Attached files
file | filename |
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8-K - FORM 8-K - HCC INSURANCE HOLDINGS INC/DE/ | h68221e8vk.htm |
EX-99.4 - EX-99.4 - HCC INSURANCE HOLDINGS INC/DE/ | h68221exv99w4.htm |
EX-99.6 - EX-99.6 - HCC INSURANCE HOLDINGS INC/DE/ | h68221exv99w6.htm |
EX-99.1 - EX-99.1 - HCC INSURANCE HOLDINGS INC/DE/ | h68221exv99w1.htm |
EX-99.5 - EX-99.5 - HCC INSURANCE HOLDINGS INC/DE/ | h68221exv99w5.htm |
EX-99.2 - EX-99.2 - HCC INSURANCE HOLDINGS INC/DE/ | h68221exv99w2.htm |
EX-23.1 - EX-23.1 - HCC INSURANCE HOLDINGS INC/DE/ | h68221exv23w1.htm |
Exhibit 99.3
Item 7. | Managements Discussion and Analysis of Financial Condition and Results of Operations |
The following Managements Discussion and Analysis should
be read in conjunction with the Selected Financial Data, the
Consolidated Financial Statements and the related Notes thereto.
As discussed in Note 1 to the Consolidated Financial Statements, we adopted FSP APB 14-1 and FSP EITF 03-6-1 on January 1, 2009. The following Managements
Discussion and Analysis has been adjusted for the retrospective application of these new accounting standards.
Overview
We are a specialty insurance group with offices in the United
States, the United Kingdom, Spain, Bermuda and Ireland,
transacting business in approximately 150 countries. Our group
consists of insurance companies, participations in two
Lloyds of London syndicates that we manage, underwriting
agencies and a London-based reinsurance broker. Our shares are
traded on the New York Stock Exchange and closed at $26.75 on
December 31, 2008. We had a market capitalization of
$2.5 billion at February 20, 2009.
We have shareholders equity of $2.6 billion at
December 31, 2008. Our book value per share increased 10%
in 2008 to $23.27 at December 31, 2008, up from $21.24 per
share at December 31, 2007. We had net earnings of
$302.1 million, or $2.61 per diluted share, and generated
$506.0 million of cash flow from operations in 2008. We
declared dividends of $0.47 per share in 2008, compared to $0.42
per share in 2007, and paid $52.5 million of dividends in
2008. We repurchased 3.0 million shares of our common stock
for $63.3 million, at an average cost of $21.02 per share
in 2008. We currently have $4.3 billion of fixed maturity
securities with an average rating of AA+ that are available to
fund claims and other liabilities. We maintain a
$575.0 million Revolving Loan Facility that allows us to
borrow up to the maximum on a revolving basis, under which we
have $340 million of additional capacity at
February 20, 2009. The facility expires in December 2011.
We are rated AA (Very Strong) by
Standard & Poors Corporation and AA (Very
Strong) by Fitch Ratings. Our major domestic insurance
companies are rated A+ (Superior) by A.M. Best
Company, Inc.
We earned $302.1 million or $2.61 per diluted share in
2008, compared to $391.6 million or $3.35 per diluted share
in 2007. The reductions are due to catastrophic losses from
hurricanes occurring in 2008 and lower income from
investment-related items, which are discussed in the Results of
Operations section. Profitability from our underwriting
operations remains at acceptable levels despite rate pressure
from competitors on certain lines of business and losses from
the 2008 hurricanes. During 2008, we had $82.4 million of
positive reserve development, of which 70% was offset by
increases in ultimate loss ratios in accident year 2008 above
those set at the beginning of the year for certain of our
business written in 2007 and 2008, due to higher notices of
claims stemming from recent credit market issues. We had
$26.4 million of positive reserve development in 2007, of
which 50% was offset by increases in ultimate loss ratios in
accident year 2007 for certain business written in 2006 and
2007. Our 2008 combined ratio was 85.4%, which included
1.2 percentage points for the 2008 hurricane losses,
compared to 83.4% for 2007. Investment income on our fixed
income securities grew $24.1 million in 2008, but our
alternative investments, consisting mainly of fund-of-fund hedge
fund investments, incurred losses of $30.8 million, and we
had realized investment losses of $27.9 million from the
sale or other-than-temporary impairment of fixed income
securities with credit-related issues.
We underwrite a variety of specialty lines of business
identified as diversified financial products; group life,
accident and health; aviation; London market account; and other
specialty lines of business. Products in each line are marketed
by our insurance companies and agencies, through a network of
independent agents and brokers, directly to customers or through
third party administrators. The majority of our business is low
limit or small premium business that has less intense price
competition, as well as lower catastrophe and volatility risk.
We reinsure a significant portion of our catastrophic exposure
to hurricanes and earthquakes to minimize the impact on our net
earnings and shareholders equity.
We generate our revenue from six primary sources:
| risk-bearing earned premium produced by our insurance companies operations, | |
| non-risk-bearing fee and commission income received by our underwriting agencies and brokers, | |
| ceding commissions in excess of policy acquisition costs earned by our insurance companies, | |
| investment income earned by all of our operations, |
| realized investment gains and losses related to our fixed income securities portfolio, and | |
| other operating income and losses, mainly from strategic investments. |
We produced $2.3 billion of total revenue in 2008, which
was 5% lower than in 2007. Total revenue decreased
$109.0 million year-over-year due to certain
investment-related items discussed in the Results of Operations
section.
During the past several years, we substantially increased our
shareholders equity by retaining most of our earnings.
With this additional equity, we increased the underwriting
capacity of our insurance companies and made strategic
acquisitions, adding new lines of business or expanding those
with favorable underwriting characteristics. During the past
three years, we acquired two insurance businesses for total
consideration of $152.2 million and eight underwriting
agencies for total consideration of $100.2 million. Net
earnings and cash flows from each acquired entity are included
in our operations beginning on the effective date of each
transaction.
The following section discusses our key operating results. The
reasons for any significant variations between 2007 and 2006 are
the same as those discussed for variations between 2008 and
2007, unless otherwise noted. Amounts in the following tables
are in thousands, except for earnings per share, percentages,
ratios and number of employees.
Results
of Operations
Net earnings were $302.1 million ($2.61 per diluted share)
in 2008 compared to $391.6 million ($3.35 per diluted
share) in 2007. The decrease in net earnings primarily resulted
from hurricane losses and the investment-related items described
below. Diluted earnings per share benefited from the repurchase
of 3.0 million shares of our common stock in 2008. Both the
share repurchases and our lower stock price in 2008 caused the
reduction in our diluted weighted-average shares outstanding
from 117.0 million in 2007 to 115.5 million in 2008.
The following items affected pretax earnings in 2008 compared to
2007:
2008 | 2007 | 2006 | ||||||||||
Pretax earnings (loss) from:
|
||||||||||||
2008 hurricanes (including reinsurance reinstatement premium)
|
$ | (22,304 | ) | $ | | $ | | |||||
Prior years reserve development, net of increases in
current year loss ratios
|
24,893 | 13,132 | 11,915 | |||||||||
Alternative investments
|
(30,766 | ) | 23,930 | 14,161 | ||||||||
Net realized investment loss (excluding 2007 foreign currency
gain)
|
(16,808 | ) | (209 | ) | (841 | ) | ||||||
Other-than-temporary impairments
|
(11,133 | ) | | | ||||||||
Trading securities
|
(11,698 | ) | 3,881 | 24,100 | ||||||||
Strategic investments
|
9,158 | 21,618 | 39,368 |
| We incurred gross losses of $98.2 million resulting from Hurricanes Gustav and Ike (referred to herein as the 2008 hurricanes). Our pretax loss after reinsurance in 2008 was $22.3 million, which included $19.4 million of losses reported in loss and loss adjustment expense and $2.9 million of premiums to reinstate our excess of loss reinsurance protection, which reduced net earned premium. | |
| In 2008, we had favorable development of our prior years net loss reserves of $82.4 million, which was offset by $57.5 million of loss expense for increases in ultimate loss ratios in accident year 2008 above those set at the beginning of the year for business written in 2007 and 2008. In 2007, we had favorable development of prior years loss reserves of $26.4 million, which was offset by $13.3 million of loss expense for increases in ultimate loss ratios in accident year 2007 for business written in 2006 and 2007. |
| Our alternative investments generated $30.8 million of market-related losses in 2008, compared to $23.9 million of income in 2007. The related income or loss is included in net investment income. We gave notice to redeem all of the alternative investments in the third quarter of 2008. We received $48.6 million of cash through February 2009, which we reinvested in fixed income securities. We had $46.0 million of alternative investments at year-end 2008, for which we will receive the funds in 2009. | |
| In 2008, to manage credit-related risk in our investment portfolio, we sold all of our investments in preferred stock and certain bonds of entities that were experiencing financial difficulty. We recorded a realized investment loss of $23.4 million related to these sales. The total net realized investment loss on the sale of all securities was $16.8 million in 2008, compared to a net realized investment gain of $13.2 million in 2007. The 2007 gain included $13.4 million of embedded currency conversion gains on certain available for sale fixed income securities that we sold in 2007, which was offset by a $13.4 million foreign currency loss recorded in other operating expense. | |
| We recognized other-than-temporary impairments on securities in our available for sale securities portfolio of $11.1 million in 2008, which we recorded in net realized investment loss. There were no such impairments recorded in 2007. | |
| Our trading portfolio had losses of $11.7 million in 2008, compared to gains of $3.9 million in 2007. These gains and losses are reported in other operating income. We discontinued the active trading of securities in late 2006 and sold the remaining two positions in 2008. | |
| We sold strategic investments in 2008 and 2007 and realized gains of $9.2 million and $21.6 million, respectively. These gains are reported within other operating income. |
Net earnings increased 16% in 2007, from $337.9 million
($2.89 per diluted share) in 2006 to $391.6 million ($3.35
per diluted share) in 2007, mainly due to growth in underwriting
profits, favorable prior year loss development and higher net
investment income. Net earnings in 2006 included an after-tax
loss of $13.1 million due to a reinsurance commutation.
During 2006, we reached agreements with various reinsurers to
commute a large reinsurance contract on certain run-off assumed
accident and health reinsurance business included in our
discontinued lines, for which we had reinsurance recoverables of
$120.2 million at the date of commutation. In consideration
for discounting the recoverables and reassuming the associated
loss reserves, we agreed to accept cash payments that were less
than the related recoverables. We recorded pretax losses of
$20.2 million in 2006 related to this commutation, which
was included in loss and loss adjustment expense in our
insurance company segment. We expect to recoup these losses over
future years as we earn interest on the cash proceeds from the
commutations prior to the related claims being paid.
The following table sets forth the relationships of certain
income statement items as a percent of total revenue.
2008 | 2007 | 2006 | ||||||||||
(as adjusted) | (as adjusted) | (as adjusted) | ||||||||||
Net earned premium
|
88.1 | % | 83.1 | % | 82.3 | % | ||||||
Fee and commission income
|
5.5 | 5.9 | 6.6 | |||||||||
Net investment income
|
7.2 | 8.6 | 7.4 | |||||||||
Net realized investment gain (loss)
|
(1.2 | ) | 0.6 | | ||||||||
Other operating income
|
0.4 | 1.8 | 3.7 | |||||||||
Total revenue
|
100.0 | 100.0 | 100.0 | |||||||||
Loss and loss adjustment expense, net
|
53.2 | 49.6 | 48.8 | |||||||||
Policy acquisition costs, net
|
16.7 | 15.4 | 15.4 | |||||||||
Other operating expense
|
10.2 | 10.1 | 10.7 | |||||||||
Interest expense
|
0.9 | 0.6 | 0.9 | |||||||||
Earnings before income tax expense
|
19.1 | 24.3 | 24.3 | |||||||||
Income tax expense
|
5.8 | 7.9 | 8.0 | |||||||||
Net earnings
|
13.3 | % | 16.4 | % | 16.3 | % | ||||||
Total revenue decreased 5% to $2.3 billion in 2008 and
increased 15% to $2.4 billion in 2007. The 2008 decrease
was due to lower income and losses from the investment-related
items discussed in the Results of Operation section. The 2007
increase was driven by significant growth in net earned premium
and higher investment income. Approximately 55% of the increase
in revenue in 2007 was due to the acquisition of businesses.
Gross written premium, net written premium and net earned
premium are detailed below. Premium increased in 2008
principally from growth in our diversified financial products
and other specialty lines of business and our recent
acquisitions. Net written premium and net earned premium
increased for the same reasons, as well as from higher
retentions and lower reinsurance costs. The 2007 increases in
written and earned premium were primarily due to our 2006
acquisition of the Health Products Division and organic growth
in our surety, credit and other specialty lines of business. See
the Insurance Company Segment section for further discussion of
the relationship and changes in our premium revenue.
2008 | 2007 | 2006 | ||||||||||
Gross written premium
|
$ | 2,498,763 | $ | 2,451,179 | $ | 2,235,648 | ||||||
Net written premium
|
2,060,618 | 1,985,609 | 1,812,552 | |||||||||
Net earned premium
|
2,007,774 | 1,985,086 | 1,709,189 |
The table below shows the source of our fee and commission
income. The lower fee and commission income in 2008 resulted
from a higher percentage of business being written directly by
our insurance companies rather than being underwritten on behalf
of third party insurance companies by our underwriting agencies,
and higher retentions on certain lines of business.
2008 | 2007 | 2006 | ||||||||||
Agencies
|
$ | 81,521 | $ | 92,230 | $ | 92,566 | ||||||
Insurance companies
|
43,680 | 47,862 | 44,565 | |||||||||
Fee and commission income
|
$ | 125,201 | $ | 140,092 | $ | 137,131 | ||||||
The sources of our net investment income are detailed below.
2008 | 2007 | 2006 | ||||||||||
Fixed income securities
|
||||||||||||
Taxable
|
$ | 98,538 | $ | 88,550 | $ | 61,386 | ||||||
Exempt from U.S. income taxes
|
76,172 | 62,044 | 51,492 | |||||||||
Total fixed income securities
|
174,710 | 150,594 | 112,878 | |||||||||
Short-term investments
|
24,173 | 37,764 | 30,921 | |||||||||
Alternative investments
|
(30,766 | ) | 23,930 | 14,161 | ||||||||
Other investments
|
575 | | 17 | |||||||||
Total investment income
|
168,692 | 212,288 | 157,977 | |||||||||
Investment expense
|
(3,941 | ) | (5,826 | ) | (5,173 | ) | ||||||
Net investment income
|
$ | 164,751 | $ | 206,462 | $ | 152,804 | ||||||
Net investment income decreased 20% in 2008 and increased 35% in
2007. The 2008 decrease was primarily due to lower short-term
interest rates and losses on our alternative investments, which
are primarily fund-of-fund hedge fund investments compared to
alternative investment income in 2007. These investments were
impacted by the severe decline in the equity and debt markets.
During the third quarter of 2008, we notified the fund managers
that we planned to liquidate all of our alternative investments.
At December 31, 2008, we recorded a $52.6 million
receivable for redemption proceeds in the process of
liquidation, of which we had collected cash of
$48.6 million through February 2009. We expect the
remaining cash will be received later in 2009. At
December 31, 2008, the value of our remaining alternative
investments was $46.0 million, for which we expect the
liquidation process to be completed in 2009. In 2009, we expect
to invest the majority of our funds in fixed income securities.
Our 2008 investment expense decreased due to the lower or
negative investment returns on alternative investments.
Investment income on our fixed income securities increased 16%
in 2008 due to higher fixed income investments, which increased
to $4.3 billion at December 31, 2008 compared to
$3.7 billion at December 31, 2007. The growth in fixed
income securities in 2008 resulted primarily from cash flow from
operations, the increase in net loss reserves (particularly from
our diversified financial products line of business, which
generally has a longer time period between reporting and payment
of claims), and our shift away from short-term investments in
the first half of 2008 as short-term interest rates declined.
The 2007 increase in net investment income was primarily due to
growth in fixed income securities, which increased to
$3.7 billion at December 31, 2007 compared to
$3.0 billion at December 31, 2006, and higher interest
rates. The 2007 increase was also due to higher short-term
interest rates and higher returns on alternative investments.
The growth in fixed income securities in 2007 resulted primarily
from cash flow from operations, higher retentions and
commutations of reinsurance recoverables in 2006. We increased
our investments in tax-exempt securities over the past three
years as the relative yields in this sector were higher than in
other sectors.
In 2008, we had a $27.9 million net realized investment
loss, compared to a net gain of $13.2 million in 2007 and a
net loss of $0.8 million in 2006. The 2008 loss included
other-than-temporary impairment losses of $11.1 million and
$16.8 million of net realized losses related to bonds and
preferred stock sold during the year. The 2007 gain included
$13.4 million of embedded currency conversion gains on
certain available for sale fixed income securities that we sold
in December 2007. This realized gain was offset by a
$13.4 million foreign currency loss recorded in other
operating expense.
We evaluate the securities in our investment portfolio for
possible other-than-temporary impairment losses at each quarter
end. When we conclude that a decline in a securitys fair
value is other than temporary, we recognize the impairment as a
realized investment loss. We determine the impairment loss based
on the decline in fair value below our cost on the balance sheet
date. We recognized other-than-temporary impairment losses of
$11.1 million in 2008. There were no other-than-temporary
impairment losses in 2007 or 2006.
Other operating income decreased $33.9 million in 2008 and
$33.5 million in 2007. The 2008 and 2007 decreases were due
to reductions in the net gains from trading securities and from
the sales of different strategic investments. The market value
of our trading securities declined in 2008, consistent with
recent market conditions. We sold our remaining trading
positions in 2008. The 2008 decline in income from financial
instruments was due to the effect on their value of foreign
currency fluctuations in the British pound sterling compared to
the U.S. dollar. In 2008, we entered into an agreement to
provide reinsurance coverage for certain residential mortgage
guaranty contracts. We recorded this contract using the deposit
method of accounting, whereby all consideration received is
initially recorded as a deposit liability. We are reporting the
change in the deposit liability as a component of other
operating income. Period to period comparisons of our other
operating income may vary substantially, depending on the
earnings generated by new transactions or investments, income or
loss related to changes in the market values of certain
investments, and gains or losses related to any disposition. The
following table details the components of other operating income.
2008 | 2007 | 2006 | ||||||||||
Strategic investments
|
$ | 12,218 | $ | 27,627 | $ | 43,627 | ||||||
Trading securities
|
(11,698 | ) | 3,881 | 24,100 | ||||||||
Financial instruments
|
(608 | ) | 5,572 | 4,772 | ||||||||
Contract using deposit accounting
|
2,013 | | | |||||||||
Sale of non-operating assets
|
2,972 | 2,051 | | |||||||||
Other
|
4,741 | 4,414 | 4,513 | |||||||||
Other operating income
|
$ | 9,638 | $ | 43,545 | $ | 77,012 | ||||||
Loss and loss adjustment expense increased 2% in 2008 and 17% in
2007. Both years increased due to growth in net retained premium
and were affected by changes in ultimate loss ratios, prior year
redundant development and the 2008 hurricanes, as discussed
above. Policy acquisition costs increased 4% in 2008 and 15% in
2007, primarily due to the growth in net earned premium and
change in the mix of business to lines with a lower loss ratio
but higher expense ratio. See the Insurance Company Segment
section for further discussion of the changes in loss and loss
adjustment expense and policy acquisition costs.
Other operating expense, which includes compensation expense,
decreased 3% in 2008 and increased 9% in 2007. Excluding the
effect of the $13.4 million charge in 2007 that is
described below, other operating expense increased 2% in 2008
and 3% in 2007. The increase in both years primarily resulted
from compensation and other operating expenses of acquired
subsidiaries. We had 1,864 employees at December 31,
2008, compared to 1,682 a year earlier, of which 70% of the
increase was from acquired companies. Our 2007 and 2006 other
operating expense also included professional fees and legal
costs related to our 2006 stock option investigation. In 2007,
we had a $13.4 million charge to correct the accounting for
embedded currency conversion gains on certain fixed income
securities classified as available for sale. Between 2005 and
2007, we used certain available for sale fixed income
securities, denominated in British pound sterling, to
economically hedge foreign currency exposure on certain
insurance reserves and other liabilities, denominated in the
same currency. We had incorrectly recorded the unrealized
exchange rate fluctuations on these securities through earnings
as an offset to the opposite fluctuations in the liabilities
they hedged, rather than through other comprehensive income
within shareholders equity. In 2007, to correct our
accounting, we reversed $13.4 million of cumulative
unrealized exchange rate gains. We recorded this reversal as a
charge to our gain or loss from currency conversion account,
with an offsetting credit to other comprehensive income. We
reported our net loss from currency conversion, which included
this $13.4 million charge, as a component of other
operating expense in the consolidated statements of earnings. In
2007, we sold these available for sale securities and realized
the $13.4 million of embedded cumulative currency
conversion gains. This gain was included in the net realized
investment gain (loss) line of our consolidated statements of
earnings. The offsetting effect of these transactions had no
impact on our 2007 consolidated net earnings. In 2008, we
purchased a portfolio of bonds that we designated as held to
maturity to economically hedge our foreign currency exposure.
Other operating expense includes $13.7 million,
$12.0 million and $13.1 million in 2008, 2007 and
2006, respectively, of stock-based compensation expense, after
the effect of the deferral and amortization of policy
acquisition costs related to stock-based compensation for our
underwriters. At December 31, 2008, there was approximately
$31.8 million of total unrecognized compensation expense
related to unvested options and restricted stock awards and
units that is expected to be recognized over a weighted-average
period of 2.8 years.
Our effective income tax rate was 30.1% for 2008, compared to
32.5% for 2007 and 32.8% for 2006. The lower rate in 2008
related to the increased benefit from more tax-exempt investment
income on a lower pretax base.
At December 31, 2008, book value per share was $23.27,
compared to $21.24 at December 31, 2007 and $18.35 at
December 31, 2006. In 2008, our Board of Directors approved
the repurchase of up to $100.0 million of our common stock.
We repurchased 3.0 million shares for a total cost of
$63.3 million and a weighted-average cost of $21.02 per
share. The impact of the share repurchases increased our book
value per share by $0.06 in 2008. Total assets were
$8.3 billion and shareholders equity was
$2.6 billion, up from $8.1 billion and
$2.4 billion, respectively, at December 31, 2007.
Segments
We operate our businesses in three segments: insurance company,
agency and other operations. Our Chief Executive Officer, as
chief decision maker, monitors and evaluates the individual
financial results of each subsidiary in the insurance company
and agency segments. Each subsidiary provides monthly reports of
its actual and budgeted results, which are aggregated on a
segment basis for management review and monitoring. The
operating results of our insurance company, agency, and other
operations segments are discussed below.
Insurance
Company Segment
Net earnings of our insurance company segment decreased to
$301.7 million in 2008 compared to $357.8 million in
2007, which increased from $272.0 million in 2006. The 2008
decrease was primarily due to alternative investment losses
(compared to income in 2007 and 2006), net realized investment
losses (compared to a gain in 2007), and the 2008 hurricane
losses. The growth in 2007 net earnings was driven by
improved underwriting results, increased investment income, and
the operations of acquired subsidiaries. The 2006 net
earnings included $13.1 million of after-tax losses related
to a commutation. Even though there is pricing competition in
many of our markets, our margins in our insurance companies
remain at an acceptable level of profitability due to our
underwriting expertise and discipline.
Premium
Gross written premium increased 2% in 2008 to $2.5 billion
and 10% in 2007. Net written premium increased 4% to
$2.1 billion and net earned premium increased 1% to
$2.0 billion in 2008 compared to increases of 10% and 16%,
respectively, in 2007. Premium increased in 2008 due to the 2008
acquisitions. However, decreased writings and lower prices in
lines impacted by competitive market pressures moderated the
effect of more demand and increased prices in certain products.
We elected to write less premium in 2008 in certain lines
affected by competition. We wrote more business than planned in
our diversified financial products lines, particularly in
directors and officers liability and domestic
credit, as prices increased in late 2008 and the market reacted
to financial issues with other insurance companies. A majority
of this additional written premium will be earned in 2009. The
2007 increases in written and earned premium were primarily due
to our 2006 acquisition of the Health Products Division and
organic growth in our surety, credit and other specialty lines
of business. The overall percentage of retained premium of 82%
in 2008 essentially remained constant compared to 81% in 2007
and 2006.
The following table details premium amounts and their
percentages of gross written premium.
2008 | 2007 | 2006 | ||||||||||||||||||||||
Amount | % | Amount | % | Amount | % | |||||||||||||||||||
Direct
|
$ | 2,156,613 | 86 | % | $ | 2,000,552 | 82 | % | $ | 1,867,908 | 84 | % | ||||||||||||
Reinsurance assumed
|
342,150 | 14 | 450,627 | 18 | 367,740 | 16 | ||||||||||||||||||
Gross written premium
|
2,498,763 | 100 | 2,451,179 | 100 | 2,235,648 | 100 | ||||||||||||||||||
Reinsurance ceded
|
(438,145 | ) | (18 | ) | (465,570 | ) | (19 | ) | (423,096 | ) | (19 | ) | ||||||||||||
Net written premium
|
2,060,618 | 82 | 1,985,609 | 81 | 1,812,552 | 81 | ||||||||||||||||||
Change in unearned premium
|
(52,844 | ) | (2 | ) | (523 | ) | | (103,363 | ) | (5 | ) | |||||||||||||
Net earned premium
|
$ | 2,007,774 | 80 | % | $ | 1,985,086 | 81 | % | $ | 1,709,189 | 76 | % | ||||||||||||
The following tables provide premium information by line of
business.
Gross |
NWP |
|||||||||||||||
Written |
Net Written |
as% of |
Net Earned |
|||||||||||||
Premium | Premium | GWP | Premium | |||||||||||||
Year Ended December 31, 2008
|
||||||||||||||||
Diversified financial products
|
$ | 1,051,722 | $ | 872,007 | 83 | % | $ | 805,604 | ||||||||
Group life, accident and health
|
829,903 | 789,479 | 95 | 777,268 | ||||||||||||
Aviation
|
185,786 | 136,019 | 73 | 139,838 | ||||||||||||
London market account
|
175,561 | 107,234 | 61 | 106,857 | ||||||||||||
Other specialty lines
|
251,021 | 151,120 | 60 | 173,449 | ||||||||||||
Discontinued lines
|
4,770 | 4,759 | nm | 4,758 | ||||||||||||
Totals
|
$ | 2,498,763 | $ | 2,060,618 | 82 | % | $ | 2,007,774 | ||||||||
Year ended December 31, 2007
|
||||||||||||||||
Diversified financial products
|
$ | 963,355 | $ | 771,648 | 80 | % | $ | 777,414 | ||||||||
Group life, accident and health
|
798,684 | 759,207 | 95 | 758,516 | ||||||||||||
Aviation
|
195,809 | 145,761 | 74 | 153,121 | ||||||||||||
London market account
|
213,716 | 118,241 | 55 | 124,609 | ||||||||||||
Other specialty lines
|
280,040 | 191,151 | 68 | 171,824 | ||||||||||||
Discontinued lines
|
(425 | ) | (399 | ) | nm | (398 | ) | |||||||||
Totals
|
$ | 2,451,179 | $ | 1,985,609 | 81 | % | $ | 1,985,086 | ||||||||
Year ended December 31, 2006
|
||||||||||||||||
Diversified financial products
|
$ | 956,057 | $ | 794,232 | 83 | % | $ | 728,861 | ||||||||
Group life, accident and health
|
621,639 | 590,811 | 95 | 591,070 | ||||||||||||
Aviation
|
216,208 | 166,258 | 77 | 152,886 | ||||||||||||
London market account
|
234,868 | 127,748 | 54 | 112,362 | ||||||||||||
Other specialty lines
|
205,651 | 133,481 | 65 | 123,981 | ||||||||||||
Discontinued lines
|
1,225 | 22 | nm | 29 | ||||||||||||
Totals
|
$ | 2,235,648 | $ | 1,812,552 | 81 | % | $ | 1,709,189 | ||||||||
nm Not meaningful comparison
The changes in premium volume and retention levels between years
resulted principally from the following factors:
| Diversified financial products Written premium increased in 2008 due to higher policy count and price increases in our directors and officers liability and domestic professional indemnity lines, particularly for financial institution accounts, and in our credit business. The increases in these lines in 2008 increased our net written premium. Increases in quota share retentions on employment practices liability businesses and some parts of our U.S. professional indemnity liability business in 2008 increased net written premium and the retention rate. Premium volume of our other major products was stable, although pricing for certain products is down. During 2007, competition in our directors and officers liability business resulted in less gross written premium compared to 2006. Net written premium also declined in 2007 due to additional quota share reinsurance purchased for our international directors and officers liability business. Our surety business grew in both years because pricing had been stable and competition was reasonable, but it began to be affected by the economic downturn late in 2008. | |
| Group life, accident and health The 2008 increase in premium is from our current-year acquisition of MultiNational Underwriters, for which we use one of our managed Lloyds syndicates as the issuing carrier. The 2007 increase was from our 2006 acquisition of the Health Products Division, which writes medical stop-loss and medical excess products. We retain all of our medical stop-loss and medical excess business because the business is non-volatile and has very little catastrophe exposure. | |
| Aviation Our domestic aviation written premium volume is down over the three-year period due to competition and lack of growth in the general aviation industry. Underwriting margins continue to be good. Our international aviation premium increased in late 2008 as rates are beginning to rise for the first time in several years, allowing us to write more profitable business. | |
| London market account Net written premium decreased in 2008 and 2007 due to increased competition in this line of business. This followed a large increase in energy writings in 2006 that resulted from significantly increased rates after the 2005 hurricanes. Our aggregate property exposure in hurricane-exposed areas was reduced in 2006, and we have maintained that reduced exposure in 2007 and 2008. Also, in 2008, we discontinued writing our marine excess of loss book of business due to unacceptable rates. The net impact of these changes was moderated by reduced reinsurance spending, which increased the 2008 retention rate. As we enter 2009, pricing on many of these products appears to be increasing again, particularly in catastrophe exposed areas. | |
| Other specialty lines We experienced growth in 2008 and 2007 from an increase in our Lloyds syndicate participation, a 2006 acquisition and increased writings in several lines. This growth was offset by the expiration of an assumed quota share contract in 2008 and discontinuance of a motor line written through one of our Lloyds syndicates, which caused the large reduction in premium in 2008. Markets for these products are competitive and rates are down slightly. The changes in average retention are due to the change in mix of business in this line. |
Reinsurance
Annually, we analyze our threshold for risk in each line of
business and on an overall consolidated basis, based on a number
of factors, including market conditions, pricing, competition
and the inherent risks associated with each business type, and
then we structure our reinsurance programs. Based on our
analysis of these factors, we may determine not to purchase
reinsurance for some lines of business. We generally purchase
reinsurance to reduce our net liability on individual risks and
to protect against catastrophe losses and volatility. We
purchase reinsurance on a proportional basis to cover loss
frequency, individual risk severity and catastrophe exposure.
Some of the proportional reinsurance agreements may have maximum
loss limits, most of which are at or greater than a 200% loss
ratio. We also purchase reinsurance on an excess of loss basis
to cover individual risk severity and catastrophe exposure.
Additionally, we may obtain facultative reinsurance protection
on a single risk. The type and amount of reinsurance we purchase
varies year to year based on our risk assessment, our desired
retention levels based on profitability and other
considerations, and on the market
availability of quality reinsurance at prices we consider
acceptable. Our reinsurance programs renew throughout the year,
and the price changes in recent years have not been material to
our net underwriting results. Our reinsurance generally does not
cover war or terrorism risks, which are excluded from most of
our policies.
Our Reinsurance Security Committee carefully monitors the credit
quality of the reinsurers with which we do business on all new
and renewal reinsurance placements and on an ongoing, current
basis. The Reinsurance Security Committee uses objective
criteria to select and retain our reinsurers, which include
requiring: 1) minimum surplus of $250 million;
2) minimum capacity of £100 million for
Lloyds syndicates; 3) financial strength rating of
A− or better from A.M. Best Company, Inc.
or Standard & Poors Corporation; 4) an
unqualified opinion on the reinsurers financial statements
from an independent audit; 5) approval from the reinsurance
broker, if a party to the transaction; and 6) a minimum of
five years in business for
non-U.S. reinsurers.
The Committee approves exceptions to these criteria when
warranted. Our recoverables are due principally from
highly-rated reinsurers.
We decided for the 2006 underwriting year to retain more
underwriting risk in certain lines of business in order to
retain a greater proportion of expected underwriting profits. In
doing so, we purchased less reinsurance and converted some
reinsurance from proportional to excess of loss, which
significantly reduced the amount of ceded premium in 2006. Since
then, ceded premium as a percentage of gross written premium has
essentially remained constant. We have chosen not to purchase
any reinsurance on business where volatility or catastrophe
risks are considered remote and limits are within our risk
tolerance.
In our proportional reinsurance programs, we generally receive
an overriding (ceding) commission on the premium ceded to
reinsurers. This compensates our insurance companies for the
direct costs associated with production of the business, the
servicing of the business during the term of the policies ceded,
and the costs associated with placement of the related
reinsurance. In addition, certain of our reinsurance treaties
allow us to share in any net profits generated under such
treaties with the reinsurers. Various reinsurance brokers,
including subsidiaries, arrange for the placement of this
proportional and other reinsurance coverage on our behalf and
are compensated, directly or indirectly, by the reinsurers.
One of our insurance companies previously sold its entire block
of individual life insurance and annuity business to Swiss Re
Life & Health America, Inc. (rated A+ by
A.M. Best Company, Inc.) in the form of an indemnity
reinsurance contract. Ceded life and annuity benefits amounted
to $64.2 million and $66.2 million at
December 31, 2008 and 2007, respectively.
Our reinsurance recoverables decreased in amount and as a
percentage of our shareholders equity during 2007, as we
reinsured less business, especially on a proportional basis, and
as 2005 hurricane losses were paid and we collected amounts due
from our reinsurers for their portion of these paid losses. The
amount of reinsurance recoverables increased in 2008 due to
reinsured losses from the 2008 hurricanes and several other
large individual losses that were highly reinsured.
Additionally, we continued to write and reinsure more
professional liability business where it takes longer for claims
reserves to result in paid claims. The percentage of reinsurance
recoverables compared to our shareholders equity remained
constant at 40% and 39% at December 31, 2008 and 2007.
We continuously monitor our financial exposure to the
reinsurance market and take necessary actions in an attempt to
mitigate our exposure to possible loss. We have a reserve of
$8.4 million at December 31, 2008 for potential
collectibility issues related to reinsurance recoverables,
including disputed amounts and associated expenses. We review
the level and adequacy of our reserve at each quarter-end. While
we believe the year-end reserve is adequate based on information
currently available, conditions may change or additional
information might be obtained that may require us to change the
reserve in the future.
Losses
and Loss Adjustment Expenses
The table below shows the composition of gross incurred loss and
loss adjustment expense.
2008 | 2007 | 2006 | ||||||||||||||||||||||
Amount | Loss Ratio | Amount | Loss Ratio | Amount | Loss Ratio | |||||||||||||||||||
(Redundant) adverse development:
|
||||||||||||||||||||||||
Discontinued accident and health adjustments
|
$ | 34,148 | 1.4 | % | $ | (46,531 | ) | (1.9 | )% | $ | 15,054 | 0.7 | % | |||||||||||
Discontinued international medical malpractice adjustments
|
(536 | ) | | 11,568 | 0.5 | 2,353 | 0.1 | |||||||||||||||||
Other reserve redundancies
|
(105,656 | ) | (4.3 | ) | (55,658 | ) | (2.3 | ) | (20,708 | ) | (1.0 | ) | ||||||||||||
Total (redundant) adverse development
|
(72,044 | ) | (2.9 | ) | (90,621 | ) | (3.7 | ) | (3,301 | ) | (0.2 | ) | ||||||||||||
2008 hurricanes
|
98,200 | 4.0 | | | | | ||||||||||||||||||
All other net incurred loss and loss adjustment expense
|
1,609,338 | 65.5 | 1,443,031 | 59.2 | 1,222,139 | 56.9 | ||||||||||||||||||
Gross incurred loss and loss adjustment expense
|
$ | 1,635,494 | 66.6 | % | $ | 1,352,410 | 55.5 | % | $ | 1,218,838 | 56.7 | % | ||||||||||||
Our gross redundant reserve development relating to prior
years losses was $72.0 million in 2008,
$90.6 million in 2007 and $3.3 million in 2006. The
other reserve redundancies resulted primarily from our review
and reduction of gross reserves where the anticipated
development was considered to be less than the recorded
reserves. Redundancies and deficiencies also occur as a result
of claims being settled for amounts different from recorded
reserves, or as claims exposures change. The other gross reserve
redundancies in 2008 and 2007 related primarily to reserve
reductions in our diversified financial products and other
specialty lines of business from the 2002 2006
underwriting years. The other gross reserve redundancies in 2006
related primarily to a reduction in aviation reserves from the
2004 and 2005 accident years.
Loss reserves on international medical malpractice business, in
run-off since we acquired the subsidiary that wrote this
business in 2002, were strengthened in 2007 in response to a
deteriorating legal and settlement environment.
For certain run-off assumed accident and health reinsurance
business that is reported in our discontinued lines of business,
the gross (redundant) adverse development related to prior
accident years has changed substantially year-over-year, as
shown in the above table. The gross losses have fluctuated due
to our processing of additional information received and our
continuing evaluation of gross and net reserves related to this
business. To establish our loss reserves, we consider a
combination of factors including: 1) the nature of the
business, which is primarily excess of loss reinsurance;
2) late reported losses by insureds, reinsureds and state
guaranty associations; and 3) changes in our actuarial
assumptions to reflect additional information received during
the year. The run-off assumed accident and health reinsurance
business is primarily reinsurance that provides excess coverage
for large losses related to workers compensation policies.
This business is slow to develop and may take as many as twenty
years to pay out. Losses in lower layers must develop first
before our excess coverage attaches. Thus, the losses are
reported to excess of loss reinsurers later in the life cycle of
the claim. Compounding this late reporting is the fact that a
number of large insurance companies that were cedants of this
business failed and were taken over by state regulatory
authorities in 2002 and 2003. The state guaranty associations
covering these failed companies have been slow to report losses
to us. At each quarter-end, we evaluate and consider all
currently available information and adjust our gross and net
reserves to amounts that management determines are appropriate
to cover projected losses, given the risk inherent in this type
of business. Because of substantial reinsurance, the net effect
on our consolidated net earnings of the adjustments in each year
has been much less than the gross effects shown above.
The table below shows the composition of net incurred loss and
loss adjustment expense.
2008 | 2007 | 2006 | ||||||||||||||||||||||
Amount | Loss Ratio | Amount | Loss Ratio | Amount | Loss Ratio | |||||||||||||||||||
(Redundant) adverse development:
|
||||||||||||||||||||||||
Discontinued accident and health commutations
|
$ | | | % | $ | 2,616 | 0.1 | % | $ | 20,199 | 1.2 | % | ||||||||||||
Discontinued accident and health adjustments
|
3,429 | 0.2 | 376 | | 4,898 | 0.3 | ||||||||||||||||||
Discontinued international medical malpractice adjustments
|
(526 | ) | | 11,568 | 0.6 | 2,738 | 0.2 | |||||||||||||||||
Other reserve redundancies
|
(85,264 | ) | (4.2 | ) | (40,957 | ) | (2.1 | ) | (34,361 | ) | (2.1 | ) | ||||||||||||
Total (redundant) adverse development
|
(82,361 | ) | (4.0 | ) | (26,397 | ) | (1.4 | ) | (6,526 | ) | (0.4 | ) | ||||||||||||
2008 hurricanes
|
19,379 | 1.1 | | | | | ||||||||||||||||||
All other net incurred loss and loss adjustment expense
|
1,274,855 | 63.3 | 1,210,344 | 61.0 | 1,018,382 | 59.6 | ||||||||||||||||||
Net incurred loss and loss adjustment expense
|
$ | 1,211,873 | 60.4 | % | $ | 1,183,947 | 59.6 | % | $ | 1,011,856 | 59.2 | % | ||||||||||||
Our net redundant reserve development relating to prior
years losses was $82.4 million in 2008,
$26.4 million in 2007, and $6.5 million in 2006. The
other reserve redundancies in 2008 and 2007 related primarily to
reserve reductions in our diversified financial products and
other specialty lines of business from the 2002 2006
underwriting years. The other net reserve redundancies in 2006
related primarily to a reduction in aviation reserves from the
2004 and 2005 accident years, which were partially reinsured,
and $17.7 million of net redundancies on the 2005
hurricanes. The losses on commutations completed in 2007 and
2006 related to certain run-off assumed accident and health
reinsurance business reported in our discontinued lines of
business. They primarily represent the discount for the time
value of money based on the present value of the reinsurance
recoverables commuted. The discontinued accident and health
business was substantially reinsured; therefore, the impact on
our net earnings was substantially less than the amount of the
gross redundant or adverse development. Loss reserves on
international medical malpractice business, in run-off since we
acquired the subsidiary that wrote this business in 2002, were
strengthened in 2007 in response to a deteriorating legal and
settlement environment. These losses were not reinsured.
We have no material exposure to environmental or asbestos
losses. We believe we have provided for all material net
incurred losses as of December 31, 2008.
The following table provides comparative net loss ratios by line
of business.
2008 | 2007 | 2006 | ||||||||||||||||||||||
Net |
Net |
Net |
Net |
Net |
Net |
|||||||||||||||||||
Earned |
Loss |
Earned |
Loss |
Earned |
Loss |
|||||||||||||||||||
Premium | Ratio | Premium | Ratio | Premium | Ratio | |||||||||||||||||||
Diversified financial products
|
$ | 805,604 | 48.1 | % | $ | 777,414 | 40.6 | % | $ | 728,861 | 48.2 | % | ||||||||||||
Group life, accident and health
|
777,268 | 73.1 | 758,516 | 76.4 | 591,070 | 73.1 | ||||||||||||||||||
Aviation
|
139,838 | 62.6 | 153,121 | 58.6 | 152,886 | 53.8 | ||||||||||||||||||
London market account
|
106,857 | 46.4 | 124,609 | 55.2 | 112,362 | 43.0 | ||||||||||||||||||
Other specialty lines
|
173,449 | 67.2 | 171,824 | 67.4 | 123,981 | 56.0 | ||||||||||||||||||
Discontinued lines
|
4,758 | nm | (398 | ) | nm | 29 | nm | |||||||||||||||||
Totals
|
$ | 2,007,774 | 60.4 | % | $ | 1,985,086 | 59.6 | % | $ | 1,709,189 | 59.2 | % | ||||||||||||
Expense ratio
|
25.0 | 23.8 | 25.0 | |||||||||||||||||||||
Combined ratio
|
85.4 | % | 83.4 | % | 84.2 | % | ||||||||||||||||||
nm | Not meaningful comparison since ratios relate to discontinued lines of business. |
The change in net loss ratios by line of business between years
resulted principally from the following factors:
| Diversified financial products There was redundant reserve development of $43.8 million in 2008 compared to $51.9 million in 2007. The 2008 redundancy primarily related to our directors and officers liability and international professional indemnity product lines for 2005 and prior underwriting years, whereas the 2007 redundancy primarily related to 2004 and prior underwriting years for those product lines. Offsetting the redundant reserve development in 2008 was an increase of $50.1 million in our loss estimates on the 2008 accident year affecting business written in the 2007 and 2008 underwriting years, primarily for our directors and officers liability and credit businesses. Our U.S. surety business also had favorable loss development in 2008 and 2007. | |
| Group life, accident and health The net loss ratio was higher in 2007 on business acquired in the Health Products Division acquisition in late 2006. As the business has been re-underwritten, the loss ratio has declined. In addition, 2007 included some adverse development from prior years losses, while 2008 included some redundant development. | |
| Aviation The 2008 hurricanes increased losses by $1.4 million and increased the 2008 loss ratio by 1.0 percentage point. Underwriting results in 2006 were better than expected, due in part to the release of redundant reserves on the 2004 and 2005 accident years. | |
| London market account The 2008 hurricanes increased losses by $12.1 million and increased the 2008 loss ratio by 11.3 percentage points. There was also $21.4 million of redundant reserve development in 2008, mostly from our property and energy businesses, which included a $5.4 million reduction of the 2005 hurricane losses. The loss ratio in 2007 was slightly higher than expected due to adverse development in our London accident and health and energy businesses. The reduction of 2005 hurricane losses lowered the 2006 net loss ratio by 9.1 percentage points. The London market account line of business can have relatively high year-to-year volatility due to catastrophe exposure. | |
| Other specialty lines The 2008 hurricanes increased losses by $5.9 million and increased the 2008 loss ratio by 3.4 percentage points. There was also $8.7 million of redundant reserve development in 2008, primarily from an assumed quota share program, compared to $4.4 million of redundant development in 2007 and a $4.7 million reduction in the 2005 hurricane losses in 2006. The increase in the 2007 net loss ratio compared to 2006 related to losses in our marine and United Kingdom liability lines of business. |
| Discontinued lines These were adversely affected by the commutations and net loss reserve adjustments discussed previously. In addition, loss reserves on our international medical malpractice business, in run-off since we acquired the subsidiary that wrote this business in 2002, were strengthened in 2007 in response to a deteriorating legal and settlement environment. |
The net paid loss ratio is the percentage of losses paid, net of
reinsurance, divided by net earned premium for the period. Our
net paid loss ratios were 54.0%, 49.3% and 36.3% in 2008, 2007
and 2006, respectively. The ratio has increased steadily over
the past three years due to a variety of factors. In the fourth
quarter of 2008, it was particularly high at 62.1% due to
quarterly volatility of claims payments in our London market
account and our diversified financial products line of business.
The factors driving the year-over-year increases included the
following:
| a higher percentage of medical stop-loss business, which has a higher paid loss ratio than other lines, | |
| earlier payment of claims in 2008 due to shortening the required reporting period, bringing claims processing in-house, and responding to faster reporting of claims by insureds on certain lines of business, | |
| growth in lines of business with shorter duration, | |
| commutations of assumed accident and health business in our London market account, | |
| payment of claims related to the Health Products Division business acquired in 2006, and | |
| payments in 2006 were reduced $100.0 million (5.9 percentage points) due to the discontinued accident and health commutation. |
Policy
Acquisition Costs
Policy acquisition costs, which are reported net of the related
portion of commissions on reinsurance ceded, increased to
$381.4 million in 2008 from $366.6 million in 2007 and
$319.9 million in 2006. Policy acquisition costs as a
percentage of net earned premium increased to 19.0% in 2008 from
18.5% in 2007 and 18.7% in 2006. The changes are due to changes
in the mix of business and commission rates on certain lines of
business. In addition, net earned premium has grown on our
surety and credit businesses that have higher acquisition rates.
The GAAP expense ratio of 25.0% in 2008 changed in comparison to
23.8% in 2007 and 25.0% in 2006 for the same reasons.
Statutory
Regulatory guidelines suggest that a property and casualty
insurers annual statutory gross written premium should not
exceed 900% of its statutory policyholders surplus and net
written premium should not exceed 300% of its statutory
policyholders surplus. However, industry and rating agency
guidelines place these ratios at 300% and 200%, respectively.
Our property and casualty insurance companies have maintained
premium to surplus ratios lower than such guidelines. For 2008,
our statutory gross written premium to policyholders
surplus was 135.5% and our statutory net written premium to
policyholders surplus was 111.4%. At December 31,
2008, each of our domestic insurance companies total
adjusted capital significantly exceeded the authorized control
level risk-based capital level prescribed by the National
Association of Insurance Commissioners.
Agency
Segment
Revenue from our agency segment increased to $188.4 million
in 2008 from $178.6 million in 2007 and $180.0 million
in 2006, primarily due to underwriting agencies acquired in
2008. However, Agency segment earnings decreased to
$28.4 million in 2008 from $33.9 million in 2007 and
$42.3 million in 2006, primarily due to higher interest
expense and operating expense in 2007 and 2008 related to
acquired underwriting agencies. In addition, over the past two
years, a higher percentage of business is being written directly
by our insurance companies, rather than being underwritten on
behalf of third party insurance companies by our
underwriting agencies. The effect of this shift reduced fee and
commission income in our agency segment, but added revenue and
net earnings to our insurance company segment.
Other
Operations Segment
Revenue generated by our other operations segment was
$7.3 million, $38.9 million and $75.1 million in
2008, 2007 and 2006, respectively. Net earnings were
$2.2 million, $22.8 million and $48.8 million in
the respective years. The significant drops in 2007 and again in
2008 were due to reduced income from gains on the sales of
strategic investments and losses on our trading securities. We
sold one strategic investment for a gain of $9.2 million in
2008 and others for gains of $21.6 million in 2007 and
$39.4 million in 2006. We held a trading portfolio that we
began to liquidate in the fourth quarter of 2006 and completed
in 2008. The portfolio generated market gains in 2006, which
declined substantially in 2007 due to the reduced trading
positions. Before their sales in 2008, the two remaining
positions generated losses due to poor market conditions. We
invested the proceeds from all sales in fixed income securities.
Results of this segment may vary substantially period to period
depending on our investment in or disposition of strategic
investments
Liquidity
and Capital Resources
During 2008, there were significant disruptions in the
world-wide and U.S. financial markets. A number of large
financial institutions failed, received substantial capital
infusions and loans from the U.S. and various other governments,
or were merged into other companies. The market disruptions have
resulted in a tightening of available sources of credit,
increases in the cost of credit and significant liquidity
concerns for many companies. We believe we have sufficient
sources of liquidity at a reasonable cost at the present time,
based on the following:
| We held $524.8 million of cash and liquid short-term investments at December 31, 2008. We have generated an annual average $588.2 million in cash from our operating activities, excluding cash from commutations, in the three-year period ended December 31, 2008. | |
| Our available for sale bond portfolio had a fair value of $4.1 billion at December 31, 2008 and has an average rating of AA+. We have the intent and ability to hold these securities until their maturity; however, should we have to sell certain securities in the portfolio earlier to generate cash, given the current credit market volatility, it is possible we might not recoup the full year-end fair value of the securities sold. | |
| As shown in the Contractual Obligations section, we project that our insurance companies will pay approximately $1.2 billion of claims in 2009 based on historical payment patterns and claims history. After projected collections on their reinsurance programs, our insurance companies estimate that net claims payable in 2009 will be approximately $831.1 million. These subsidiaries have a total $1.0 billion of cash, short-term investments, maturing bonds, and principal payments from asset-backed and mortgage-backed securities in 2009 that will be available to pay these expected claims, before consideration of expected cash flow from the insurance companies 2009 operations. We project that there will be $211.1 million of available cash flow to fund any additional claims payments, if needed. | |
| We have a committed line of credit, led by Wells Fargo, through a syndicate group of large domestic banks and one large foreign bank. Our Revolving Loan Facility provides borrowing capacity to $575.0 million through December 2011. At February 20, 2009, we had $340.0 million of unused capacity, which we can draw against at any time at our request. We believe that the banks will be able and willing to perform on their commitments to us. |
| Our 1.3% Convertible Notes are subject to redemption anytime after April 4, 2009, or holders may require us to repurchase the Notes on April 1, 2009. Our available capacity on the Revolving Loan Facility is sufficient to cover the $124.7 million of Notes outstanding at December 31, 2008. If the notes are not put to us by the holders, we can select a date for redemption in 2009 at our choosing or elect not to redeem the notes. The next put date by the holders would be April 1, 2014. | |
| Our domestic insurance subsidiaries have the ability to pay $199.2 million in dividends in 2009 to our holding company without obtaining special permission from state regulatory authorities. Our |
underwriting agencies have no restrictions on the amount of dividends that can be paid to our holding company. The holding company can utilize these dividends to pay down debt, pay dividends to shareholders, fund acquisitions, repurchase common stock and pay operating expenses. Cash flow available to the holding company in 2009 is expected to be more than ample to cover the holding companys required cash disbursements. |
| Our debt to total capital ratio was 11.5% at December 31, 2008 and 11.6% at December 31, 2007. We have a Universal Shelf registration that provides for the issuance of an aggregate of $1.0 billion of securities. These securities may be debt securities, equity securities, trust preferred securities, or a combination thereof. Although due to pricing we may not wish to issue securities in the current financial market, the shelf registration provides us the means to access the debt and equity markets. Our shelf registration expires in May 2009, and we plan to file for a new shelf registration prior to that date. We do not anticipate a problem obtaining a new Universal Shelf registration, and we do not anticipate using either the current or the new shelf registration in the near future. |
Cash
Flow
We receive substantial cash from premiums, reinsurance
recoverables, commutations, fee and commission income, proceeds
from sales and redemptions of investments and investment income.
Our principal cash outflows are for the payment of claims and
loss adjustment expenses, premium payments to reinsurers,
commutations, purchases of investments, debt service, policy
acquisition costs, operating expenses, taxes and dividends.
Cash provided by operating activities can fluctuate due to
timing differences in the collection of premiums and reinsurance
recoverables and the payment of losses and premium and
reinsurance balances payable and the completion of commutations.
We generated cash from operations of $506.0 million in
2008, $726.4 million in 2007 and $653.4 million in
2006. Factors that contributed to our strong cash flow include
the following:
| our net earnings, | |
| growth in net written premium and net loss reserves due to organic growth and increased retentions, | |
| expansion of our diversified financial products line of business, where we retain premium for a longer duration and pay claims later than for our short-tailed businesses, and | |
| commutations of selected reinsurance agreements. |
The components of our net operating cash flows are detailed in
the following table.
2008 | 2007 | 2006 | ||||||||||
(as adjusted) | (as adjusted) | (as adjusted) | ||||||||||
Net earnings
|
$ | 302,120 | $ | 391,553 | $337,911 | |||||||
Change in premium, claims and other receivables, net of
reinsurance, other payables and restricted cash
|
(41,248 | ) | (60,671 | ) | (139,906 | ) | ||||||
Change in unearned premium, net
|
43,835 | 3,062 | 122,571 | |||||||||
Change in loss and loss adjustment expense payable, net of
reinsurance recoverables
|
89,910 | 342,556 | 328,569 | |||||||||
Change in trading portfolio
|
49,091 | 9,362 | (19,919 | ) | ||||||||
(Gain) loss on investments
|
49,549 | (58,736 | ) | (52,688 | ) | |||||||
Other, net
|
12,711 | 99,310 | 76,850 | |||||||||
Cash provided by operating activities
|
$ | 505,968 | $ | 726,436 | $653,388 | |||||||
Cash provided by operating activities decreased
$220.5 million in 2008 and increased $73.0 million in
2007. Cash received from commutations, included in cash provided
by operating activities, totaled $7.5 million,
$101.0 million, and $12.8 million in 2008, 2007 and
2006, respectively. Excluding the commutations and cash flow
from liquidating our trading portfolio in 2008 and 2007, cash
provided by operating activities was
$449.4 million in 2008, $616.0 million in 2007 and
$660.6 million in 2006. The decrease in 2008 primarily
resulted from a decrease in net earnings, as well as the timing
of the collection of reinsurance recoverables and the payment of
insurance claims. We collected more cash from reinsurers in
early 2007 than in 2008 as a result of reimbursement of 2005
hurricane claims that we had paid in late 2006. In addition, we
are paying claims at a faster pace in 2008 than in prior years.
The higher level of claims payments is reflected in our higher
paid loss ratios over the three-year period, discussed in the
Loss and Loss Adjustment Expense section.
Investments
Our investment policy is determined by our Board of Directors
and our Investment and Finance Committee and is reviewed on a
regular basis. Our policy for each of our insurance company
subsidiaries must comply with applicable state and Federal
regulations that prescribe the type, quality and concentration
of investments. These regulations permit investments, within
specified limits and subject to certain qualifications, in
federal, state and municipal obligations, obligations of foreign
countries, corporate bonds and preferred and common equity
securities. The regulations generally allow certain other types
of investments subject to maximum limitations.
We engage independent investment advisors to oversee our fixed
income investments, based on the investment policies promulgated
by our Investment and Finance Committee of the Board of
Directors, and to make investment recommendations. We invest our
funds principally in highly-rated fixed income securities. Our
historical investment strategy has been to maximize interest
income and yield, within our risk tolerance, rather than to
maximize total return. Our investment portfolio turnover will
fluctuate, depending upon opportunities. Realized gains and
losses from sales of securities are usually minimal, unless we
sell securities for investee credit-related reasons or to
capture gains to enhance statutory capital and surplus of our
insurance company subsidiaries, or because we can take gains and
reinvest the proceeds at a higher effective yield.
At December 31, 2008, we had $4.8 billion of
investment assets, an increase of $132.0 million from the
end of 2007. The increase resulted from our operating cash
flows. The majority of our investment assets are held by our
insurance companies. We held $4.3 billion of fixed income
securities at year-end 2008. The fair value of these fixed
income securities and the related investment income fluctuate
depending on general economic and market conditions, including
the recent downturn in the market due to credit-related issues.
Our fixed income securities portfolio has an average rating of
AA+ and a weighted-average maturity of 6.0 years.
This table summarizes our investments by type, substantially all
of which are reported at fair value, at December 31, 2008.
Amount | % | |||||||
Short-term investments
|
$ | 497,477 | 10 | % | ||||
U.S. government and government guaranteed fixed income securities
|
227,607 | 5 | ||||||
Fixed income securities of states, municipalities and political
subdivisions
|
808,697 | 17 | ||||||
Special revenue fixed income securities of states,
municipalities and political subdivisions
|
1,182,838 | 25 | ||||||
Corporate fixed income securities
|
511,638 | 10 | ||||||
Asset-backed and mortgage-backed securities
|
1,040,866 | 22 | ||||||
Foreign fixed income securities
|
485,072 | 10 | ||||||
Other investments
|
50,088 | 1 | ||||||
Total investments
|
$ | 4,804,283 | 100 | % | ||||
At year-end 2008, within our portfolio of fixed income
securities, we held a portfolio of residential mortgage-backed
securities (MBSs) and collateralized mortgage obligations (CMOs)
with a fair value of $813.0 million. Within our residential
MBS/CMO portfolio, $723.5 million of securities were issued
by the Federal National Mortgage Association (Fannie Mae) and
the Federal Home Loan Mortgage Corporation (Freddie Mac), which
are backed by the U.S. government, while
$79.6 million, $7.6 million and $2.3 million of
bonds are collateralized by prime, Alt A and subprime mortgages,
respectively. All of these securities were
current as to principal and interest. The prime securities have
an average rating of AA and a weighted-average life of
approximately 4.1 years, and the subprime and Alt A
securities have an average rating of AA+ and a weighted-average
life of approximately 3.2 years.
At December 31, 2008, we held a commercial MBS securities
portfolio with a fair value of $145.8 million, an average
rating of AAA, an average loan-to-value ratio of 66%, and a
weighted-average life of approximately 5.0 years. We also
held a corporate bond portfolio (47% of which related to
financial institutions) with a fair value of
$511.6 million, an overall rating of A+, and a
weighted-average life of approximately 3.2 years. In
addition, we held $24.5 million of senior debt obligations
of Fannie Mae and Freddie Mac, with an unrealized gain of
$1.2 million. We owned no collateralized debt obligations
(CDOs) or collateralized loan obligations (CLOs), and we have
never been counterparty to any credit default swap.
We evaluate the securities in our fixed income securities
portfolio for possible other-than-temporary impairment losses at
each quarter end, based on all relevant facts and circumstances
for each impaired security. Our evaluation considers various
factors including:
| amount by which the securitys fair value is less than its cost, | |
| length of time the security has been impaired, | |
| the securitys credit rating and any recent downgrades, | |
| stress testing of expected cash flows under various scenarios, | |
| whether the impairment is due to an issuer-specific event, credit issues or change in market interest rates, and | |
| our ability and intent to hold the security for a period of time sufficient to allow full recovery or until maturity. |
Our outside investment advisors also perform detailed credit
evaluations of all of our fixed income securities on an ongoing
basis and alert us to any securities that may present a credit
problem.
When we conclude that a decline in a securitys fair value
is other-than-temporary, we recognize the impairment as a
realized investment loss in our consolidated statements of
earnings. The impairment loss equals the difference between the
securitys fair value and cost at the balance sheet date.
During 2008, we reviewed our fixed income securities for
other-than-temporary impairments at each quarter end. Based on
the results of our reviews, we recognized other-than-temporary
impairment losses of $11.1 million in 2008. There were no
other-than-temporary impairment losses in 2007 or 2006.
During 2008, we transferred $108.9 million of
foreign-denominated bonds from our available for sale portfolio
to a new held to maturity portfolio. This portfolio includes
foreign-denominated securities for which we have the ability and
intent to hold the securities to maturity or redemption. We hold
these securities to hedge the foreign exchange risk associated
with insurance claims that we will pay in foreign currencies. At
December 31, 2008, we held bonds with an amortized cost of
$123.6 million and a fair value of $125.6 million. The
majority of these bonds mature in March 2009. Any foreign
exchange gain/loss on these bonds will be recorded through
income and will substantially offset any foreign exchange
gain/loss on the related liabilities. Conversely, the foreign
exchange gain/loss on available for sale securities is recorded
as a component of accumulated other comprehensive income within
shareholders equity until the related bonds mature or are
sold and, therefore, does not offset the opposite foreign
currency movement on the hedged liabilities that is recorded
through income.
At December 31, 2008, we had cash and short-term
investments of $524.8 million, of which $289.1 million
was held by our insurance companies. We maintain cash and liquid
short-term instruments in our insurance companies in order to be
able to fund losses of our insureds. Cash and short-term
investments were higher than normal at December 31, 2007
due to proceeds from the sale of fixed income securities that
hedged certain foreign currency denominated liabilities. We
reduced our short-term investments in 2008 and reinvested in
fixed income securities to take advantage of higher yields.
This table shows a profile of our fixed income and short-term
investments. The table shows the average amount of investments,
income earned and the related yield.
2008 | 2007 | 2006 | ||||||||||
Average investments, at cost
|
$ | 4,681,954 | $ | 4,214,798 | $ | 3,529,671 | ||||||
Net investment income*
|
164,751 | 206,462 | 152,804 | |||||||||
Average short-term yield*
|
3.8 | % | 5.2 | % | 4.5 | % | ||||||
Average long-term yield*
|
4.4 | % | 4.5 | % | 4.4 | % | ||||||
Average long-term tax equivalent yield*
|
5.2 | % | 5.4 | % | 5.2 | % | ||||||
Weighted-average combined tax equivalent yield*
|
4.2 | % | 5.6 | % | 5.0 | % | ||||||
Weighted-average maturity
|
6.0 years | 7.0 years | 6.9 years | |||||||||
Weighted-average duration
|
4.8 years | 4.9 years | 4.6 years | |||||||||
Average rating
|
AA+ | AAA | AAA |
* | Excluding realized and unrealized investment gains and losses. |
This table summarizes, by rating, our investments in fixed
income securities at December 31, 2008.
Available for Sale |
Held to Maturity |
|||||||||||||||
Fair Value | Amortized Cost | |||||||||||||||
Amount | % | Amount | % | |||||||||||||
AAA
|
$ | 2,101,752 | 51 | % | $ | 123,553 | 100 | % | ||||||||
AA
|
1,327,871 | 32 | | | ||||||||||||
A
|
582,594 | 14 | | | ||||||||||||
BBB
|
112,856 | 3 | | | ||||||||||||
BB and below
|
8,092 | | | | ||||||||||||
Total fixed income securities
|
$ | 4,133,165 | 100 | % | $ | 123,553 | 100 | % | ||||||||
This table indicates the expected maturity distribution of our
fixed income securities at December 31, 2008.
Available |
Asset-backed and |
Held to |
Total |
|||||||||||||||||||||||||||||
for Sale |
Mortgage-backed |
Maturity |
Fixed Income |
|||||||||||||||||||||||||||||
Amortized Cost | Amortized Cost | Amortized Cost | Securities | |||||||||||||||||||||||||||||
Amount | % | Amount | % | Amount | % | Amount | % | |||||||||||||||||||||||||
One year or less
|
$ | 137,466 | 4 | % | $ | 431,542 | 41 | % | $ | 87,262 | 71 | % | $ | 656,270 | 15 | % | ||||||||||||||||
One year to five years
|
1,130,926 | 37 | 617,105 | 59 | 29,937 | 24 | 1,777,968 | 42 | ||||||||||||||||||||||||
Five years to ten years
|
683,961 | 22 | | | 6,354 | 5 | 690,315 | 16 | ||||||||||||||||||||||||
Ten years to fifteen years
|
487,950 | 16 | | | | | 487,950 | 12 | ||||||||||||||||||||||||
More than fifteen years
|
629,589 | 20 | | | | | 629,589 | 15 | ||||||||||||||||||||||||
Total fixed income securities
|
$ | 3,069,892 | 100 | % | $ | 1,048,647 | 100 | % | $ | 123,553 | 100 | % | $ | 4,242,092 | 100 | % | ||||||||||||||||
The weighted-average life of our asset-backed and
mortgage-backed securities is approximately 2.4 years based
on expected future cash flows. In the table above, we allocated
the maturities of asset-backed maturities and mortgage-backed
securities based on the expected future principal payments.
At December 31, 2008, the net unrealized gain on our
available for sale fixed income securities portfolio was
$14.6 million, compared to $25.0 million at
December 31, 2007. The change in the net unrealized gain or
loss, net of the related income tax effect, is recorded in other
comprehensive income and fluctuates principally due to changes
in market interest rates on our available for sale bond
portfolio and conditions in the credit markets, particularly
with respect to our corporate bonds and our asset-backed and
mortgage-backed securities, which have been impacted by the
recent credit crisis. During 2008, the net unrealized gain
(loss) was
$26.2 million at March 31, 2008, ($34.1) million
at June 30, 2008, and ($98.1) million at
September 30, 2008, which caused fluctuations in our
consolidated shareholders equity throughout the year. The
net unrealized gain on our available for sale fixed income
securities portfolio at January 31, 2009 was
$64.4 million.
The fair value of our fixed income securities is sensitive to
changing interest rates. As interest rates increase, the fair
value will generally decrease, and as interest rates decrease,
the fair value will generally increase. The fluctuations in fair
value are somewhat muted by the relatively short duration of our
portfolio and our relatively high level of investments in state
and municipal obligations. We estimate that a 1% increase (e.g.
from 5% to 6%) in market interest rates would decrease the fair
value of our fixed income securities by approximately
$198.8 million and a 1% decrease in market interest rates
would increase the fair value by a like amount. Fluctuations in
interest rates have a minimal effect on the value of our
short-term investments due to their very short maturities. In
our current position, higher interest rates would have a
positive effect on net earnings.
Some of our fixed income securities have call or prepayment
options. In addition, mortgage-backed and certain asset-backed
securities have prepayment or other market-related credit risk.
Prepayment risk exists if the timing of cash flows that result
from the repayment of principal might occur earlier than
anticipated because of declining interest rates or later than
anticipated because of rising interest rates. Credit risk exists
if mortgagees default on the underlying mortgages. Net
investment income
and/or cash
flows from investments that carry call or prepayment options and
prepayment or credit risk may differ from those anticipated at
the time of investment. Calls and prepayments subject us to
reinvestment risk should interest rates fall or issuers call
their securities and we reinvest the proceeds at lower interest
rates. Conversely, lower interest rates subject us to extension
risk on the portfolios duration if interest rates rise.
For asset-backed and mortgage-backed securities, prepayment or
credit risk could reduce the yield or the return of the
remaining principal of these securities. We mitigate this risk
by investing in investment grade securities with varied maturity
dates so that only a portion of our portfolio will mature at any
point in time.
Fair
Value Measurements
Effective January 1, 2008, we adopted Statement of
Financial Accounting Standards (SFAS) No. 157, Fair
Value Measurements, for financial assets and financial
liabilities measured at fair value on a recurring basis (at
least annually). SFAS 157 defines fair value, establishes a
consistent framework for measuring fair value and expands
disclosure requirements about fair value measurements.
SFAS 157 also established a hierarchy that prioritizes the
inputs used to measure fair value into three levels, as
described below. Our adoption of SFAS 157 did not did not
impact our 2008 or prior years consolidated financial
position, results of operations or cash flows.
SFAS 157 applies to all financial instruments that are
measured and reported at fair value. SFAS 157 defines fair
value as the price that would be received to sell an asset or
would be paid to transfer a liability in an orderly transaction
between market participants at the measurement date. In 2008,
the Financial Accounting Standards Board (FASB) issued FSP
FAS 157-3,
Determining the Fair Value of a Financial Asset When the
Market for That Asset Is Not Active (FSP
FAS 157-3).
FSP
FAS 157-3
clarifies SFAS 157 with respect to the fair value
measurement of a security when the market for that security is
inactive. Our adoption of FSP
FAS 157-3
did not did not impact our consolidated financial position,
results of operations or cash flows.
In determining fair value, we generally apply the market
approach, which uses prices and other relevant data based on
market transactions involving identical or comparable assets and
liabilities. The degree of judgment used to measure fair value
generally correlates to the type of pricing and other data used
as inputs, or assumptions, in the valuation process. Observable
inputs reflect market data obtained from independent sources,
while unobservable inputs reflect our own market assumptions
using the best information available to us. Based on the type of
inputs used to measure the fair value of our financial
instruments, we classify them into the three-level hierarchy
established by SFAS 157:
| Level 1 Inputs are based on quoted prices in active markets for identical instruments. |
| Level 2 Inputs are based on observable market data (other than quoted prices), or are derived from or corroborated by observable market data. | |
| Level 3 Inputs are unobservable and not corroborated by market data. |
Our Level 1 investments are primarily U.S. Treasuries
listed on stock exchanges. We use quoted prices for identical
instruments to measure fair value.
Our Level 2 investments include most of our fixed income
securities, which consist of U.S. government agency
securities, municipal bonds, certain corporate debt securities,
and certain mortgage and asset-backed securities. Our
Level 2 instruments also include our interest rate swap
agreements, which were reflected as liabilities in our
consolidated balance sheet at December 31, 2008. We measure
fair value for the majority of our Level 2 investments
using quoted prices of securities with similar characteristics.
The remaining investments are valued using pricing models or
matrix pricing. The fair value measurements consider observable
assumptions, including benchmark yields, reported trades,
broker/dealer quotes, issuer spreads, two-sided markets,
benchmark securities, bids, offers, default rates, loss severity
and other economic measures.
We use independent pricing services to assist us in determining
fair value for over 99% of our Level 1 and Level 2
investments. We use data provided by our third party investment
managers to value the remaining Level 2 investments. We did
not apply the criteria of FSP
FAS 157-3,
since no markets for our investments were judged to be inactive.
To validate quoted and modeled prices, we perform various
procedures, including evaluation of the underlying
methodologies, analysis of recent sales activity, and analytical
review of our fair values against current market prices, other
pricing services and historical trends.
Our Level 3 securities include certain fixed income
securities and two insurance contracts that we account for as
derivatives. Fair value is based on internally developed models
that use our assumptions or other data that are not readily
observable from objective sources. Because we use the lowest
level significant input to determine our hierarchy
classifications, a financial instrument may be classified in
Level 3 even though there may be significant
readily-observable inputs.
We excluded from our SFAS 157 disclosures certain assets,
such as alternative investments and certain strategic
investments in insurance-related companies, since we account for
them using the equity method of accounting and have not elected
to measure them at fair value, pursuant to the guidance of
SFAS 159. These assets had a recorded value of
$63.0 million at December 31, 2008. We also excluded
our held to maturity portfolio valued at $123.6 million and
an investment valued at $4.1 million at December 31,
2008, which are measured at amortized cost and at cost,
respectively.
The following table presents our assets and liabilities that
were measured at fair value as of December 31, 2008.
Level 1 | Level 2 | Level 3 | Total | |||||||||||||
Fixed income securities
|
$ | 87,678 | $ | 4,038,972 | $ | 6,515 | $ | 4,133,165 | ||||||||
Other investments
|
16 | | | 16 | ||||||||||||
Other assets
|
| 1,125 | 16,100 | 17,225 | ||||||||||||
Total assets measured at fair value
|
$ | 87,694 | $ | 4,040,097 | $ | 22,615 | $ | 4,150,406 | ||||||||
Accounts payable and accrued liabilities
|
$ | | $ | (8,031 | ) | $ | | $ | (8,031 | ) | ||||||
Total liabilities measured at fair value
|
$ | | $ | (8,031 | ) | $ | | $ | (8,031 | ) | ||||||
We classified our residential MBS/CMO portfolio, substantially
all of which is either backed by U.S. government agencies
or collateralized by prime mortgages, as Level 2 assets
because the fair value of the securities is derived from
industry-standard models using observable market-based data.
These securities have an average rating of AAA and a
weighted-average life of approximately 2.1 years based on
expected future cash flows.
The following table presents the changes in fair value of our
Level 3 category during 2008.
Fixed |
||||||||||||||||
Income |
Other |
Other |
||||||||||||||
Securities | Investments | Assets | Total | |||||||||||||
Balance at January 1, 2008
|
$ | 7,623 | $ | 5,492 | $ | 16,804 | $ | 29,919 | ||||||||
Net redemptions
|
(242 | ) | (5,261 | ) | | (5,503 | ) | |||||||||
Losses realized
|
| (299 | ) | | (299 | ) | ||||||||||
Other-than-temporary impairment losses realized
|
(2,575 | ) | | | (2,575 | ) | ||||||||||
Gains and (losses) unrealized
|
(566 | ) | 68 | (704 | ) | (1,202 | ) | |||||||||
Net transfers in/out of Level 3
|
2,275 | | | 2,275 | ||||||||||||
Balance at December 31, 2008
|
$ | 6,515 | $ | | $ | 16,100 | $ | 22,615 | ||||||||
Unrealized gains and losses on our Level 3 fixed income
securities and other investments are reported in other
comprehensive income within shareholders equity, and
unrealized gains and losses on our Level 3 other assets are
reported in other operating income.
At December 31, 2008, our Level 3 financial
investments represented approximately 0.5% of our total assets
that are measured at fair value. The fixed income securities
consisted of six bonds, most of which had been reduced to
estimated fair value at their date of impairment, based on our
other-than-temporary impairment assessment. The other assets
were $16.1 million of receivables for the reinsured
interests in two long-term mortgage impairment insurance
contracts that are accounted for as derivative financial
instruments. The exposure with respect to these two contracts is
measured based on movement in a specified UK housing index. We
determine their fair value based on our estimate of the present
value of expected future cash flows, modified to reflect
specific contract terms. During 2008, the Level 3 asset
balance was reduced due to cash receipts for returned principal
on certain investments and for impairments recognized on fixed
income securities. During 2008, four bonds valued at
$10.7 million transferred into Level 3, and two bonds
valued at $8.5 million transferred out of Level 3
based on changes in the availability of observable market
information for these securities. We believe that our expected
future cash receipts from our Level 3 financial investments
will equal or exceed their fair value at December 31, 2008.
Contractual
Obligations
The following table presents a summary of our total contractual
cash payment obligations by estimated payment date at
December 31, 2008.
Estimated Payment Dates | ||||||||||||||||||||
Total | 2009 | 2010-2011 | 2012-2013 | Thereafter | ||||||||||||||||
Gross loss and loss adjustment expense payable(1):
|
||||||||||||||||||||
Diversified financial products
|
$ | 1,666,343 | $ | 481,962 | $ | 684,688 | $ | 336,874 | $ | 162,819 | ||||||||||
Group life, accident and health
|
305,225 | 251,974 | 42,751 | 8,413 | 2,087 | |||||||||||||||
Aviation
|
161,634 | 75,645 | 53,208 | 21,413 | 11,368 | |||||||||||||||
London market account
|
404,548 | 181,845 | 159,208 | 43,050 | 20,445 | |||||||||||||||
Other specialty lines
|
407,691 | 135,041 | 164,550 | 67,360 | 40,740 | |||||||||||||||
Discontinued lines
|
469,789 | 53,462 | 84,238 | 86,505 | 245,584 | |||||||||||||||
Total loss and loss adjustment expense payable
|
3,415,230 | 1,179,929 | 1,188,643 | 563,615 | 483,043 | |||||||||||||||
Life and annuity policy benefits
|
64,235 | 2,306 | 4,362 | 4,049 | 53,518 | |||||||||||||||
1.30% Convertible Notes(2)
|
125,525 | 125,525 | | | | |||||||||||||||
$575.0 million Revolving Loan Facility(3)
|
234,036 | 8,883 | 225,153 | | | |||||||||||||||
Operating leases
|
72,539 | 12,361 | 23,006 | 14,818 | 22,354 | |||||||||||||||
Earnout liabilities
|
24,458 | 23,026 | 1,432 | | | |||||||||||||||
Indemnifications
|
18,692 | 4,077 | 6,226 | 5,786 | 2,603 | |||||||||||||||
Total obligations
|
$ | 3,954,715 | $ | 1,356,107 | $ | 1,448,822 | $ | 588,268 | $ | 561,518 | ||||||||||
In preparing the previous table, we made the following estimates and assumptions. | ||
(1) | The estimated loss and loss adjustment expense payments for future periods assume that the percentage of ultimate losses paid from one period to the next will be relatively consistent over time. Actual payments will be influenced by many factors and could vary from the estimated amounts. | |
(2) | While the 1.30% Convertible Notes mature in 2023, they are shown in the 2009 column since the holders may require us to repurchase the Notes on April 1, 2009. The Notes have various put and redemption dates as disclosed in Note 7 to the Consolidated Financial Statements. Amounts include interest payable in respective periods. | |
(3) | The $575.0 million Revolving Loan Facility expires on December 19, 2011. Interest on $200.0 million of the facility is included at an effective fixed rate of 4.60% through November 2009 and interest on $105.0 million of the facility is included at an effective interest rate of 2.94% from December 2009 through November 2010 due to interest rate swaps. Interest on the remaining facility is included at 30-day LIBOR plus 25 basis points (0.69% at December 31, 2008). |
Claims
Payments
The table below shows our estimated claims payable before
reinsurance. The following table compares our insurance company
subsidiaries cash and investment maturities with their
estimated future claims payments, net of reinsurance, at
December 31, 2008.
Maturities/Estimated Payment Dates | ||||||||||||||||||||
Total | 2009 | 2010-2011 | 2012-2013 | Thereafter | ||||||||||||||||
Cash and investment maturities of insurance companies
|
$ | 4,633,132 | $ | 1,042,209 | $ | 1,183,945 | $ | 605,477 | $ | 1,801,501 | ||||||||||
Estimated loss and loss adjustment expense payments, net of
reinsurance
|
2,416,271 | 831,123 | 798,877 | 409,338 | 376,933 | |||||||||||||||
Estimated available cash flow
|
$ | 2,216,861 | $ | 211,086 | $ | 385,068 | $ | 196,139 | $ | 1,424,568 | ||||||||||
The average duration of claims in many of our lines of business
is relatively short, and, accordingly, our investment portfolio
has a relatively short duration. The average duration of all
claims was approximately 2.5 years in 2008 and 2007. In
recent years, we have expanded the directors and
officers liability and professional indemnity components
of our diversified financial products line of business, which
have a longer claims duration than our other lines of business.
We consider these different claims payment patterns in
determining the duration of our investment portfolio.
We maintain sufficient liquidity from our current cash,
short-term investments and investment maturities, in combination
with future operating cash flow, to pay anticipated policyholder
claims on their expected payment dates. We manage the liquidity
of our insurance company subsidiaries such that each
subsidiarys anticipated claims payments will be met by its
own current operating cash flows, cash, short-term investments
or investment maturities. We do not foresee the need to sell
securities prior to their maturity to fund claims payments.
Convertible
Notes
Our 1.30% Convertible Notes are due in 2023. We pay
interest semi-annually on April 1 and October 1. Each one
thousand dollar principal amount of notes is convertible into
44.1501 shares of our common stock, which represents an
initial conversion price of $22.65 per share. The initial
conversion price is subject to standard anti-dilution provisions
designed to maintain the value of the conversion option in the
event we take certain actions with respect to our common stock,
such as stock splits, reverse stock splits, stock dividends and
extraordinary dividends, that affect all of the holders of our
common stock equally and that could have a dilutive effect on
the value of the conversion rights of the holders of the notes
or that confer a benefit upon our current shareholders not
otherwise available to the Convertible Notes. Holders may
surrender notes for conversion if, as of the last day of the
preceding calendar quarter, the closing sale price of our common
stock for at least 20 consecutive trading days during the period
of 30 consecutive trading days ending on the last trading day of
that quarter is more than 130% ($29.45 per share) of the
conversion price per share of our common stock. This condition
was not met at December 31, 2008. We must settle any
conversions by paying cash for the principal amount of the notes
and issuing our common stock for the value of the conversion
premium. We can redeem the notes for cash at any time on or
after April 4, 2009. Holders may require us to repurchase
the notes on April 1, 2009, 2014 or 2019, or if a change in
control of HCC Insurance Holdings, Inc. occurs on or before
April 4, 2009. The repurchase price to settle any such put
or change in control provisions will equal the principal amount
of the notes plus accrued and unpaid interest and will be paid
in cash.
Revolving
Loan Facility
Our $575.0 million Revolving Loan Facility allows us to
borrow up to the maximum allowed by the facility on a revolving
basis until the facility expires on December 19, 2011. We
had $220.0 million outstanding at December 31, 2008.
The interest rate is the 30-day LIBOR plus a margin of 15 to
50 basis
points and the commitment fee ranges from 7.5 to 15.0 basis
points, depending on our debt rating by Standard &
Poors Corporation, as follows:
LIBOR |
Commitment Fees |
|||||||
Debt Rating
|
Basis Points | Basis Points | ||||||
A+ or higher
|
15.0 | 7.5 | ||||||
A to A+
|
25.0 | 10.0 | ||||||
A- to A
|
30.0 | 12.5 | ||||||
BBB+ to A-
|
40.5 | 12.5 | ||||||
BBB or lower
|
50.0 | 15.0 |
At December 31, 2008, the contractual interest rate on the
outstanding balance was
30-day LIBOR
plus 25 basis points (0.69%), but the effective interest
rate on $200.0 million of the facility was 4.60% due to the
fixed interest rate swaps discussed below. The commitment fee
was 10.0 basis points. The facility is collateralized by
guarantees entered into by our domestic underwriting agencies.
The facility agreement contains two restrictive financial
covenants, with which we were in compliance at December 31,
2008. Our debt to capital ratio, including the Standby Letter of
Credit Facility discussed below, cannot exceed 35%, and our
combined ratio, calculated under statutory accounting principles
on a trailing four-quarter average, cannot be greater than 105%.
At December 31, 2008, our actual ratios under these
covenants were 13.9% and 85.2%, respectively.
In 2007, we entered into three interest rate swap agreements to
exchange
30-day LIBOR
(0.44% at December 31, 2008) for a 4.60% fixed rate on
$200.0 million of our Revolving Loan Facility. The swaps
qualify for cash flow hedge accounting treatment. The three
swaps expire in November 2009. As of December 31, 2008, we
had entered into two additional swaps for $105.0 million,
which will begin when the original swaps expire in November 2009
and will expire in November 2010. The fixed rate on the new
swaps is 2.94%. These swaps were entered into in 2008 with a
future effective date to minimize our exposure to expected
interest rate increases due to the recent credit and market
conditions. All of our swaps were in a total unrealized loss
position of $8.0 million at December 31, 2008.
Standby
Letter of Credit Facility
We have an $82.0 million Standby Letter of Credit Facility
that is used to guarantee our performance in two Lloyds of
London syndicates. Letters of credit issued under the Standby
Letter of Credit Facility are unsecured commitments of HCC. The
Standby Letter of Credit Facility contains the same two
restrictive financial covenants as our Revolving Loan Facility,
with which we were in compliance at December 31, 2008.
Subsidiary
Lines of Credit
At December 31, 2008, certain of our subsidiaries
maintained revolving lines of credit with banks in the combined
maximum amount of $50.1 million available through
November 30, 2009. Advances under the lines of credit are
limited to amounts required to fund draws, if any, on letters of
credit issued by the bank on behalf of the subsidiaries and
short-term direct cash advances. The lines of credit are
collateralized by securities having an aggregate market value of
up to $62.8 million, the actual amount of collateral at any
one time being 125% of the aggregate amount outstanding.
Interest on the lines is payable at the banks prime rate
of interest (3.25% at December 31, 2008) for draws on
the letters of credit and either prime or prime less 1% on
short-term cash advances. At December 31, 2008, letters of
credit totaling $20.1 million had been issued to insurance
companies by the bank on behalf of our subsidiaries, with total
securities of $25.2 million collateralizing the lines.
Earnouts
Our prior acquisition of HCC Global Financial Products, LLC (HCC
Global) includes a contingency for future earnout payments, as
defined in the purchase agreement, as amended. The earnout is
based on HCC Globals pretax earnings from the acquisition
date through September 30, 2007, with no maximum amount due
to the former owners. Pretax earnings include underwriting
results on longer-duration business until all future losses are
paid. When the conditions for accrual have been satisfied under
the purchase agreement, we record a liability to the
former owners with an offsetting increase to goodwill. Accrued
amounts are paid according to the contractual requirements, with
the majority of the payments in the next year. At
December 31, 2008, unpaid accrued earnout totaled
$20.2 million, of which $18.8 million will be paid in
2009. The total amount of all future earnout cannot be finally
determined until all future losses are paid. Our 2008
acquisition of MultiNational Underwriters, LLC includes a
possible additional earnout depending upon achievement of
certain underwriting profit levels. At December 31, 2008,
we accrued $4.2 million for this earnout, with an
offsetting increase to goodwill, which will be paid in 2009.
Indemnifications
In conjunction with the sales of business assets and
subsidiaries, we have provided indemnifications to the buyers.
Certain indemnifications cover typical representations and
warranties related to our responsibilities to perform under the
sales contracts. Other indemnifications agree to reimburse the
purchasers for taxes or ERISA-related amounts, if any, assessed
after the sale date but related to pre-sale activities. We
cannot quantify the maximum potential exposure covered by all of
our indemnifications because the indemnifications cover a
variety of matters, operations and scenarios. Certain of these
indemnifications have no time limit. For those with a time
limit, the longest such indemnification expires on
December 31, 2009. We accrue a loss when a valid claim is
made by a buyer and we believe we have potential exposure. We
currently have several claims under an indemnification that
covers certain net losses alleged to have been incurred in
periods prior to our sale of a subsidiary. At December 31,
2008, we have recorded a liability of $15.8 million and
have provided $6.7 million of letters of credit to cover
our obligations or anticipated payments under this
indemnification.
Subsidiary
Dividends
The principal assets of HCC Insurance Holdings, Inc. (HCC), the
parent holding company, are the shares of capital stock of its
insurance company subsidiaries. HCCs obligations include
servicing outstanding debt and interest, paying dividends to
shareholders, repurchasing HCCs common stock, and paying
corporate expenses. Historically, we have not relied on
dividends from our insurance companies to meet HCCs
obligations as we have had sufficient cash flow from our
underwriting agencies and reinsurance broker to meet our
corporate cash flow requirements. However, as a greater
percentage of profit is now being earned in our insurance
companies, we may have to increase the amount of dividends paid
by our insurance companies in the future to fund HCCs
cash obligations.
The payment of dividends by our insurance companies is subject
to regulatory restrictions and will depend on the surplus and
future earnings of these subsidiaries. HCCs direct
U.S. insurance company subsidiaries can pay an aggregate of
$199.2 million in dividends in 2009 without obtaining
special permission from state regulatory authorities. In 2008,
2007 and 2006, our insurance company subsidiaries paid HCC
dividends of $111.8 million, $22.6 million and
$44.0 million, respectively.
Other
Our debt to total capital ratio was 11.5% at December 31,
2008 and 11.6% at December 31, 2007.
On June 20, 2008, our Board of Directors approved the
repurchase of up to $100.0 million of our common stock, as
part of our philosophy of building long-term shareholder value.
The share repurchase plan authorizes repurchases to be made in
the open market or in privately negotiated transactions from
time-to-time. Repurchases under the plan will be subject to
market and business conditions, as well as the level of cash
generated from our operations, cash required for acquisitions,
debt covenant compliance, trading price of our stock being at or
below book value, and other relevant factors. The repurchase
plan does not obligate us to purchase any particular number of
shares and may be suspended or discontinued at any time at our
discretion. In 2008, we repurchased 3.0 million shares of
our common stock in the open market for a total cost of
$63.3 million and a weighted-average cost of $21.02 per
share.
We believe that our operating cash flows, investments, Revolving
Loan Facility, Standby Letter of Credit Facility, shelf
registration and other sources of liquidity are sufficient to
meet our operating and liquidity needs for the foreseeable
future.
Impact of
Inflation
Our operations, like those of other property and casualty
insurers, are susceptible to the effects of inflation because
premiums are established before the ultimate amounts of loss and
loss adjustment expense are known. Although we consider the
potential effects of inflation when setting premium rates, our
premiums, for competitive reasons, may not fully offset the
effects of inflation. However, because the majority of our
business is comprised of lines that have relatively short lead
times between the occurrence of an insured event, reporting of
the claims to us and the final settlement of the claims, or have
claims that are not significantly impacted by inflation, the
effects of inflation are minimized.
A portion of our revenue is related to healthcare insurance and
reinsurance products that are subject to the effects of the
underlying inflation of healthcare costs. Such inflation in the
costs of healthcare tends to generate increases in premiums for
medical stop-loss coverage, resulting in greater revenue but
also higher claim payments. Inflation also may have a negative
impact on insurance and reinsurance operations by causing higher
claim settlements than may originally have been estimated,
without an immediate increase in premiums to a level necessary
to maintain profit margins. We do not specifically provide for
inflation when setting underwriting terms and claim reserves,
although we do consider trends. We continually review claim
reserves to assess their adequacy and make necessary adjustments.
Inflation can also affect interest rates. Any significant
increase in interest rates could have a material adverse effect
on the fair value of our investments. In addition, the interest
rate payable under our Revolving Loan Facility fluctuates with
market interest rates. Any significant increase in interest
rates could have a material adverse effect on our net earnings,
depending on the unhedged amount borrowed on that facility. We
have entered into interest rate swap agreements that fix the
interest rate at 4.60% on $200.0 million of the outstanding
balance of our facility through November 2009 and additional
swaps, which become effective on November 30, 2009, that
will fix the interest rate at 2.94% on $105.0 million of
our facility through November 2010.
Foreign
Exchange Rate Fluctuations
We underwrite risks that are denominated in a number of foreign
currencies. As a result, we have receivables and payables in
foreign currencies and we establish and maintain loss reserves
with respect to our insurance policies in their respective
currencies. There could be a negative impact on our net earnings
from the effect of exchange rate fluctuations on these assets
and liabilities. Our principal area of exposure is related to
fluctuations in the exchange rates between the British pound
sterling, the Euro and the U.S. dollar. We constantly
monitor the balance between our receivables and payables and
loss reserves to mitigate the potential exposure should an
imbalance be expected to exist for other than a short period of
time. Imbalances are generally net liabilities, and we hedge
such imbalances with cash and short-term investments denominated
in the same foreign currency as the net imbalance. Our gain
(loss) from currency conversion was $1.9 million in 2008,
($1.8) million in 2007 and zero in 2006. The 2007 loss
excludes a $13.4 million charge to correct the accounting
for unrealized cumulative foreign exchange gains related to
certain available for sale securities discussed previously. This
loss was offset by a $13.4 million realized gain for
embedded net foreign currency exchange gains when the securities
were sold in 2007.
Critical
Accounting Policies
The preparation of our consolidated financial statements in
conformity with accounting principles generally accepted in the
United States of America (generally accepted accounting
principles) requires us to make estimates and assumptions when
applying our accounting policies. The following sections provide
information about our estimation processes related to certain of
our critical accounting policies.
Loss
and Loss Adjustment Expense
Our net loss and loss adjustment expense reserves are composed
of reserves for reported losses and reserves for incurred but
not reported losses (which include provisions for potential
movement in reported losses, as well as for claims that have
occurred but have not been reported to us), less a reduction for
reinsurance recoverables related to those reserves. Reserves are
recorded by product line and are undiscounted, except for
reserves related to acquisitions.
The process of estimating our loss and loss adjustment expense
reserves involves a considerable degree of judgment by
management and is inherently uncertain. The recorded reserves
represent managements best estimate of unpaid loss and
loss adjustment expense by line of business. Because we provide
insurance coverage in specialized lines of business that often
lack statistical stability, management considers many factors,
and not just the actuarial point estimates discussed below, in
determining ultimate expected losses and the level of net
reserves required and recorded.
To record reserves on our lines of business, we utilize expected
loss ratios, which management selects based on the following:
1) information used to price the applicable policies;
2) historical loss information where available; 3) any
public industry data for that line or similar lines of business;
4) an assessment of current market conditions and 5) a
claim-by-claim
review by management, where actuarial homogenous data is
unavailable. Management also considers the point estimates and
ranges calculated by our actuaries, together with input from our
experienced underwriting and claims personnel. Because of the
nature and complexities of the specialized types of business we
insure, management may give greater weight to the expectations
of our underwriting and claims personnel, who often perform a
claim by claim review, rather than to the actuarial estimates.
However, we utilize the actuarial point and range estimates to
monitor the adequacy and reasonableness of our recorded reserves.
Each quarter-end, management compares recorded reserves to the
most recent actuarial point estimate and range for each line of
business. If the recorded reserves vary significantly from the
actuarial point estimate, management determines the reasons for
the variances and may adjust the reserves up or down to an
amount that, in managements judgment, is adequate based on
all of the facts and circumstances considered, including the
actuarial point estimates. We consistently maintain total
consolidated net reserves above the total actuarial point
estimate but within the actuarial range.
The table below shows our recorded net reserves at
December 31, 2008 by line of business, the actuarial
reserve point estimates, and the high and low ends of the
actuarial reserve range as determined by our reserving actuaries.
Recorded |
Actuarial |
Low End of |
High End of |
|||||||||||||
Net Reserves | Point Estimate | Actuarial Range | Actuarial Range | |||||||||||||
Total net reserves
|
$ | 2,416,271 | $ | 2,313,524 | $ | 2,150,619 | $ | 2,548,285 | ||||||||
Individual lines of business:
|
||||||||||||||||
Diversified financial products
|
$ | 1,205,244 | $ | 1,141,230 | $ | 982,767 | $ | 1,355,613 | ||||||||
Group life, accident and health
|
279,622 | 276,896 | 251,672 | 304,201 | ||||||||||||
Aviation
|
100,259 | 94,963 | 87,713 | 103,676 | ||||||||||||
London market account
|
178,447 | 177,534 | 168,657 | 199,024 | ||||||||||||
Other specialty lines
|
265,756 | 250,215 | 237,090 | 282,261 | ||||||||||||
Discontinued lines
|
386,943 | 372,687 | 327,340 | 450,215 | ||||||||||||
Total net reserves
|
$ | 2,416,271 | ||||||||||||||
The excess of the total recorded net reserves over the actuarial
point estimate was 4.3% of recorded net reserves at
December 31, 2008 compared to 4.2% at December 31,
2007. The percentage will vary in total and by line depending on
current economic events, the potential volatility of the line,
the severity of claims reported and of claims incurred but not
reported, managements judgment with respect to the risk of
development, the nature of business acquired in acquisitions,
and historical development patterns.
The actuarial point estimates represent our actuaries
estimate of the most likely amount that will ultimately be paid
to settle the net reserves we have recorded at a particular
point in time. While, from an actuarial standpoint, a point
estimate is considered the most likely amount to be paid, there
is inherent uncertainty in the point estimate, and it can be
thought of as the expected value in a distribution of possible
reserve estimates. The actuarial ranges represent our
actuaries estimate of a likely lowest amount and highest
amount that will ultimately be paid to settle the net reserves
we have recorded at a particular point in time. While there is
still a possibility of ultimately paying an amount below the
range or above the range, the actuarial probability is very
small. The range determinations are based on estimates and
actuarial judgments and are intended to encompass reasonably
likely changes in one or more of the variables that were used to
determine the point estimates.
The low end of the actuarial range and the high end of the
actuarial range for the total net reserves will not equal the
sum of the low and high ends for the individual lines of
business. Moreover, in actuarial terms, it would not be
appropriate to add the ranges for each line of business to
obtain a range around the total net reserves because this would
not reflect the diversification effects across our various lines
of business. The diversification effects result from the fact
that losses across the different lines of business are not
completely correlated.
In actuarial practice, some of our lines of business are more
effectively modeled by a statistical distribution that is skewed
or non-symmetric. These distributions are usually skewed towards
large losses, which causes the midpoint of the range to be above
the actuarial point estimate or mean value of the range. This
should be kept in mind when using the midpoint as a proxy for
the mean. Our assumptions, estimates and judgments can change
based on new information and changes in conditions, and, if they
change, it will affect the determination of the range amounts.
The following table details, by major products within our lines
of business, the characteristics and major actuarial assumptions
utilized by our actuaries in the determination of actuarial
point estimates and ranges. We considered all major lines of
business written by the insurance industry when determining the
relative characteristics of claims duration, speed of loss
reporting and reserve volatility. Other companies may classify
their own insurance products in different lines of business or
utilize different actuarial assumptions.
Claims |
||||||||||||
Characteristics | ||||||||||||
Speed of |
||||||||||||
Claim |
Reserve |
Major Actuarial |
||||||||||
Line of Business
|
Products | Underwriting | Duration | Reporting | Volatility | Assumptions | ||||||
Diversified financial products
|
Directors and officers | Direct and subscription | Medium to long | Moderate | Medium to high |
Historical and industry loss reporting patterns
|
||||||
liability |
Loss trends
|
|||||||||||
Rate changes
|
||||||||||||
Professional indemnity | Direct | Medium | Moderate | Medium |
Historical loss reporting patterns
|
|||||||
Surety | Direct | Medium | Fast | Low |
Historical loss payment and reporting patterns
|
|||||||
Group life, accident and health
|
Medical stop-loss | Direct | Short | Fast | Low |
Medical cost and utilization trends
|
||||||
Historical loss payment and reporting patterns
|
||||||||||||
Rate changes
|
||||||||||||
Medical excess | Direct and assumed | Short | Fast | Low to medium |
Historical loss payment and reporting patterns
|
|||||||
Loss trends
|
||||||||||||
Rate changes
|
||||||||||||
Aviation
|
Aviation |
Direct and subscription |
Medium | Fast | Medium |
Historical loss payment and reporting patterns
|
||||||
Claims |
||||||||||||
Characteristics | ||||||||||||
Speed of |
||||||||||||
Claim |
Reserve |
Major Actuarial |
||||||||||
Line of Business
|
Products | Underwriting | Duration | Reporting | Volatility | Assumptions | ||||||
London market account
|
Accident and health | Direct and assumed | Medium to long | Slow | High |
Historical loss payment and reporting patterns
|
||||||
Energy* | Subscription | Medium | Moderate | Medium |
Historical and industry loss payment and reporting patterns
|
|||||||
Historical large loss experience
|
||||||||||||
Property* | Subscription | Medium | Moderate | Medium |
Historical loss payment and reporting patterns
|
|||||||
Historical large loss experience
|
||||||||||||
Marine | Subscription | Medium | Moderate | Medium |
Historical loss payment and reporting patterns
|
|||||||
Historical large loss experience
|
||||||||||||
Other specialty
|
Liability | Direct and assumed | Medium | Moderate | Medium |
Historical loss payment and reporting patterns
|
||||||
Property | Direct and assumed | Short | Fast | Low |
Historical loss payment and reporting patterns
|
|||||||
Discontinued
|
Accident and health insurance | Assumed | Long | Slow | High |
Historical and industry loss payment and reporting patterns
|
||||||
Medical malpractice | Direct | Medium to long | Moderate | Medium to high |
Historical loss payment and reporting patterns
|
* | Includes catastrophe losses |
Direct insurance is coverage that is originated by our insurance
companies and brokers in return for premium. Assumed reinsurance
is coverage written by another insurance company, for which we
assume all or a portion of the risk in exchange for all or a
portion of the premium. Subscription business is direct
insurance or assumed reinsurance where we only take a percentage
of the total risk and premium and other insurers take their
proportionate percentage of the remaining risk and premium.
Assumed reinsurance represented 14% of our gross written premium
in 2008 and 25% of our gross reserves at December 31, 2008.
Approximately 41% of the assumed reinsurance reserves related to
business in our discontinued lines, 26% related to assumed
reinsurance in our London market account, aviation and
diversified financial products lines of business, 14% related to
assumed quota share surplus lines business in our other
specialty lines, 12% related Lloyds of London business in
our other specialty lines, and 5% related to assumed business in
our group life, accident and health line of business. The
remaining assumed reinsurance reserves covered various other
reinsurance programs. The table above recaps the underwriting,
claims characteristics and major actuarial assumptions for our
assumed reinsurance business.
The discontinued lines include run-off assumed accident and
health reinsurance business, which is primarily reinsurance that
provides excess coverage for large losses related to
workers compensation policies. This business is subject to
late reporting of claims by cedants and state guaranty
associations. To mitigate our exposure to unexpected losses
reported by cedants, our claims personnel review reported losses
to ensure they are reasonable and consistent with our
expectations. In addition, our claims personnel periodically
audit the cedants claims processing functions to assess
whether cedants are submitting timely and accurate claims
reports to us. Disputes with insureds related to claims or
coverage issues are administered in the normal course of
business or settled through arbitration. Based on the late
reporting of claims in the past and the higher risk of this
discontinued line of business relative to our continuing lines
of business, management believes there may be a greater
likelihood of future adverse development in the run-off assumed
accident and health reinsurance business than in our other lines
of business. We reassess loss reserves for this assumed business
at each quarter end and adjust them, if needed.
The majority of the assumed reinsurance in our London market
account, aviation and diversified financial products lines of
business is facultative reinsurance. This business involves
reinsurance of a companys entire captive insurance program
or business that must be written through another insurance
company licensed to
write insurance in a particular country or locality. In all
cases, we underwrite the business and administer the claims,
which are reported without a lag by the brokers. Disputes, if
any, generally relate to claims or coverage issues with insureds
and are administered in the normal course of business. We
establish loss reserves for this assumed reinsurance using the
same methods and assumptions we use to set reserves for
comparable direct business.
Our assumed quota share surplus lines business in our other
specialty lines is recorded monthly with a two-month time lag.
Case reserves are reported directly to us by the cedant, and we
establish incurred but not reported reserves based on our
estimates. We periodically contact and visit the cedant to
discuss loss trends and review claim files. We also receive
copies of the cedants loss triangles on individual
products. Because of the frequent communication, we receive
sufficient information to use many of the same methods and
assumptions we would use to set reserves for comparable direct
business. We have not had any disputes with the cedant.
Our Lloyds of London business is reported as reinsurance.
We underwrite the assumed group life, accident and health and
Lloyds of London business and administer the claims.
Disputes, if any, are administered in the normal course of
business. The majority of the assumed reinsurance in our group
life, accident and health line of business is due to medical
excess products in our Health Products Division. Although very
similar to our direct medical stop-loss business, it is written
as excess reinsurance of HMOs, provider groups, hospitals and
other insurance companies. We establish loss reserves for these
lines of business using the same methods and assumptions we
would use to set reserves for comparable direct business.
The following tables show the composition of our gross, ceded
and net reserves at the respective balance sheet dates.
% Net |
||||||||||||||||
IBNR to |
||||||||||||||||
Net Total |
||||||||||||||||
At December 31, 2008
|
Gross | Ceded | Net | Reserves | ||||||||||||
Reported loss reserves:
|
||||||||||||||||
Diversified financial products
|
$ | 682,446 | $ | 207,750 | $ | 474,696 | ||||||||||
Group life, accident and health
|
171,326 | 8,550 | 162,776 | |||||||||||||
Aviation
|
101,720 | 35,894 | 65,826 | |||||||||||||
London market account
|
272,795 | 165,468 | 107,327 | |||||||||||||
Other specialty lines
|
167,703 | 59,087 | 108,616 | |||||||||||||
Subtotal reported reserves
|
1,395,990 | 476,749 | 919,241 | |||||||||||||
Incurred but not reported reserves:
|
||||||||||||||||
Diversified financial products
|
983,897 | 253,349 | 730,548 | 61 | % | |||||||||||
Group life, accident and health
|
133,899 | 17,204 | 116,695 | 42 | ||||||||||||
Aviation
|
59,914 | 25,481 | 34,433 | 34 | ||||||||||||
London market account
|
131,753 | 60,482 | 71,271 | 40 | ||||||||||||
Other specialty lines
|
239,988 | 82,848 | 157,140 | 59 | ||||||||||||
Subtotal incurred but not reported reserves
|
1,549,451 | 439,364 | 1,110,087 | 55 | ||||||||||||
Discontinued lines reported reserves
|
326,314 | 58,814 | 267,500 | |||||||||||||
Discontinued lines incurred but not reported reserves
|
143,475 | 24,032 | 119,443 | 31 | ||||||||||||
Total loss and loss adjustment expense payable
|
$ | 3,415,230 | $ | 998,959 | $ | 2,416,271 | 51 | % | ||||||||
% Net |
||||||||||||||||
IBNR to |
||||||||||||||||
Net Total |
||||||||||||||||
At December 31, 2007
|
Gross | Ceded | Net | Reserves | ||||||||||||
Reported loss reserves:
|
||||||||||||||||
Diversified financial products
|
$ | 593,378 | $ | 187,256 | $ | 406,122 | ||||||||||
Group life, accident and health
|
194,670 | 2,244 | 192,426 | |||||||||||||
Aviation
|
116,983 | 44,219 | 72,764 | |||||||||||||
London market account
|
242,918 | 134,658 | 108,260 | |||||||||||||
Other specialty lines
|
131,012 | 45,672 | 85,340 | |||||||||||||
Subtotal reported reserves
|
1,278,961 | 414,049 | 864,912 | |||||||||||||
Incurred but not reported reserves:
|
||||||||||||||||
Diversified financial products
|
892,669 | 260,347 | 632,322 | 61 | % | |||||||||||
Group life, accident and health
|
157,213 | 19,036 | 138,177 | 42 | ||||||||||||
Aviation
|
52,771 | 20,650 | 32,121 | 31 | ||||||||||||
London market account
|
134,398 | 32,773 | 101,625 | 48 | ||||||||||||
Other specialty lines
|
211,798 | 70,469 | 141,329 | 62 | ||||||||||||
Subtotal incurred but not reported reserves
|
1,448,849 | 403,275 | 1,045,574 | 55 | ||||||||||||
Discontinued lines reported reserves
|
335,177 | 44,141 | 291,036 | |||||||||||||
Discontinued lines incurred but not reported reserves
|
164,093 | 22,815 | 141,278 | 33 | ||||||||||||
Total loss and loss adjustment expense payable
|
$ | 3,227,080 | $ | 884,280 | $ | 2,342,800 | 51 | % | ||||||||
We determine our incurred but not reported reserves by first
projecting the ultimate expected losses by product within each
line of business. We then subtract paid losses and reported loss
reserves from the ultimate loss reserves. The remainder is our
incurred but not reported reserves. The level of incurred but
not reported reserves in relation to total reserves depends upon
the characteristics of the specific line of business,
particularly with respect to the speed with which losses are
reported and outstanding claims reserves are adjusted. Lines for
which losses are reported fast will have a lower percentage of
incurred but not reported loss reserves than slower reporting
lines, and lines for which reserve volatility is low will have a
lower percentage of incurred but not reported loss reserves than
high volatility lines.
The reserves for reported losses related to our direct business
and certain reinsurance assumed are initially set by our claims
personnel or independent claims adjusters we retain. The
reserves are subject to our review, with a goal of setting them
at the ultimate expected loss amount as soon as possible when
the information becomes available. Reserves for reported losses
related to other reinsurance assumed are recorded based on
information supplied to us by the ceding company. Our claims
personnel monitor these reinsurance assumed reserves on a
current basis and audit ceding companies claims to
ascertain that claims are being recorded currently and that net
reserves are being set at levels that properly reflect the
liability related to the claims.
The percentage of net incurred but not reported reserves to net
total reserves was 51% at December 31, 2008 and 2007. The
reasons, by line of business, for changes in net reserves and
the percentage of incurred but not reported reserves to total
net reserves, other than changes related to normal maturing of
claims, follow:
| Diversified financial products Total net reserves increased $166.8 million from 2007 to 2008 as this relatively new line of business continues to grow. The incurred but not reported portion of the total reserves for this line of business is higher than in most of our other lines, since these losses report slower and have a longer duration. This line includes our directors and officers liability, professional indemnity and fiduciary liability coverages, which have experienced increased notices of claims, primarily from financial institutions, due to current market and credit-related issues. As a result, we increased our ultimate loss ratios for the 2007 and 2008 accident years in these lines. Although the percentage of incurred but not reported reserves will decrease as the claims start to mature, the |
percentage is consistent year-over-year due to the higher level of incurred but not reported reserves on the 2007 and 2008 accident years at December 31, 2008. |
| Group life, accident and health Total net reserves decreased year-over-year due to the lower incurred loss ratio on this short-duration line of business. In addition, the length of time to pay claims decreased in 2008 due to shorter required reporting periods and more efficient claims processing. | |
| London market account Total net reserves and the percentage of incurred but not reported reserves both decreased due to the continued payment of long-tailed claims related to the 2005 hurricanes. In addition, redundant development more than offset the effect of the 2008 hurricanes. | |
| Other specialty lines Total net reserves increased due to our increased participation in one of our Lloyds of London syndicates, as well as growth in new lines of business. | |
| Discontinued lines Total net reserves for our discontinued lines decreased $45.4 million in 2008 as a result of claims payments. |
Our net reserves historically have shown favorable development
except for the effects of commutations, which we have completed
in the past and may negotiate in the future. Commutations can
produce adverse prior year development because, under generally
accepted accounting principles, any excess of undiscounted
reserves assumed over assets received must be recorded as a loss
at the time the commutation is completed. Economically, the loss
generally represents the discount for the time value of money
that will be earned over the payout of the reserves; thus, the
loss may be recouped as investment income is earned on the
assets received. Based on our reserving techniques and our past
results, we believe that our net reserves are adequate.
Throughout 2008, we conducted detailed reviews of our loss
exposures stemming from the current U.S. and international
economic environment, including issues related to subprime
lending and credit market issues. We write directors and
officers liability, professional indemnity and fiduciary
liability coverage for public and private companies and
not-for-profit organizations and continue to closely monitor our
exposure to subprime and credit market related issues. We
provide coverage for certain financial institutions, which have
potential exposure to shareholder lawsuits. At December 31,
2008, we had 15 Side A only and 57 non-Side A
only directors and officers liability,
professional indemnity and fiduciary liability claims related to
subprime and credit related issues. In reviewing our exposure,
we considered the types of risks we wrote, the industry of our
insured, attachment points with respect to excess business,
types of coverage, policy limits, actual claims reported, and
current legal interpretations and decisions. As part of our
review, we increased certain ultimate loss ratios in the 2008
accident year for business written in 2007 and 2008 due to the
continued uncertainty in the financial markets, which caused us
to book $57.5 million of additional reserves. The largest
portion of this was in our directors and officers
liability business, primarily for policies written in 2007.
Based on our present knowledge, we believe our ultimate losses
from these coverages will be contained within our current
overall loss reserves for these lines of business.
We have no material exposure to asbestos claims or environmental
pollution losses. Our largest insurance company subsidiary only
began writing business in 1981, and its policies normally
contain pollution exclusion clauses that limit pollution
coverage to sudden and accidental losses only, thus
excluding intentional dumping and seepage claims. Policies
issued by our other insurance company subsidiaries do not have
significant environmental exposures because of the types of
risks covered.
Reinsurance
Recoverables
We limit our liquidity exposure for uncollected recoverables by
holding funds, letters of credit or other security, such that
net balances due from reinsurers are significantly less than the
gross balances shown in our consolidated balance sheets. We
constantly monitor the collectibility of the reinsurance
recoverables of our insurance companies and record a reserve for
uncollectible reinsurance when we determine an amount is
potentially uncollectible. Our evaluation is based on our
periodic reviews of our disputed and aged recoverables, as well
as our assessment of recoverables due from reinsurers known to
be in financial difficulty. In some cases, we make estimates as
to what portion of a recoverable may be uncollectible. Our
estimates and
judgment about the collectibility of the recoverables and the
financial condition of reinsurers can change, and these changes
can affect the level of reserve required.
The reserve was $8.4 million at December 31, 2008,
compared to $8.5 million at December 31, 2007. We
assessed the collectibility of our year-end recoverables and
believe amounts are collectible and any potential losses are
adequately reserved based on currently available information.
Deferred
Taxes
We recognize deferred tax assets and liabilities based on the
differences between the financial statement carrying amounts and
the tax bases of assets and liabilities. We regularly review our
deferred tax assets for recoverability and establish a valuation
allowance based on our history of earnings, expectations for
future earnings, taxable income in carry back years and the
expected timing of the reversals of existing temporary
differences. Although realization is not assured, we believe
that, as of December 31, 2008, it is more likely than not
that we will be able to realize the benefit of recorded deferred
tax assets, with the exception of certain pre-acquisition tax
loss carryforwards for which valuation allowances have been
provided. If there is a material change in the tax laws such
that the actual effective tax rate changes or the time periods
within which the underlying temporary differences become taxable
or deductible change, we will need to reevaluate our
assumptions, which could result in a change in the valuation
allowance required.
Valuation
of Goodwill
We assess the impairment of goodwill annually, or if an event
occurs or circumstances change that would more likely than not
reduce the fair value of a reporting unit below its carrying
amount. Our annual goodwill assessment was conducted as of
June 30, 2008, which is consistent with the timeframe for
our annual assessment in prior years. As of December 31,
2008, we reviewed the results of our June goodwill assessment
for indicators of impairment, particularly considering the
current market conditions. We did not identify any indicators of
impairment that would have caused us to conduct another
comprehensive goodwill impairment assessment for calendar-year
2008.
We utilize the expected cash flow approach to determine the fair
value of our reporting units. This approach utilizes estimated
future cash flows, probabilities as to occurrence of these cash
flows, a risk-free rate of interest, and a risk premium for
uncertainty in the cash flows. We utilize our budgets and
projections of future operations based on historical and
expected industry trends to estimate our future cash flows and
the probability of their occurring as projected. Based on our
June 30, 2008 impairment test, the fair value of each of
our reporting units exceeded its carrying amount by a
satisfactory margin.
Other-Than-Temporary
Impairments on Investments
We evaluate the securities in our fixed income securities
portfolio for possible other-than-temporary impairment losses at
each quarter end, based on all relevant facts and circumstances
for each impaired security. Our evaluation considers various
factors including:
| amount by which the securitys fair value is less than its cost, | |
| length of time the security has been impaired, | |
| the securitys credit rating and any recent downgrades, | |
| stress testing of expected cash flows under various scenarios, | |
| whether the impairment is due to an issuer-specific event, credit issues or change in market interest rates, and | |
| our ability and intent to hold the security for a period of time sufficient to allow full recovery or until maturity. |
When we conclude that a decline in a securitys fair value
is other-than-temporary, we recognize the impairment as a
realized investment loss in our consolidated statements of
earnings. The impairment loss equals the difference between the
securitys fair value and cost at the balance sheet date.
During 2008, we reviewed our fixed income securities for
other-than-temporary impairments at each quarter end. Our
reviews covered all impaired securities where the loss exceeded
$0.5 million and the loss either exceeded 10% of cost or
the security had been in a loss position for longer than 12
consecutive months. At December 31, 2008, we had gross
unrealized losses on available for sale fixed income securities
of $91.3 million (2.2% of aggregate fair value of total
fixed income securities) compared to $18.3 million (0.5% of
aggregate fair value) at December 31, 2007. Our review in
the fourth quarter of 2008 covered 82% of the total unrealized
losses in the portfolio. Based on the results of our reviews in
2008, we recognized other-than-temporary impairment losses of
$11.1 million. There were no other-than-temporary
impairment losses in 2007 or 2006.
Recent
Accounting Pronouncements
The FASB has issued FSP
FAS 157-2,
Effective Date of FASB Statement No. 157, to delay
the effective date of SFAS No. 157, Fair Value
Measurements, for nonfinancial assets and nonfinancial
liabilities measured at fair value on a nonrecurring basis, such
as goodwill. For these items,
FSP 157-2
is effective January 1, 2009. We will finalize our
assessment of the impact on our consolidated financial
statements from our adoption of FSP 157-2 as applicable
during 2009.
SFAS No. 159, The Fair Value Option for Financial
Assets and Financial Liabilities, issued by the FASB, was
effective January 1, 2008. SFAS 159 allows a company
to make an irrevocable election to measure eligible financial
assets and financial liabilities at fair value that are not
otherwise measured at fair value. Unrealized gains and losses
for those items are reported in current earnings at each
subsequent reporting date. As of December 31, 2008, we have
not elected to value any additional assets or liabilities at
fair value under the guidance of SFAS 159.
The FASB has issued SFAS No. 141 (revised 2007)
(SFAS 141(R)), Business Combinations, and
SFAS No. 160, Noncontrolling Interests in
Consolidated Financial Statements, an amendment of Accounting
Research Bulletin No. 51. SFAS 141(R) will
change the accounting treatment for business combinations and
will impact presentation of financial statements on the
acquisition date and accounting for acquisitions in subsequent
periods. SFAS 160 will change the accounting and reporting
for minority interests, which will be recharacterized as
noncontrolling interests and classified as a component of
shareholders equity. SFAS 141(R) and SFAS 160
are effective January 1, 2009, and early adoption is not
permitted. We will apply the guidelines of SFAS 141(R) to
future acquisitions. We do not expect the adoption of
SFAS 141(R) and SFAS 160 to have a material impact on
our future consolidated financial statements.
The FASB has issued SFAS No. 161, Disclosures about
Derivative Instruments and Hedging Activities an
amendment of FASB Statement No. 133, which expands the
required disclosures about a companys derivative and
hedging activities. SFAS 161 will be effective
January 1, 2009. We do not expect adoption to have a
material impact on the notes to our consolidated financial
statements.
The FASB has issued SFAS No. 162, The Hierarchy of
Generally Accepted Accounting Principles. SFAS 162
identifies the sources of accounting principles and the
framework for selecting the principles to be used in the
preparation of financial statements in conformity with generally
accepted accounting principles in the United States.
SFAS 162 is effective 60 days after the Securities and
Exchange Commissions approval of the Public Company
Accounting Oversight Boards amendments to AU 411, The
Meaning of Present Fairly in Conformity with Generally Accepted
Accounting Principles. Our usage of the hierarchical
guidance provided by SFAS 162 is not expected to have a
material impact on our consolidated financial statements.
Adoption
of Recent Accounting Pronouncements
FSP No. EITF 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions
are Participating Securities, became effective January 1, 2009 and required retrospective
application to prior periods. FSP EITF 03-6-1 clarifies whether instruments granted in share-based
payments, such as restricted stock, are participating securities prior to vesting and, therefore,
must be included in the earnings allocation in calculating earnings per share under the two-class
method described in SFAS No. 128, Earnings per Share. Under FSP EITF 03-6-1, unvested share-based
payments that contain non-forfeitable rights to dividends or dividend-equivalents are treated as
participating securities. Our adoption of FSP EITF 03-6-1 had no impact on our consolidated
earnings per share in 2008 due to immateriality of our restricted stock awards that have such
terms. There were no restricted stock awards outstanding prior to
2008.
FSP No. APB 14-1, Accounting for Convertible Debt Instruments That May Be Settled in Cash upon
Conversion (Including Partial Cash Settlement) became effective
January 1, 2009 and required
retrospective application to prior financial statements. FSP APB
14-1 clarifies that convertible debt instruments that may be settled in cash upon conversion are
not totally debt and requires issuers to bifurcate and separately account for the liability and
equity components. In our consolidated financial statements, we adopted FSP APB 14-1 for
our 1.30% Convertible Notes and 2.00% Convertible Notes and retrospectively adjusted our
consolidated financial statements for all periods presented. The effective interest rate on our
1.30% and 2.00% Convertible Notes increased to 4.80% and 3.86%, respectively, which resulted in the
recognition of a $22.6 million and $8.3 million discount, respectively, with the offsetting
after-tax impact recorded in additional paid-in capital. The
following line items in our consolidated financial statements were
affected by the adoption of FSP APB 14-1:
Twelve months ended December 31, 2008 | ||||||||||||
As originally | ||||||||||||
reported | As adjusted | Change | ||||||||||
Interest expense |
$ | 16,288 | $ | 20,362 | $ | 4,074 | ||||||
Earnings before income tax expense |
436,312 | 432,238 | (4,074 | ) | ||||||||
Income tax expense |
131,544 | 130,118 | (1,426 | ) | ||||||||
Net earnings |
304,768 | 302,120 | (2,648 | ) | ||||||||
Basic
earnings per share |
$ | 2.65 | $ | 2.63 | $ | (0.02 | ) | |||||
Diluted earnings per share |
2.64 | 2.61 | (0.03 | ) | ||||||||
Twelve months ended December 31, 2007 | ||||||||||||
As originally | ||||||||||||
reported | As adjusted | Change | ||||||||||
Interest expense |
$ | 10,304 | $ | 16,270 | $ | 5,966 | ||||||
Earnings before income tax expense |
585,870 | 579,904 | (5,966 | ) | ||||||||
Income tax expense |
190,441 | 188,351 | (2,090 | ) | ||||||||
Net earnings |
395,429 | 391,553 | (3,876 | ) | ||||||||
Basic
earnings per share |
$ | 3.50 | $ | 3.47 | $ | (0.03 | ) | |||||
Diluted earnings per share |
3.38 | 3.35 | (0.03 | ) | ||||||||
Twelve months ended December 31, 2006 | ||||||||||||
As originally | ||||||||||||
reported | As adjusted | Change | ||||||||||
Interest expense |
$ | 11,396 | $ | 18,128 | $ | 6,732 | ||||||
Earnings before income tax expense |
509,834 | 503,102 | (6,732 | ) | ||||||||
Income tax expense |
167,549 | 165,191 | (2,358 | ) | ||||||||
Net earnings |
342,285 | 337,911 | (4,374 | ) | ||||||||
Basic
earnings per share |
$ | 3.08 | $ | 3.04 | $ | (0.04 | ) | |||||
Diluted earnings per share |
2.93 | 2.89 | (0.04 | ) | ||||||||
December 31, 2008 | ||||||||||||
As originally | ||||||||||||
reported | As adjusted | Change | ||||||||||
Other assets
(debt issuance costs and deferred tax asset) |
$ | 153,964 | $ | 153,581 | $ | (383 | ) | |||||
Notes payable |
344,714 | 343,649 | (1,065 | ) | ||||||||
Additional paid-in capital |
861,867 | 881,534 | 19,667 | |||||||||
Retained earnings |
1,696,816 | 1,677,831 | (18,985 | ) | ||||||||
Total shareholders equity |
2,639,341 | 2,640,023 | 682 | |||||||||
December 31, 2007 | ||||||||||||
As originally | ||||||||||||
reported | As adjusted | Change | ||||||||||
Other assets (debt issuance costs) |
$ | 170,314 | $ | 170,189 | $ | (125 | ) | |||||
Notes payable |
324,714 | 319,471 | (5,243 | ) | ||||||||
Accounts
payable and accrued liabilities (deferred tax liability) |
375,561 | 377,349 | 1,788 | |||||||||
Additional paid-in capital |
831,419 | 851,086 | 19,667 | |||||||||
Retained earnings |
1,445,995 | 1,429,658 | (16,337 | ) | ||||||||
Total
shareholders equity |
2,440,365 | 2,443,695 | 3,330 | |||||||||
The reduction in retained earnings and the increase in additional paid-in capital resulted from
amortization of the implied discount as interest expense through the first contractual put date of
the 2.00% Convertible Notes at September 1, 2007 and the 1.30% Convertible Notes at April 1, 2009.
The 2.00% Convertible Notes were submitted for conversion during September and October 2007. At
December 31, 2008, the 1.30% Convertible Notes had an equity component of $1.1 million and a
liability component of $123.6 million, consisting of a principal amount of $124.7 million less a
discount of $1.1 million.
While the notes are not convertible during the first quarter of 2009,
the convertible value of the notes, if converted, at December 31,
2008 was $147.3 million, which exceeds the principal amount by $22.6
million.
At December 31, 2007, the 1.30% Convertible Notes had an equity
component of $5.2 million and a liability component of $119.5 million, consisting of a principal
amount of $124.7 million less a discount of $5.2 million. The contractual interest expense was $1.6
million in 2008, 2007 and 2006. Interest expense resulting from amortization of the implied
discount was $4.1 million, $6.0 million and $6.7 million in 2008, 2007 and 2006, respectively. The
adoption of FSP APB 14-1 did not impact our past or current consolidated cash flows.