19.4 million of unrealized gains in 2011, primarily due to the net appreciation of our fixed maturity investment portfolio as a result of tightening credit spreads during 2012. Included in net realized and unrealized gains on investments in 2012 is$7.6 million of net unrealized gains on equity investments trading due to increases in the share prices of our equity positions. Net realized and unrealized gains on investments were$70.7 million in 2011, compared to$144.4 million in 2010, a decrease of$73.8 million . The unrealized gains on our fixed maturity investments trading of$19.4 million during 2011 decreased$5.4 million , compared to$24.8 million in 2010, primarily as a result of an increase in credit spreads during 2011. Equity in Earnings (Losses) ofOther Ventures Year ended December 31, 2012 2011 2010 (in thousands) Top Layer Re $ 20,792 $ (37,471 ) $ (12,103 ) Tower Hill Companies 4,965 2,923 1,151 Other (2,519 ) (1,985 ) (862 ) Total equity in earnings (losses) of other ventures $ 23,238 $ (36,533 ) $ (11,814 ) 112
-------------------------------------------------------------------------------- Equity in earnings (losses) of other ventures primarily represents our pro-rata share of the net income (loss) from our investments in Top Layer Re and the Tower Hill Companies with the equity in earnings from the Tower Hill Companies recorded one quarter in arrears. Equity in earnings of other ventures was$23.2 million in 2012, compared to losses of$36.5 million in 2011. The$59.8 million improvement in equity in earnings of other ventures was primarily due to our equity in earnings of Top Layer Re of$20.8 million during 2012, as a result of the absence of net claims and claim expenses in Top Layer Re 2012, compared to 2011, which was negatively impacted by net claims and claim expenses related to the 2011 New Zealand and Tohoku earthquakes. Equity in losses of other ventures was$36.5 million in 2011, compared to$11.8 million in 2010. The$24.7 million deterioration in equity in losses of other ventures was primarily due to our equity in losses of Top Layer Re of$37.5 million during 2011, primarily as a result of Top Layer Re experiencing net claims and claim expenses related to the 2011 New Zealand and Tohoku earthquakes. During 2011, we sold our entire ownership interest inNBIC Holdings, Inc. ("NBIC"), a holding company for a specialty underwriter of homeowners' insurance products and services, for$12.0 million . Included in Other in the table above, is equity in losses of NBIC of$2.8 million in 2011. Other (Loss) Income Year ended December 31, 2012 2011 2010 (in thousands) Gain on NBIC $ - $ 4,836 $ - Mark-to-market on Platinum warrant - 2,975
10,054
Gain on sale of ChannelRe - -
15,835
Assumed and ceded reinsurance contracts
accounted for as derivatives and deposits (4,648 ) 37,414
5,214
Weather and energy risk management
operations (20,785 ) (45,030 ) 8,149 Other 2,528 (880 ) 1,868 Total other (loss) income $ (22,905 ) $ (685 ) $ 41,120 In 2012 we incurred an other loss of$22.9 million , compared to an other loss of$0.7 million in 2011. The$22.2 million deterioration in other income is primarily due to: • a$42.1 million decrease in other income generated by our assumed and ceded reinsurance contracts accounted for at fair value, principally as a
result of
during 2011 not reoccurring in 2012;
• the absence in 2012 of a mark-to-market adjustment on the Platinum warrant
due to its sale during the first quarter of 2011 and the sale of NBIC in
the third quarter of 2011; and partially offset by • a relatively lower level of losses from our weather and energy risk
management operations of
experienced in parts of the
during the first quarter of 2012, compared to losses from these operations
of
In 2011, we incurred an other loss of$0.7 million , compared to generating$41.1 million of other income in 2010. The$41.8 million decrease is primarily due to losses from our weather and energy risk management operations of$45.0 million due to the unusually warm weather experienced in theUnited Kingdom and certain parts ofthe United States during the fourth quarter of 2011, compared to income of$8.1 million in 2010, combined with two nonrecurring items: a decrease in the mark-to-market adjustment on the Platinum warrant due to its sale during the first quarter of 2011, and the absence of a gain of$15.8 million which occurred in the third quarter of 2010 on the sale of our entire ownership inChannelRe Holdings Ltd. ("ChannelRe"), as noted below. Offsetting the items noted above, was other income of$37.4 million generated by our assumed and ceded reinsurance contracts accounted for at fair value, compared to$5.2 million in 2010, principally as a result of net recoverables from the Tohoku earthquake and a gain on sale of NBIC of$4.8 million , as noted above. 113 -------------------------------------------------------------------------------- In 2010, we sold our entire ownership interest in ChannelRe, a financial guaranty reinsurance company, for$15.8 million and recorded other income of$15.8 million as a result of the sale. We no longer have an ownership interest in ChannelRe and have no contractual obligations to provide capital or other financial support to ChannelRe. Certain contracts we enter into in our weather and energy risk operations are informed in part on proprietary weather forecasts provided by our Weather Predict subsidiary. The weather and energy risk operations in which we engage are both seasonal and volatile, and there is no assurance that our performance to date will be indicative of future periods. We continue to allocate capital to our weather and energy risk management operations. This operation continually seeks new markets and relationships for its weather and energy risk products, including leveraging strategic affiliations and ceding risk where appropriate. Given current market opportunities, we have ceded a substantial portion of this operation's risk portfolio under a master swap agreement with a highly rated counterparty. Our results from these activities will therefore fluctuate on an absolute or relative basis over time. We have expanded our weather and energy risk management operations in the last several years to include weather contingent energy products and by increasing the size and volume of transactions with respect to our previously existing weather and energy risk management operations. The weather and energy risk management operations results include net realized and unrealized gains and losses on agreements with end users and net realized and unrealized gains and losses on hedging and trading activities. These activities present certain operational as well as financial risks, which we seek to mitigate, although there can be no assurance that we will be able to successfully mitigate such risks. Corporate Expenses Year ended December 31, 2012 2011 2010 (in thousands) Total corporate expenses $ 16,692 $ 18,264 $ 20,136 Corporate expenses include certain executive, director, legal and consulting expenses, costs for research and development, impairment charges related to goodwill and other intangible assets, and other miscellaneous costs, including those associated with operating as a publicly traded company. Corporate expenses were$16.7 million in 2012, compared to$18.3 million in 2011, with the decrease driven by the absence of certain goodwill and intangible asset impairments of$5.2 million which were incurred in 2011, and partially offset by a corporate insurance recovery of$1.7 million , recorded in 2011, which did not reoccur in 2012. Corporate expenses were$18.3 million in 2011, compared to$20.1 million in 2010, with the decrease primarily due to a decrease in legal and consulting expenses. Included in corporate expenses during 2011, was$5.2 million of impairment charges related to goodwill and intangible assets and a corporate insurance recovery of$1.7 million which reduced our corporate expenses by a like amount. 114 --------------------------------------------------------------------------------
Interest Expense and Preferred Share Dividends
Year ended December 31, 2012 2011 2010 (in thousands) Interest expense DaVinciRe revolving credit facility $ - $ 474 $ 2,029 $100 million 5.875% Senior Notes 5,875 5,875 5,875 $250 million 5.75% Senior Notes 14,375 14,375 11,373 Other 2,847 2,644 2,552 Total interest expense 23,097 23,368 21,829 Preferred share dividends $100 million 7.30% Series B Preference Shares - - 7,118 $250 million 6.08% Series C Preference Shares 15,200 15,200 15,200 $150 million 6.60% Series D Preference Shares (1) 19,695 19,800 19,800 Total preferred share dividends 34,895 35,000 42,118 Total interest expense and preferred share dividends $ 57,992 $ 58,368 $ 63,947
(1) On
million of our outstanding Series D Preference Shares at a redemption price
of
by random lottery in accordance with the
procedures and on
Preference Shares called for redemption for
unpaid dividends thereon. Following this transaction, 6.0 million Series D
Preference Shares remain outstanding.
Interest expense was relatively flat at$23.1 million in 2012, compared to$23.4 million in 2011. In addition, our preferred share dividends were also relatively flat at$34.9 million in 2012, compared to$35.0 million in 2011; however with the redemption of 6.0 million of our outstanding Series D Preference Shares as noted in the table above, and in the absence of issuing new preference shares, we expect our future preference share dividends to decrease in 2013. Interest expense increased$1.5 million to$23.4 million in 2011, compared to$21.8 million in 2010, primarily due to a full year of interest expense on the$250.0 million of 5.75% Senior Notes which were issued by RRNAH onMarch 17, 2010 . During 2011, our preferred share dividends decreased$7.1 million to$35.0 million , compared to$42.1 million in 2010, principally due to the redemption of our 7.30% Series B Preference Shares onDecember 20, 2010 , as noted below. Income Tax Benefit (Expense) Year ended December 31, 2012 2011 2010 (in thousands) Income tax (expense) benefit $ (1,429 ) $ 315 $ 6,124 We are subject to income taxes in certain jurisdictions in which we operate; however, since the majority of our income is currently earned inBermuda , a non-taxable jurisdiction, the tax impact to our operations has historically been minimal. During 2012, we incurred an income tax expense of$1.4 million , and in 2011 and 2010 we generated an income tax benefit of$0.3 million and$6.1 million , respectively, which was principally the result of our U.S. operations incurring pretax losses. Losses incurred within our U.S. tax-paying subsidiaries in the fourth quarter of 2011 were significant enough to result in a cumulative GAAP taxable loss for the three year period endedDecember 31, 2011 . We reassess our valuation allowance on a quarterly basis and commencing with our reassessment effectiveDecember 31, 2011 , we determined that it was more likely than not that we would not be able to recover our U.S. net deferred tax asset and increased our valuation allowance in the fourth quarter of 2011 to reduce our net deferred tax asset to $Nil. AtDecember 31, 2012 , our U.S. tax-paying subsidiaries had a net deferred tax asset of$37.7 million , for which a full valuation allowance has been provided. The remaining valuation allowance as ofDecember 31, 2012 relates exclusively to our operations inIreland and theU.K. OurIreland andU.K. operations have produced GAAP taxable losses and we currently do not believe it is 115 -------------------------------------------------------------------------------- more likely than not that we will be able to recover our net deferred tax assets from these jurisdictions. Our valuation allowance totaled$48.2 million and$35.0 million atDecember 31, 2012 and 2011, respectively. Our effective income tax rate, which we calculate as income tax expense divided by net income before taxes, may fluctuate significantly from period to period depending on the geographic distribution of pre-tax net income in any given period between different jurisdictions with comparatively higher tax rates and those with comparatively lower tax rates. The geographic distribution of pre-tax net income can vary significantly between periods due to, but not limited to, the following factors: the business mix of net premiums written and earned; the size and nature of net claims and claim expenses incurred; the amount and geographic location of operating expenses, net investment income, net realized and unrealized gains (losses) on investments; outstanding debt and related interest expense; and the amount of specific adjustments to determine the income tax basis in each of our operating jurisdictions. In addition, a significant portion of our gross and net premiums are currently written and earned inBermuda , a non-taxable jurisdiction, including the majority of our catastrophe business, which can result in significant volatility to our pre-tax net income (loss) in any given period. We expect our consolidated effective tax rate to increase in the future, as our global operations outside ofBermuda expand. In addition, it is possible that we could be adversely affected by changes in tax laws, regulation, or enforcement, any of which could increase our effective tax rate more rapidly or steeply than we currently anticipate. The preponderance of our revenue, and pre-tax income is generated by our domestic operations (i.e.Bermuda ) in the form of underwriting income and net investment income, when compared to our foreign operations. The geographic distribution of pre-tax net income can vary significantly between periods due to, but not limited, to the following factors: the business mix of net premiums written and earned; the size and nature of net claims and claim expenses incurred; the amount and geographic location of operating expenses, net investment income, net realized and unrealized gains (losses) on investments; and the amount of specific adjustments to determine the income tax basis in each of our operating jurisdictions. Pre-tax income for our domestic operations (i.e.Bermuda ) was higher compared to our foreign operations for the years endedDecember 31, 2012 and 2010 primarily as a result of the more volatile catastrophe business underwritten in ourBermuda operations during these periods being relatively free of catastrophe losses and thus generating higher levels of net underwriting income than our foreign operations, which underwrite primarily less volatile business and as a result produce lower levels of net underwriting income in benign loss years. During the year endedDecember 31, 2011 , our domestic operations incurred a loss from continuing operations primarily as a result of significant catastrophe losses experienced during the period resulting in underwriting losses. In addition, our U.S. operations, which principally includes our weather and energy risk management operations, experienced pre-tax losses during the years endedDecember 31, 2012 , 2011 and 2010. Net (Income) Loss Attributable to Noncontrolling Interests Year ended December 31, 2012 2011 2010 (in thousands) Net (income) loss attributable to noncontrolling interests $ (148,040 ) $ 33,157 $ (116,421 ) Our net income attributable to the noncontrolling interests was$148.0 million in 2012, compared to a net loss attributable to noncontrolling interests of$33.2 million in 2011. The$181.2 million change is primarily due to increased profits at DaVinciRe as a result of significantly lower insured losses in respect of large events, improved investment results and partially offset by a decrease in our ownership percentage in DaVinciRe from 42.8% atDecember 31, 2011 to 30.8% atDecember 31, 2012 . We expect our ownership in DaVinciRe to fluctuate over time. Our net loss attributable to the noncontrolling interests was$33.2 million in 2011, compared to net income attributable to noncontrolling interests of$116.4 million in 2010. The change is primarily due to net losses of DaVinciRe as DaVinciRe incurred an underwriting loss in 2011, compared to underwriting income in 2010, principally due to the 2011 Large Losses, as discussed above. 116 --------------------------------------------------------------------------------
Income (Loss) from Discontinued Operations
Year ended December 31, 2012 2011
2010
(in thousands)
Income (loss) from discontinued operations
Income (loss) from discontinued operations includes the financial results of substantially all of our U.S.-based insurance operations sold to QBE. Income from discontinued operations of$2.3 million in 2012 is primarily due to recognizing a gain of$1.0 million on the settlement of the Reserve Collar, as noted below, compared to a loss from discontinued operations of$15.9 million in 2011 which was primarily due to the recognition of a$10.0 million expense related to the contractually agreed obligation to pay, or otherwise reimburse, QBE for amounts potentially up to$10.0 million in respect of net adverse development on prior accident years net claims and claim expenses. EffectiveMay 23, 2012 ,RenaissanceRe and QBE reached an agreement in respect of the Reserve Collar, andRenaissanceRe paid QBE the sum of$9.0 million onJune 1, 2012 , representing full and final settlement of the Reserve Collar. We had recognized a$10.0 million liability and corresponding expense related to the Reserve Collar due to purported net adverse development on prior accident years net claims and claim expenses. The$10.0 million represented the maximum amount payable under the Reserve Collar. Included in income from discontinued operations in 2010 is underwriting income of$57.0 million primarily attributable to strong underwriting results for the 2010 crop year. Included in the underwriting result for 2010 was favorable development on prior accident years of$56.0 million primarily related to the crop insurance line of business which experienced a decrease in the frequency and severity of reported loss activity in 2010 on the 2009 crop year. LIQUIDITY AND CAPITAL RESOURCES Financial ConditionRenaissanceRe is a holding company, and we therefore rely on dividends from our subsidiaries and investment income to make principal and interest payments on our debt and to make dividend payments to our preference and common shareholders. The payment of dividends by our subsidiaries is, under certain circumstances, limited under statutory regulations and insurance law, which require our insurance subsidiaries to maintain certain measures of solvency and liquidity. In addition,Bermuda regulations require approval from theBermuda Monetary Authority ("BMA") for any reduction of capital in excess of 15% of statutory capital, as defined in the Insurance Act. The Insurance Act also requires theseBermuda insurance subsidiaries of the Company to maintain certain measures of solvency and liquidity. AtDecember 31, 2012 , the statutory capital and surplus of ourBermuda insurance subsidiaries was$3.1 billion (December 31, 2011 -$2.7 billion ) and the minimum amount required to be maintained underBermuda law, the Minimum Solvency Margin, was$554.8 million (December 31, 2011 -$552.9 million ). During 2012, Renaissance Reinsurance, DaVinciRe and the operating subsidiaries ofRenRe Insurance Holdings Ltd. returned capital to our holding company, which included dividends declared and return of capital, net of capital contributions received of$282.0 million ,$133.3 million and $Nil, respectively (2011 -$6.7 million ,$77.9 million and$547.3 million , respectively). As discussed in the "Capital Resources" section below, Renaissance Reinsurance is obligated to make a mandatory capital contribution of up to$50.0 million in the event that a loss reduces Top Layer Re's capital below a specified level. Under the Insurance Act, Renaissance Reinsurance and DaVinci are classified as Class 4 insurers, and therefore must maintain capital at a level equal to its Enhanced Capital Requirement ("ECR") which is established by reference to the Bermuda Solvency and Capital Requirement ("BSCR") model. The BSCR is a standard mathematical model designed to give the BMA more advanced methods for determining an insurer's capital adequacy. Underlying the BSCR is the belief that all insurers should operate on an ongoing basis with a view to maintaining their capital at a prudent level in excess of the minimum solvency margin otherwise prescribed under the Insurance Act. Alternatively, under the Insurance Act, insurers may, subject to the terms of the Insurance Act and to the BMA's oversight, elect to utilize an approved internal 117 -------------------------------------------------------------------------------- capital model to determine regulatory capital. In either case, the ECR shall at all times equal or exceed the Class 4 insurer's Minimum Solvency Margin and may be adjusted in circumstances where the BMA concludes that the insurer's risk profile deviates significantly from the assumptions underlying its ECR or the insurer's assessment of its risk management policies and practices used to calculate the ECR applicable to it. While not specifically referred to in the Insurance Act, the BMA has also established a Target Capital Level ("TCL") for each Class 4 insurer equal to 120% of its ECR. While a Class 4 insurer is not currently required to maintain its statutory capital and surplus at this level, the TCL serves as an early warning tool for the BMA and failure to maintain statutory capital at least equal to the TCL will likely result in increased BMA regulatory oversight. The 2012 BSCR for Renaissance Reinsurance and DaVinci must be filed with the BMA on or beforeApril 30, 2013 ; at this time, we believe both companies will exceed the target level of required capital.RenaissanceRe Corporate Capital (UK) Limited and Syndicate 1458 are subject to oversight by theCouncil of Lloyd's .RenaissanceRe Syndicate Management Limited is subject to regulation by theFinancial Services Authority ("FSA") under the Financial Services and Markets Act 2000. Underwriting capacity of a member of Lloyd's must be supported by providing a deposit in the form of cash, securities or letters of credit, which are referred to as Funds at Lloyd's ("FAL"). This amount is determined by Lloyd's and is based on Syndicate 1458's solvency and capital requirement as calculated through its internal model. In addition, if the FAL are not sufficient to cover all losses, the Lloyd'sCentral Fund provides an additional level of security for policyholders. AtDecember 31, 2012 , the FAL requirement set by Lloyd's for Syndicate 1458 is £183.2 million based on its business plan, approved inNovember 2012 (2011 - £93.8 million based on its business plan, approvedNovember 2011 ). Actual FAL posted for Syndicate 1458 atDecember 31, 2012 by RenaissanceRe CCL is$222.0 million and £45.5 million supported 100% by letters of credit (2011 -$118.5 million and £24.5 million). As discussed in the "Capital Resources" section below, Renaissance Reinsurance is obligated to make a mandatory capital contribution of up to$50.0 million in the event that a loss reduces Top Layer Re's capital below a specified level. Although not required to maintain Top Layer Re's minimum solvency margin as defined by the BMA, nor contractually obligated to, Renaissance Reinsurance contributed$38.5 million in additional paid-in capital to Top Layer Re during 2011, following the 2011 New Zealand and Tohoku earthquakes. In the aggregate, our operating subsidiaries have historically produced sufficient cash flows to meet their expected claims payments and operational expenses and to provide dividend payments to us. Our subsidiaries also maintain a concentration of investments in high quality liquid securities, which management believes will provide additional liquidity for extraordinary claims payments should the need arise. See "Capital Resources" section below. Liquidity and Cash Flows Holding Company Liquidity As aBermuda -domiciled holding company,RenaissanceRe has no operations of its own and its assets consist primarily of investments in subsidiaries. Accordingly,RenaissanceRe's future cash flows largely depend on the availability of dividends or other statutorily permissible payments from subsidiaries. The ability to pay such dividends is limited by the applicable laws and regulations of the various countries and states in which these subsidiaries operate, including, among others,Bermuda , the U.S.,Ireland , and theU.K. Refer to "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations, Liquidity and Capital Resources, Financial Condition" for further discussion and details regarding dividend capacity of our major operating subsidiaries.RenaissanceRe's principal uses of liquidity are common share related transactions including dividend payments to holders of its common shareholders as well as share buybacks, preference share related transactions including dividend payments to its preference shareholders as well as preference share buybacks from time to time, interest and principal payments on debt, capital investments in its subsidiaries and certain corporate operating expenses. 118 -------------------------------------------------------------------------------- We attempt to structure our organization such that it facilitates efficient capital movements betweenRenaissanceRe and its operating subsidiaries and to ensure that adequate liquidity is available when required, giving consideration to applicable laws and regulations, and the domiciliary location of sources of liquidity and related obligations. Sources of Liquidity Historically, cash receipts from operations, consisting of premiums and investment income, generally have provided sufficient funds to pay losses as well as operating expenses of our subsidiaries and to fund dividends toRenaissanceRe . Cash receipts from operations are generally derived from the receipt of investment income on our investment portfolio as well as the net receipt of premiums less claims and claims expenses related to our underwriting activities. The Company's operating subsidiaries provide liquidity in that premiums are generally received months or even years before losses are paid under the policies related to such premiums. Premiums and acquisition expenses are settled based on terms of trade as stipulated by an underwriting contract, and generally are received within the first year of inception of a policy when the premium is written, but can be longer on certain reinsurance business assumed. Operating expenses are generally paid within a year of being incurred. Claims and claims expenses, may take a much longer time before they are reported and ultimately settled, requiring the establishment of reserves for claims and claim expenses. Therefore, the amount of claims paid in any one year is not necessarily related to the amount of net claims incurred, as reported in the consolidated statement of operations. As a result of the combination of current market conditions, lower investment yields, and a large portion of the coverages we provide can produce losses of high severity and low frequency, it is not possible to accurately predict our future cash flows from operating activities. As a consequence, cash flows from operating activities may fluctuate, perhaps significantly, between individual quarters and years. Due to the magnitude and relatively recent occurrence of certain large loss events, meaningful uncertainty remains regarding losses from these events and our actual ultimate net losses from these events may vary from preliminary estimates, perhaps materially. As a result, our cash flows from operations would be impacted accordingly. We are a "well-known seasoned issuer" as defined by the rules promulgated under the Securities Act and we maintain a "shelf" Registration Statement on Form S-3 (the "Shelf Registration Statement") under the Securities Act and are eligible to file additional automatically effective Registration Statements of Form S-3 in the future for the potential offering and sale of an unlimited amount of debt and equity securities. The Shelf Registration Statement allows for various types of securities to be offered, including, but not limited to the following: common shares, preference shares and debt securities. In addition we maintain letter of credit facilities which provide liquidity. Refer to "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations, Liquidity and Capital Resources, Capital Resources" for details of these facilities. 119 -------------------------------------------------------------------------------- Cash Flows Year ended December 31, 2012 2011 2010 (in thousands) Net cash provided by operating activities $ 716,929 $ 165,933 $ 494,720 Net cash (used in) provided by investing activities (71,677 ) 315,031 108,610 Net cash used in financing activities (538,570 ) (542,236 ) (531,592 ) Effect of exchange rate changes on foreign currency cash 1,692 518 (1,003 ) Net increase (decrease) in cash and cash equivalents 108,374 (60,754 ) 70,735 Cash and cash equivalents, beginning of period 216,984 277,738 203,112 Cash and cash equivalents, end of period $ 325,358 $ 216,984 $ 277,738 During 2012, our cash and cash equivalents increased$108.4 million , to$325.4 million atDecember 31, 2012 , compared to$217.0 million atDecember 31, 2011 . Cash flows provided by operating activities. Cash flows provided by operating activities during 2012 were$716.9 million , compared to$165.9 million in 2011. Cash flows provided by operating activities during 2012 were primarily the result of certain adjustments to reconcile our net income of$748.9 million to net cash provided by operating activities, including: a reduction in reinsurance recoverable of$211.5 million primarily due to the collection of those balances, an increase in unearned premiums of$51.9 million due to the timing of, and growth in, our gross premiums written, and a$33.5 million increase in reinsurance balances payable due to the timing of, and increase in, our premiums ceded, and partially offset by an adjustment for net realized and unrealized gains on investments of$164.0 million due to improved total returns in our portfolios of fixed maturity and other investments, a decrease in our reserve for claims and claim expenses of$113.0 million driven by the payment of claims and by favorable development on prior accident years net claims and claims expenses during 2012, an increase in premiums receivable of$19.5 million due to increased gross premiums written and an increase in our prepaid reinsurance premiums of$18.6 million due to the timing of, and increase in, our premiums ceded. As discussed under "Summary of Results of Operations", we generated higher underwriting income and higher investment results in 2012 compared to 2011, which contributed to the increase in cash flows provided by operating activities. Cash flows used in investing activities. During 2012, our cash flows used in investing activities were$71.7 million , principally reflecting our net investment in fixed maturity investments trading of$343.4 million , which was funded primarily by cash provided by our operating activities and net sales of other investments, short term investments and fixed maturity investments available for sale of$150.8 million ,$68.8 million and$65.2 million , respectively. Cash flows used in financing activities. Our cash flows used in financing activities in 2012 were$538.6 million , and were principally the result of the settlement of$463.3 million of our common share repurchases, the payment of$53.4 million and$34.9 million in dividends to our common and preferred shareholders, respectively, and the redemption of$150.0 million of our Series D preference shares during the fourth quarter, partially offset by net inflows of$164.9 million related to additional third party equity capital raised during 2012 in our redeemable noncontrolling interest - DaVinciRe. 120 -------------------------------------------------------------------------------- During 2011, our cash and cash equivalents decreased$60.8 million , to$217.0 million atDecember 31, 2011 , compared to$277.7 million atDecember 31, 2010 . Cash flows provided by operating activities. Cash flows provided by operating activities during 2011 were$165.9 million , compared to$494.7 million in 2010. Cash flows provided by operating activities during 2011 were primarily the result of certain adjustments to reconcile our net loss of$90.4 million to net cash provided by operating activities, including: an increase in our reserve for claims and claim expenses of$734.5 million driven by the significant catastrophes in 2011; an increase in unearned premiums of$61.5 million due to growth in our gross premiums written; and partially offset by an increase in premiums receivable and reinsurance recoverable of$149.8 million and$302.3 million , respectively; a decrease in reinsurance balances payable of$61.1 million ; and net realized and unrealized gains on investments of$70.7 million . As discussed under "Summary of Results of Operations", in 2011 we incurred significant underwriting losses and lower investment results, which contributed to the decrease in cash flows provided by operating activities. Cash flows provided by investing activities. During 2011, our cash flows provided by investing activities were$315.0 million , which principally reflected$269.5 million in net proceeds from the sale of substantially all of our U.S.-based insurance operations to QBE and$47.9 million related to the sale of our Platinum warrant during the first quarter of 2011. In response to the large catastrophes of 2011 and our payment of valid claims quickly, we had net sales of short term investments of$103.1 million . In addition, we invested a portion of our net cash provided by operating activities in fixed maturity investments and investments in other ventures. Cash flows used in financing activities. Our cash flows used in financing activities in 2011 were$542.2 million , principally comprised of the repurchase of$191.6 million of our common shares, the payment of$53.5 million and$35.0 million in dividends to our common and preferred shareholders, respectively, the repurchase of$132.2 million of DaVinciRe shares and the repayment of the outstanding principal of the DaVinciRe revolving credit facility of$200.0 million , as discussed below in the "Capital Resources" section. Partially offsetting the above cash flows used in financing activities was a$70.0 million cash inflow attributable to redeemable noncontrolling interest related to the DaVinciRe equity capital raise executed during the second quarter of 2011. Reserves for Claims and Claim Expenses We believe the most significant accounting judgment made by management is our estimate of claims and claim expense reserves. Claims and claim expense reserves represent estimates, including actuarial and statistical projections at a given point in time, of the ultimate settlement and administration costs for unpaid claims and claim expenses arising from the insurance and reinsurance contracts we sell. We establish our claims and claim expense reserves by taking claims reported to us by insureds and ceding companies, but which have not yet been paid ("case reserves"), adding the costs for additional case reserves ("additional case reserves") which represent our estimates for claims previously reported to us which we believe may not be adequately reserved as of that date, and adding estimates for the anticipated cost of IBNR. 121 --------------------------------------------------------------------------------
The following table summarizes our claims and claim expense reserves by line of business and split between case reserves, additional case reserves and IBNR:
Case Additional At December 31, 2012 Reserves Case Reserves IBNR Total (in thousands) Catastrophe $ 706,264 $ 222,208 $ 255,786 $ 1,184,258 Specialty 111,234 80,971 286,108 478,313 Total Reinsurance 817,498 303,179 541,894 1,662,571 Lloyd's 29,260 10,548 109,662 149,470 Other 17,016 8,522 41,798 67,336 Total $ 863,774 $ 322,249 $ 693,354 $ 1,879,377
At
(in thousands) Catastrophe $ 681,771 $ 271,990 $ 388,147 $ 1,341,908 Specialty 120,189 49,840 301,589 471,618 Total Reinsurance 801,960 321,830 689,736 1,813,526 Lloyd's 17,909 14,459 55,127 87,495 Other 32,944 3,515 54,874 91,333 Total $ 852,813 $ 339,804 $ 799,737 $ 1,992,354 Our estimates of claims and claim expense reserves are not precise in that, among other matters, they are based on predictions of future developments and estimates of future trends and other variable factors. Some, but not all, of our reserves are further subject to the uncertainty inherent in actuarial methodologies and estimates. Because a reserve estimate is simply an insurer's estimate at a point in time of its ultimate liability, and because there are numerous factors which affect reserves and claims payments that cannot be determined with certainty in advance, our ultimate payments will vary, perhaps materially, from our estimates of reserves. If we determine in a subsequent period that adjustments to our previously established reserves are appropriate, such adjustments are recorded in the period in which they are identified. During the year endedDecember 31, 2012 , changes to prior year estimated claims reserves increased our net income by$158.0 million (2011 - decreased our net loss by$132.0 million , 2010 - increased out net income by$302.1 million ), excluding the consideration of changes in reinstatement premium, profit commissions, redeemable noncontrolling interest - DaVinciRe, equity in net claims and claim expenses of Top Layer Re and income tax. Our reserving methodology for each line of business uses a loss reserving process that calculates a point estimate for the Company's ultimate settlement and administration costs for claims and claim expenses. We do not calculate a range of estimates. We use this point estimate, along with paid claims and case reserves, to record our best estimate of additional case reserves and IBNR in our consolidated financial statements. Under GAAP, we are not permitted to establish estimates for catastrophe claims and claim expense reserves until an event occurs that gives rise to a loss. Reserving for our reinsurance claims involves other uncertainties, such as the dependence on information from ceding companies, which among other matters, includes the time lag inherent in reporting information from the primary insurer to us or to our ceding companies and differing reserving practices among ceding companies. The information received from ceding companies is typically in the form of bordereaux, broker notifications of loss and/or discussions with ceding companies or their brokers. This information can be received on a monthly, quarterly or transactional basis and normally includes estimates of paid claims and case reserves. We sometimes also receive an estimate or provision for IBNR. This information is often updated and adjusted from time to time during the loss settlement period as new data or facts in respect of initial claims, client accounts, industry or event trends may be reported or emerge in addition to changes in applicable statutory and case laws. Our estimates of losses from large events are based on factors including currently available information derived from the Company's claims information from certain customers and brokers, industry assessments of losses from the events, proprietary models, and the terms and conditions of our contracts. The 122 -------------------------------------------------------------------------------- uncertainty of our estimates for certain of these large events is additionally impacted by the preliminary nature of the information available, the magnitude and relative infrequency of the events, the expected duration of the respective claims development period, inadequacies in the data provided thus far by industry participants and the potential for further reporting lags or insufficiencies (particularly in respect of the Chilean, 2010New Zealand , 2011New Zealand and Tohoku earthquakes); and in the case of storm Sandy and theThailand flooding, significant uncertainty as to the form of the claims and legal issues, under the relevant terms of insurance contracts and reinsurance treaties. In addition, a significant portion of the net claims and claim expenses associated with storm Sandy and theNew Zealand and Tohoku earthquakes are concentrated with a few large clients and therefore the loss estimates for these events may vary significantly based on the claims experience of those clients. Loss reserve estimation in respect of our retrocessional contracts poses further challenges compared to directly assumed reinsurance. A significant portion of our reinsurance recoverable relates to theNew Zealand and Tohoku earthquakes. There is inherent uncertainty and complexity in evaluating loss reserve levels and reinsurance recoverable amounts, due to the nature of the losses relating to earthquake events, including that loss development time frames tend to take longer with respect to earthquake events. The contingent nature of business interruption and other exposures will also impact losses in a meaningful way, especially with regard to storm Sandy, the Tohoku earthquake andThailand flooding, which we believe may give rise to significant complexity in respect of claims handling, claims adjustment and other coverage issues, over time. Given the magnitude and relatively recent occurrence of these large events, meaningful uncertainty remains regarding total covered losses for the insurance industry and, accordingly, several of the key assumptions underlying our loss estimates. In addition, our actual net losses from these events may increase if our reinsurers or other obligors fail to meet their obligations. Because of the inherent uncertainties discussed above, we have developed a reserving philosophy which attempts to incorporate prudent assumptions and estimates, and we have generally experienced favorable net development on prior year reserves in the last several years. However, there is no assurance that this will occur in future periods Our reserving techniques, assumptions and processes differ between our property catastrophe reinsurance and specialty reinsurance units within our Reinsurance segment and within our Lloyd's segment. Refer to "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations, Summary of Critical Accounting Estimates, Claims and Claim Expense Reserves" for more information on the risks we insure and reinsure, the reserving techniques, assumptions and processes we follow to estimate our claims and claim expense reserves, and our current estimates versus our initial estimates of our claims reserves, for each of these units. Capital Resources Our total capital resources are as follows: At December 31, 2012 2011 Change (in thousands) Common shareholders' equity $ 3,103,065 $ 3,055,193 $ 47,872 Preference shares 400,000 550,000 (150,000 ) Total shareholders' equity attributable to RenaissanceRe 3,503,065 3,605,193 (102,128 ) 5.875% Senior Notes 100,000 100,000 - 5.750% Senior Notes 249,339 249,247 92RenaissanceRe revolving credit facility - borrowed - - -RenaissanceRe revolving credit facility - unborrowed 150,000 150,000 - Renaissance Trading credit facility - borrowed 2,436 4,373 (1,937 ) Renaissance Trading credit facility - unborrowed 17,564 5,627 11,937 Total capital resources $ 4,022,404 $ 4,114,440 $ (92,036 ) 123
-------------------------------------------------------------------------------- In 2012, our capital resources decreased by$92.0 million , principally due to the redemption of 6.0 million of our Series D Preferences Shares, or$150.0 million , as discussed below,$53.4 million of dividends on our common shares,$494.4 million of common share repurchases as discussed in more detail in "Part II, Item 2. Unregistered Sales ofEquity Securities and Use of Proceeds", and partially offset by comprehensive income of$602.8 million . Preference Shares InDecember 2006 , we raised$300.0 million through the issuance of 12.0 million Series D Preference Shares; inMarch 2004 , we raised$250.0 million through the issuance of 10.0 million Series C Preference Shares; and inFebruary 2003 , we raised$100.0 million through the issuance of 4.0 million Series B Preference Shares. OnNovember 17, 2010 , we gave redemption notices to the holders of the 7.30% Series B Preference Shares to redeem such shares for$25.00 per share. OnDecember 20, 2010 , we redeemed all of the issued and outstanding 7.30% Series B Preference Shares for$100.0 million plus accrued and unpaid dividends thereon. OnNovember 27, 2012 , we announced mandatory partial redemption of 6.0 million of our outstanding Series D Preference Shares at a redemption price of$25.00 per Series D Preference Share. The partial redemption was allocated by random lottery in accordance with theDepository Trust Company's rules and procedures and onDecember 27, 2012 we redeemed the 6.0 million Series D Preference Shares called for redemption for$150.0 million plus accrued and unpaid dividends thereon. Following this transaction, 6.0 million Series D Preference Shares remain outstanding. The Series D and Series C Preference Shares may be redeemed at$25.00 per share at our option. Dividends on the Series D and Series C Preference Shares are cumulative from the date of original issuance and are payable quarterly in arrears at 6.60% and 6.08%, respectively, when, if and as declared by the Board of Directors. The preference shares have no stated maturity and are not convertible into any other of our securities. 5.875% Senior Notes InJanuary 2003 , the Company issued$100.0 million , which represented the carrying amount on the Company's consolidated balance sheet, of 5.875% Senior Notes dueFebruary 15, 2013 , with interest on the notes payable onFebruary 15 andAugust 15 of each year. The Company repaid the notes in full upon their scheduled maturity onFebruary 15, 2013 using available cash and investments. The Company does not have current plans to replace the notes with additional indebtedness. 5.75% Senior Notes OnMarch 17, 2010 , RRNAH issued$250.0 million of 5.75% Senior Notes dueMarch 15, 2020 , with interest on the notes payable onMarch 15 andSeptember 15 of each year. The notes, which are senior obligations, are guaranteed byRenaissanceRe and can be redeemed by RRNAH prior to maturity, subject to the payment of a "make-whole" premium. The Notes were issued pursuant to an Indenture, dated as ofMarch 17, 2010 , by and amongRenaissanceRe , RRNAH, andDeutsche Bank Trust Company Americas , as trustee (the "Trustee"), as supplemented by the First Supplemental Indenture, dated as ofMarch 17, 2010 (as so supplemented, the "Indenture"). RenaissanceRe Revolving Credit Facility (the "Credit Agreement") EffectiveMay 17, 2012 ,RenaissanceRe entered into a credit agreement with various banks and financial institutions parties thereto (collectively, the "Lenders"),Wells Fargo Bank, National Association ("Wells Fargo"), as fronting bank, letter of credit administrator and administrative agent for the Lenders,Citibank, N.A . ("Citibank"), as syndication agent, andWells Fargo Securities, LLC andCitigroup Global Markets Inc. , as joint lead arrangers and joint lead bookrunners (the "Credit Agreement"). The Credit Agreement replaced the prior credit agreement, dated as ofApril 22, 2010 , which was terminated concurrently with the effectiveness of the Credit Agreement. The Credit Agreement provides for a revolving commitment toRenaissanceRe of$150.0 million , including the issuance of letters of credit for the account ofRenaissanceRe andRenaissanceRe's insurance subsidiaries of up to$150.0 million and the issuance of letters of credit for the account ofRenaissanceRe's non-insurance subsidiaries of up to$50.0 million .RenaissanceRe has the right, subject to satisfying certain conditions, to increase the size of the facility to$250.0 million . Amounts borrowed under the Credit 124 -------------------------------------------------------------------------------- Agreement bear interest at a rate selected byRenaissanceRe equal to the Base Rate or LIBOR (each as defined in the Credit Agreement) plus a margin, all as more fully set forth in the Credit Agreement. The Credit Agreement contains representations, warranties and covenants customary for bank loan facilities of this type. In addition to customary covenants which limitRenaissanceRe and its subsidiaries' ability to merge, consolidate, enter into negative pledge agreements, sell a substantial amount of assets, incur liens and declare or pay dividends under certain circumstances, the Credit Agreement also contains certain financial covenants. These financial covenants generally provide that consolidated debt to capital shall not exceed the ratio of 0.35:1 and that the consolidated net worth ofRenaissanceRe and Renaissance Reinsurance shall equal or exceed approximately$2.1 billion and$1.1 billion , respectively (the "Net Worth Requirements"). The Net Worth Requirements are recalculated effective as of the end of each fiscal year, all as more fully set forth in the Credit Agreement. The scheduled commitment maturity date of the Credit Agreement isMay 17, 2015 . In the event of the occurrence and continuation of certain events of default, the administrative agent shall, at the request of the Required Lenders (as defined in the Credit Agreement), or may, with the consent of the Required Lenders, among other things, take any or all of the following actions: terminate the Lenders' obligations to make loans or issue letters of credit, accelerate the outstanding obligations ofRenaissanceRe under the Credit Agreement and requireRenaissanceRe to cash collateralize the outstanding letter of credit obligations in an amount equal to 103% thereof. DaVinciRe Revolving Credit Facility DaVinciRe was a party to a Third Amended and Restated Credit Agreement, dated as ofApril 5, 2006 (the "DaVinciRe Credit Agreement"), which provided for a revolving credit facility in an aggregate amount of up to$200.0 million and was scheduled to mature onApril 5, 2011 . OnApril 1, 2011 , DaVinciRe repaid in full the$200.0 million borrowed under the DaVinciRe Credit Agreement and terminated the lenders' lending commitment thereunder. In connection with such repayment and termination, onMarch 30, 2011 , DaVinciRe entered into a loan agreement withRenaissanceRe (the "Loan Agreement") under whichRenaissanceRe made a loan to DaVinciRe in the principal amount of$200.0 million onApril 1, 2011 . The loan matures onMarch 31, 2021 and interest on the loan is payable at a rate of three month LIBOR plus 3.5% and is due at the end of each March, June, September and December, commencing onJune 30, 2011 . Under the terms of the Loan Agreement, DaVinciRe is required to maintain a debt to capital ratio of no greater than 0.40:1 and a net worth of no less than$500.0 million . OnDecember 21, 2012 , DaVinciRe repaid$100.0 million of principal under the Loan Agreement and atDecember 31, 2012 ,$100.0 million remained outstanding under the Loan Agreement. No additional amounts may be borrowed by DaVinciRe under the Loan Agreement. Principal Letter of Credit Facility EffectiveMay 17, 2012 ,RenaissanceRe and certain of its affiliates, Renaissance Reinsurance, ROE, Glencoe and DaVinci (such affiliates, collectively, the "Account Parties"), entered into a Fourth Amended and Restated Reimbursement Agreement with various banks and financial institutions parties thereto (collectively, the "Banks"), Wells Fargo, as issuing bank, administrative agent and collateral agent for the Banks, and certain other agents (the "Reimbursement Agreement"). The Reimbursement Agreement amended and restated in its entirety the Third Amended and Restated Reimbursement Agreement, dated as ofApril 22, 2010 (the "Prior Reimbursement Agreement"), which was terminated concurrently with the effectiveness of the Reimbursement Agreement. The Reimbursement Agreement continues to serve asRenaissanceRe's principal secured letter of credit facility and the commitments thereunder expire onMay 17, 2015 . The Reimbursement Agreement provides a commitment from the Banks in an aggregate amount of$450.0 million , which may be increased up to an amount not to exceed$800.0 million , subject toRenaissanceRe satisfying certain conditions. The Reimbursement Agreement contains representations, warranties and covenants in respect ofRenaissanceRe , the Account Parties and their respective subsidiaries that are customary for facilities of this type, including customary covenants limiting the ability to merge, consolidate and sell a substantial amount of assets. The Reimbursement Agreement contains certain financial covenants requiringRenaissanceRe and DaVinci to maintain a minimum net worth of approximately$1.8 billion and$749.1 million , respectively, 125 -------------------------------------------------------------------------------- which requirements are recalculated effective as of the end of each fiscal year, all as more fully set forth in the Reimbursement Agreement. Under the Reimbursement Agreement, eachAccount Party is required to pledge eligible collateral having a value sufficient to cover all of its obligations under the Reimbursement Agreement, including reimbursement obligations for outstanding letters of credit issued for its account. In the case of an event of default under the Reimbursement Agreement, and in certain other circumstances set forth in the Reimbursement Agreement, including, among others, a decrease in the net worth of anAccount Party below the level specified therein for suchAccount Party , a decline in collateral value, and certain failures to maintain specified ratings, the Banks may exercise certain remedies, including conversion of collateral into cash. Under the Reimbursement Agreement, redeemable preference shares ofRenaissance Investment Holdings Ltd. are no longer eligible collateral. Therefore, the Second Amended and Restated RIHL Undertaking and Agreement, dated as ofApril 22, 2010 , entered into in connection with the Prior Reimbursement Agreement, was terminated concurrently with the execution of the Reimbursement Agreement. AtDecember 31, 2012 , we had$204.6 million of letters of credit with effective dates on or beforeDecember 31, 2012 outstanding under the Reimbursement Agreement. Bilateral Letter of Credit Facility ("Bilateral Facility") EffectiveSeptember 17, 2010 , each of Renaissance Reinsurance, DaVinci and Glencoe (collectively, the "Bilateral Facility Participants"), entered into a secured letter of credit facility withCitibank Europe plc ("CEP"). The Bilateral Facility provides a commitment from CEP to issue letters of credit for the account of one or more of the Bilateral Facility Participants and their respective subsidiaries in multiple currencies and in an aggregate amount of up to$300.0 million . The Bilateral Facility expires onDecember 31, 2013 and is evidenced by a Facility Letter (as amended) and three separate Master Agreements between CEP and each of the Bilateral Facility Participants, as well as certain ancillary agreements. AtDecember 31, 2012 ,$292.9 million remained unused and available to the Bilateral Facility Participants under the Bilateral Facility. Under the Bilateral Facility, each of the Bilateral Facility Participants is severally obligated to pledge to CEP at all times during the term of the Bilateral Facility certain securities with a collateral value (as determined as therein provided) that equals or exceeds 100% of the aggregate amount of its then-outstanding letters of credit. In the case of an event of default under the Bilateral Facility with respect to a Bilateral Facility Participant, CEP may exercise certain remedies with respect to such Bilateral Facility Participant, including terminating its commitment to such Bilateral Facility Participant under the Bilateral Facility and taking certain actions with respect to the collateral pledged by such Bilateral Facility Participant (including the sale thereof). In the Facility Letter, each of Renaissance Reinsurance, DaVinci and Glencoe makes, as to itself, representations and warranties that are customary for facilities of this type and severally agrees that it will comply with certain informational and other undertakings, including those regarding the delivery of quarterly and annual financial statements. Funds at Lloyd's Letter of Credit Facility OnApril 26, 2010 , Renaissance Reinsurance and CEP entered into an Amended and Restated Pledge Agreement (the "Pledge Agreement") in respect of its letter of credit facility with CEP which is evidenced by the Master Reimbursement Agreement, dated as ofApril 29, 2009 , which provides for the issuance and renewal of letters of credit used to support business written by Syndicate 1458. AtDecember 31, 2012 $222.0 million and £45.5 million, respectively. Pursuant to the Pledge Agreement, Renaissance Reinsurance has agreed to pledge to CEP at all times during the term of the Reimbursement Agreement certain securities with a collateral value equal to 100% of the aggregate amount of the then-outstanding letters of credit issued under the Reimbursement Agreement. 126 -------------------------------------------------------------------------------- Letters of Credit AtDecember 31, 2012 , we had total letters of credit outstanding under all facilities of$507.2 million . Renaissance Reinsurance is also party to a collateralized letter of credit and reimbursement agreement in the amount of$37.5 million that supports our Top Layer Re joint venture. Renaissance Reinsurance is obligated to make a mandatory capital contribution of up to$50.0 million in the event that a loss reduces Top Layer Re's capital below a specified level. Multi-Beneficiary Reinsurance Trusts EffectiveMarch 15, 2011 , each of Renaissance Reinsurance and DaVinci was approved as a Trusteed Reinsurer in theState of New York and established a multi-beneficiary reinsurance trust ("MBRT") to collateralize its respective (re)insurance liabilities associated with U.S. domiciled cedants. The MBRTs are subject to the rules and regulations of theState of New York and the respective deed of trust, including but not limited to certain minimum capital funding requirements, investment guidelines, capital distribution restrictions and regulatory reporting requirements. Following the initial approval in theState of New York , Renaissance Reinsurance and DaVinci submitted applications to all U.S. states to become Trusteed Reinsurers. As ofDecember 31, 2012 , Renaissance Reinsurance and DaVinci are approved in 51 and 50 U.S. states, respectively. We expect, over time, to transition cedants with existing outstanding letters of credit, to the appropriate MBRT as determined by cedant state of domicile, thereby reducing our absolute and relative reliance on letters of credit. New business incepting with cedants domiciled in approved states will be collateralized using a MBRT. Cedants collateralized with a MBRT will be eligible for automatic reinsurance credit in their respective U.S. regulatory filings. Assets held under trust atDecember 31, 2012 with respect to the MBRTs totaled$508.7 million and$180.1 million for Renaissance Reinsurance and DaVinci, respectively, compared to the minimum amount required under U.S. state regulations of$494.9 million and$169.1 million , respectively. Multi-Beneficiary Reduced Collateral Reinsurance Trusts EffectiveDecember 31, 2012 , each of Renaissance Reinsurance and DaVinci was approved as an Accredited Reinsurer in the state ofNew York and established a multi-beneficiary reduced collateral reinsurance trust ("RCT") to collateralize its (re)insurance liabilities associated with U.S. domiciled cedants in certain states where Renaissance Reinsurance or DaVinci is approved as an Accredited Reinsurer, thereby providing for a reduction in collateral requirements to 20% of the net outstanding insurance liabilities. The RCTs are subject to the rules and regulations of the state ofNew York and the respective deed of trust, including but not limited to certain minimum capital funding requirements, investment guidelines, capital distribution restrictions and regulatory reporting requirements. Assets held under trust atDecember 31, 2012 with respect to the RCTs totaled$11.0 million and$11.0 million for Renaissance Reinsurance and DaVinci, respectively, compared to the minimum amount required under U.S. state regulations of$10.0 million and$10.0 million , respectively. Renaissance Trading Margin Facility and Guarantees Renaissance Trading maintains a brokerage facility with a prime broker, which has an associated margin facility of$20.0 million . This margin facility, which allows Renaissance Trading to manage its cash position related to its exchange traded products, is supported by a$25.0 million guarantee issued byRenaissanceRe . Interest on amounts outstanding under this facility is at overnight LIBOR plus 200 basis points. AtDecember 31, 2012 ,$2.4 million was outstanding under the facility. AtDecember 31, 2012 ,RenaissanceRe had provided guarantees in the aggregate amount of$304.3 million to certain counterparties of the weather and energy risk operations of Renaissance Trading. In the future,RenaissanceRe may issue guarantees for other purposes or increase the amount of guarantees issued to counterparties of Renaissance Trading. Redeemable Noncontrolling Interest - DaVinciRe DaVinciRe shareholders are party to a shareholders agreement (the "Shareholders Agreement") which provides DaVinciRe shareholders, excluding us, with certain redemption rights that enable each shareholder to notify DaVinciRe of such shareholder's desire for DaVinciRe to repurchase up to half of such shareholder's aggregate number of shares held, subject to certain limitations, such as limiting the aggregate 127 -------------------------------------------------------------------------------- of all share repurchase requests to 25% of DaVinciRe's capital in any given year and satisfying all applicable regulatory requirements. If total shareholder requests exceed 25% of DaVinciRe's capital, the number of shares repurchased will be reduced among the requesting shareholders pro-rata, based on the amounts desired to be repurchased. Shareholders desiring to have DaVinciRe repurchase their shares must notify DaVinciRe beforeMarch 1 of each year. The repurchase price will be based on GAAP book value as of the end of the year in which the shareholder notice is given, and the repurchase will be effective as of such date. Payment will be made byApril 1 of the following year, following delivery of the audited financial statements for the year in which the repurchase was effective. The repurchase price is subject to a true-up for development on outstanding loss reserves after settlement of all claims relating to the applicable years. EffectiveJanuary 1, 2012 , an existing third party shareholder sold a portion of its shares in DaVinciRe to a new third party shareholder. In connection with the sale by the existing third party shareholder, DaVinciRe retained a$4.9 million holdback. In addition, effectiveJanuary 1, 2012 , we sold a portion of our shares ofDaVinci Re to a separate new third party shareholder. We sold these shares for$98.9 million , net of a$10.0 million reserve holdback due from DaVinciRe. Certain third party shareholders of DaVinciRe submitted repurchase notices on or before the required annual redemption notice date ofMarch 1, 2012 , in accordance with the Shareholders Agreement. The repurchase notices submitted on or beforeMarch 1, 2012 , were for shares of DaVinciRe with a GAAP book value of$53.2 million atDecember 31, 2012 . OnJune 1, 2012 , DaVinciRe completed an equity raise of$49.3 million from a new third party investor. In addition, the Company and an existing third party investor each sold$24.7 million in common shares of DaVinciRe to another existing third party investor, for a total of$49.4 million . In connection with the sale by the Company and the existing third party investor, DaVinciRe retained a$5.0 million holdback. As a result of the above transactions, the Company's ownership in DaVinciRe decreased to 31.5% effective retroactively toJanuary 1, 2012 . OnOctober 1, 2012 , the Company sold a portion of its shares of DaVinciRe to a new third party shareholder for$9.8 million . The Company's ownership in DaVinciRe decreased to 30.8% effectiveOctober 1, 2012 as a result of this sale. DuringJanuary 2013 DaVinciRe redeemed shares from certain DaVinciRe shareholders, including the Company, while certain other existing DaVinciRe shareholders purchased additional shares in DaVinciRe. The net redemption as a result of these transactions was$150.0 million . In connection with the redemptions, DaVinciRe retained a$20.5 million holdback. Our ownership in DaVinciRe was 30.8% atDecember 31, 2012 and subsequent to the above transactions, our ownership in DaVinciRe increased to 32.9% effectiveJanuary 1, 2013 . We expect our ownership in DaVinciRe to fluctuate over time. Ratings Financial strength ratings are an important factor in respect of the competitive position of reinsurance and insurance companies. Rating organizations continually review the financial positions of our reinsurers and insurers. We continue to receive high claims-paying and financial strength ratings fromA.M. Best , S&P, Moody's and Fitch. These ratings represent independent opinions of an insurer's financial strength, operating performance and ability to meet policyholder obligations, and are not an evaluation directed toward the protection of investors or a recommendation to buy, sell or hold any of our securities. 128 -------------------------------------------------------------------------------- Presented below are the ratings of our principal operating subsidiaries and joint ventures by segment and the ERM rating ofRenaissanceRe as ofFebruary 20, 2013 . February 20, 2013 A.M. Best S&P (4) Moody's Fitch REINSURANCE SEGMENT (1) Renaissance Reinsurance A+ AA- A1 A+ DaVinci A A+ A3 - Glencoe A A - - Top Layer Re A+ AA - - ROE A+ AA- - - LLOYD'S SEGMENT Syndicate 1458 - - - - Lloyd's Overall Market Rating (2) A A+ - A+ RENAISSANCERE (3) - Excellent - -
(1) The
Reinsurance segment reflect the insurer's financial strength rating.
(2) The
represent its financial strength rating.
(3) The S&P rating for
Management practices.
(4) The S&P ratings for the companies in the Reinsurance segment reflect, in
addition to the insurer's financial strength rating, the insurer's issuer
credit rating.
A.M. Best . "A+" is the second highest designation ofA.M. Best's sixteen rating levels. "A+" rated insurance companies are defined as "Superior" companies and are considered byA.M. Best to have a very strong ability to meet their obligations to policyholders. "A" is the third highest designation assigned byA.M. Best , representingA.M. Best's opinion that the insurer has an "Excellent" ability to meet its ongoing obligations to policyholders. OnMay 21, 2012 ,A.M. Best affirmed the financial strength rating ("FSR") of "A+" (Superior) of each of Renaissance Reinsurance and ROE. Concurrently,A.M. Best affirmed the FSR of "A" (Excellent) of each of DaVinci and Glencoe. The outlook is stable for these ratings. OnMay 23, 2011 ,A.M. Best affirmed the FSR of A+ (Superior) of Top Layer Re. The outlook is stable for this rating. S&P. The "AA" range ("AA+", "AA", AA-"), which has been assigned by S&P to Renaissance Reinsurance, ROE and Top Layer Re, is the second highest rating assigned by S&P, and indicates that S&P believes the insurers have very strong financial security characteristics, differing only slightly from those rated higher. S&P assigns an issuer credit rating to an entity which is an opinion on the credit worthiness of the obligor with respect to a specific financial obligation. OnJune 23, 2011 , S&P affirmed its "A" issuer credit rating ("ICR") onRenaissanceRe . At the same time, S&P affirmed its "A" senior debt rating on our senior unsecured notes. In addition, S&P affirmed its "AA-" ICR and FSR on Renaissance Reinsurance and ROE and its "A+" and "A" ICR and FSR on DaVinci and Glencoe, respectively. The outlook is stable for these ratings. OnMay 17, 2011 , following the sale of substantially all of our U.S.-based insurance operations, S&P lowered Glencoe's ICR to "A" from "A+". The outlook is stable for this rating. OnNovember 1, 2010 , S&P revised its outlook on Top Layer to stable from negative and at the same time, affirmed Top Layer's ICR and FSR of "AA". In addition, S&P assesses companies' ERM practices, which is an opinion on the many critical dimensions of risk that determine overall creditworthiness.RenaissanceRe has been assigned an ERM rating of "Excellent", which is the highest rating assigned by S&P, and indicates that S&P believesRenaissanceRe has extremely strong capabilities to consistently identify, measure, and manage risk exposures and losses withinRenaissanceRe's predetermined tolerance guidelines. 129 -------------------------------------------------------------------------------- Moody's. Moody's Insurance Financial Strength Ratings and Moody's Credit Ratings represent its opinions of the ability of insurance companies to pay punctually policyholder claims and obligations and senior unsecured debt instruments. Moody's believes that insurance companies rated "A1", such as Renaissance Reinsurance, and companies rated "A3", such as DaVinci, offer good financial security. However, Moody's believes that elements may be present which suggest a susceptibility to impairment sometime in the future. OnJune 30, 2011 , Moody's assigned an "A3" insurance FSR to DaVinci and a "Baa2" long-term issuer rating toDaVinciRe Holdings Ltd. The outlook is stable for this rating. OnNovember 18, 2010 , following the public announcement that we entered into a definitive agreement with QBE to sell substantially all of our U.S. based insurance operations, Moody's affirmed the "A1" insurance FSR of Renaissance Reinsurance. The outlook is stable for this rating. Fitch. Fitch's Issuer Financial Strength ("IFS") ratings provide an assessment of the financial strength of an insurance organization. Fitch believes that insurance companies rated "A+", such as Renaissance Reinsurance, have "Strong" capacity to meet policyholders and contract obligations on a timely basis with a low expectation of ceased or interrupted payments. OnJanuary 3, 2013 , Fitch affirmed the IFS of Renaissance Reinsurance at "A+". The outlook is stable for this rating. Lloyd's Overall Market RatingA.M. Best , S&P and Fitch have each assigned an FSR to the Lloyd's overall market. The financial risks to policy holders of syndicates within the Lloyd's market are partially mutualized through the Lloyd'sCentral Fund , to which all underwriting members contribute. Because of the presence of the Lloyd'sCentral Fund , and the current legal and regulatory structure of the Lloyd's market, FSRs on individual syndicates would not be particularly meaningful and in any event would not be lower than the FSR of the Lloyd's overall market. While the ratings of our principal operating subsidiaries and joint ventures remain among the highest in our business, adverse ratings actions could have a negative effect on our ability to fully realize current or future market opportunities. In addition, it is common for our reinsurance contracts to contain provisions permitting our customers to cancel coverage pro-rata if our relevant operating subsidiary is downgraded below a certain rating level. Whether a client would exercise this right would depend, among other factors, on the reason for such a downgrade, the extent of the downgrade, the prevailing market conditions and the pricing and availability of replacement reinsurance coverage. Therefore, in the event of a downgrade, it is not possible to predict in advance the extent to which this cancellation right would be exercised, if at all, or what effect such cancellations would have on our financial condition or future operations, but such effect potentially could be material. To date we are not aware that we have experienced such a cancellation. Our ratings are subject to periodic review and may be revised or revoked by the agencies which issue them. None of our operating subsidiaries which conduct the trading activities of REAL are currently rated by any of the nationally recognized rating agencies. 130 --------------------------------------------------------------------------------
Investments
The table below shows the aggregate amounts of our invested assets:
At December 31, 2012 2011
(in thousands, except percentages)
U.S. treasuries $ 1,259,800 19.8
%
Agencies 315,154 5.0
% 158,561 2.6 %
Non-U.S. government (Sovereign debt) 133,198 2.1
% 227,912 3.7 %
FDIC guaranteed corporate - -
% 423,630 6.8 %
Non-U.S. government-backed corporate 349,514 5.5 % 641,082 10.3 % Corporate 1,615,207 25.4 % 1,206,904 19.4 % Agency mortgage-backed 408,531 6.4 % 441,749 7.1 % Non-agency mortgage-backed 248,339 3.9 % 104,771 1.7 % Commercial mortgage-backed 406,166 6.4 % 325,729 5.2 % Asset-backed 12,954 0.2 % 18,027 0.3 %
Total fixed maturity investments, at fair value 4,748,863 74.7 % 4,433,517 71.4 %
Short term investments, at fair value 821,163 12.9
% 905,477 14.6 %
Equity investments trading, at fair value 58,186 0.9
% 50,560 0.8 %
Other investments, at fair value 644,711 10.1
% 748,984 12.1 %
Total managed investment portfolio 6,360,647 98.6
% 6,138,538 98.9 %
Investments in other ventures, under equity method 87,724 1.4 % 70,714 1.1 % Total investments $ 6,360,647 100.0 % $ 6,209,252 100.0 % AtDecember 31, 2012 , we held investments totaling$6.4 billion , compared to$6.2 billion atDecember 31, 2011 , with net unrealized appreciation included in accumulated other comprehensive income of$13.6 million atDecember 31, 2012 , compared to$11.8 million atDecember 31, 2011 . Our investment guidelines stress preservation of capital, market liquidity, and diversification of risk. Notwithstanding the foregoing, our investments are subject to market-wide risks and fluctuations, as well as to risks inherent in particular securities. Refer to "Note 6. Fair Value Measurements" in our notes to the consolidated financial statements for additional information regarding the fair value of measurement of our investments. As the reinsurance coverages we sell include substantial protection for damages resulting from natural and man-made catastrophes, we expect from time to time to become liable for substantial claim payments on short notice. Accordingly, our investment portfolio as a whole is structured to seek to preserve capital and provide a high level of liquidity which means that the large majority of our investment portfolio consists of highly rated fixed income securities, including U.S. treasuries, agencies, highly rated sovereign and supranational securities, high-grade corporate securities and mortgage-backed and asset-backed securities. We also have an allocation to other investments, including hedge funds, private equity partnerships, senior secured bank loan funds and other investments. AtDecember 31, 2012 , these other investments totaled$644.7 million , or 10.1%, of our total investments (2011 -$749.0 million or 12.1%). 131 -------------------------------------------------------------------------------- The following table summarizes the composition of the amortized cost and fair value of our investment portfolio at the dates indicated by ratings as assigned by S&P, or Moody's and/or other rating agencies when S&P ratings were not available, and the respective effective yield. Credit Rating (1) % of Total Non- Amortized Investment Weighted Average Investment December 31, 2012 Cost Fair Value Portfolio Effective Yield AAA AA A BBB Grade Not Rated Short term investments $ 821,163 $ 821,163 12.9 % 0.2 % $ 753,883 $ 63,737 $ 163 $ 3,371 $ 9 $ - 100.0 % 91.8 % 7.8 % - % 0.4 % - % - % Fixed maturity investments U.S. treasuries 1,256,607 1,259,800 19.8 % 0.4 % - 1,259,800 - - - - Agencies Fannie Mae & Freddie Mac 289,884 292,098 4.6 % 0.6 % - 292,098 - - - - Other agencies 22,865 23,056 0.4 % 0.7 % - 23,056 - - - - Total agencies 312,749 315,154 5.0 % 0.7 % - 315,154 - - - - Non-U.S. government (Sovereign debt) 128,207 133,198 2.1 % 1.9 % 66,653 23,914 6,828 21,767 13,793 243 Non-U.S. government-backed corporate 343,924 349,514 5.5 % 0.7 % 287,288 56,059 6,167 - - - Corporate 1,552,194 1,615,207 25.4 % 2.6 % 25,361 263,541 765,050 280,598 265,045 15,612 Mortgage-backed Residential mortgage-backed Agency securities 404,423 408,531 6.4 % 1.3 % - 408,531 - - - - Non-agency securities - Prime 124,832 131,819 2.1 % 3.6 % 17,159 7,402 6,247 8,286 92,725 - Non-agency securities - Alt A 107,485 116,520 1.8 % 5.2 % 5,152 1,951 13,385 11,876 84,156 - Total residential mortgage-backed 636,740 656,870 10.3 % 2.5 % 22,311 417,884 19,632 20,162 176,881 - Commercial mortgage-backed 383,176 406,166 6.4 % 1.7 % 266,325 92,820 47,021 - - -
Total mortgage-backed 1,019,916 1,063,036 16.7 %
2.2 % 288,636 510,704 66,653 20,162 176,881 - Asset-backed Credit cards 4,270 4,623 0.1 % 1.7 % 4,623 - - - - - Auto loans 2,119 2,238 - % 0.9 % 2,238 - - - - - Student loans 1,626 1,650 - % 1.0 % 1,650 - - - - - Other 4,195 4,443 0.1 % 2.7 % 4,443 - - - - - Total asset-backed 12,210 12,954 0.2 % 1.8 % 12,954 - - - - -
Total securitized assets 1,032,126 1,075,990 16.9 %
2.2 % 301,590 510,704 66,653 20,162 176,881 -
Total fixed maturity
investments 4,625,807 4,748,863 74.7 % 1.6 % 680,892 2,429,172 844,698 322,527 455,719 15,855 100.0 % 14.3 % 51.2 % 17.8 % 6.8 % 9.6 % 0.3 % Equity investments trading 58,186 0.9 % - - - - - 58,186 100.0 % - % - % - % - % - % 100.0 % Other investments Private equity partnerships 344,669 5.4 % - - - - - 344,669 Senior secured bank loan funds 202,929 3.2 % - - - - 172,334 30,595 Catastrophe bonds 91,310 1.4 % - - - - 91,310 - Hedge funds 5,803 0.1 % - - - - - 5,803 Total other investments 644,711 10.1 % - - - - 263,644 381,067 100.0 % - % - % - % - % 40.9 % 59.1 % Investments in other ventures 87,724 1.4 % - - - - - 87,724 100.0 % - % - % - % - % - % 100.0 % Total investment portfolio $ 6,360,647 100.0 % $ 1,434,775 $ 2,492,909 $ 844,861 $ 325,898 $ 719,372 $ 542,832 100.0 % 22.6 % 39.2 % 13.3 % 5.1 % 11.3 % 8.5 %
(1) The credit ratings included in this table are those assigned by S&P. When
ratings provided by S&P were not available, ratings from other nationally
recognized rating agencies were used. The Company has grouped short term
investments with an A-1+ and A-1 short term issue credit rating as AAA, short
term investments with A-2 short term issue credit rating as AA and short term
investments with an A-3 short term issue credit rating as A. 132
-------------------------------------------------------------------------------- Fixed Maturity Investments and Short Term Investments AtDecember 31, 2012 , our fixed maturity investments and short term investment portfolio had a dollar-weighted average credit quality rating of AA (2011 - AA) and a weighted average effective yield of 1.4% (2011 - 1.9%). AtDecember 31, 2012 , our non-investment grade and not rated fixed maturity investments totaled$471.6 million or 9.9% of our fixed maturity investments (2011 -$199.1 million or 4.5%, respectively). In addition, within our other investments category we have several funds that invest in non-investment grade and not rated fixed income securities and non-investment grade cat-linked securities. AtDecember 31, 2012 , the funds that invest in non-investment grade and not rated fixed income securities and non-investment grade cat-linked securities totaled$294.2 million (2011 -$328.9 million ). AtDecember 31, 2012 , we had$821.2 million of short term investments (2011 -$905.5 million ). Short term investments are managed as part of our investment portfolio and have a maturity of one year or less when purchased. Short term investments are carried at amortized cost, which approximates fair value. Our duration for our fixed maturity investments and short term investments atDecember 31, 2012 was 2.2 years (2011 - 2.6 years). From time to time, we may reevaluate the duration of our portfolio in light of the duration of our liabilities and market conditions. As with other fixed income investments, the value of our fixed maturity investments will fluctuate with changes in the interest rate environment and when changes occur in the overall investment market and in overall economic conditions. Additionally, our differing asset classes expose us to other risks which could cause a reduction in the value of our investments. Examples of some of these risks include: • Changes in the overall interest rate environment can expose us to "prepayment risk" on our mortgage-backed investments. When interest rates decline, consumers will generally make prepayments on their mortgages and, as a result, our investments in mortgage-backed securities will be repaid to us
more quickly than we might have originally anticipated. When we receive these
prepayments, our opportunities to reinvest these proceeds back into the
investment markets will likely be at reduced interest rates. Conversely, when
interest rates increase, consumers will generally make fewer prepayments on
their mortgages and, as a result, our investments in mortgage-backed
securities will be repaid to us less quickly than we might have originally
anticipated. This will increase the duration of our portfolio, which is
disadvantageous to us in a rising interest rate environment.
• Our investments in mortgage-backed securities are also subject to default
risk. This risk is due in part to defaults on the underlying securitized
mortgages, which would decrease the market value of the investment and be
disadvantageous to us. Similar risks apply to other asset-backed securities
in which we may invest from time to time.
• Our investments in debt securities of other corporations are exposed to
losses from insolvencies of these corporations, and our investment portfolio
can also deteriorate based on reduced credit quality of these corporations.
We are also exposed to the impact of widening credit spreads even if specific
securities are not downgraded.
• Our investments in asset-backed securities are subject to prepayment risks,
as noted above, and to the structural risks of these securities. The
structural risks primarily emanate from the priority of each security in the
issuer's overall capital structure. We are also exposed to the impact of
widening credit spreads.
• Within our other investments category, we have several funds that invest in
non-investment grade fixed income securities as well as securities
denominated in foreign currencies. These investments expose us to losses from
insolvencies and other credit-related issues. We are also exposed to
fluctuations in foreign exchange rates that may result in realized losses to
us if our exposures are not hedged or if our hedging strategies are not effective and also to widening of credit spreads. 133
-------------------------------------------------------------------------------- The following table summarizes the fair value by contractual maturity of our fixed maturity investment portfolio at the dates indicated. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without penalty. At December 31, 2012 2011 (in thousands, except percentages) Due in less than one year $ 433,074 9.1 % $ 619,845 14.0 % Due after one through five years 2,389,856 50.3 % 2,035,383 45.9 % Due after five through ten years 711,844 15.0 % 742,050 16.7 % Due after ten years 138,099 2.9 % 145,963 3.3 % Mortgage-backed 1,063,036 22.4 % 872,249 19.7 % Asset-backed 12,954 0.3 % 18,027 0.4 % Total fixed maturity investments, at fair value $ 4,748,863 100.0 % $ 4,433,517 100.0 % Corporate Fixed Maturity Investments The following table summarizes the composition of the fair value of our corporate fixed maturity investments at the date indicated by ratings as assigned by S&P, or Moody's and/or other rating agencies when S&P ratings were not available. AtDecember 31, 2012 (in thousands) Non-Investment Sector Total AAA AA A BBB Grade Not Rated Financials $ 697,161 $ 15,908 $ 148,549 $ 417,084 $ 61,095 $ 41,534 $ 12,991 Industrial, utilities and energy 342,474 6,908 32,997 125,294 103,725 71,852 1,698 Communications and technology 229,444 1,656 13,866 106,747 51,493 55,682 - Consumer 157,828 - 11,036 54,766 37,648 53,533 845 Health care 110,827 - 52,523 30,802 3,372 24,130 - Basic materials 60,068 - - 22,649 21,258 16,083 78 Other 17,405 889 4,570 7,708 2,007 2,231 - Total corporate fixed maturity investments, at fair value (1) $ 1,615,207 $ 25,361 $ 263,541 $ 765,050 $ 280,598 $ 265,045 $ 15,612
(1) Excludes non-U.S. government-backed corporate fixed maturity investments, at
fair value. 134
-------------------------------------------------------------------------------- The following table summarizes the composition of the fair value of the fixed maturity investments and short term investments of our top ten corporate issuers at the date indicated. AtDecember 31, 2012 (in thousands) Short term Fixed maturity Issuer Total investments investments JP Morgan Chase & Co. $ 64,532 $ 1,552 $ 62,980 General Electric Company 56,039 - 56,039 Bank of America Corp. 53,290 163 53,127 Goldman Sachs Group Inc. 52,126 - 52,126 Citigroup Inc. 47,160 - 47,160 HSBC Holdings PLC 37,872 - 37,872 Morgan Stanley 32,984 - 32,984 AT&T Inc. 27,881 - 27,881 BP PLC 21,920 - 21,920 Wells Fargo & Co. 20,587 - 20,587 Total (1) $ 414,391 $ 1,715 $ 412,676
(1) Excludes non-U.S. government-backed corporate fixed maturity investments,
repurchase agreements and commercial paper, at fair value. 135
-------------------------------------------------------------------------------- European Debt Exposures The table below presents our exposure by country to European government and corporate issuers within our fixed maturity and short term investments portfolio, further segregated by sector, subsector and credit rating. For corporate issuers, the country of issuer is determined by assessing both the location of principal management as well as the primary country of business activity. Sector Credit Rating Non-U.S. Non-U.S. At December 31, Amortized Fair Value Government Government-backed Non-Investment 2012 Cost (1) (1) (Sovereign debt) Corporate Corporate AAA AA A BBB Grade (in thousands) Country of Issuer Non-Eurozone United Kingdom $ 135,475 $ 140,486 $ 10,296 $ 26,730 $ 103,460 $ 37,026 $ 19,500 $ 68,618 $ 10,467 $ 4,875 Sweden 27,751 28,531 - 10,155 18,376 10,155 17,846 530 - - Norway 26,068 26,799 - 8,047 18,752 11,260 7,368 988 - 7,183 Denmark 36,256 36,498 7,787 28,590 121 36,498 - - - - Switzerland 42,771 44,157 - - 44,157 - 19,197 23,886 1,074 - Russian Federation 14,139 15,220 4,628 - 10,592 - - - 14,217 1,003 Other 8,814 9,441 7,419 - 2,022 - - 1,372 3,930 4,139 Non-Eurozone Total $ 291,274 $ 301,132 $ 30,130 $ 73,522 $ 197,480 $ 94,939 $ 63,911 $ 95,394 $ 29,688 $ 17,200 Eurozone Netherlands $ 119,744 $ 122,049 $ 8,134 $ 79,944 $ 33,971 $ 89,123 $ 11,532 $ 18,688 $ 1,552 $ 1,154 France 45,042 46,149 - 23,824 22,325 - 28,978 16,148 517 506 Austria 40,214 40,342 7,721 32,621 - - 40,342 - - - Germany 57,900 58,645 142 29,447 29,056 32,997 - 22,345 744 2,559 Finland 21,352 21,414 21,414 - - 21,414 - - - - Luxembourg 6,249 6,167 - - 6,167 - - - - 6,167 Belgium 17,433 17,640 - - 17,640 - - 14,938 2,702 - 307,934 312,406 37,411 165,836 109,159 143,534 80,852 72,119 5,515 10,386 Ireland 1,042 1,049 - - 1,049 - - - 1,049 - Italy 834 902 - - 902 - - - - 902 Spain 4,047 4,110 - - 4,110 - - 1,341 674 2,095 Greece - - - - - - - - - - Portugal - - - - - - - - - - $ 5,923 $ 6,061 $ - $ - $ 6,061 $ - $ - $ 1,341 $ 1,723 $ 2,997 Eurozone Total $ 313,857 $ 318,467 $ 37,411 $ 165,836 $ 115,220 $ 143,534 $ 80,852 $ 73,460 $ 7,238 $ 13,383 European Issuer Total $ 605,131 $ 619,599 $ 67,541 $ 239,358 $ 312,700 $ 238,473 $ 144,763 $ 168,854 $ 36,926 $ 30,583 Subsector Non-US Government $ 65,710 $ 67,541 $ 67,541 $ - $ - $ 47,774 $ 7,721 $ 1,371 $ 6,924 $ 3,751 Financial 336,178 343,669 - 198,747 144,922 174,077 70,397 81,941 8,252 9,002 Industrial, Utilities & Energy 92,963 95,659 - 23,990 71,669 - 44,018 41,247 7,574 2,820 Other 110,280 112,730 - 16,621 96,109 16,622 22,627 44,295 14,176 15,010 Total $ 605,131 $ 619,599 $ 67,541 $ 239,358 $ 312,700 $ 238,473 $ 144,763 $ 168,854 $ 36,926 $ 30,583
(1) Included in amortized cost and fair value is
respectively, of fixed maturity investments available for sale.
AtDecember 31, 2012 , we held fixed maturity and short term investments with a fair value of$619.6 million and weighted average credit rating of AA in European issuers, including holdings of$67.5 million ,$239.4 million and$312.7 million related to non-U.S. government (Sovereign debt), non-U.S. government backed corporates and corporates, respectively. Our holdings of fixed maturity investment and short term investments inIreland ,Italy ,Spain ,Greece andPortugal was comprised entirely of corporate securities and had a fair value of$6.1 million atDecember 31, 2012 . 136 -------------------------------------------------------------------------------- AtDecember 31, 2012 , we had European foreign currency forward contracts outstanding, primarily related to the Euro, British pound sterling and Norwegian krone, with$103.5 million in notional long positions,$130.7 million in notional short positions and fair value liability position of$0.1 million . From time to time, we enter into foreign currency forward contracts to economically hedge our exposure to currency fluctuations from certain non-U.S. denominated investments. We typically use these hedges to hedge fixed maturity investments with exposure to European currencies. In certain instances, we may assume foreign exchange risk as part of our investment strategy. In addition to our Eurozone sovereign debt exposure noted above, we have investments in private equity funds, hedge funds, bank loan funds and a non-U.S. dollar fixed income fund that may have exposure to European sovereign debt.
We
also have exposure to European sovereign debt directly and indirectly through our underwriting portfolio. This portfolio contains insurance and reinsurance risks that we have assumed and ceded in respect of risks related to companies located withinEurope , to companies that provide coverage withinEurope , and to companies that have investments in European sovereign debt. We underwrite these risks in accordance with our underwriting standards as described in "Item 1. Business, Underwriting and Enterprise Risk Management". As a result of the underwriting operations noted above, our cash and cash equivalents, premiums receivable, reinsurance recoverable, reserve for claims and claim expenses may be indirectly impacted by European debt exposure. In addition, see "Note. 19 Derivative Instruments of our Notes to Consolidated Financial Statements" for additional information regarding underwriting operations related foreign currency contracts outstanding related to the balances noted above. We will continue to monitor our Eurozone risks, but to date, the financial turmoil withinEurope has not materially impacted our results of operations or financial condition. Other Investments The table below shows our portfolio of other investments: At December 31, 2012 2011 Change (in thousands) Private equity partnerships $ 344,669 $ 367,909 $ (23,240 ) Senior secured bank loan funds 202,929 257,870 (54,941 ) Catastrophe bonds 91,310 70,999 20,311 Hedge funds 5,803 21,344 (15,541 ) Non-U.S. fixed income funds - 28,862 (28,862 ) Miscellaneous other investments - 2,000 (2,000 ) Total other investments $ 644,711 $ 748,984 $ (104,273 ) We account for our other investments at fair value in accordance with FASB ASC Topic Financial Instruments. The fair value of certain of our fund investments, which principally include hedge funds, private equity funds, senior secured bank loan funds and non-U.S. fixed income funds, are recorded on our balance sheet in other investments, and is generally established on the basis of the net valuation criteria established by the managers of such investments, if applicable. The net valuation criteria established by the managers of such investments is established in accordance with the governing documents of such investments. Many of our fund investments are subject to restrictions on redemptions and sales which are determined by the governing documents and limit our ability to liquidate these investments in the short term. Certain of our fund managers, fund administrators, or both, are unable to provide final fund valuations as of our current reporting date. The typical reporting lag experienced by us to receive a final net asset value report is one month for hedge funds, senior secured bank loan funds and non-U.S. fixed income funds and three months for private equity funds, although, in the past, in respect of certain of our private equity funds, we have on occasion experienced delays of up to six months at year end, as the private equity funds typically complete their respective year-end audits before releasing their final net asset value statements. In circumstances where there is a reporting lag between the current period end reporting date and the reporting date of the latest fund valuation, we estimate the fair value of these funds by starting with the prior month or quarter-end fund valuations, adjusting these valuations for actual capital calls, redemptions or distributions, as well as the impact of changes in foreign currency exchange rates, and then estimating the 137 -------------------------------------------------------------------------------- return for the current period. In circumstances in which we estimate the return for the current period, all information available to us is utilized. This principally includes preliminary estimates reported to us by our fund managers, obtaining the valuation of underlying portfolio investments where such underlying investments are publicly traded and therefore have a readily observable price, using information that is available to us with respect to the underlying investments, reviewing various indices for similar investments or asset classes, as well as estimating returns based on the results of similar types of investments for which we have obtained reported results, or other valuation methods, where possible. Actual final fund valuations may differ, perhaps materially so, from our estimates and these differences are recorded in our statement of operations in the period in which they are reported to us as a change in estimate. Included in net investment income for the year endedDecember 31, 2012 is a loss of$4.7 million (2011 - loss of$1.4 million , 2010 - income of$5.3 million ) representing the change in estimate during the period related to the difference between our estimated net investment income due to the lag in reporting discussed above and the actual amount as reported in the final net asset values provided by our fund managers. Our estimate of the fair value of catastrophe bonds are based on quoted market prices, or when such prices are not available, by reference to broker or underwriter bid indications. Refer to "Note 6. Fair Value Measurements" in our notes to the consolidated financial statements for additional information regarding the fair value of measurement of our other investments. Interest income, income distributions and realized and unrealized gains (losses) on other investments are included in net investment income and resulted in$74.4 million of net investment income for the year endedDecember 31, 2012 (2011 -$36.0 million , 2010 -$103.7 million ). Of this amount,$38.2 million relates to net unrealized gains (2011 - unrealized gains of$12.7 million , 2010 - unrealized gains of$57.5 million ). We have committed capital to private equity partnerships and other entities of$708.9 million , of which$655.5 million has been contributed atDecember 31, 2012 . Our remaining commitments to these investments atDecember 31, 2012 totaled$133.2 million . In the future, we may enter into additional commitments in respect of private equity partnerships or individual portfolio company investment opportunities. Measuring the Fair Value of Other Investments Using Net Asset Valuations The table below shows our portfolio of other investments measured using net asset valuations: Redemption Redemption Notice Notice Period Period Unfunded Redemption (Minimum (Maximum At December 31, 2012 Fair Value Commitments Frequency Days) Days) Private equity partnerships $ 344,669 $ 91,762 See below See below See below Senior secured bank loan funds 202,929 17,506 See below See below See below Hedge funds 5,803 - See below See below See below
Total other investments measured using net asset valuations $ 553,401 $ 109,268 Private equity partnerships - Included in our investments in private equity partnerships are alternative asset limited partnerships (or similar corporate structures) that invest in certain private equity asset classes including U.S. and global leveraged buyouts; mezzanine investments; distressed securities; real estate; and oil, gas and power. The fair values of the investments in this category have been estimated using the net asset value of the investments, as discussed in detail above. We generally have no right to redeem our interest in any of these private equity partnerships in advance of dissolution of the applicable partnership. Instead, the nature of these investments is that distributions are received by us in connection with the liquidation of the underlying assets of the applicable limited partnership. It is estimated that the majority of the underlying assets of the limited partnerships would liquidate over 7 to 10 years from inception of the limited partnership. 138 -------------------------------------------------------------------------------- Senior secured bank loan funds - Our investment in senior secured bank loan funds includes funds that invest primarily in bank loans and other senior debt instruments. The fair values of the investments in this category have been determined using the net asset value per share of the funds or the estimated net asset per share where applicable, as discussed in detail above. Investments of$172.3 million are redeemable, in part on a monthly basis, or in whole over a three month period. We also have$30.6 million invested in closed end funds which invest in loans. We have no right to require redemption of our investment in these funds. Hedge funds - We invest in hedge funds that pursue multiple strategies. The fair values of the investments in this category are estimated using the net asset value per share of the funds, as discussed in detail above. Our investments in hedge funds atDecember 31, 2012 , are$5.8 million of so called "side pocket" investments which are not redeemable at the option of the shareholder. We fully redeemed the remaining non-side pocket investments in hedge funds inJune 2012 . We have retained our interest in the side pocket investments until the underlying investments attributable to such side pockets are liquidated, realized or deemed realized at the discretion of the fund manager. Investments inOther Ventures , under Equity Method The table below shows our investments in other ventures, under equity method: At December 31, 2012 2011 (in thousands, except percentages) Investment Ownership % Carrying Value Investment Ownership % Carrying Value THIG $ 50,000 25.0 % $ 28,303 $ 50,000 25.0 % $ 32,645 Tower Hill 10,000 28.6 % 13,969 10,000 28.6 % 14,173 Tower Hill Signature 500 25.0 % 896 500 25.0 % - Total Tower Hill Companies 60,500 43,168 60,500 46,818 Top Layer Re 65,375 50.0 % 36,664 65,375 50.0 % 15,872 Other 8,226 38.8 % 7,892 6,000 40.0 % 8,024 Total investments in other ventures, under equity method $ 134,101 $ 87,724 $ 131,875 $ 70,714 Top Layer Re incurred net claims and claims expenses from the 2011 New Zealand and Tohoku earthquakes; subsequently, the Company contributed$38.5 million of additional paid-in capital to Top Layer Re to replenish its capital position. Our equity in earnings of the Tower Hill Companies are reported one quarter in arrears. Effects of Inflation The potential exists, after a catastrophe loss, for the development of inflationary pressures in a local economy. The anticipated effects on us are considered in our catastrophe loss models. Our estimates of the potential effects of inflation are also considered in pricing and in estimating reserves for unpaid claims and claim expenses. In addition, it is possible that the risk of general economic inflation has increased which could, among other things, cause claims and claim expenses to increase and also impact the performance of our investment portfolio. The actual effects of this potential increase in inflation on our results cannot be accurately known until, among other items, claims are ultimately settled. The onset, duration and severity of an inflationary period cannot be estimated with precision. Off-Balance Sheet and Special Purpose Entity Arrangements AtDecember 31, 2012 , we have not entered into any off-balance sheet arrangements, as defined by Item 303(a)(4) of Regulation S-K. 139 -------------------------------------------------------------------------------- Contractual Obligations In the normal course of its business, the Company is a party to a variety of contractual obligations and these are considered by the Company when assessing its liquidity requirements. The table below shows our contractual obligations: Less than 1 More than 5 At December 31, 2012 Total year 1-3 years 3-5 years years (in thousands) Long term debt obligations (1) 5.875% Senior Notes $ 100,740 $ 100,740 $ - $ - $ - 5.75% Senior Notes 363,539 14,375 28,750 38,750 281,664 Private equity and investment commitments (2) 133,161 133,161 - - - Operating lease obligations 26,267 6,829 10,647 5,777 3,014 Capital lease obligations 43,082 3,017 6,034 5,434 28,597 Payable for investments purchased 278,787 278,787 - - - Reserve for claims and claim expenses (3) 1,879,377 642,819 659,865 230,006 346,687 Renaissance Trading credit facility 2,436 2,436 - - - Other 7,324 5,915 1,206 203 - Total contractual obligations $ 2,834,713 $ 1,188,079 $ 706,502 $ 280,170 $ 659,962
(1) Includes contractual interest payments.
(2) The private equity and investment commitments do not have a defined
contractual commitment date and we have therefore included them in the less
than one year category.
(3) We caution the reader that the information provided above related to
estimated future payment dates of our reserves for claims and claim expenses
is not prepared or utilized for internal purposes and that we currently do
not estimate the future payment dates of claims and claim expenses. Because
of the nature of the coverages that we provide, the amount and timing of the
cash flows associated with our policy liabilities will fluctuate, perhaps
significantly, and therefore are highly uncertain. We have based our
estimates of future claim payments upon benchmark industry payment patterns,
drawing upon available relevant sources of loss and allocated loss adjustment
expense development data. These benchmarks are revised periodically as new
trends emerge. We believe that it is likely that this benchmark data will not
be predictive of our future claim payments and that material fluctuations can
occur due to the nature of the losses which we insure and the coverages which
we provide.
In certain circumstances, many of our contractual obligations may be accelerated to dates other than those reflected in the table, due to defaults under the agreements governing those obligations (including pursuant to cross-default provisions in such agreements) or in connection with certain changes in control of the Company, if applicable. In addition, in connection with any such default under the agreement governing these obligations, in certain circumstances, these obligations may bear an increased interest rate or be subject to penalties as a result of such a default. CURRENT OUTLOOK Catastrophe Exposed Market Developments Notwithstanding the severe global catastrophic losses during 2011, the advent in late 2012 of storm Sandy, one of the most significant insured losses on record, and the increased frequency of severe weather events during this period in many high-insurance-penetration regions, the global insurance and reinsurance markets entered 2013 with near-record levels of industry wide capital held by private market insurers and reinsurers, and diminished growth of demand for many coverages and solutions, outside of the impacted regions and in respect of certain products and lines. During theJanuary 2013 and June andJuly 2012 reinsurance renewals, we believe that supply, principally from traditional market participants and complemented by alternative capital providers, more than offset market demand, resulting in a dampening of overall market pricing on a risk-adjusted basis, except for, in general, loss impacted treaties and contracts. Moreover, we believe that many of the positive factors that had previously impacted market conditions have now been absorbed by the market and, we believe, are unlikely to drive further improvement in our core catastrophe-exposed markets absent new developments. Moreover, we believe that supply of capital remains at historically high levels, from both traditional and alternative market 140 -------------------------------------------------------------------------------- participants, and may well increase in respect of the June andJuly 2013 renewals. Accordingly, we cannot assure you that the recent level of market demand and renewals will be sustained, or that we can continue to improve the size and portfolio quality of our book of business. According to theNational Oceanic and Atmospheric Administration ("NOAA"), whose records date back to 1895, 2012 continued a period of high Atlantic basin hurricane activity, with 19 named storms, of which 10 became hurricanes, with one major hurricane. In late October, storm Sandy impacted the Mid-Atlantic and Northeast coasts of the U.S., ultimately making landfall inNew Jersey , with tropical storm force or greater winds at landfall extending over approximately 550,000 square miles. In addition, storm Sandy generated significant storm surge, which contributed substantially to loss of life, widespread power outages, significant disruptions to travel and devastating flooding throughout a number of states, includingNew York andNew Jersey .Storm Sandy is currently estimated to have been the largest Atlantic hurricane in diameter ever recorded and to have produced the lowest barometric pressure readings for an Atlantic windstorm north ofNorth Carolina . In addition, according to NOAA, 2012 was the hottest year ever recorded in the U.S., continuing a period of increasing air and water temperatures at measured locations. Among other things, the extreme weather experienced, particularly including the severe and ongoing drought conditions throughout most of the Midwestern region of the U.S., adversely impacted the production of a range of crops, including those subject to the U.S. federal government's multi-peril crop insurance program. General Economic Conditions Meaningful uncertainty remains regarding the strength, duration and comprehensiveness of any economic recovery in the U.S. and our other key markets. In particular, global economic markets, including many of the key markets which we serve, may continue to be adversely impacted by the financial and fiscal instability of several European jurisdictions and, increasingly, the Eurozone market as a whole. Accordingly, we continue to believe that meaningful risk remains for continued uncertainty or disruptions in general economic and financial market conditions, which could give rise to increased economic uncertainty, or to further deterioration of economic conditions. Moreover, if economic growth were to return, such growth may be only at a comparably suppressed rate for a relatively extended period of time. Declining or weak economic conditions could reduce demand for the products sold by us or our customers, or our overall ability to write business at risk-adequate rates could weaken. In addition, persistent low levels of economic activity could adversely impact other areas of our financial performance, such as by contributing to unforeseen premium adjustments, mid-term policy cancellations or commutations, or asset devaluation. Any of the foregoing or other outcomes of a prolonged period of relative economic weakness could adversely impact our financial position or results of operations. In addition, during a period of extended economic weakness, we believe our consolidated credit risk, reflecting our counterparty dealings with customers, agents, brokers, retrocessionaires, capital providers and parties associated with our investment portfolio, among others, is likely to be increased. Several of these risks could materialize, and our financial results could be negatively impacted, even after the end of any economic downturn. Moreover, we continue to monitor the risk that our principal markets will experience increased inflationary conditions, which would, among other things, cause costs related to our claims and claim expenses to increase, and impact the performance of our investment portfolio. The onset, duration and severity of an inflationary period cannot be estimated with precision. The sovereign debt crisis inEurope and the related financial restructuring efforts has, among other factors, made it more difficult to predict the inflationary environment. Our catastrophe-exposed operations are subject to the ever-present potential for significant volatility in capital due primarily to our exposure to severe catastrophic events. Our specialty reinsurance portfolio is also exposed to emerging risks arising from the ongoing relative economic weakness, including with respect to a potential increase of claims in directors and officers, errors and omissions, surety, casualty clash and other lines of business. Historically low interest rates and lower spreads have lowered the yields at which we invest our assets relative to historical levels. We expect these developments, combined with the current composition of our investment portfolio and other factors, to continue to put substantial downward pressure on our net investment income for the near term. In addition to impacting our reported net income, potential future losses on our investment portfolio, including potential future mark-to-market results, would adversely impact our equity capital. Moreover, as we invest cash from new premiums written or reinvest the proceeds of 141 -------------------------------------------------------------------------------- invested assets that mature or that we choose to sell, the yield on our portfolio is impacted by the prevailing environment of comparably low yields. While it is possible yields will improve in future periods, we currently expect the challenging economic conditions to persist and we are unable to predict with certainty when conditions will substantially improve, or the pace of any such improvement. Market Conditions and Competition Leading global intermediaries and other sources have generally reported that the U.S. casualty reinsurance market continues to reflect a relatively soft pricing environment, with pockets of niche or specialty casualty renewals providing more attractive opportunities for stronger or well-positioned reinsurers. We anticipate that persistent low investment returns and, to a degree, balance sheet issues in the broader market may favorably impact demand for coverages on terms that we find attractive. However, we cannot assure you that any increased demand will indeed materialize or that we will be successful in consummating new or expanded transactions. We currently anticipate a continued level of demand for our catastrophe coverages over coming periods, offset by ample and likely increasing supplies of private market capital. Even in the aftermath of storm Sandy and continued capital return initiatives by many market participants, the primary insurance and reinsurance sectors each continue to hold historically high levels of capital. While we do not anticipate industry capital to diminish, or the impairment of meaningful market participants, as a result of storm Sandy, it is possible that storm Sandy will contribute to enhanced perceptions of risk, particularly of mid-Atlantic and Northeastern windstorm exposure, the risks which arise from business interruption and commercial interruption exposure, and the penetration of U.S. flood risk in the private insurance market. Moreover, it is possible consumer demand will increase compared to market expectations prior to storm Sandy. However, it is possible that none of these factors may be borne out or influence the market in any meaningful way; moreover, the relatively attractive prevailing market conditions for many of the products in which we specialize could in any case also be offset by adverse or unforeseen factors, including the availability of alternative capital and the high levels of capital held by traditional reinsurers. Renewal terms vary widely by insured account and our ability to shape our portfolio to improve its risk and return characteristics as estimated by us is subject to a range of competitive and commercial factors. While we believe that our strong relationships, and track record of superior claims paying ability and other client service will enable us to compete for the business we find attractive, we may not succeed in doing so; moreover, our relationships in emerging markets are not as developed as they are in our current core markets. The market for our catastrophe reinsurance products is generally dynamic and volatile. The market dynamics noted above, increased or decreased catastrophe loss activity, and changes in the amount of capital in the industry can result in significant changes to the pricing, policy terms and demand for our catastrophe reinsurance products over a relatively short period of time. In addition, changes in state-sponsored catastrophe funds, or residual markets, which have generally grown dramatically in recent years, or the implementation of new government-subsidized or sponsored programs, can dramatically alter market conditions. We believe that the overall trend of increased frequency and severity of tropical cyclones experienced in recent years may continue for the foreseeable future. Increased understanding of the potential increase in frequency and severity of storms may contribute to increased demand for protection in respect of coastal risks which could impact pricing and terms and conditions in coastal areas over time. Overall, we expect higher property loss cost trends, driven by increased severity and by the potential for increased frequency, to continue in the future. At the same time, certain markets we target continue to be impacted by fundamental weakness experienced by primary insurers, due to ongoing economic weakness and, in many cases, inadequate primary insurance rate levels, including without limitation insurers operating on an admitted basis inFlorida . These conditions, which occurred in a period characterized by relatively low insured catastrophic losses for these respective regions, have contributed to certain publicly announced instances of insolvency, regulatory supervision and other regulatory actions, and have weakened the ability of certain carriers to invest in reinsurance and other protections for coming periods, and in some cases to meet their existing premium obligations. It is possible that these dynamics will continue in future periods. 142 -------------------------------------------------------------------------------- In addition, we continue to explore potential strategic transactions or investments, and other opportunities, from time to time that are presented to us or that we originate. In evaluating these potential investments and opportunities, we seek to improve the portfolio optimization of our business as a whole, to enhance our strategy, to achieve an attractive estimated return on equity in respect of investments, to develop or capitalize on a competitive advantage, and to source business opportunities that will not detract from our core operations. Legislative and Regulatory Update InAugust 2012 , CongressmanAlbio Sires introduced the Taxpayers' Protection Act (HR 6477). The bill would establish a federal catastrophe fund where eligible states can purchase reinsurance directly from the federal government. InJanuary 2013 , CongresswomanFrederica Wilson introduced the Homeowners' Defense Act which would, if enacted, provide for the creation of (i) a federal reinsurance catastrophe fund; (ii) a federal consortium to facilitate qualifying state residual markets and catastrophe funds in securing reinsurance; and (iii) a federal bond guarantee program for state catastrophe funds in qualifying state residual markets. InJanuary 2013 , CongressmanDennis Ross introduced the Homeowners' Insurance Protection Act (HR 240). The bill would create a federal catastrophe reinsurance program to back up federal reinsurance programs. If enacted, any of these bills, or legislation similar to these proposals, would, we believe, likely contribute to the growth of state entities offering below market priced insurance and reinsurance in a manner adverse to us and market participants more generally. While none of this legislation has been enacted to date, and although we believe such legislation will continue to be vigorously opposed, if adopted these bills would likely diminish the role of private market catastrophe reinsurers and could adversely impact our financial results, perhaps materially. InJune 2012 ,Congress passed the Biggert-Waters Flood Insurance Reform and Modernization Act of 2012, which provided for a five-year renewal of the NFIP and effected substantial reforms in the program. The NFIP had not been subject to a long-term renewal since 2004. Among other things, pursuant to this statute, theFederal Emergency Management Agency ("FEMA") is explicitly authorized to carry out initiatives to determine the capacity of private insurers, reinsurers, and financial markets to assume a greater portion of the flood risk exposure in the U.S., and to assess the capacity of the private reinsurance market to assume some of the program's risk.FEMA is required to submit a report on this assessment within six months of enactment. The bill also increased the annual limitation on program premium increases from 10% to 20% of the average of the risk premium rates for certain properties concerned; established a four-year phase-in, after the first year, in annual 20% increments, of full actuarial rates for a newly mapped risk premium rate area; instructedFEMA to establish new flood insurance rate maps; allows multi-family properties to purchase NFIP polices; and introduces minimum deductibles for flood claims. We believe that these reforms could increase the role of private risk-bearing capital in respect of U.S. flood perils, perhaps significantly. However, we cannot assure you that the bill will materially benefit private carriers, or that we will succeed in participating in any positive market developments that may transpire. In 2007, theState of Florida enacted legislation to expand theFlorida Hurricane Catastrophe Fund's ("FHCF") provision of below-market rate reinsurance to up to$28.0 billion per season (the "2007 Florida Bill"). In May of 2009, theFlorida legislature enacted Bill No. CS/HB 1495 (the "2009 Bill"), which will gradually phase out$12.0 billion in optional reinsurance coverage under the FHCF over the succeeding five years. The 2009 Bill similarly allows the state-sponsored property insurer,Citizens Property Insurance Corporation ("Citizens"), to raise its rates up to 10% starting in 2010 and every year thereafter, until such time that it has sufficient funds to pay its claims and expenses. The rate increases and cut back on coverage by FHCF and Citizens are expected to support, over time, a relatively increased role of the private insurers inFlorida , a market in which we have established substantial market share. InMay 2011 , theFlorida legislature passedFlorida Senate bill 408 ("SB 408"), relating principally to property insurance. Among other things, SB 408 requires an increase in minimum capital and surplus for newly licensedFlorida domestic insurers from$5.0 million to$15.0 million ; institutes a 3-year claims filing deadline for new and reopened claims from the date of a hurricane or windstorm; allows an insurer to offer coverage where replacement cost value is paid, but initial payment is limited to actual cash value; allows admitted insurers to seek rate increases up to 15% to adjust for third party reinsurance costs; and institutes a range of reforms relating to various matters that have increased the costs of insuring sinkholes inFlorida . 143 -------------------------------------------------------------------------------- While we believe SB 408 should contribute over time to stabilization of theFlorida market, legislation intended to further reform and stabilize Citizens was not passed in the 2011 or 2012 legislative sessions and is uncertain in 2013. OnFebruary 16, 2012 , theFlorida Senate Banking and Insurance Committee approved, with one dissenting vote, legislation to reform the FHCF and solidify its financial fund. The bill provided for incremental reductions in the FHCF limit which admitted carriers are mandated to buy from the FHCF from an industry aggregate of$17.0 billion to $12.0 billion by 2015; would have reduced the 90% purchase option (the percentage of the FHCF mandatory coverage layer a company purchases) which is selected by most insurers to 75% by 2015; and would have increased the industry wide "retention", or deductible, from$7.3 to$8.0 billion . While the bill did not pass the full legislature in 2012, its sponsor has announced an intention to reintroduce the legislation in 2013. We cannot estimate the likelihood of enactment, or the possible final form of this or similar legislation. We believe the 2007 Florida Bill caused a substantial decline in the private reinsurance and insurance markets in and relating toFlorida , and contributed to the ongoing instability in theFlorida primary insurance market, where many insurers have reported substantial and continuing losses from 2009 through 2012, an unusually low period for catastrophe losses in the state. Because of our position as one of the largest providers of catastrophe-exposed coverage, both on a global basis and in respect of theFlorida market, the 2007 Florida Bill and the weakened financial position ofFlorida insurers may have a disproportionate adverse impact on us compared to other reinsurance market participants. The advent of a large windstorm, or of multiple smaller storms, could challenge the assessment-based claims paying capacity of Citizens and the FHCF. InMay 2012 , theFHCF Advisory Council approved official bonding capacity estimates in respect of the current contract year, reflecting the amount of post-catastrophe bonding currently estimated to be achievable by the FHCF's management and lead financial advisor. The FHCF projected a 2012 year-end fund balance of approximately$8.5 billion , and a total bonding capacity estimate of$7.0 billion ; given the FHCF's total potential claims-paying obligation of$17.3 billion , this estimated claims-paying capacity of approximately$15.6 billion was therefore estimated by the FHCF's lead adviser to reflect a potential shortfall of$1.8 billion in respect of an initial season or event. Any inability, or delay, in the claims paying ability of these entities or of private market participants could further weaken or destabilize theFlorida market, potentially giving rise to an unpredictable range of adverse impacts. The FHCF and theFlorida Office of Insurance Regulation ("OIR") have each estimated that even partial failure, or deferral, of the FHCF's ability to pay claims in full could substantially weaken numerous private insurers, with the OIR having estimated that a 25% shortfall in the FHCF's claims-paying capacity could cause as many as 24 of the top 50 insurers in the state to have less than the statutory minimum surplus of$5.0 million , with such insurers representing approximately 35% of the market based on premium volume, or approximately 2.2 million policies. Adverse market, regulatory or legislative changes impactingFlorida could affect our ability to sell certain of our products, to collect premiums we may be owed on policies we have already written, to renew business with our customers for future periods, or have other adverse impacts, some of which may be difficult to foresee, and could therefore have a material adverse effect on our operations. Internationally, in the wake of the large natural catastrophes in 2011 a number of proposals have been introduced to alter the financing of natural catastrophes in several of the markets in which we operate. For example, theThailand government has announced it is studying proposals for a natural catastrophe fund, under which the government would provide coverage for natural disasters in excess of an industry retention and below a certain limit, after which private reinsurers would continue to participate. The government ofthe Philippines has announced that it is considering similar proposals. A range of proposals from varying stakeholders have been reported to have been made to alter the current regimes for insuring flood risk in theU.K. , flood risk inAustralia and earthquake risk inNew Zealand . If these proposals are enacted and reduce market opportunities for our clients or for the reinsurance industry, we could be adversely impacted. Over the past few years theU.S. Congress has considered legislation which, if passed, would deny U.S. insurers and reinsurers the deduction for reinsurance placed with non-U.S. affiliates. InFebruary 2012 , the Obama administration included a formal proposal for such a provision in its budget proposal. As described in the administration's 2012 budget request, the proposal would deny an insurance company a deduction for premiums and other amounts paid to affiliated foreign companies with respect to reinsurance of property and casualty risks to the extent that the foreign reinsurer (or its parent company) is not subject to U.S. income tax with respect to the premiums received; and would exclude from the insurance company's income (in the same proportion in which the premium deduction was denied) any return premiums, ceding 144
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commissions, reinsurance recovered, or other amounts received with respect to reinsurance policies for which a premium deduction is wholly or partially denied. We believe that the passage of such legislation could adversely affect the reinsurance market broadly and potentially impact our own current or future operations in particular. OnFebruary 11, 2013 , U.S. Senators Carl Levin and Sheldon Whitehouse introduced legislation in theU.S. Senate entitled the "Cut Unjustified Tax Loopholes Act". Similar legislation was also proposed earlier in 2013 as well as in 2012, 2011 and 2010. If enacted, this legislation would, among other things, cause to be treated as a U.S. corporation for U.S. tax purposes generally, certain corporate entities if the "management and control" of such a corporation is, directly or indirectly, treated as occurring primarily within the U.S. The proposed legislation provides that a corporation will be so treated if substantially all of the executive officers and senior management of the corporation who exercise day-to-day responsibility for making decisions involving strategic, financial, and operational policies of the corporation are located primarily within the U.S. To date, this legislation has not been approved by either theHouse of Representatives or theSenate . However, we can provide no assurance that this legislation or similar legislation will not ultimately be adopted. While we do not believe that the legislation would negatively impact us, it is possible that an adopted bill would include additional or expanded provisions which could negatively impact us, or that the interpretation or enforcement of the current proposal, if enacted, would be more expansive or adverse than we currently estimate.
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HUMANA INC – 10-K – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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