Attached files
file | filename |
---|---|
EX-31.1 - EX-31.1 - ODYSSEY RE HOLDINGS CORP | o61507exv31w1.htm |
EX-32.1 - EX-32.1 - ODYSSEY RE HOLDINGS CORP | o61507exv32w1.htm |
EX-31.2 - EX-31.2 - ODYSSEY RE HOLDINGS CORP | o61507exv31w2.htm |
EX-32.2 - EX-32.2 - ODYSSEY RE HOLDINGS CORP | o61507exv32w2.htm |
EX-10.28 - EX-10.28 - ODYSSEY RE HOLDINGS CORP | o61507exv10w28.htm |
Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
(Mark One)
þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended: March 31, 2010
or
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission File Number: 1-16535
Odyssey Re Holdings Corp.
(Exact Name of Registrant as Specified in its Charter)
Delaware | 52-2301683 | |
(State or Other Jurisdiction Of Incorporation or Organization) |
(I.R.S. Employer Identification Number) |
|
Odyssey Re Holdings Corp. | ||
300 First Stamford Place | ||
Stamford, Connecticut | 06902 | |
(Address of principal executive offices) | (Zip Code) |
Registrants telephone number, including area code: (203) 977-8000
Indicate by check mark whether the registrant (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. YES þ NO o
Indicate by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period
that the registrant was required to submit and post such files). YES o NO
o
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of
large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the
Exchange Act. (Check one):
Large accelerated filer þ | Accelerated filer o | Non-accelerated filer o | Smaller reporting company o | |||
(Do not check if a smaller reporting company) |
Indicate by check mark whether the registrant is a shell company (as defined in rule 12b-2 of
the Exchange Act). YES o NO þ
Indicate the number of shares outstanding of each of the issuers classes of common
stock, as of the latest practicable date:
Class | Number of Shares Outstanding at May 6, 2010 | ||||||
Common Stock, par value $0.01 per share |
56,604,650 | ||||||
TABLE OF CONTENTS
ODYSSEY RE HOLDINGS CORP.
INDEX TO FORM 10-Q
1
Table of Contents
PART I FINANCIAL INFORMATION
PART I Item 1. Financial Statements
ODYSSEY RE HOLDINGS CORP.
CONSOLIDATED BALANCE SHEETS
MARCH 31, 2010 AND DECEMBER 31, 2009 (UNAUDITED)
(In thousands, except share and per share amounts)
MARCH 31, 2010 AND DECEMBER 31, 2009 (UNAUDITED)
(In thousands, except share and per share amounts)
March 31, | December 31, | |||||||
2010 | 2009 | |||||||
ASSETS |
||||||||
Investments and cash: |
||||||||
Fixed income securities, available for sale, at fair value (amortized cost $3,974,251
and $3,971,139, respectively) |
$ | 4,387,344 | $ | 4,373,965 | ||||
Fixed income securities, held as trading securities, at fair value (amortized cost $608,457 and $598,918, respectively) |
579,164 | 532,718 | ||||||
Redeemable preferred stock, at fair value (cost $108 and $108, respectively) |
108 | 108 | ||||||
Convertible preferred stock, held as trading securities, at fair value (cost $75,000
and $75,000, respectively) |
69,293 | 82,470 | ||||||
Equity securities: |
||||||||
Common stocks, at fair value (cost $1,539,412 and $1,679,748, respectively) |
2,076,358 | 2,071,037 | ||||||
Common stocks, at equity |
160,345 | 158,460 | ||||||
Short-term investments, at fair value (amortized cost $74,582 and $125,100,
respectively) |
74,582 | 125,100 | ||||||
Short-term investments, held as trading securities, at fair value (cost $153,025
and $238,419, respectively) |
153,025 | 238,403 | ||||||
Cash and cash equivalents |
1,077,601 | 941,444 | ||||||
Cash and cash equivalents held as collateral |
63,182 | 56,720 | ||||||
Other invested assets |
203,576 | 146,728 | ||||||
Total investments and cash |
8,844,578 | 8,727,153 | ||||||
Accrued investment income |
86,269 | 79,400 | ||||||
Premiums receivable |
436,931 | 473,878 | ||||||
Reinsurance recoverable on paid losses |
42,228 | 70,511 | ||||||
Reinsurance recoverable on unpaid losses |
899,470 | 841,486 | ||||||
Prepaid reinsurance premiums |
117,601 | 113,047 | ||||||
Funds held by reinsureds |
145,062 | 140,480 | ||||||
Deferred acquisition costs |
129,243 | 126,466 | ||||||
Federal and foreign income taxes receivable |
18,233 | 45,333 | ||||||
Other assets |
231,382 | 167,686 | ||||||
Total assets |
$ | 10,950,997 | $ | 10,785,440 | ||||
LIABILITIES |
||||||||
Unpaid losses and loss adjustment expenses |
$ | 5,636,968 | $ | 5,507,766 | ||||
Unearned premiums |
709,375 | 691,213 | ||||||
Reinsurance balances payable |
158,430 | 178,428 | ||||||
Funds held under reinsurance contracts |
41,172 | 41,250 | ||||||
Debt obligations |
489,433 | 489,402 | ||||||
Other liabilities |
196,542 | 322,147 | ||||||
Total liabilities |
7,231,920 | 7,230,206 | ||||||
Commitments and Contingencies (Note 10) |
||||||||
SHAREHOLDERS EQUITY |
||||||||
Preferred shares, $0.01 par value; 200,000,000 shares authorized; 2,000,000
Series A shares issued and outstanding; 1,167,263 Series B shares issued and outstanding |
32 | 32 | ||||||
Common shares, $0.01 par value; 500,000,000 shares authorized; 56,604,650 shares
issued |
567 | 567 | ||||||
Additional paid-in capital |
529,522 | 515,066 | ||||||
Accumulated other comprehensive income, net of deferred income taxes |
659,449 | 546,580 | ||||||
Retained earnings |
2,529,507 | 2,492,989 | ||||||
Total shareholders equity |
3,719,077 | 3,555,234 | ||||||
Total liabilities and shareholders equity |
$ | 10,950,997 | $ | 10,785,440 | ||||
See accompanying notes to consolidated financial statements.
2
Table of Contents
ODYSSEY RE HOLDINGS CORP.
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
THREE MONTHS ENDED MARCH 31, 2010 AND 2009 (UNAUDITED)
(In thousands, except share and per share amounts)
THREE MONTHS ENDED MARCH 31, 2010 AND 2009 (UNAUDITED)
(In thousands, except share and per share amounts)
Three Months Ended | ||||||||
March 31, | ||||||||
2010 | 2009 | |||||||
REVENUES |
||||||||
Gross premiums written |
$ | 561,656 | $ | 554,920 | ||||
Ceded premiums written |
88,469 | 75,941 | ||||||
Net premiums written |
473,187 | 478,979 | ||||||
Increase in net unearned premiums |
(16,092 | ) | (8,961 | ) | ||||
Net premiums earned |
457,095 | 470,018 | ||||||
Net investment income |
84,104 | 67,461 | ||||||
Net realized investment gains (losses): |
||||||||
Net realized investment gains (losses) |
58,010 | (17,989 | ) | |||||
Other-than-temporary impairment losses |
(4,053 | ) | (81,374 | ) | ||||
Total net realized investment gains (losses) |
53,957 | (99,363 | ) | |||||
Total revenues |
595,156 | 438,116 | ||||||
EXPENSES |
||||||||
Losses and loss adjustment expenses |
375,898 | 317,591 | ||||||
Acquisition costs |
89,040 | 93,004 | ||||||
Other underwriting expenses |
51,007 | 43,105 | ||||||
Other expense, net |
31,939 | 4,202 | ||||||
Interest expense |
7,485 | 8,085 | ||||||
Total expenses |
555,369 | 465,987 | ||||||
Income (loss) before income taxes |
39,787 | (27,871 | ) | |||||
Federal and foreign income tax provision (benefit): |
||||||||
Current |
37,797 | 34,622 | ||||||
Deferred |
(35,799 | ) | (56,702 | ) | ||||
Total federal and foreign income tax provision (benefit) |
1,998 | (22,080 | ) | |||||
Net income (loss) |
37,789 | (5,791 | ) | |||||
Preferred dividends |
(1,271 | ) | (1,336 | ) | ||||
Gain on purchase of Series B preferred shares |
| 7,997 | ||||||
NET INCOME AVAILABLE TO COMMON SHAREHOLDERS |
$ | 36,518 | $ | 870 | ||||
BASIC |
||||||||
Weighted average common shares outstanding |
N/A | 59,375,095 | ||||||
Basic earnings per common share |
$ | N/A | $ | 0.01 | ||||
DILUTED |
||||||||
Weighted average common shares outstanding |
N/A | 59,848,828 | ||||||
Diluted earnings per common share |
$ | N/A | $ | 0.01 | ||||
DIVIDENDS |
||||||||
Dividends declared per common share |
$ | N/A | $ | 0.075 | ||||
COMPREHENSIVE INCOME (LOSS) |
||||||||
Net income (loss) |
$ | 37,789 | $ | (5,791 | ) | |||
Other comprehensive income (loss), net of tax |
112,869 | (86,810 | ) | |||||
Comprehensive income (loss) |
$ | 150,658 | $ | (92,601 | ) | |||
See accompanying notes to consolidated financial statements.
3
Table of Contents
ODYSSEY RE HOLDINGS CORP.
CONSOLIDATED
STATEMENTS OF SHAREHOLDERS EQUITY
THREE MONTHS ENDED MARCH 31, 2010 AND 2009
(UNAUDITED)
(In thousands, except share amounts)
(In thousands, except share amounts)
Three Months Ended | ||||||||
March 31, | ||||||||
2010 | 2009 | |||||||
PREFERRED SHARES (par value) |
||||||||
Balance, beginning of period |
$ | 32 | $ | 39 | ||||
Preferred shares purchased |
| (7 | ) | |||||
Balance, end of period |
32 | 32 | ||||||
COMMON SHARES (par value) |
||||||||
Balance, beginning and end of period |
567 | 603 | ||||||
ADDITIONAL PAID-IN CAPITAL |
||||||||
Balance, beginning of period |
515,066 | 614,203 | ||||||
Capital contribution |
14,456 | | ||||||
Preferred shares purchased |
| (17,173 | ) | |||||
Net change due to stock option exercises and restricted share awards |
| (7,512 | ) | |||||
Net effect of share-based compensation |
| 2,914 | ||||||
Common shares issued |
| 37 | ||||||
Balance, end of period |
529,522 | 592,469 | ||||||
TREASURY SHARES (at cost) |
||||||||
Balance, beginning of period |
| (795 | ) | |||||
Purchases of treasury shares |
| (9,390 | ) | |||||
Reissuance of treasury shares |
| 7,512 | ||||||
Balance, end of period |
| (2,673 | ) | |||||
ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
NET OF DEFERRED INCOME TAXES |
||||||||
Balance, beginning of period |
546,580 | 82,421 | ||||||
Unrealized net appreciation (depreciation) on securities, net of reclassification adjustments |
102,497 | (85,479 | ) | |||||
Foreign currency translation adjustments |
10,372 | (1,331 | ) | |||||
Balance, end of period |
659,449 | (4,389 | ) | |||||
RETAINED EARNINGS |
||||||||
Balance, beginning of period |
2,492,989 | 2,131,264 | ||||||
Net income (loss) |
37,789 | (5,791 | ) | |||||
Gain on purchase of Series B preferred shares |
| 7,997 | ||||||
Dividends to preferred shareholders |
(1,271 | ) | (1,336 | ) | ||||
Dividends to common shareholders |
| (4,514 | ) | |||||
Balance, end of period |
2,529,507 | 2,127,620 | ||||||
TOTAL SHAREHOLDERS EQUITY |
$ | 3,719,077 | $ | 2,713,662 | ||||
COMMON SHARES OUTSTANDING |
||||||||
Balance, beginning of period |
56,604,650 | 60,242,949 | ||||||
Net treasury shares acquired |
| (50,920 | ) | |||||
Shares issued |
| 2,000 | ||||||
Balance, end of period |
56,604,650 | 60,194,029 | ||||||
See accompanying notes to consolidated financial statements.
4
Table of Contents
ODYSSEY RE HOLDINGS CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
THREE MONTHS ENDED MARCH 31, 2010 AND 2009 (UNAUDITED)
(In thousands)
THREE MONTHS ENDED MARCH 31, 2010 AND 2009 (UNAUDITED)
(In thousands)
Three Months Ended | ||||||||
March 31, | ||||||||
2010 | 2009 | |||||||
CASH FLOWS FROM OPERATING ACTIVITIES |
||||||||
Net income (loss) |
$ | 37,789 | $ | (5,791 | ) | |||
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: |
||||||||
Decrease in premiums receivable and funds held, net |
43,489 | 56,810 | ||||||
Increase in unearned premiums and prepaid reinsurance premiums, net |
16,814 | 7,609 | ||||||
Increase in unpaid losses and loss adjustment expenses, net |
108,980 | 18,428 | ||||||
Change in current and deferred federal and foreign income taxes, net |
(37,073 | ) | (211,698 | ) | ||||
(Increase) decrease in deferred acquisition costs |
(3,406 | ) | 314 | |||||
Change in other assets and liabilities, net |
(71,767 | ) | (41,834 | ) | ||||
Net realized investment (gains) losses |
(53,958 | ) | 99,363 | |||||
Bond discount amortization, net |
(3,950 | ) | (2,397 | ) | ||||
Amortization of compensation plan costs |
7,875 | 2,914 | ||||||
Net cash provided by (used in) operating activities |
44,793 | (76,282 | ) | |||||
CASH FLOWS FROM INVESTING ACTIVITIES |
||||||||
Maturities of fixed income securities, available for sale |
| 160,000 | ||||||
Sales of fixed income securities, available for sale |
181,771 | 90,505 | ||||||
Purchases of fixed income securities, available for sale |
(187,609 | ) | (466,883 | ) | ||||
Sales of equity securities |
151,462 | 65,056 | ||||||
Purchases of equity securities |
(67,574 | ) | (312,978 | ) | ||||
Net (settlements) sales of other invested assets |
(17,421 | ) | 37,030 | |||||
Purchases of other invested assets |
(60,036 | ) | (11,915 | ) | ||||
Net change in cash and cash equivalents held as collateral |
(6,462 | ) | 75,891 | |||||
Sales of trading securities |
275,366 | 16,966 | ||||||
Purchases of trading securities |
(196,341 | ) | (111,522 | ) | ||||
Net change in short-term investments |
51,866 | 278,239 | ||||||
Net cash provided by (used in) investing activities |
125,022 | (179,611 | ) | |||||
CASH FLOWS FROM FINANCING ACTIVITIES |
||||||||
Capital contribution |
14,456 | | ||||||
Purchase of treasury shares |
| (9,390 | ) | |||||
Purchase of Series B preferred shares |
| (9,183 | ) | |||||
Dividends paid to preferred shareholders |
(1,273 | ) | (1,923 | ) | ||||
Dividends paid to common shareholders |
| (4,514 | ) | |||||
Proceeds from exercise of stock options |
| 37 | ||||||
Net cash provided by (used in) financing activities |
13,183 | (24,973 | ) | |||||
Effect of exchange rate changes on cash and cash equivalents |
(46,841 | ) | (13,096 | ) | ||||
Increase (decrease) in cash and cash equivalents |
136,157 | (293,962 | ) | |||||
Cash and cash equivalents, beginning of period |
941,444 | 755,747 | ||||||
Cash and cash equivalents, end of period |
$ | 1,077,601 | $ | 461,785 | ||||
Supplemental disclosures of cash flow information: |
||||||||
Interest paid |
$ | 889 | $ | 1,515 | ||||
Income taxes paid |
$ | 38,952 | $ | 189,561 | ||||
See accompanying notes to consolidated financial statements.
5
Table of Contents
ODYSSEY RE HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. Organization and Basis of Presentation
Odyssey Re Holdings Corp. (together with its subsidiaries, the Company or OdysseyRe) is an
underwriter of reinsurance, providing a full range of property and casualty products on a worldwide
basis, and an underwriter of specialty insurance, primarily in the United States and through the
Lloyds of London marketplace. Odyssey Re Holdings Corp. was formed as a holding company and
incorporated in Delaware in 2001 in conjunction with its initial public offering. Odyssey Re
Holdings Corp. owns all of the common shares of Odyssey America Reinsurance Corporation (Odyssey
America), its principal operating subsidiary, which is domiciled in the state of Connecticut.
Odyssey America directly or indirectly owns all of the common shares of the following subsidiaries:
Clearwater Insurance Company (Clearwater); Clearwater Select Insurance Company; Newline Holdings
U.K. Limited, Newline Underwriting Management Limited, which manages Newline Syndicate (1218), a
member of Lloyds of London, Newline Insurance Company Limited (NICL), Newline Corporate Name
Limited (NCNL), which provides capital for and receives the distributed earnings from Newline
Syndicate (1218) (collectively, Newline); Hudson Insurance Company (Hudson); Hudson Specialty
Insurance Company (Hudson Specialty), Napa River
Insurance Services, Inc. and Hudson Crop Insurance Services, Inc. As of March 31,
2010, Fairfax Financial Holdings Limited (Fairfax), a publicly-traded financial services holding
company based in Canada, owned 100% of OdysseyRe.
In September 2009, Fairfax commenced a tender offer (the Offer) to acquire all of the
outstanding shares of common stock of OdysseyRe that Fairfax and its subsidiaries did not currently
own, for $65.00 in cash per share. Pursuant to the Offer, which expired on October 21, 2009,
Fairfax acquired a total of approximately 14.3 million shares of common stock of OdysseyRe (the
Tendered Shares). The Tendered Shares, combined with the shares previously owned by Fairfax and
its subsidiaries, represented approximately 97.1% of the 58,451,922 shares of common stock of
OdysseyRe then outstanding. Following the purchase of the Tendered Shares, Fairfax caused a
short-form merger pursuant to which Fairfax Investments USA Corp., a newly-formed, wholly-owned
subsidiary of Fairfax, merged with and into OdysseyRe (the Merger). The Merger was effected on
October 28, 2009. As a result of the Merger, all of the remaining shares of OdysseyRes common
stock held by the remaining minority shareholders of OdysseyRe were cancelled and, subject to
appraisal rights under Delaware law, converted into the right to receive $65.00 per share in cash,
without interest, and subject to any applicable withholding of taxes. As a result of the Merger,
Fairfax and its subsidiaries became the owner of 100% of the outstanding shares of the Companys
common stock. The Company subsequently withdrew its shares of common stock from listing on the New
York Stock Exchange and terminated registration of these shares under the Securities Exchange Act
of 1934. All OdysseyRe common shares remaining in the Companys treasury following the Merger were
cancelled.
The accompanying consolidated financial statements have been prepared in accordance
with accounting principles generally accepted in the United States of America (GAAP). The
consolidated financial statements include the accounts of the Company and its subsidiaries.
Intercompany transactions have been eliminated. The preparation of consolidated financial
statements in conformity with GAAP requires the Company to make estimates and assumptions, which
could differ materially from actual results that affect the reported amounts of assets,
liabilities, revenues and expenses and disclosure of contingent assets and liabilities. Certain
financial information and disclosures that are usually included in annual financial statements
prepared in accordance with GAAP have been omitted since they are not required for interim
reporting purposes. Readers should review the Companys 2009 Annual Report on Form 10-K for a more
complete description of the Companys business and accounting policies. The Companys unaudited
interim consolidated financial statements include all normal recurring adjustments that, in the
Companys opinion, are required for a fair statement of its financial position on such dates, and
the results of operations and cash flows for the periods presented. Certain amounts from prior
periods have been reclassified to conform to the current years presentations. The results for the
three months ended March 31, 2010 are not necessarily indicative of the results for a full year.
In January 2010, the FASB issued an accounting standard to require more detailed disclosures
for assets and liabilities measured at fair value. The standard requires gross presentation of
purchases, issuances, settlements and sales of Level 3 assets and liabilities (see Note 3 for a
description of the Fair Value levels). The
6
Table of Contents
ODYSSEY RE HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
standard also requires disclosures of transfers between all levels and the policy and
rationale for the transfer. The disclosure requirements have been incorporated into this Form 10-Q.
2. Earnings Per Common Share
As a result of the Merger (see Note 1), Fairfax attained 100% ownership of the Company;
accordingly, the Company has not presented earnings per common share for the three months ended
March 31, 2010. On January 1, 2009, the Company adopted an accounting standard that resulted in the
Company treating its unvested share-based payment awards, for the purpose of calculating earnings
per share, as a separate class of securities, due to the non-forfeitable rights to dividends. The
following table shows the allocation of net income available to common shareholders as calculated
in accordance with the two-class method for the three months ended March 31, 2009 (in thousands):
Three Months Ended | ||||
March 31, 2009 | ||||
Net loss |
$ | (5,791 | ) | |
Preferred dividends |
(1,336 | ) | ||
Gain on purchase of Series B preferred shares |
7,997 | |||
Net income available to common shareholders |
$ | 870 | ||
Allocation of net income for basic earnings per share: |
||||
Common shares |
$ | 860 | ||
Participating securities |
10 | |||
Net income available to common shareholders |
$ | 870 | ||
Net income per common share for the three months ended March 31, 2009, as presented in the
following table, has been computed based upon weighted average common shares outstanding (in
thousands, except share and per share amounts):
Three Months Ended | ||||
March 31, 2009 | ||||
Net income to common shares basic |
$ | 860 | ||
Undistributed earnings allocated to share-based payments |
4 | |||
Net income to common shares diluted |
$ | 864 | ||
Weighted average common shares outstanding basic |
59,375,095 | |||
Effect of dilutive shares: |
||||
Restricted shares |
400,154 | |||
Stock options |
73,579 | |||
Total effect of dilutive shares |
473,733 | |||
Weighted average common shares outstanding diluted |
59,848,828 | |||
Net earnings per common share: |
||||
Basic |
$ | 0.01 | ||
Diluted |
0.01 |
In calculating diluted earnings per share, the Company is required to evaluate each stock
option and
7
Table of Contents
ODYSSEY RE HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
restricted stock grant to determine if it is dilutive or anti-dilutive in nature. For the
three months ended March 31, 2009, 110,044 existing stock options and restricted stock awards
outstanding were excluded from the computation of weighted average common shares for diluted
earnings per common share, due to the anti-dilutive effect.
Net income per participating security for the three months ended March 31, 2009, as presented
in the following table, has been computed based upon weighted average restricted shares outstanding
(in thousands, except share and per share amounts):
Three Months Ended | ||||
March 31, 2009 | ||||
Net income to participating securities basic |
$ | 10 | ||
Weighted average restricted shares outstanding basic |
840,472 | |||
Net earnings per participating security basic |
$ | 0.01 |
3. Fair Value Measurements
The Company accounts for a significant portion of its financial instruments at fair value as
permitted or required by GAAP.
Fair Value Hierarchy
The Company has categorized its financial instruments, based on the priority of the inputs to
the valuation technique, into a three-level fair value hierarchy. The fair value hierarchy gives
the highest priority to quoted prices in active markets for identical assets or liabilities (Level
1) and the lowest priority to unobservable inputs (Level 3). When the inputs used to measure fair
value fall within different levels of the hierarchy, the level within which the fair value
measurement is categorized is based on the lowest level input that is significant to the fair value
measurement in its entirety. Gains and losses for assets and liabilities categorized within the
Level 3 table below, therefore, may include changes in fair value that are attributable to both
observable inputs (Levels 1 and 2) and unobservable inputs (Level 3). Financial assets and
liabilities recorded in the consolidated balance sheets are categorized based on the inputs to the
valuation techniques as follows:
Level 1: Level 1 financial instruments are financial assets and liabilities for which the
values are based on unadjusted quoted prices for identical assets or liabilities in an active
market that the Company has the ability to access.
Level 2: Level 2 financial instruments are financial assets and liabilities for which the
values are based on quoted prices in markets that are not active, or model inputs that are
observable either directly or indirectly for substantially the full term of the asset or liability.
Level 2 inputs include the following:
a) | Quoted prices for similar assets or liabilities in active markets; | ||
b) | Quoted prices for identical or similar assets or liabilities in non-active markets; | ||
c) | Pricing models, the inputs for which are observable for substantially the full term of the asset or | ||
liability; and | |||
d) | Pricing models, the inputs for which are derived principally from, or corroborated by, observable market data through correlation or other means, for substantially the full term of the asset or liability. |
8
Table of Contents
ODYSSEY RE HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
Level 3: Level 3 financial instruments are financial assets and liabilities for which the
values are based on prices or valuation techniques that require inputs that are both unobservable
and significant to the overall fair value measurement. These inputs reflect the Companys own
assumptions about the methodology and valuation techniques that a market participant would use in
pricing the asset or liability.
The Company is responsible for determining the fair value of its investment portfolio by
utilizing market-driven fair value measurements obtained from active markets where available, by
considering other observable and unobservable inputs and by employing valuation techniques that
make use of current market data. For the majority of the Companys investment portfolio, the
Company uses quoted prices and other information from independent pricing sources in determining
fair values.
For determining the fair value of its Level 1 investments, the Company utilizes quoted market
prices. The majority of the Companys Level 1 investments are common stocks that are actively
traded in a public market. Short-term investments and cash equivalents, for which the cost basis
approximates fair value, are also classified as Level 1 investments.
The Companys Level 2 investments, the majority of which are in government, corporate and
municipal fixed income securities, are priced using publicly traded over-the-counter prices and
broker-dealer quotes. Observable inputs such as benchmark yields, reported trades, broker-dealer
quotes, issuer spreads and bids are available for these investments. For determining the fair value
of derivatives, which are classified as Level 2, the Company utilizes broker-dealer quotes that
include observable market information. Also included in Level 2 are inactively traded convertible
corporate debentures that are valued using a pricing model that includes observable inputs such as
credit spreads and discount rates in the calculation.
The Company uses valuation techniques to establish the fair value of Level 3 investments.
During the three months ended March 31, 2010, the Company purchased $6.3 million of investments
that are classified as Level 3. As of March 31, 2010, the Company held $48.5 million of investments
that are classified as Level 3. These Level 3 investments are valued using a discounted cash flow
model, including unobservable inputs that are supported by limited market-based activity. To verify
Level 3 pricing, the Company assesses the reasonableness of the fair values by comparison to
economic pricing models, by reference to movements in credit spreads, and by comparing the fair
values to recent transaction prices for similar assets, where available.
A review of fair value hierarchy classifications is conducted on a quarterly basis. To ensure
accuracy in the classification within the fair value hierarchy, the Company evaluates changes in
market conditions, availability of observable market data, changes in pricing methodologies and
other critical factors to determine if it is appropriate to re-classify any of its investments
between levels. Reclassifications impacting any of the levels of the fair value hierarchy are
generally reported as transfers in or out of the level as of the beginning of the period in which
the reclassifications occur. The Company has determined that it should not re-classify any of its
investments between levels for the three months ended March 31, 2010.
9
Table of Contents
ODYSSEY RE HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
The following tables present the fair value hierarchy for those assets and liabilities
measured at fair value on a recurring basis as of March 31, 2010 and December 31, 2009 (in
thousands):
Fair Value Measurements as of March 31, 2010 | ||||||||||||||||
Asset / Liability | Quoted Prices in | Significant | ||||||||||||||
Measured at | Active Markets | Other | Significant | |||||||||||||
Fair Value | for Identical | Observable | Unobservable | |||||||||||||
March 31, | Assets / Liabilities | Inputs | Inputs | |||||||||||||
2010 | (Level 1) | (Level 2) | (Level 3) | |||||||||||||
Fixed income securities, available for sale: |
||||||||||||||||
United States government, government agencies
and authorities |
$ | 142,897 | $ | | $ | 142,897 | $ | | ||||||||
States, municipalities and political subdivisions |
3,193,678 | | 3,193,678 | | ||||||||||||
Foreign governments |
760,909 | | 760,909 | | ||||||||||||
Corporate |
289,860 | | 289,860 | | ||||||||||||
Total fixed income securities,
available for sale |
4,387,344 | | 4,387,344 | | ||||||||||||
Fixed income securities, held as trading securities: |
||||||||||||||||
Foreign governments |
103,494 | | 103,494 | | ||||||||||||
Mortgage-related |
90,066 | | 72,867 | 17,199 | ||||||||||||
Corporate |
385,604 | | 385,604 | | ||||||||||||
Total fixed income securities, held as
trading securities |
579,164 | | 561,965 | 17,199 | ||||||||||||
Redeemable preferred stock, available for sale |
108 | | 108 | | ||||||||||||
Convertible preferred stock, held as trading
securities |
69,293 | | 69,293 | | ||||||||||||
Common stocks, available for sale |
2,076,358 | 2,040,982 | 35,376 | | ||||||||||||
Short-term investments, available for sale |
74,582 | 74,582 | | | ||||||||||||
Short-term investments, held as trading securities |
153,025 | 153,025 | | | ||||||||||||
Cash equivalents |
802,503 | 802,503 | | | ||||||||||||
Derivatives |
65,487 | | 65,487 | | ||||||||||||
Other investments |
46,857 | 3,899 | 11,649 | 31,309 | ||||||||||||
Total assets measured at fair value |
$ | 8,254,721 | $ | 3,074,991 | $ | 5,131,222 | $ | 48,508 | ||||||||
Derivative liabilities |
$ | 38,071 | $ | | $ | 38,071 | $ | | ||||||||
10
Table of Contents
ODYSSEY RE HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
Fair Value Measurements as of December 31, 2009 | ||||||||||||||||
Asset / Liability | Quoted Prices in | Significant | ||||||||||||||
Measured at | Active Markets | Other | Significant | |||||||||||||
Fair Value | for Identical | Observable | Unobservable | |||||||||||||
December 31, | Assets / Liabilities | Inputs | Inputs | |||||||||||||
2009 | (Level 1) | (Level 2) | (Level 3) | |||||||||||||
Fixed income securities, available for sale: |
||||||||||||||||
United States government, government agencies
and authorities |
$ | 141,037 | $ | | $ | 141,037 | $ | | ||||||||
States, municipalities and political subdivisions |
3,087,556 | | 3,087,556 | | ||||||||||||
Foreign governments |
796,611 | | 796,611 | | ||||||||||||
Corporate |
348,761 | | 348,761 | | ||||||||||||
Total fixed income securities,
available for sale |
4,373,965 | | 4,373,965 | | ||||||||||||
Fixed income securities, held as trading
securities: |
||||||||||||||||
Foreign governments |
99,399 | | 99,399 | | ||||||||||||
Mortgage-related |
70,344 | | 56,098 | 14,246 | ||||||||||||
Corporate |
362,975 | | 362,975 | | ||||||||||||
Total fixed income securities, held as
trading securities |
532,718 | | 518,472 | 14,246 | ||||||||||||
Redeemable preferred stock, available for sale |
108 | | 108 | | ||||||||||||
Convertible preferred stock, held as trading
securities |
82,470 | | 82,470 | | ||||||||||||
Common stocks, available for sale |
2,071,037 | 2,035,131 | 35,906 | | ||||||||||||
Short-term investments, available for sale |
125,100 | 125,100 | | | ||||||||||||
Short-term investments, held as trading
securities |
238,403 | 238,403 | | | ||||||||||||
Cash equivalents |
776,136 | 776,136 | | | ||||||||||||
Derivatives |
19,981 | | 19,981 | | ||||||||||||
Other investments |
46,131 | 1,553 | 11,280 | 33,298 | ||||||||||||
Total assets measured at fair value |
$ | 8,266,049 | $ | 3,176,323 | $ | 5,042,182 | $ | 47,544 | ||||||||
Derivative liabilities |
$ | 39,295 | $ | | $ | 39,295 | $ | | ||||||||
The following tables provide a summary of changes in the fair value of Level 3 financial
assets for the three months ended March 31, 2010 and 2009 (in thousands):
Three Months Ended March 31, | ||||||||||||
2010 | 2009 | 2010 | ||||||||||
Fixed Income | Other Invested | |||||||||||
Securities | Assets | |||||||||||
Beginning balance |
$ | 14,246 | $ | 67,423 | $ | 33,298 | ||||||
Total realized investment gains (losses)
included in net income |
1,675 | (3,201 | ) | (2,689 | ) | |||||||
Purchases |
5,567 | 17,632 | 700 | |||||||||
Settlements |
(4,289 | ) | (3,974 | ) | | |||||||
Transfers from Level 3 to Level 2 |
| (47,787 | ) | | ||||||||
Ending balance |
$ | 17,199 | $ | 30,093 | $ | 31,309 | ||||||
11
Table of Contents
ODYSSEY RE HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
The following table presents realized investment gains and losses included in net income
related to Level 3 assets for the three months ended March 31, 2010 and 2009 (in thousands):
Net Realized Investment Gains (Losses) on: | ||||||||||||
Fixed | Other | |||||||||||
Income | Invested | |||||||||||
Securities | Assets | |||||||||||
2010 | 2009 | 2010 | ||||||||||
Realized investment gains related to securities sold |
$ | 1,766 | $ | 270 | $ | | ||||||
Realized investment losses related to securities held |
(91 | ) | (3,471 | ) | (2,689 | ) | ||||||
Total net realized investment gains (losses) relating to
Level 3 assets |
$ | 1,675 | $ | (3,201 | ) | $ | (2,689 | ) | ||||
Fair Value Option
The fair value option (FVO) available under GAAP allows companies to irrevocably elect fair
value as the initial and subsequent measurement attribute for certain financial assets and
liabilities. Changes in the fair value of assets and liabilities for which the election is made
will be recognized in net income as they occur. The FVO election is permitted on an
instrument-by-instrument basis at initial recognition of an asset or liability or upon the
occurrence of an event that gives rise to a new basis of accounting for that instrument.
On January 1, 2008, the Company elected the FVO for its investment in Advent Capital
(Holdings) PLC (Advent). At the time, Advent was publicly traded on a foreign stock exchange and
its traded price was determined to be a better indicator of its value than its carrying value under
the equity method. During 2009, Fairfax and certain of its subsidiaries, including the Company,
purchased additional shares of Advent, bringing Fairfaxs ownership in Advent to 100%, of which the
Company holds 21.7%.
To determine the fair value of Advent, the Company evaluates observable price-to-book
multiples of peer companies and applies such to Advents most recently available book value per
share. As of March 31, 2010, the Companys investment in Advent is recorded at fair value of $30.6
million in other invested assets, with related changes in fair value recognized as a realized
investment gain or loss in the period in which they occur. The change in Advents fair value
resulted in the recognition of a realized investment loss of $2.3 million for both the three months
ended March 31, 2010 and 2009. Advents value as of March 31, 2010, calculated in accordance with
the equity method of accounting, would have been $38.5 million.
As of March 31, 2010, the Company has not elected the FVO for any of its liabilities.
12
Table of Contents
ODYSSEY RE HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
4. Investments and Cash
A summary of the Companys investment portfolio as of March 31, 2010, excluding common stocks,
at equity, other invested assets, fixed income securities held as trading securities, convertible
preferred stock held as trading securities and short-term investments held as trading securities,
is as follows (in thousands):
Cost or | Gross | Gross | ||||||||||||||
Amortized | Unrealized | Unrealized | ||||||||||||||
Cost | Appreciation | Depreciation | Fair Value | |||||||||||||
Fixed income securities, available
for sale: |
||||||||||||||||
United States government, government
agencies and authorities |
$ | 139,849 | $ | 7,966 | $ | 4,918 | $ | 142,897 | ||||||||
States, municipalities and political
subdivisions |
2,890,254 | 309,098 | 5,674 | 3,193,678 | ||||||||||||
Foreign governments |
709,946 | 52,017 | 1,054 | 760,909 | ||||||||||||
Corporate |
234,202 | 56,710 | 1,052 | 289,860 | ||||||||||||
Total fixed income securities,
available
for sale |
3,974,251 | 425,791 | 12,698 | 4,387,344 | ||||||||||||
Redeemable preferred stock, at fair value |
108 | | | 108 | ||||||||||||
Common stocks, at fair value |
1,539,412 | 540,920 | 3,974 | 2,076,358 | ||||||||||||
Short-term investments, at fair value |
74,582 | | | 74,582 | ||||||||||||
Cash and cash equivalents |
1,077,601 | | | 1,077,601 | ||||||||||||
Cash and cash equivalents held as
collateral |
63,182 | | | 63,182 | ||||||||||||
Total |
$ | 6,729,136 | $ | 966,711 | $ | 16,672 | $ | 7,679,175 | ||||||||
Common stocks accounted for under the equity method of accounting were carried at $160.3
million as of March 31, 2010, reflecting gross unrealized appreciation of $35.8 million and no
gross unrealized depreciation. Other invested assets were carried at $203.6 million as of March 31,
2010, reflecting no gross unrealized appreciation or depreciation. Fixed income securities held as
trading securities were carried at fair value of $579.2 million as of March 31, 2010, with changes
in fair value reflected as realized investment gains or losses in the consolidated statement of
operations. Fixed income securities held as trading securities include corporate, foreign
government and mortgage-related securities, with fair values of $385.6 million, $103.5 million and
$90.1 million, respectively, as of March 31, 2010. Convertible preferred stock and short-term
investments held as trading securities were carried at fair value of $69.3 million and $153.0
million, respectively, as of March 31, 2010, with changes in fair value reflected in realized
investment gains or losses in the consolidated statement of operations.
13
Table of Contents
ODYSSEY RE HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
A summary of the Companys investment portfolio as of December 31, 2009, excluding common
stocks, at equity, other invested assets, fixed income securities held as trading securities,
convertible preferred stock held as trading securities, and short-term investments held as trading
securities, is as follows (in thousands):
Cost or | Gross | Gross | ||||||||||||||
Amortized | Unrealized | Unrealized | ||||||||||||||
Cost | Appreciation | Depreciation | Fair Value | |||||||||||||
Fixed income securities, available for
sale: |
||||||||||||||||
United States government, government
agencies and authorities |
$ | 138,033 | $ | 7,309 | $ | 4,305 | $ | 141,037 | ||||||||
States, municipalities and political
subdivisions |
2,808,873 | 318,037 | 39,354 | 3,087,556 | ||||||||||||
Foreign governments |
748,680 | 48,060 | 129 | 796,611 | ||||||||||||
Corporate |
275,553 | 73,292 | 84 | 348,761 | ||||||||||||
Total fixed income securities, available
for sale |
3,971,139 | 446,698 | 43,872 | 4,373,965 | ||||||||||||
Redeemable preferred stock, at fair value |
108 | | | 108 | ||||||||||||
Common stocks, at fair value |
1,679,748 | 395,222 | 3,933 | 2,071,037 | ||||||||||||
Short-term investments, at fair value |
125,100 | | | 125,100 | ||||||||||||
Cash and cash equivalents |
941,444 | | | 941,444 | ||||||||||||
Cash and cash equivalents held as collateral |
56,720 | | | 56,720 | ||||||||||||
Total |
$ | 6,774,259 | $ | 841,920 | $ | 47,805 | $ | 7,568,374 | ||||||||
Common stocks accounted for under the equity method of accounting were carried at $158.5
million as of December 31, 2009, reflecting gross unrealized appreciation of $34.1 million and no
gross unrealized depreciation. Other invested assets were carried at $146.7 million as of December
31, 2009, reflecting no gross unrealized appreciation or depreciation. Fixed income securities held
as trading securities were carried at fair value of $532.7 million as of December 31, 2009, with
changes in fair value reflected as realized investment gains or losses in the consolidated
statement of operations. Fixed income securities held as trading securities include corporate,
foreign government and mortgage-related securities, with fair values of $363.0 million, $99.4
million and $70.3 million, respectively, as of December 31, 2009. Convertible preferred stock and
short-term investments held as trading securities were carried at fair value of $82.5 million and
$238.4 million, respectively, as of December 31, 2009, with changes in fair value reflected in
realized investment gains or losses in the consolidated statement of operations.
The fair values of fixed income securities and common stocks are based on the quoted
market prices of the investments as of the close of business on March 31, 2010 and December 31,
2009, respectively.
14
Table of Contents
ODYSSEY RE HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
(a) Net Investment Income and Realized Investment Gains (Losses)
The following table sets forth the components of net investment income for the three months
ended March 31, 2010 and 2009 (in thousands):
Three Months Ended | ||||||||
March 31, | ||||||||
2010 | 2009 | |||||||
Interest on fixed income securities |
$ | 69,870 | $ | 56,589 | ||||
Dividends on common stocks, at fair value |
10,785 | 16,886 | ||||||
Net income (loss) of common stocks, at equity |
64 | (802 | ) | |||||
Interest on cash and short-term investments |
2,417 | 4,890 | ||||||
Other invested assets |
10,597 | (4,837 | ) | |||||
Gross investment income |
93,733 | 72,726 | ||||||
Less: investment expenses |
8,785 | 4,352 | ||||||
Less: interest on funds held under reinsurance contracts |
844 | 913 | ||||||
Net investment income |
$ | 84,104 | $ | 67,461 | ||||
The following table sets forth the components of net realized investment gains and losses for
the three months ended March 31, 2010 and 2009 (in thousands):
Three Months Ended March 31, 2010 | Three Months Ended March 31, 2009 | |||||||||||||||||||||||
Gross | Gross | Net Realized | Gross | Gross | Net Realized | |||||||||||||||||||
Realized | Realized | Investment | Realized | Realized | Investment | |||||||||||||||||||
Investment | Investment | Gains | Investment | Investment | (Losses) | |||||||||||||||||||
Gains | Losses | (Losses) | Gains | Losses | Gains | |||||||||||||||||||
Fixed income securities,
available for sale |
$ | 19,416 | $ | 3,677 | $ | 15,739 | $ | 3,760 | $ | 4,057 | $ | (297 | ) | |||||||||||
Fixed income securities,
held as trading securities |
40,240 | 1,479 | 38,761 | 6,020 | 26,795 | (20,775 | ) | |||||||||||||||||
Redeemable preferred stock |
| | | | 178 | (178 | ) | |||||||||||||||||
Convertible preferred stock,
held as trading securities |
| 13,178 | (13,178 | ) | | | | |||||||||||||||||
Equity securities |
82,301 | 1,867 | 80,434 | 3,351 | 78,423 | (75,072 | ) | |||||||||||||||||
Derivative securities |
13,594 | 66,830 | (53,236 | ) | 21,644 | 6,978 | 14,666 | |||||||||||||||||
Other securities |
29,040 | 43,603 | (14,563 | ) | 20,651 | 38,358 | (17,707 | ) | ||||||||||||||||
Total |
$ | 184,591 | $ | 130,634 | $ | 53,957 | $ | 55,426 | $ | 154,789 | $ | (99,363 | ) | |||||||||||
Included in net realized investment gains for the three months ended March 31, 2010 and 2009
are $4.1 million and $81.4 million, respectively, of realized investment losses on the
other-than-temporary impairment of investments, as follows (in thousands):
Three Months Ended | ||||||||
March 31, | ||||||||
2010 | 2009 | |||||||
Fixed income securities |
$ | 2,911 | $ | 3,136 | ||||
Equity securities |
1,142 | 78,238 | ||||||
Total other-than-temporary impairments |
$ | 4,053 | $ | 81,374 | ||||
15
Table of Contents
ODYSSEY RE HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
For those fixed income securities that were determined to be other-than-temporarily impaired,
the Company determined that such impairments were either related to credit or were incurred on
securities maturing before sufficient time would elapse for market value recovery, requiring the
recognition of an impairment charge to income. Impairments related to other factors for securities
not maturing in the near term (e.g., interest rates and market conditions) would have required
charges to other comprehensive income.
(b) Unrealized Appreciation (Depreciation)
The following table sets forth the changes in unrealized net appreciation (depreciation) of
investments, and the related tax effect, reflected in accumulated other comprehensive income for
the three months ended March 31, 2010 and 2009 (in thousands):
Three Months Ended | ||||||||
March 31, | ||||||||
2010 | 2009 | |||||||
Fixed income securities |
$ | 10,267 | $ | 110,533 | ||||
Redeemable preferred stock |
| 179 | ||||||
Equity securities |
147,421 | (242,272 | ) | |||||
Short-term investments |
| 50 | ||||||
Increase (decrease) in unrealized net appreciation of investments |
157,688 | (131,510 | ) | |||||
Deferred income tax (expense) benefit |
(55,191 | ) | 46,031 | |||||
Change in net unrealized appreciation (depreciation)
of investments included in other comprehensive income |
$ | 102,497 | $ | (85,479 | ) | |||
(c) Common Stocks, at Equity
Common stocks, at equity, totaled $160.3 million as of March 31, 2010 and $158.5 million as of
December 31, 2009. The following table sets forth the components of common stocks, at equity, as of
March 31, 2010 and December 31, 2009 (in thousands):
March 31, | December 31, | |||||||
2010 | 2009 | |||||||
Fairfax Asia Limited |
$ | 85,991 | $ | 84,086 | ||||
TRG Holding Corporation |
74,327 | 74,347 | ||||||
Other |
27 | 27 | ||||||
Total common stocks, at equity |
$ | 160,345 | $ | 158,460 | ||||
For common stocks, at equity, as of March 31, 2010, the relative ownership held by the Company
was 13.0% for TRG Holding Corporation (which is 100% owned by Fairfax) and 26.2% (economic) for
Fairfax Asia Limited (which is 100% owned by Fairfax).
16
Table of Contents
ODYSSEY RE HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
(d) Derivative Investments and Short Sales
The Company has utilized credit default swaps, call options and warrants, total return swaps,
interest rate options, forward currency contracts, futures contracts and short sales to manage
against adverse changes in the values of assets and liabilities. These products are typically not
linked to specific assets or liabilities on the consolidated balance sheets or a forecasted
transaction and, therefore, do not qualify for hedge accounting. The following tables set forth the
Companys derivative positions, which are included in other invested assets or other liabilities in
the consolidated balance sheets, as of March 31, 2010 and December 31, 2009, respectively (in
thousands):
As of March 31, 2010 | ||||||||||||||||
Exposure/ | ||||||||||||||||
Notional | Fair Value | Fair Value | ||||||||||||||
Amount | Cost | Asset | Liability | |||||||||||||
Credit default swaps |
$ | 1,161,002 | $ | 19,779 | $ | 8,691 | $ | | ||||||||
Total return swaps |
985,936 | | | 1,242 | ||||||||||||
Forward currency contracts |
512,003 | | | 34,791 | ||||||||||||
Other |
| 71,101 | 56,797 | 2,038 |
As of December 31, 2009 | ||||||||||||||||
Exposure/ | ||||||||||||||||
Notional | Fair Value | Fair Value | ||||||||||||||
Amount | Cost | Asset | Liability | |||||||||||||
Credit default swaps |
$ | 1,295,187 | $ | 20,583 | $ | 9,986 | $ | | ||||||||
Total return swaps |
818,416 | | 3,132 | | ||||||||||||
Forward currency contracts |
416,293 | | | 39,251 | ||||||||||||
Other |
| 9,335 | 6,864 | 43 |
17
Table of Contents
ODYSSEY RE HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
The following tables summarize the effect of the hedging instruments and related hedged items
on the Companys historical financial position, results of operations and cash flows as of and for
the three months ended March 31, 2010 and 2009 (in thousands):
As of and for the Three Months Ended March 31, 2010 | ||||||||||||||||||||||||
Effect on Pre-tax: | ||||||||||||||||||||||||
Exposure / | Other | Net Realized | Net Cash | |||||||||||||||||||||
Notional | Carrying | Comprehensive | Investment | Flow from | ||||||||||||||||||||
Value | Value | Income | Gains | Net Equity | Disposals | |||||||||||||||||||
Equity risk exposures: |
||||||||||||||||||||||||
Preferred stocks |
$ | 69,401 | $ | 69,401 | $ | | $ | (13,178 | ) | $ | (13,178 | ) | $ | | ||||||||||
Common stocks, at fair value |
2,076,358 | 2,076,358 | 145,657 | 80,435 | 226,092 | 80,837 | ||||||||||||||||||
Other |
129,855 | (1,504 | ) | | (1,504 | ) | (1,504 | ) | | |||||||||||||||
Total equity exposure |
$ | 2,275,614 | $ | 2,144,255 | 145,657 | 65,753 | 211,410 | 80,837 | ||||||||||||||||
Hedging instruments: |
||||||||||||||||||||||||
Other invested assets: |
||||||||||||||||||||||||
Total return swaps |
$ | 856,081 | $ | 262 | | (40,534 | ) | (40,534 | ) | (37,664 | ) | |||||||||||||
Total equity hedging instruments |
$ | 856,081 | $ | 262 | | (40,534 | ) | (40,534 | ) | (37,664 | ) | |||||||||||||
Net equity impact |
$ | 145,657 | $ | 25,219 | $ | 170,876 | $ | 43,173 | ||||||||||||||||
Credit risk exposures: |
||||||||||||||||||||||||
Fixed income securities |
$ | 4,966,508 | $ | 4,966,508 | $ | 10,267 | $ | 54,500 | $ | 64,767 | $ | 16,564 | ||||||||||||
Derivatives other invested assets |
56,797 | 56,797 | | (11,692 | ) | (11,692 | ) | 141 | ||||||||||||||||
Cash, cash equivalents and
short-term investments |
1,368,390 | 1,368,390 | | (11,221 | ) | (11,221 | ) | (11,221 | ) | |||||||||||||||
Premiums receivable |
436,931 | 436,931 | | (250 | ) | (250 | ) | (250 | ) | |||||||||||||||
Reinsurance recoverable |
1,204,361 | 1,204,361 | | (250 | ) | (250 | ) | | ||||||||||||||||
Total credit risk exposure |
$ | 8,032,987 | $ | 8,032,987 | 10,267 | 31,087 | 41,354 | 5,234 | ||||||||||||||||
Hedging instruments: |
||||||||||||||||||||||||
Other invested assets: |
||||||||||||||||||||||||
Credit default swaps: |
||||||||||||||||||||||||
Banking |
$ | 317,683 | $ | 2,845 | | (253 | ) | (253 | ) | (804 | ) | |||||||||||||
Insurance |
843,319 | 5,846 | | (1,042 | ) | (1,042 | ) | | ||||||||||||||||
Total credit default swaps |
$ | 1,161,002 | $ | 8,691 | | (1,295 | ) | (1,295 | ) | (804 | ) | |||||||||||||
Net equity impact |
$ | 10,267 | $ | 29,792 | $ | 40,059 | $ | 4,430 | ||||||||||||||||
18
Table of Contents
ODYSSEY RE HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
As of and for the Three Months Ended March 31, 2009 | ||||||||||||||||||||||||
Effect on Pre-tax: | ||||||||||||||||||||||||
Exposure / | Other | Net Realized | Net Cash | |||||||||||||||||||||
Notional | Carrying | Comprehensive | Investment | Flow from | ||||||||||||||||||||
Value | Value | Loss | Losses | Net Equity | Disposals | |||||||||||||||||||
Equity risk exposures: |
||||||||||||||||||||||||
Preferred stocks |
$ | 108 | $ | 108 | $ | 179 | $ | (178 | ) | $ | 1 | $ | (1,096 | ) | ||||||||||
Common stocks, at fair value |
1,485,873 | 1,485,873 | (243,567 | ) | (75,072 | ) | (318,639 | ) | 3,166 | |||||||||||||||
Total equity exposure |
$ | 1,485,981 | $ | 1,485,981 | (243,388 | ) | (75,250 | ) | (318,638 | ) | 2,070 | |||||||||||||
Hedging instruments: |
||||||||||||||||||||||||
Other invested assets: |
||||||||||||||||||||||||
Total return swaps |
$ | | $ | | | | | | ||||||||||||||||
Total equity hedging instruments |
$ | | $ | | | | | | ||||||||||||||||
Net equity impact |
$ | (243,388 | ) | $ | (75,250 | ) | $ | (318,638 | ) | $ | 2,070 | |||||||||||||
Credit risk exposures: |
||||||||||||||||||||||||
Fixed income securities |
$ | 4,258,802 | $ | 4,258,802 | $ | 110,533 | $ | (21,072 | ) | $ | 89,461 | $ | 3,092 | |||||||||||
Derivatives other invested assets |
40,246 | 40,246 | | 12,043 | 12,043 | (237 | ) | |||||||||||||||||
Cash, cash equivalents and
short-term investments |
1,371,515 | 1,371,515 | 50 | (10,848 | ) | (10,798 | ) | (10,848 | ) | |||||||||||||||
Premiums receivable |
486,337 | 486,337 | | | | | ||||||||||||||||||
Reinsurance recoverable |
981,838 | 981,838 | | (750 | ) | (750 | ) | | ||||||||||||||||
Total credit risk exposure |
$ | 7,138,738 | $ | 7,138,738 | 110,583 | (20,627 | ) | 89,956 | (7,993 | ) | ||||||||||||||
Hedging instruments: |
||||||||||||||||||||||||
Other invested assets: |
||||||||||||||||||||||||
Credit default swaps: |
||||||||||||||||||||||||
Banking |
$ | 486,673 | $ | 19,511 | | 8,939 | 8,939 | 7,715 | ||||||||||||||||
Insurance |
843,767 | 29,027 | | (5,868 | ) | (5,868 | ) | 20,665 | ||||||||||||||||
Total credit default swaps |
$ | 1,330,440 | $ | 48,538 | | 3,071 | 3,071 | 28,380 | ||||||||||||||||
Net equity impact |
$ | 110,583 | $ | (17,556 | ) | $ | 93,027 | $ | 20,387 | |||||||||||||||
In the normal course of effecting its economic hedging strategy with respect to credit
risk and equity risk, the Company expects that there may be periods where the notional value of the
hedging instrument may exceed or be less than the exposure item being hedged. This situation may
arise when management compensates for imperfect correlations between the hedging item and the
hedge, due to the timing of opportunities related to the Companys ability to exit and enter hedged
or hedging items at attractive prices or when management desires to only partially hedge an
exposure.
The Company holds credit default swaps, referenced to certain issuers in the banking and
insurance sectors of the financial services industry worldwide, that serve as an economic hedge
against declines in the fair value of investments and other corporate assets resulting from
systemic financial and credit risk. Under a credit default swap, as the buyer, the Company agrees
to pay to a specific counterparty, at specified periods, fixed premium amounts based on an agreed
notional principal amount in exchange for protection against default by the issuers of specified
referenced debt securities. The credit events, as defined by the respective credit default swap
contracts, establishing the rights to recover amounts from the counterparties are comprised of
ISDA-standard credit events, which are: bankruptcy, obligation acceleration, obligation default,
failure to pay, repudiation/moratorium and restructuring. As of March 31, 2010, all credit default
swap contracts held by the Company have been purchased from and entered into with either Citibank,
N.A., Deutsche Bank AG or Barclays Bank PLC as the counterparty, with positions on certain covered
risks with more than one of these counterparties. The Company obtains market-derived fair values
for its credit default swaps from third-party
19
Table of Contents
ODYSSEY RE HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
providers, principally broker-dealers. The Company assesses the reasonableness of the fair values
obtained from these providers by comparison to models validated by qualified personnel, by
reference to movements in credit spreads and by comparing the fair values to recent transaction
prices for similar credit default swaps, where available.
The initial premium paid for each credit default swap contract is recorded as a derivative
asset and is subsequently adjusted for changes in the unrealized fair value of the contract at each
balance sheet date. As these contracts do not qualify for hedge accounting, changes in the
unrealized fair value of the contract are recorded as net realized investment gains or losses in
the Companys consolidated statements of operations and comprehensive income. Sales of credit
default swap contracts required the Company to reverse through net realized investment gains
previously recorded unrealized fair value changes since the inception of the contract, and to
record the actual amount based upon the final cash settlement. Derivative assets are reported
gross, on a contract-by-contract basis, at fair value in other invested assets in the consolidated
balance sheets. The sale, expiration or early settlement of a credit default swap will not result
in a cash payment owed by the Company; rather, such an event can only result in a cash payment by a
third party purchaser of the contract, or the counterparty, to the Company. Accordingly, there is
no opportunity for netting of amounts owed in settlement. Cash receipts at the date of sale of the
credit default swaps are recorded as cash flows from investing activities arising from net sales of
assets and liabilities classified as held for trading.
The fair values of credit default swaps may be subject to significant volatility, given
potential differences in the perceived risk of default of the underlying issuers, movements in
credit spreads and the length of time to the contracts maturities. The fair value of the credit
default swaps may vary dramatically either up or down in short periods, and their ultimate value
may therefore only be known upon their disposition. Credit default swap transactions generally
settle in cash. As a result of the appreciation in the fair value of the credit default swaps,
counterparties to these transactions are required to place government securities as collateral,
pursuant to the swap agreements. The fair value of the collateral as of March 31, 2010 was $0.9
million. As the Company funds all of its obligations relating to these contracts upon initiation of
the transaction, there are no requirements in these contracts for the Company to provide
collateral.
The Companys holdings of credit default swap contracts declined significantly in 2009
relative to prior years, largely as a result of significant sales in 2008. In the latter part of
2008, the Company revised the financial objectives of its hedging program by determining not to
replace its credit default swap hedge position as sales or expiries occurred, primarily based on
the Companys judgment that its exposure to elevated levels of credit risk had moderated, but also
due to (i) the significant increase in the cost of purchasing credit protection (reducing the
attractiveness of the credit default swap contract as a hedging instrument), (ii) improvement in
the Companys capital and liquidity (having benefited significantly from, among other things, more
than $568.0 million in gains from sales of credit default swaps realized since 2007), and (iii) the
Companys judgment that managing credit risk through means other than the use of derivatives was,
given the market environment, once again appropriate for mitigating the Companys credit exposure
arising from financial assets.
The fair value of the credit default swaps portfolio was $8.7 million as of March 31, 2010,
compared to $10.0 million as of December 31, 2009. The credit default swaps portfolio has an
average term to expiration of 1.4 years as of March 31, 2010, a decrease from 1.5 years as of
December 31, 2009.
The Company has entered into forward currency contracts to manage its foreign currency
exchange rate risk on a macro basis. Under a forward currency contract, the Company and the
counterparty are obligated to purchase or sell an underlying currency at a specified price and
time. The collateral requirement related to the forward currency contracts was $6.6 million as of March 31, 2010. As a result in the
appreciation in the fair value of some of the forward currency contracts, counterparties to these
contracts are required to place government securities as collateral, pursuant to the forward
currency agreements. The fair value of this collateral as of March 31, 2010 was $2.4 million.
Forward currency contracts are recorded at fair value in other liabilities as of March 31, 2010 and
December 31, 2009, with the related changes in fair value recognized as realized investment gains
or losses in the consolidated statements of operations in the period in which they occur.
20
Table of Contents
ODYSSEY RE HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
The Company has investments in warrants, which are contracts that grant the holder the right,
but not the obligation, to purchase an underlying financial instrument at a given price and time or
at a series of prices and times. Warrants, which are included in other invested assets as of March
31, 2010 and December 31, 2009, are recorded at fair value, with the related changes in fair value
recognized as realized investment gains or losses in the consolidated statements of operations in
the period in which they occur.
The Company has entered into interest rate swaps to protect it from adverse movements in
interest rates. Under its current interest rate swap contracts, the Company receives a floating
interest rate and pays a fixed interest rate based on the notional amounts in the contracts.
Interest rate swaps are recorded at fair value in other liabilities as of March 31, 2010 and
December 31, 2009, with the related changes in fair value recognized as realized investment gains
or losses in the consolidated statements of operations in the period in which they occur.
The Company has purchased equity index total return swaps as an economic hedge against a
broad market downturn. During the fourth quarter of 2008, the Company had removed the then-existing
economic hedge on its portfolio, closing all of its total return swap contracts for a gain. Since
closing these positions, however, the Company has increased its holdings in equity securities
through additional acquisitions. In addition, the equity markets have experienced significant
appreciation in value since the end of 2008, further increasing the value of the Companys holdings
as well as the Companys exposure to market volatility. As a result, in September 2009, the Company
initiated U.S. equity index total return swap contracts, which had a notional value of $856.1
million as of March 31, 2010, to protect against potential future broad market downturns. The
collateral requirement related to entering the total return swaps was $65.2 million as of March 31,
2010. These total return swap transactions terminate during the third quarter of 2010. The equity
index total return swaps, in the aggregate, are recorded at fair value in other liabilities and
other invested assets as of March 31, 2010 and December 31, 2009, respectively, with the related
changes in the fair values recorded as realized gains or losses in the consolidated statements of
operations in the period in which they occur.
During the first quarter of 2010,
the Company purchased a common stock
total return swap, with a total notional value of
$129.9 million, as a replication of a long position in a publicly-listed common stock. The collateral requirement related
to this swap, which
terminates in the first quarter of 2011, was $13.0 million as of March 31, 2010. The common stock
total return swap was in a loss position as of March 31, 2010,
and is recorded in
other liabilities. Changes in the fair value of common stock total return swaps are recorded as
realized gains or losses in the consolidated statements of operations in the period in which they
occur.
As an economic hedge against the potential adverse impact on the Company of changes in price
levels in the economy, the Company has purchased inflation-linked derivative contracts referenced
to inflation indices in the geographic regions in which the Company operates. As of March 31, 2010
and December 31, 2009, the Company had 34 and three inflation-linked derivative contracts,
respectively, outstanding, with a carrying value in the consolidated balance sheet of $55.2 million
and $4.1 million, respectively, and a cost of $65.7 million and $4.0 million, respectively. The initial premium paid for inflation-linked derivative contracts
is recorded as a derivative asset and subsequently adjusted for changes in the unrealized fair
value of the contracts at each balance sheet date. Changes in the unrealized fair value of the
contracts are recorded as realized gains or losses on investments in the Companys consolidated statements
of operations with a corresponding adjustment to the carrying value of the
derivative asset. In the event of a sale, expiration or early settlement of one of the Companys
inflation-linked derivative contracts, the Company would receive the fair value of that contract on
the date of the transaction. The Companys maximum potential cash loss is limited to the premiums
paid to enter into the derivative contracts. Pursuant to the agreements governing the
inflation-linked derivatives, counterparties to these transactions are contractually required to
periodically deposit eligible collateral for the benefit of the Company in support of the
then-current fair value of the derivative contracts. As of March 31, 2010, the fair value of this
collateral was $39.1 million.
During 2008, the Company entered into Eurodollar futures contracts to manage its interest rate
risk with
21
Table of Contents
ODYSSEY RE HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
respect to certain investments. During the first quarter of 2009, the Company closed the futures
contracts. A futures contract is a variation of a forward currency contract, with some additional
features, such as a clearinghouse guarantee against credit losses, a daily settlement of gains and
losses, and trading on an organized electronic or floor trading facility. Futures contracts are
entered either long or short. The Company had entered into the long position, which agrees to buy
the underlying currency at the future date at the price agreed upon.
Counterparties to the derivative instruments expose the Company to credit risk in the event of
non-performance. The Company believes this risk is low, given the diversification among various
highly rated counterparties. The credit risk exposure is reflected in the fair value of the
derivative instruments.
The net realized investment gains or losses on disposal in the table below represent the total
gains or losses from the purchase dates of the investments and have been reported in net realized
investment gains in the consolidated statements of operations. The change in fair value presented
below consists of two components: (i) the reversal of the gain or loss recognized in previous years
on securities sold and (ii) the change in fair value resulting from mark-to-market adjustments on
contracts still outstanding. The following table sets forth the total net realized investment gains
and losses on derivatives for the three months ended March 31, 2010 and 2009 (in thousands):
Three Months Ended | ||||||||
March 31, | ||||||||
2010 | 2009 | |||||||
Credit default swaps: |
||||||||
Net realized investment (losses) gains on disposal |
$ | (804 | ) | $ | 28,380 | |||
Change in fair value |
(491 | ) | (25,309 | ) | ||||
Net realized investment (losses) gains |
(1,295 | ) | 3,071 | |||||
Total return swaps: |
||||||||
Net realized investment losses on disposal |
(37,664 | ) | | |||||
Change in fair value |
(4,374 | ) | | |||||
Net realized investment losses |
(42,038 | ) | | |||||
Forward currency contracts: |
||||||||
Net realized investment gains on disposal |
107 | | ||||||
Change in fair value |
4,460 | 11,997 | ||||||
Net realized investment gains |
4,567 | 11,997 | ||||||
Other: |
||||||||
Net realized investment losses on disposal |
(642 | ) | (687 | ) | ||||
Change in fair value |
(13,828 | ) | 285 | |||||
Net realized investment losses |
(14,470 | ) | (402 | ) | ||||
Total derivatives: |
||||||||
Net realized investment (losses) gains on disposal |
(39,003 | ) | 27,693 | |||||
Change in fair value |
(14,233 | ) | (13,027 | ) | ||||
Net realized investment (losses) gains |
$ | (53,236 | ) | $ | 14,666 | |||
22
Table of Contents
ODYSSEY RE HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
(e) Assets on Deposit
The Company is required to maintain assets on deposit with various regulatory authorities to
support its insurance and reinsurance operations. These requirements are generally promulgated in
the statutes and regulations of the individual jurisdictions. The assets on deposit are available
to settle insurance and reinsurance liabilities. The Company utilizes trust funds in certain
transactions where the trust funds are set up for the benefit of the ceding companies and generally
take the place of letter of credit requirements. As of March 31, 2010, restricted assets supporting
these deposits and trust fund requirements totaled $1,099.7 million, as depicted in the following
table (in thousands):
As of March 31, 2010 | ||||||||||||
Restricted Assets Relating to: | ||||||||||||
U.S. | Foreign | |||||||||||
Regulatory | Regulatory | |||||||||||
Requirements | Requirements | Total | ||||||||||
Fixed income securities |
$ | 387,340 | $ | 574,559 | $ | 961,899 | ||||||
Cash, cash equivalents and short-term investments |
6,768 | 130,997 | 137,765 | |||||||||
Total |
$ | 394,108 | $ | 705,556 | $ | 1,099,664 | ||||||
5. Accumulated Other Comprehensive Income (Loss)
The following table shows the components of the change in accumulated other comprehensive
income (loss), net of deferred income taxes, for the three months ended March 31, 2010 and 2009 (in
thousands):
Three Months Ended | ||||||||
March 31, | ||||||||
2010 | 2009 | |||||||
Beginning balance of accumulated other comprehensive income |
$ | 546,580 | $ | 82,421 | ||||
Beginning balance of unrealized net appreciation on securities |
538,335 | 75,166 | ||||||
Ending balance of unrealized net appreciation (depreciation) on securities |
640,832 | (10,313 | ) | |||||
Current period change in unrealized net appreciation (depreciation) on
securities |
102,497 | (85,479 | ) | |||||
Beginning balance of foreign currency translation adjustments |
13,484 | 10,716 | ||||||
Ending balance of foreign currency translation adjustments |
23,856 | 9,385 | ||||||
Current period change in foreign currency translation adjustments |
10,372 | (1,331 | ) | |||||
Beginning balance of benefit plan liabilities |
(5,239 | ) | (3,461 | ) | ||||
Ending balance of benefit plan liabilities |
(5,239 | ) | (3,461 | ) | ||||
Current period change in benefit plan liabilities |
| | ||||||
Current period change in accumulated other comprehensive income (loss) |
112,869 | (86,810 | ) | |||||
Ending balance of accumulated other comprehensive income (loss) |
$ | 659,449 | $ | (4,389 | ) | |||
23
Table of Contents
ODYSSEY RE HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
The components of comprehensive income (loss) for the three months ended March 31, 2010 and
2009 are shown in the following table (in thousands):
Three Months Ended | ||||||||
March 31, | ||||||||
2010 | 2009 | |||||||
Net income (loss) |
$ | 37,789 | $ | (5,791 | ) | |||
Other comprehensive income (loss), before tax: |
||||||||
Unrealized net appreciation (depreciation) on securities arising
during the period |
255,602 | (199,020 | ) | |||||
Reclassification adjustment for realized investment (gains) losses |
||||||||
included in net income (loss) |
(97,914 | ) | 67,510 | |||||
Foreign currency translation adjustments |
15,957 | (2,047 | ) | |||||
Other comprehensive income (loss), before tax |
173,645 | (133,557 | ) | |||||
Tax (provision) benefit: |
||||||||
Unrealized net (appreciation) depreciation on securities arising
during the period |
(89,461 | ) | 69,659 | |||||
Reclassification adjustment for realized investment gains (losses)
included in net income (loss) |
34,270 | (23,628 | ) | |||||
Foreign currency translation adjustments |
(5,585 | ) | 716 | |||||
Total tax (provision) benefit |
(60,776 | ) | 46,747 | |||||
Other comprehensive income (loss), net of tax |
112,869 | (86,810 | ) | |||||
Comprehensive income (loss) |
$ | 150,658 | $ | (92,601 | ) | |||
24
Table of Contents
ODYSSEY RE HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
6. Unpaid Losses and Loss Adjustment Expenses
The following table sets forth the activity in the liability for unpaid losses and loss
adjustment expenses for the three months ended March 31, 2010 and 2009 (in thousands):
Three Months Ended | ||||||||
March 31, | ||||||||
2010 | 2009 | |||||||
Gross unpaid losses and loss adjustment expenses, beginning of period |
$ | 5,507,766 | $ | 5,250,484 | ||||
Less: Ceded unpaid losses and loss adjustment expenses, beginning of
period |
841,486 | 690,171 | ||||||
Net unpaid losses and loss adjustment expenses, beginning of period |
4,666,280 | 4,560,313 | ||||||
Add: Net losses and loss adjustment expenses incurred related to: |
||||||||
Current period |
380,774 | 329,405 | ||||||
Prior periods |
(4,876 | ) | (11,814 | ) | ||||
Total net losses and loss adjustment expenses incurred |
375,898 | 317,591 | ||||||
Less: Net paid losses and loss adjustment expenses related to: |
||||||||
Current period |
20,963 | 26,624 | ||||||
Prior periods |
259,739 | 268,042 | ||||||
Total net paid losses and loss adjustment expenses |
280,702 | 294,666 | ||||||
Effects of exchange rate changes |
(23,978 | ) | (6,143 | ) | ||||
Net unpaid losses and loss adjustment expenses, end of period |
4,737,498 | 4,577,095 | ||||||
Add: Ceded unpaid losses and loss adjustment expenses, end of period |
899,470 | 689,208 | ||||||
Gross unpaid losses and loss adjustment expenses, end of period |
$ | 5,636,968 | $ | 5,266,303 | ||||
Estimates of reserves for unpaid losses and loss adjustment expenses, with respect to loss
events that have occurred on or before the balance sheet date, are contingent on many assumptions
that may or may not occur in the future. These assumptions include loss estimates attributable to a
variety of loss events, including earthquakes, hurricanes, windstorms and floods. The eventual outcome of these
loss events may be different from the assumptions underlying the Companys reserve estimates. When
the business environment and loss trends diverge from expected trends, the Company may have to
adjust its reserves accordingly, potentially resulting in adverse or favorable effects to the
Companys financial results. The Company believes that the recorded estimate represents the best
estimate of unpaid losses and loss adjustment expenses based on the information available as of
March 31, 2010. The estimate is reviewed on a quarterly basis and the ultimate liability may be
more or less than the amounts provided, for which any adjustments will be reflected in the periods
in which they become known.
Net losses and loss adjustment expenses incurred related to the current year, as reflected in
the table above, were $380.8 million and $329.4 million for the three months ended March 31, 2010
and 2009, respectively. The increase in losses and loss adjustment expenses incurred for the three
months ended March 31, 2010 was principally attributable to an increase in property catastrophe
losses. For the three months ended March 31, 2010 and 2009, current year property catastrophe losses were
$121.1 million and $47.7 million, respectively. For the three months ended March 31, 2010, current
year property catastrophe losses included $85.2 million related to the Chile earthquake and $17.6
million related to Windstorm Xynthia in Europe. For the three months ended March 31, 2009, current
year property catastrophe losses included $43.9 million related to Windstorm Klaus in Europe.
The loss estimates for property catastrophe losses such as the Chile earthquake and Windstorm
Xynthia represent the Companys best estimate based on the most recent information available.
The Company used various approaches in estimating its losses, including a detailed review of
exposed contracts and information from ceding companies. As additional information becomes
available, including information from ceding companies, actual
25
Table of Contents
ODYSSEY RE HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
losses may exceed the Companys estimated losses, potentially resulting in adverse effects to
the Companys financial results.
Net losses and loss adjustment expenses incurred related to prior years decreased $4.9 million
and $11.8 million for the three months ended March 31, 2010 and March 31, 2009, respectively. The
decrease in prior period losses and loss adjustment expenses for the three months ended March 31,
2010 was attributable to reduced loss estimates due to loss emergence lower than expectations in
the period on business written in the London Market and U.S. Insurance divisions, partially offset
by increased loss estimates due to loss emergence greater than expectations in the period on business written in the
Americas division. The decrease in prior period losses and loss adjustment expenses for the three
months ended March 31, 2009 was attributable to reduced loss estimates due to loss emergence lower
than expectations in the period on business written in all divisions.
The effects of exchange rate changes on net unpaid losses and loss adjustment expenses
resulted in decreases of $24.0 million and $6.1 million for the three months ended March 31, 2010
and 2009, respectively. The effects of exchange rate changes were attributable to changes in
foreign currency exchange rates for unpaid losses and loss adjustment expenses in the London Market
division.
Ceded unpaid losses and loss adjustment expenses were $899.5 million and $689.2 million as of
March 31, 2010 and 2009, respectively. The increase in ceded unpaid losses and loss adjustment
expenses was principally attributable to a $104.1 million increase in unpaid reinsurance
recoverables related to non-catastrophe exposure in the London Market division and an $80.7 million
increase in unpaid reinsurance recoverables related to property catastrophe events.
The Company uses tabular reserving for workers compensation indemnity loss reserves, which
are considered to be fixed and determinable, and discounts such reserves using an interest rate of
3.5%. Workers compensation indemnity loss reserves have been discounted using the Life Table for
Total Population: United States, 2004. Reserves reported at the discounted value were $117.2
million and $115.8 million as of March 31, 2010 and December 31, 2009, respectively. The amount of
case reserve discount was $54.2 million and $54.3 million as of March 31, 2010 and December 31,
2009, respectively. The amount of incurred but not reported reserve discount was $22.1 million and
$21.9 million as of March 31, 2010 and December 31, 2009, respectively.
7. Asbestos and Environmental Losses and Loss Adjustment Expenses
The Company has exposure to losses from asbestos, environmental pollution and other latent
injury damage claims. Net unpaid asbestos and environmental losses and loss adjustment expenses as
of March 31, 2010 were $252.8 million, representing 5.3% of total net unpaid losses and loss
adjustment expenses, compared to $265.5 million, or 5.7% of total net unpaid losses and loss
adjustment expenses as of December 31, 2009. Exposure arises from reinsurance contracts written by
Clearwater prior to 1986 under which the Company has assumed liabilities, on an indemnity or
assumption basis, from ceding companies, primarily in connection with general liability insurance
policies issued by such ceding companies. The Companys estimate of its ultimate liability for
these exposures includes case basis reserves and a provision for liabilities incurred but not
reported. Case basis reserves are a combination of reserves reported to the Company by ceding
companies and additional case reserves determined by the Company. The provision for liabilities
incurred but not reported is established based on an annual review of the Companys experience and
external trends in reported loss and claim payments, with monitoring of emerging experience on a
quarterly basis.
Estimation of ultimate asbestos and environmental liabilities is unusually complex due to
several factors resulting from the long period between exposure and manifestation of these claims.
This lag can complicate the identification of the sources of asbestos and environmental exposure,
the verification of coverage, and the allocation of liability among insurers and reinsurers over
multiple years. This lag also exposes the claim
26
Table of Contents
ODYSSEY RE HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
settlement process to changes in underlying laws and judicial interpretations. There continues
to be substantial uncertainty regarding the ultimate number of insureds with injuries resulting
from these exposures.
In addition, other issues have emerged regarding asbestos exposure that have further impacted
the ability to estimate ultimate liabilities for this exposure. These issues include an
increasingly aggressive plaintiffs bar, an increased involvement of defendants with peripheral
exposure, the use of bankruptcy filings due to asbestos liabilities as an attempt to resolve these
liabilities to the disadvantage of insurers, the concentration of litigation in venues favorable to
plaintiffs, and the potential of asbestos litigation reform at the state or federal level.
The Companys reserves for asbestos and environmental-related liabilities displayed below are
from business written prior to 1986. The Companys asbestos and environmental reserve development,
gross and net of reinsurance, for the three months ended March 31, 2010 and 2009, is set forth in
the table below (in thousands):
Three Months Ended | ||||||||
March 31, | ||||||||
2010 | 2009 | |||||||
Asbestos |
||||||||
Gross unpaid losses and loss adjustment expenses, beginning of
period |
$ | 386,735 | $ | 360,733 | ||||
Add: Gross losses and loss adjustment expenses incurred |
| | ||||||
Less: Gross calendar period paid losses and loss adjustment expenses |
18,335 | 11,582 | ||||||
Gross unpaid losses and loss adjustment expenses, end of period |
$ | 368,400 | $ | 349,151 | ||||
Net unpaid losses and loss adjustment expenses, beginning of period |
$ | 241,572 | $ | 230,486 | ||||
Add: Net losses and loss adjustment expenses incurred |
| | ||||||
Less: Net calendar period paid losses and loss adjustment expenses |
12,365 | 5,589 | ||||||
Net unpaid losses and loss adjustment expenses, end of period |
$ | 229,207 | $ | 224,897 | ||||
Environmental |
||||||||
Gross unpaid losses and loss adjustment expenses, beginning of
period |
$ | 27,142 | $ | 34,242 | ||||
Add: Gross losses and loss adjustment expenses incurred |
| | ||||||
Less: Gross calendar period paid losses and loss adjustment expenses |
249 | 4,479 | ||||||
Gross unpaid losses and loss adjustment expenses, end of period |
$ | 26,893 | $ | 29,763 | ||||
Net unpaid losses and loss adjustment expenses, beginning of period |
$ | 23,885 | $ | 29,819 | ||||
Add: Net losses and loss adjustment expenses incurred |
| | ||||||
Less: Net calendar period paid losses and loss adjustment expenses |
249 | 3,115 | ||||||
Net unpaid losses and loss adjustment expenses, end of period |
$ | 23,636 | $ | 26,704 | ||||
The Company did not incur net losses and loss adjustment expenses related to asbestos or
environmental claims for either of the three month periods ended March 31, 2010 or 2009.
The Companys survival ratio for asbestos and environmental-related liabilities as of March
31, 2010 is seven years. The Companys underlying survival ratio for asbestos-related liabilities
is seven years and for environmental-related liabilities is three years. The asbestos and
environmental-related liability survival ratio represents the asbestos and environmental reserves,
net of reinsurance, as of March 31, 2010, divided by the average paid asbestos and environmental
claims for the last three years of $39.0 million, which is net of reinsurance. Our survival ratios
may fluctuate over time due to the variability of large payments and adjustments to liabilities.
27
Table of Contents
ODYSSEY RE HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
8. Debt Obligations and Preferred Shares
Debt Obligations
The components of the Companys debt obligations as of March 31, 2010 and December 31, 2009
were as follows (in thousands):
March 31, | December 31, | |||||||
2010 | 2009 | |||||||
7.65% Senior Notes due 2013 |
$ | 224,844 | $ | 224,833 | ||||
6.875% Senior Notes due 2015 |
124,589 | 124,569 | ||||||
Series A Floating Rate Senior Debentures due 2021 |
50,000 | 50,000 | ||||||
Series B Floating Rate Senior Debentures due 2016 |
50,000 | 50,000 | ||||||
Series C Floating Rate Senior Debentures due 2021 |
40,000 | 40,000 | ||||||
Total debt obligations |
$ | 489,433 | $ | 489,402 | ||||
On November 28, 2006, the Company completed the private sale of $40.0 million aggregate
principal amount of floating rate senior debentures, series C, due December 15, 2021 (the Series C
Notes). Interest on the Series C Notes accrues at a rate per annum equal to the three-month London
Interbank Offer Rate (LIBOR), reset quarterly, plus 2.50%, and is payable quarterly in arrears on
March 15, June 15, September 15 and December 15 of each year. The Company has the option to redeem
the Series C Notes at par, plus accrued and unpaid interest, in whole or in part on any interest
payment date on or after December 15, 2011. For the three months ended March 31, 2010 and 2009, the
average annual interest rate on the Series C Notes was 2.75% and 4.37%, respectively.
On February 22, 2006, the Company issued $100.0 million aggregate principal amount of floating
rate senior debentures, pursuant to a private placement. The net proceeds from the offering, after
fees and expenses, were $99.3 million. The debentures were sold in two tranches: $50.0 million of
series A, due March 15, 2021 (the Series A Notes), and $50.0 million of series B, due March 15,
2016 (the Series B Notes). Interest on each series of debentures is due quarterly in arrears on
March 15, June 15, September 15 and December 15 of each year. The interest rate on each series of
debentures is equal to the three-month LIBOR, reset quarterly, plus 2.20%. The Series A Notes are
callable by the Company on any interest payment date on or after March 15, 2011 at their par value,
plus accrued and unpaid interest, and the Series B Notes are callable by the Company on any
interest payment date on or after March 15, 2009 at their par value, plus accrued and unpaid
interest. For the three months ended March 31, 2010 and 2009, the average annual interest rate on
each series of notes was 2.45% and 4.07%, respectively.
During the second quarter of 2005, the Company issued $125.0 million aggregate principal
amount of senior notes due May 1, 2015. The issue was sold at a discount of $0.8 million, which is
being amortized over the life of the notes. Interest accrues on the senior notes at a fixed rate of
6.875% per annum, which is due semi-annually on May 1 and November 1.
During the fourth quarter of 2003, the Company issued $225.0 million aggregate principal
amount of senior notes due November 1, 2013. The issue was sold at a discount of $0.4 million,
which is being amortized over the life of the notes. Interest accrues on the senior notes at a
fixed rate of 7.65% per annum, which is due semi-annually on May 1 and November 1.
28
Table of Contents
ODYSSEY RE HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
As of March 31, 2010, the aggregate maturities of the Companys debt obligations, at face
value, were as follows (in thousands):
Year | Amount | |||
2013 |
$ | 225,000 | ||
2015 |
125,000 | |||
2016 |
50,000 | |||
2021 |
90,000 | |||
Total |
$ | 490,000 | ||
As of both March 31, 2010 and December 31, 2009, the amortized cost of the Companys debt
obligations was $489.4 million as reflected in the respective consolidated balance sheets. As of
March 31, 2010 and December 31, 2009, the estimated fair value of the Companys debt obligations
was $509.7 million and $503.6 million, respectively. The estimated fair value is based on quoted
market prices of the Companys debt, where available, and for debt similar to the Companys, and
discounted cash flow calculations.
On July 13, 2007, the Company entered into a $200.0 million credit facility (the Credit
Agreement) with Wachovia Bank National Association (Wachovia), KeyBank National Association and
a syndicate of lenders. The original Credit Agreement provided for a five-year credit facility of
$200.0 million, $100.0 million of which was available for direct, unsecured borrowings by the
Company, and all of which was available for the issuance of collateralized letters of credit to
support the Companys insurance and reinsurance business. As of June 17, 2009, the Credit Agreement
was amended to explicitly permit the Company to pledge collateral to secure its obligations under
swap agreements, subject to certain financial limitations, in the event that such collateral is
required by the counterparty or counterparties. As of February 24, 2010, the Credit Agreement was
amended (i) to reduce the size of the facility to $100.0 million, removing the unsecured $100.0
million tranche, (ii) to remove the previous limitation on dividends and other restricted
payments that the Company may pay to its shareholders and (iii) amend certain of the covenants and
default provisions, the minimum ratings requirement, and the pricing of the credit facility.
The amended Credit Agreement contains an option that permits the Company to request an
increase in the aggregate amount of the facility by an amount up to $50.0 million, to a maximum
facility size of $150.0 million. Following such a request, each lender has the right, but not the
obligation, to commit to all or a portion of the proposed increase. As of March 31, 2010, there
was $33.7 million outstanding under the Credit Agreement, all of which was in support of secured
letters of credit.
In December 2008, the Company entered into interest rate swaps, with an aggregate notional
value of $140.0 million, to protect it from adverse movements in interest rates. Under these swap
contracts, the Company receives a floating interest rate of three-month LIBOR and pays a fixed
interest rate of 2.49% on the $140.0 million notional value of the contracts, for a five-year
period ending in December 2013.
Preferred Shares
During the first quarter of 2009, Odyssey America purchased 704,737 shares of the Companys
Series B preferred shares, with a liquidation preference of $17.2 million, for $9.2 million. As a
result of the purchase of the Series B preferred shares, the Company recorded a gain of $8.0
million during the three months ended March 31, 2009, which was reflected in the Companys retained
earnings and included in net income available to common shareholders.
29
Table of Contents
ODYSSEY RE HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
9. Segment Reporting
The Companys operations are managed through four operating divisions: Americas, EuroAsia,
London Market and U.S. Insurance. The Americas division is comprised of the Companys reinsurance
operations in the United States, Canada and Latin America, and writes property and casualty
reinsurance business on a treaty and facultative basis. The EuroAsia division writes treaty
reinsurance business. The London Market division operates through three distribution channels:
Newline Syndicate (1218) at Lloyds and NICL, which focus on casualty insurance, and the London
branch of Odyssey America, which focuses on worldwide property and casualty reinsurance. The U.S.
Insurance division writes specialty insurance lines and classes of business, such as medical
professional liability, professional liability, crop and commercial automobile.
The financial results of these divisions for the three months ended March 31, 2010 and 2009
are as follows (in thousands):
London | U.S. | |||||||||||||||||||
Three Months Ended March 31, 2010 | Americas | EuroAsia | Market | Insurance | Total | |||||||||||||||
Gross premiums written |
$ | 197,683 | $ | 164,839 | $ | 82,952 | $ | 116,182 | $ | 561,656 | ||||||||||
Net premiums written |
183,396 | 155,487 | 67,855 | 66,449 | 473,187 | |||||||||||||||
Net premiums earned |
$ | 176,656 | $ | 137,812 | $ | 67,584 | $ | 75,043 | $ | 457,095 | ||||||||||
Losses and loss adjustment expenses |
186,282 | 96,062 | 44,831 | 48,723 | 375,898 | |||||||||||||||
Acquisition costs and other underwriting
expenses |
62,294 | 33,710 | 18,494 | 25,549 | 140,047 | |||||||||||||||
Total underwriting deductions |
248,576 | 129,772 | 63,325 | 74,272 | 515,945 | |||||||||||||||
Underwriting (loss) income |
$ | (71,920 | ) | $ | 8,040 | $ | 4,259 | $ | 771 | (58,850 | ) | |||||||||
Net investment income |
84,104 | |||||||||||||||||||
Net realized investment gains |
53,957 | |||||||||||||||||||
Other expense, net |
(31,939 | ) | ||||||||||||||||||
Interest expense |
(7,485 | ) | ||||||||||||||||||
Income before income taxes |
$ | 39,787 | ||||||||||||||||||
Underwriting ratios: |
||||||||||||||||||||
Losses and loss adjustment expenses |
105.4 | % | 69.7 | % | 66.3 | % | 64.9 | % | 82.3 | % | ||||||||||
Acquisition costs and other
underwriting
expenses |
35.3 | 24.5 | 27.4 | 34.1 | 30.6 | |||||||||||||||
Combined ratio |
140.7 | % | 94.2 | % | 93.7 | % | 99.0 | % | 112.9 | % | ||||||||||
30
Table of Contents
ODYSSEY RE HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
London | U.S. | |||||||||||||||||||
Three Months Ended March 31, 2009 | Americas | EuroAsia | Market | Insurance | Total | |||||||||||||||
Gross premiums written |
$ | 195,297 | $ | 160,317 | $ | 72,942 | $ | 126,364 | $ | 554,920 | ||||||||||
Net premiums written |
190,697 | 153,586 | 52,487 | 82,209 | 478,979 | |||||||||||||||
Net premiums earned |
$ | 195,203 | $ | 138,215 | $ | 54,424 | $ | 82,176 | $ | 470,018 | ||||||||||
Losses and loss adjustment expenses |
117,375 | 110,675 | 34,661 | 54,880 | 317,591 | |||||||||||||||
Acquisition costs and other underwriting
expenses |
60,524 | 34,680 | 15,400 | 25,505 | 136,109 | |||||||||||||||
Total underwriting deductions |
177,899 | 145,355 | 50,061 | 80,385 | 453,700 | |||||||||||||||
Underwriting income (loss) |
$ | 17,304 | $ | (7,140 | ) | $ | 4,363 | $ | 1,791 | 16,318 | ||||||||||
Net investment income |
67,461 | |||||||||||||||||||
Net realized investment losses |
(99,363 | ) | ||||||||||||||||||
Other expense, net |
(4,202 | ) | ||||||||||||||||||
Interest expense |
(8,085 | ) | ||||||||||||||||||
Loss before income taxes |
$ | (27,871 | ) | |||||||||||||||||
Underwriting ratios: |
||||||||||||||||||||
Losses and loss adjustment expenses |
60.1 | % | 80.1 | % | 63.7 | % | 66.8 | % | 67.6 | % | ||||||||||
Acquisition costs and other
underwriting
expenses |
31.0 | 25.1 | 28.3 | 31.0 | 28.9 | |||||||||||||||
Combined ratio |
91.1 | % | 105.2 | % | 92.0 | % | 97.8 | % | 96.5 | % | ||||||||||
10. Commitments and Contingencies
On February 8, 2007, the Company was added as a co-defendant in an amended and consolidated
complaint in an existing action against the Companys then-majority (now 100%) shareholder,
Fairfax, and certain of Fairfaxs officers and directors, who included certain of the Companys
current and former directors. The amended and consolidated complaint was filed in the United States
District Court for the Southern District of New York by the lead plaintiffs, who sought to
represent a class of all purchasers and acquirers of securities of Fairfax between May 21, 2003 and
March 22, 2006, inclusive, and allege, among other things, that the defendants violated U.S.
federal securities laws by making material misstatements or failing to disclose certain material
information. The amended and consolidated complaint sought, among other things, certification of
the putative class, unspecified compensatory damages, unspecified injunctive relief, reasonable
costs and attorneys fees and other relief. Motions to dismiss were argued before the Court in
December 2007. On March 29, 2010, the Court granted defendants motion to dismiss on the grounds
that the Court lacked subject matter jurisdiction over the case. The Court also denied plaintiffs
request to move for leave to file a second amended complaint.
In July 2006, Fairfax, the Companys then-majority (now 100%) shareholder, filed a lawsuit in
the Superior Court, Morris County, New Jersey, seeking damages from a number of defendants who, the
complaint alleges, participated in a stock market manipulation scheme involving Fairfax shares, and
the complaint was subsequently amended to add additional allegations and two defendants. In January
2008, two of these defendants filed a counterclaim against Fairfax and a third-party complaint
against, among others, OdysseyRe and certain of its directors. Those counterclaims and third-party
claims were voluntarily withdrawn in March 2008. In September 2008, the same two defendants filed
an amended counterclaim against Fairfax, as well as third-party claims against certain Fairfax
executives, OdysseyRe and certain directors, Fairfaxs outside legal counsel and
PricewaterhouseCoopers. The complaint alleges, among other things, claims of racketeering,
intentional infliction of emotional distress, tortious interference with economic advantage and
other torts, and seeks unspecified compensatory and punitive damages and other relief. In September
2008, the Court granted a motion for summary judgment brought by two defendants, and dismissed
Fairfaxs claims against those defendants without prejudice. OdysseyRe denies the allegations and
intends to vigorously defend against these
31
Table of Contents
ODYSSEY RE HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
claims. OdysseyRe has not yet responded to the complaint, and the timing of that response has
not been set. Discovery in this action is ongoing. At this early stage of the proceedings, it is
not possible to make any determination regarding the likely outcome of this matter.
The Company participates in Lloyds through its 100% ownership of Newline Syndicate (1218),
for which the Company provides 100% of the capacity. The results of Newline Syndicate (1218) are
consolidated in the financial statements of the Company. In support of Newline Syndicate (1218)s
capacity at Lloyds, NCNL and Odyssey America have pledged securities and cash with a fair value of
$136.5 million and $123.8 million, respectively, as of March 31, 2010 in a deposit trust account in
favor of the Society and Council of Lloyds. These securities may be substituted with other
securities at the discretion of the Company, subject to approval by Lloyds. The securities are
carried at fair value and are included in investments and cash in the Companys consolidated
balance sheets. Interest earned on the securities is included in investment income. The pledge of
assets in support of Newline Syndicate (1218) provides the Company with the ability to participate
in writing business through Lloyds, which remains an important part of the Companys business. The
pledged assets effectively secure the contingent obligations of Newline Syndicate (1218) should it
not meet its obligations. NCNL and Odyssey Americas contingent liability to the Society and
Council of Lloyds is limited to the aggregate amount of the pledged assets. The Company has the
ability to remove funds at Lloyds annually, subject to certain minimum amounts required to support
outstanding liabilities as determined under risk-based capital models and approved by Lloyds. The
funds used to support outstanding liabilities are adjusted annually and the obligations of the
Company to support these liabilities will continue until they are settled or the liabilities are
reinsured by a third party approved by Lloyds. The Company expects to continue to actively operate
Newline Syndicate (1218) and support its requirements at Lloyds. The Company believes that Newline
Syndicate (1218) maintains sufficient liquidity and financial resources to support its ultimate
liabilities and the Company does not anticipate that the pledged assets will be utilized.
As of July 14, 2000, Odyssey America agreed to guarantee the performance of all the insurance
and reinsurance contract obligations, whether incurred before or after the agreement, of Compagnie
Transcontinentale de Réassurance (CTR), a subsidiary of Fairfax, in the event CTR became
insolvent and CTR was not otherwise indemnified under its guarantee agreement with a Fairfax
affiliate. The guarantee, which was entered into while Odyssey America and CTR were each 100% owned
by Fairfax, was provided by Odyssey America to facilitate the transfer of renewal rights to CTRs
business, together with certain CTR employees, to Odyssey America in 2000 in order to further
expand the Companys international reinsurance business. The guarantee was terminated effective
December 31, 2001. There were no amounts received from CTR under the guarantee, and the Company did
not provide any direct consideration for the renewal rights to the business of CTR. CTR was
dissolved and its assets and liabilities were assumed by subsidiaries of Fairfax that have the
responsibility for the run-off of its liabilities. Although CTRs liabilities were assumed by
Fairfax subsidiaries, the guarantee only pertains to those liabilities attaching to the policies
written by CTR. Fairfax has agreed to indemnify Odyssey America for all its obligations incurred
under its guarantee. The Companys potential exposure in connection with this agreement stems from
CTRs remaining gross reserves, which are estimated to be $107.6 million as of March 31, 2010. The
Company believes that the financial resources of the Fairfax subsidiaries that have assumed CTRs
liabilities provide adequate protection to satisfy the obligations that are subject to this
guarantee. The Company does not expect to make payments under this guarantee and does not consider
its potential exposure under this guarantee to be material to its consolidated financial position.
Odyssey America agreed, as of April 1, 2002, to guarantee the payment of all of the insurance
contract obligations (the Subject Contracts), whether incurred before or after the agreement, of
Falcon Insurance Company (Hong Kong) Limited (Falcon), a subsidiary of Fairfax Asia Limited
(Fairfax Asia), in the event Falcon becomes insolvent. Fairfax Asia is 100% owned by Fairfax,
which includes a 26.2% economic interest owned by the Company. The guarantee by Odyssey America was
made to assist Falcon in writing business
through access to Odyssey Americas financial strength ratings and capital resources. Odyssey
America is paid a fee for this guarantee of one quarter of one percent of all gross premiums earned
associated with the Subject Contracts on a quarterly basis. For each of the three month periods
ended March 31, 2010 and 2009, Falcon paid $0.1 million to Odyssey America in connection with this
guarantee. Odyssey Americas potential exposure in
32
Table of Contents
ODYSSEY RE HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
connection with this agreement is estimated to be $55.7 million, based on Falcons loss
reserves at March 31, 2010. Falcons shareholders equity on a U.S. GAAP basis is estimated to be
$61.6 million as of March 31, 2010. Fairfax has agreed to indemnify Odyssey America for any
obligation under this guarantee. The Company believes that the financial resources of Falcon
provide adequate protection to support its liabilities in the ordinary course of business. The
Company anticipates that Falcon will meet all of its obligations in the normal course of business
and does not expect to make any payments under this guarantee. The Company does not consider its
potential exposure under this guarantee to be material to its consolidated financial position.
The Company organized O.R.E Holdings Limited (ORE), a corporation domiciled in Mauritius, on
December 30, 2003 to act as a holding company for various investments in India. On January 29,
2004, ORE was capitalized by the Company in the amount of $16.7 million. ORE is consolidated in the
Companys consolidated financial statements. During 2004, ORE entered into a joint venture
agreement relating to the purchase by ORE of 45% of the shares of Cheran Enterprises Private
Limited (CEPL). CEPL is a corporation domiciled in India, engaged in the purchase, development
and sale of commercial real estate properties. The joint venture agreement governing CEPL contains
a provision whereby Odyssey America could have been called upon to provide a guarantee of a credit
facility, if such a facility had been established by CEPL, in an amount up to $65.0 million for the
funding of proposed developments. The credit facility was never established, and the requisite
conditions for any future provision of the guarantee no longer exist. OREs Indian joint venture
partner claimed that the guarantee should be available and pursued legal actions against the
Company. The Company found this claim without merit and vigorously defended the legal actions. On
August 13, 2008, the Company Law Board in Chennai, India ruled in OREs favor and directed CEPL to
return to ORE the full amount of its investment in CEPL, plus 8% interest, within the one-year
period commencing November 1, 2008. As of March 31, 2010, the Company had written down the value of
its investment in ORE by $9.9 million. The carrying value of the Companys investment in ORE as of
both March 31, 2010 and 2009 was $6.7 million. Because no payment of the award has yet been
received and collection may require additional legal action on the part of ORE, the Company has
taken no steps to reverse the write-downs that have been taken to date. The Company continues to
vigorously pursue collection of the award.
The Company and its subsidiaries are involved from time to time in ordinary litigation and
arbitration proceedings as part of the Companys business operations. In the Companys opinion, the
outcome of these suits, individually or collectively, is not likely to result in judgments that
would be material to the financial condition or results of operations of the Company.
11. Employee Benefits
The Company maintains a qualified, non-contributory, defined benefit pension plan (Defined
Benefit Pension Plan) covering substantially all employees who have reached age twenty-one and who
have completed one year of service. The Company also maintains two non-qualified excess benefit
plans (the Supplemental Employee Retirement Plan and the Supplemental Plan) that provide
officers and certain employees with defined retirement benefits in excess of qualified plan limits
imposed by federal tax law. In addition, certain health care and life insurance benefits for
retired employees (Postretirement Benefit Plan) are provided by the Company. Generally, all
employees may become eligible for these postretirement benefits if they reach retirement age while
working for the Company.
33
Table of Contents
ODYSSEY RE HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
Net periodic benefit cost, before taxes, included in the Companys consolidated statements of
operations for the three months ended March 31, 2010 and 2009 is comprised of the following
components (in thousands):
Three Months Ended | ||||||||
March 31, | ||||||||
2010 | 2009 | |||||||
Defined Benefit Pension Plan: |
||||||||
Service cost |
$ | 1,475 | $ | 1,280 | ||||
Interest cost |
981 | 858 | ||||||
Return on Plan assets |
(861 | ) | (547 | ) | ||||
Net amortization and deferral |
16 | 14 | ||||||
Net periodic benefit cost |
$ | 1,611 | $ | 1,605 | ||||
Excess Benefit Plans: |
||||||||
Service cost |
$ | 180 | $ | 183 | ||||
Interest cost |
229 | 238 | ||||||
Recognized net actuarial loss |
27 | 31 | ||||||
Recognized prior service cost |
(9 | ) | (9 | ) | ||||
Net periodic benefit cost |
$ | 427 | $ | 443 | ||||
Postretirement Benefit Plan: |
||||||||
Service cost |
$ | 736 | $ | 391 | ||||
Interest cost |
349 | 256 | ||||||
Net amortization and deferral |
63 | (43 | ) | |||||
Net periodic benefit cost |
$ | 1,148 | $ | 604 | ||||
The Company contributed $1.1 million to the Defined Benefit Pension Plan for the three months
ended March 31, 2010. No contributions were made to the above plans for the three months ended
March 31, 2009.
Effective January 1, 2010, the Company established the Odyssey Re Holdings Corp. Non-Qualified
2010 Employee Share Purchase Plan (the Plan). Under the terms of the Plan, eligible employees are
provided the opportunity to purchase subordinate voting shares of Fairfax in an amount up to 10% of
their annual base salary. The Company purchases, on behalf of each employee, Fairfax shares equal
in value to 30% of the employees contributions. In addition, if the total shareholders equity of
the Company attributable to the common equity increases at least 15% in any calendar year,
additional Fairfax shares will be purchased by the Company for each employees benefit, in an
amount equal in value to 20% of each employees contribution during that year. Employees eligible
for the previously established Odyssey Re Holdings Corp. Non-Qualified Employee Share Purchase Plan
prior to its suspension on October 2, 2009 are eligible to make a one-time retroactive contribution
to the Plan in an amount up to 10% of their gross pay for the suspended period.
12. Federal and Foreign Income Taxes
The Companys federal and foreign income tax provisions for the three months ended March 31,
2010 and 2009 were a $2.0 million tax expense and a $22.1 million tax benefit, respectively,
resulting in effective tax rates
of 5.0% and 79.2%, respectively. The effective tax rate of 5.0% for the three months ended
March 31, 2010 is not necessarily indicative of the effective tax rate for the 2010 interim or
annual periods.
34
Table of Contents
ODYSSEY RE HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (Continued)
The following table reconciles federal and foreign income taxes at the statutory federal
income tax rate to the Companys tax provision and effective tax rate for the three months ended
March 31, 2010 and 2009 (in thousands):
Three Months Ended March 31, | ||||||||||||||||
2010 | 2009 | |||||||||||||||
% of | % of | |||||||||||||||
Pre-tax | Pre-tax | |||||||||||||||
Amount | Income | Amount | Income | |||||||||||||
Income (loss) before income taxes |
$ | 39,787 | $ | (27,871 | ) | |||||||||||
Income tax provision (benefit) computed
at the U.S. statutory tax rate on income |
$ | 13,926 | 35.0 | % | $ | (9,755 | ) | 35.0 | % | |||||||
Decrease in income taxes resulting from: |
||||||||||||||||
Dividend received deduction |
(2,176 | ) | (5.5 | ) | (2,883 | ) | 10.3 | |||||||||
Tax-exempt income |
(9,661 | ) | (24.3 | ) | (9,389 | ) | 33.7 | |||||||||
Other, net |
(91 | ) | (0.2 | ) | (53 | ) | 0.2 | |||||||||
Total federal and foreign income
tax provision (benefit) |
$ | 1,998 | 5.0 | % | $ | (22,080 | ) | 79.2 | % | |||||||
13. Subsequent Event
Effective May 1, 2010, the Company and Fairfax, Inc. (a wholly-owned subsidiary of Fairfax,
and the direct and indirect holder of 100% of the common shares of the Company) entered into a
$300.0 million two-way revolving credit facility, under which either party may borrow up to $300.0
million from the other party. Loans under the facility are unsecured and bear interest at a rate of
7.5% per annum, payable quarterly, and the principal amount is
payable on demand. Either party may terminate the facility at any
time upon demand, at which time all outstanding principal and unpaid
interest shall become due. On May 3, 2010,
the Company loaned $200.0 million to Fairfax, Inc. under the facility.
35
Table of Contents
PART I Item 2. | Managements Discussion and Analysis of Financial Condition and Results of Operations |
Overview
Odyssey Re Holdings Corp. (together with its subsidiaries, OdysseyRe) is a holding company,
incorporated in the state of Delaware, which owns all of the common shares of Odyssey America
Reinsurance Corporation (Odyssey America), its principal operating subsidiary. Odyssey America
directly or indirectly owns all of the capital stock of the following companies: Clearwater
Insurance Company (Clearwater); Clearwater Select Insurance Company; Newline Holdings U.K.
Limited, Newline Underwriting Management Ltd., which manages Newline Syndicate (1218), a member of
Lloyds of London, and Newline Insurance Company Limited (NICL) (collectively Newline); Hudson
Insurance Company (Hudson); Hudson Specialty Insurance Company (Hudson Specialty); Napa
River Insurance Services, Inc.; and Hudson Crop Insurance Services,
Inc. As of March 31, 2010, 100% of the common stock of OdysseyRe is owned
by Fairfax Financial Holdings Limited (Fairfax) and its subsidiaries (see Note 1 to the
consolidated financial statements in this Form 10-Q).
OdysseyRe is a leading underwriter of reinsurance, providing a full range of property and
casualty products on a worldwide basis. We offer a broad range of both treaty and facultative
reinsurance to property and casualty insurers and reinsurers. We also write insurance in the United
States and through Newline.
Our gross premiums written for the three months ended March 31, 2010 were $561.7 million, an
increase of $6.8 million, or 1.2%, compared to gross premiums written of $554.9 million for the
three months ended March 31, 2009. Our United States business accounted for 46.7% of our gross
premiums written for the three months ended March 31, 2010, compared to 49.8% for the three months
ended March 31, 2009. For the three months ended March 31, 2010 and 2009, our net premiums written
were $473.2 million and $479.0 million, respectively. For the three months ended March 31, 2010 and
2009, we had net income available to common shareholders of $36.5 million and $0.9 million,
respectively. As of March 31, 2010, we had total assets of $11.0 billion and total shareholders
equity of $3.7 billion.
The property and casualty reinsurance and insurance industries use the combined ratio as a
measure of underwriting profitability. The combined ratio, computed when using amounts reported in
financial statements prepared under United States generally accepted accounting principles
(GAAP), is the sum of losses and loss adjustment expenses (LAE) incurred as a percentage of net
premiums earned, plus underwriting expenses, which include acquisition costs and other underwriting
expenses, as a percentage of net premiums earned. The combined ratio reflects only underwriting
results and does not include investment results. Underwriting profitability is subject to
significant fluctuations due to catastrophic events, competition, economic and social conditions,
foreign currency fluctuations and other factors. Our combined ratio was 112.9% for the three months
ended March 31, 2010, compared to 96.5% for the three months ended March 31, 2009.
We operate our business through four divisions: the Americas, EuroAsia, London Market and
U.S. Insurance.
The Americas division is our largest division and writes casualty, surety and property treaty
reinsurance, and casualty facultative reinsurance in the United States and Canada, and primarily
property treaty and facultative reinsurance in Latin America.
The EuroAsia division consists of our international reinsurance business, which is
geographically dispersed, mainly throughout Europe, and includes business in Asia, the Middle East,
Africa and the Americas.
The London Market division is comprised of our Lloyds of London business, in which we
participate through our 100% ownership of Newline Syndicate (1218), our London branch office, and
NICL, our London-based insurance company. The London Market division writes insurance and
reinsurance business worldwide, principally through brokers.
The U.S. Insurance division writes specialty insurance lines and classes of business, such as
medical and other professional liability, non-standard personal and commercial automobile,
specialty liability, property and package, and crop business.
36
Table of Contents
Critical Accounting Estimates
The consolidated financial
statements and related notes included in Part I, Item 1 of this
Form 10-Q have been prepared in accordance with GAAP and include the accounts of Odyssey Re
Holdings Corp. and its subsidiaries.
Critical accounting estimates are defined as those that are both important to the portrayal of
our financial condition and results of operations and require us to exercise significant judgment.
The preparation of consolidated financial statements in accordance with GAAP requires us to make
estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and
expenses and the disclosure of material contingent assets and liabilities, including litigation
contingencies. These estimates, by necessity, are based on assumptions about numerous factors.
We review our critical accounting estimates and assumptions on a quarterly basis. These
reviews include the estimate of reinsurance premiums and premium related amounts, establishing
deferred acquisition costs, an evaluation of the adequacy of reserves for unpaid losses and LAE,
review of our reinsurance and retrocession agreements, an analysis of the recoverability of
deferred income tax assets and an evaluation of our investment portfolio, including a review for
other-than-temporary declines in estimated fair value. Actual results may differ materially from
the estimates and assumptions used in preparing the consolidated financial statements.
Premium Estimates
We derive our revenues from two principal sources: (i) premiums from insurance placed and
reinsurance assumed, net of premiums ceded (net premiums written) and (ii) income from investments.
Net premiums written are earned (net premiums earned) as revenue over the terms of the underlying
contracts or certificates in force. The relationship between net premiums written and net premiums
earned will, therefore, vary depending on the volume and inception dates of the business assumed
and ceded, and the mix of such business between proportional and excess of loss reinsurance.
Consistent with our significant accounting policies, for our reinsurance business we utilize
estimates in establishing premiums written, the corresponding acquisition expenses, and unearned
premium reserves. These estimates are required to reflect differences in the timing of the receipt
of accounts from the ceding company and the actual due dates of the accounts at the close of each
accounting period.
37
Table of Contents
The following table displays, by division, the estimates included in our consolidated
financial statements as of and for the three months ended March 31, 2010 and 2009 and December 31,
2009 and 2008 related to gross premiums written, acquisition costs, premiums receivable and
unearned premium reserves (in millions):
As of | As of | As of | As of | |||||||||||||||||||||
March 31, | December 31, | March 31, | December 31, | |||||||||||||||||||||
Division | 2010 | 2009 | Change | 2009 | 2008 | Change | ||||||||||||||||||
Gross Premiums Written |
||||||||||||||||||||||||
Americas |
$ | 127.0 | $ | 111.5 | $ | 15.5 | $ | 144.2 | $ | 162.4 | $ | (18.2 | ) | |||||||||||
EuroAsia |
164.2 | 135.9 | 28.3 | 154.3 | 125.7 | 28.6 | ||||||||||||||||||
London Market |
27.1 | 21.9 | 5.2 | 22.9 | 22.8 | 0.1 | ||||||||||||||||||
Total |
$ | 318.3 | $ | 269.3 | $ | 49.0 | $ | 321.4 | $ | 310.9 | $ | 10.5 | ||||||||||||
Acquisition Costs |
||||||||||||||||||||||||
Americas |
$ | 27.5 | $ | 26.0 | $ | 1.5 | $ | 31.6 | $ | 42.5 | $ | (10.9 | ) | |||||||||||
EuroAsia |
41.6 | 35.2 | 6.4 | 43.4 | 36.9 | 6.5 | ||||||||||||||||||
London Market |
2.2 | 1.9 | 0.3 | 1.6 | 1.7 | (0.1 | ) | |||||||||||||||||
Total |
$ | 71.3 | $ | 63.1 | $ | 8.2 | $ | 76.6 | $ | 81.1 | $ | (4.5 | ) | |||||||||||
Premiums Receivable |
||||||||||||||||||||||||
Americas |
$ | 99.5 | $ | 85.5 | $ | 14.0 | $ | 112.6 | $ | 119.9 | $ | (7.3 | ) | |||||||||||
EuroAsia |
122.4 | 100.7 | 21.7 | 110.9 | 88.8 | 22.1 | ||||||||||||||||||
London Market |
25.0 | 20.0 | 5.0 | 21.3 | 21.1 | 0.2 | ||||||||||||||||||
Total |
$ | 246.9 | $ | 206.2 | $ | 40.7 | $ | 244.8 | $ | 229.8 | $ | 15.0 | ||||||||||||
Unearned Premium Reserves |
||||||||||||||||||||||||
Americas |
$ | 78.6 | $ | 83.6 | $ | (5.0 | ) | $ | 101.4 | $ | 115.5 | $ | (14.1 | ) | ||||||||||
EuroAsia |
103.3 | 93.1 | 10.2 | 108.8 | 102.2 | 6.6 | ||||||||||||||||||
London Market |
7.4 | 3.3 | 4.1 | 8.3 | 6.9 | 1.4 | ||||||||||||||||||
Total |
$ | 189.3 | $ | 180.0 | $ | 9.3 | $ | 218.5 | $ | 224.6 | $ | (6.1 | ) | |||||||||||
Estimates
of gross premiums written, acquisition costs, premiums receivable and unearned premium
reserves are established on a contract level for significant accounts due but not reported by the
ceding company at the end of each accounting period. The estimated ultimate premium for the
contract, actual accounts reported by the ceding company, and our own experience on the contract
are considered in establishing the estimate at the end of each accounting period. Subsequent
adjustments based on actual results are recorded in the period in which they become known. The
estimated premiums receivable balances are considered fully collectible. The estimates primarily
represent the unreported amounts for the most current two underwriting years of account. The
estimates are considered critical accounting estimates because changes in these estimates can
materially affect net income.
The difference between estimates and the actual accounts received may be material as a result
of different reporting practices by ceding companies across geographic locations. Estimates may be
subject to material fluctuations on an individual contract level compared to the actual information
received, and any differences are recorded in the respective financial period in which they become
known. Since the assumptions used to determine the estimates are reviewed quarterly and compared to
the information received during the quarter, the variance in the aggregate estimates compared to
the actual information when received is minimized. In addition, during the quarters review of
these contracts, any change in original estimate compared to the new estimate is
38
Table of Contents
reflected in the
appropriate financial period. In any specific financial period, the original estimated premium for
a specific contract may vary from actual premium reported through the life of the contract due
to the reporting patterns of the ceding companies and, in some cases, movements in foreign exchange
rates over the period.
In any specific financial period, the original estimated premium for a specific contract may
vary from actual premium reported through the life of the contract by up to 15% due to the
reporting patterns of the ceding companies and, in some cases, movements in foreign exchange rates
over the period. However, historically, the final reported premium compared to the original
estimated premium has deviated by insignificant amounts.
Our estimates are based on contract and policy terms. Estimates are based on information
typically received in the form of a bordereau, broker notifications and/or discussions with ceding
companies. These estimates, by necessity, are based on assumptions regarding numerous factors.
These can include premium or loss trends, which can be influenced by local conditions in a
particular region, or other economic factors and legal or legislative developments that can develop
over time. The risk associated with estimating the performance under our contracts with our ceding
companies is the impact of events or trends that could not have been reasonably anticipated at the
time the estimates were performed. Our business is diversified across ceding companies and there is
no individual ceding company that represents more than 2.6% of our gross premiums written during
the three months ended March 31, 2010. As a result, we believe the risks of material changes to
these estimates over time are mitigated.
We review information received from ceding companies for reasonableness based on past
experience with the particular ceding company or our general experience across the subject class of
business. We also query information provided by ceding companies for reasonableness. Reinsurance
contracts under which we assume business generally contain specific provisions that allow us to
perform audits of the ceding company to ensure compliance with the terms and conditions of the
contract, including accurate and timely reporting of information.
We must make judgments about the ultimate premiums written and earned by us. Reported premiums
written and earned are based upon reports received from ceding companies, supplemented by our
internal estimates of premiums written for which ceding company reports have not been received. We
establish our own estimates based on discussions and correspondence with our ceding companies and
brokers during the contract negotiation process and over the contract risk period. The
determination of premium estimates requires a review of our experience with the ceding companies,
familiarity with each market, an analysis and understanding of the characteristics of each line of
business, and the ability to project the impact of current economic indicators on the volume of
business written and ceded by our cedants. Premium estimates are updated when new information is
received. Differences between such estimates and actual amounts are recorded in the period in which
estimates are changed or the actual amounts are determined.
Reserves for Unpaid Losses and Loss Adjustment Expenses
Our losses and LAE reserves, for both reported and unreported claims obligations, are
maintained to cover the estimated ultimate liability for all of our reinsurance and insurance
obligations. Losses and LAE reserves are categorized in one of three ways: (i) case reserves, which
represent unpaid losses and LAE as reported by cedants and insureds to us, (ii) additional case
reserves (ACRs), which are reserves we establish in excess of the case reserves reported by the
cedant on individual claim events, and (iii) incurred but not reported reserves (IBNR), which are
reserves for losses and LAE that have been incurred, but have not yet been reported to us, as well
as additional amounts relating to losses already reported, that are in excess of case reserves and
ACRs. Incurred but not reported reserves are estimates based on all information currently available
to us and are reevaluated quarterly utilizing the most recent information supplied from our cedants
and claims adjusters.
We rely on initial and subsequent claim reports received from ceding companies for reinsurance
business, and the estimates advised by our claims adjusters for insurance business, to establish
our estimates of unpaid losses and LAE. The type of information that we receive from ceding
companies generally varies by the type of contract. Proportional, or quota share, reinsurance
contracts are typically reported on a quarterly basis, providing premium and loss activity as
estimated by the ceding company. Reporting for excess of loss, facultative and insurance contracts
includes detailed individual claim information, including a description of the loss, confirmation
of liability by the cedant or claims adjuster and the cedants or claims adjusters current
estimate of the ultimate liability under the claim. Upon receipt of claim notices from cedants and
insureds, we review the
39
Table of Contents
nature of the claim against the scope of coverage provided under the
contract. Questions arise from time to time regarding the interpretation of the characteristics of
a particular claim measured against the scope of contract
terms and conditions. Reinsurance contracts under which we assume business generally contain
specific dispute resolution provisions in the event that there is a coverage dispute with the
ceding company. The resolution of any individual dispute may impact estimates of ultimate claims
liabilities. Reported claims are in various stages of the settlement process. Each claim is settled
individually based on its merits, and certain claims may take several years to ultimately settle,
particularly where legal action is involved. Based on an assessment of the circumstances supporting
the claim, we may choose to establish additional case reserves over the amount reported by the
ceding company. Aggregate case reserves established in addition to reserves reported by ceding
companies were $11.6 million and $14.5 million as of March 31, 2010 and December 31, 2009,
respectively. Due to potential differences in ceding company reserving and reporting practices, we
perform periodic audits of our ceding companies to ensure the underwriting and claims procedures of
the cedant are consistent with representations made by the cedant during the underwriting process
and meet the terms of the reinsurance contract. Our estimates of ultimate loss liabilities make
appropriate adjustment for inconsistencies uncovered in this audit process. We also monitor our
internal processes to ensure that information received from ceding companies is processed in a
timely manner.
The reserve methodologies employed by us are dependent on the nature and quality of the data
that we collect from ceding companies for reinsurance business and claims adjusters for insurance
business. This data primarily consists of loss amounts reported by ceding companies and claims
adjusters, loss payments made by ceding companies and claims adjusters and premiums, written and
earned, reported by ceding companies or estimated by us. Underwriting and claim information
provided by our ceding companies and claims adjusters is aggregated by the year in which each
treaty or policy is written into groups of business by geographic region and type of business to
facilitate analysis, generally referred to as reserve cells. These reserve cells are reviewed
annually and change over time as our business mix changes. We supplement this information with
claims and underwriting audits of specific contracts and internally developed pricing trends, as
well as loss trend data developed from industry sources. This information is used to develop point
estimates of carried reserves for each business segment. These individual point estimates, when
aggregated, represent the total carried losses and LAE reserves carried in our consolidated
financial statements. Due to the uncertainty involving estimates of ultimate loss exposures, we do
not attempt to produce a range around our point estimate of loss. The actuarial techniques for
projecting losses and LAE reserves by reserve cell rely on historical paid and case reserve loss
emergence patterns and insurance and reinsurance pricing trends to establish the claims emergence
of future periods with respect to all reported and unreported insured events that have occurred on
or before the balance sheet date.
Our estimate of ultimate loss is determined based on a review of the results of several
commonly accepted actuarial projection methodologies incorporating the quantitative and qualitative
information described above. The specific methodologies we utilize in our loss reserve review
process include, but may not be limited to (i) incurred and paid loss development methods,
(ii) incurred and paid Bornhuetter Ferguson (BF) methods and (iii) loss ratio methods. The
incurred and paid loss development methods utilize loss development patterns derived from
historical loss emergence trends usually based on cedant supplied claim information to determine
ultimate loss. These methods assume that the ratio of losses in one period to losses in an earlier
period will remain constant in the future. Loss ratio methods multiply expected loss ratios,
derived from aggregated analyses of internally developed pricing trends, by earned premium to
determine ultimate loss. The incurred and paid BF methods are a blend of the loss development and
loss ratio methods. These methods utilize both loss development patterns, as well as expected loss
ratios, to determine ultimate loss. When using the BF methods, the initial treaty year ultimate
loss is based predominantly on expected loss ratios. As loss experience matures, the estimate of
ultimate loss using this methodology is based predominantly on loss development patterns. We
generally do not utilize methodologies that are dependent on claim counts reported, claim counts
settled or claim counts open. Due to the nature of our business, this information is not routinely
provided by ceding companies for every treaty. Consequently, actuarial methods utilizing this
information generally cannot be relied upon by us in our loss reserve estimation process. As a
result, for much of our business, the separate analysis of frequency and severity loss activity
underlying overall loss emergence trends is not practical. Generally, we rely on BF and loss ratio
methods for estimating ultimate loss liabilities for more recent treaty years. These methodologies,
at least in part, apply a loss ratio, determined from aggregated analyses of internally developed
pricing trends across reserve cells, to premium earned on that business. Adjustments to premium
estimates generate appropriate adjustments to ultimate loss estimates in the quarter in which they
occur using the BF and loss ratio methods. To
40
Table of Contents
estimate losses for more mature treaty years, we
generally rely on the incurred loss development methodology, which does not rely on premium
estimates. In addition, we may use other methods to estimate liabilities for specific types of
claims. For property catastrophe losses, we may utilize vendor catastrophe models to estimate
ultimate loss soon after a loss occurs, where loss information is not yet reported to us from
cedants. The provision for asbestos loss liabilities is established based on an annual review of
internal and external trends in reported loss and claim payments. IBNR is determined by subtracting
the total of paid loss and case reserves including ACRs from ultimate loss.
We complete comprehensive loss reserve reviews, which include a reassessment of loss
development and expected loss ratio assumptions, on an annual basis. The results of these reviews
are reflected in the period they are completed. Quarterly, we compare actual loss emergence to
expectations established by the comprehensive loss reserve review process. In the event that loss
trends diverge from expected trends, we may have to adjust our reserves for losses and LAE
accordingly. Any adjustments will be reflected in the periods in which they become known,
potentially resulting in adverse or favorable effects to our financial results. We believe that the
recorded estimate represents the best estimate of unpaid losses and LAE based on the information
available at March 31, 2010.
Our most significant assumptions underlying our estimate of losses and LAE reserves are as
follows: (i) that historical loss emergence trends are indicative of future loss development
trends; (ii) that internally developed pricing trends provide a reasonable basis for determining
loss ratio expectations for recent underwriting years; and (iii) that no provision is made for
extraordinary future emergence of new classes of loss or types of loss that are not sufficiently
represented in our historical database or that are not yet quantifiable if not in our database.
The ultimate settlement value of losses and LAE related to business written in prior periods
for the three month periods ended March 31, 2010 and 2009 were 0.1% and 0.3% below our estimates of
reserves for losses and LAE as previously established at December 31, 2009 and 2008, respectively.
Any future impact to income from changes in losses and LAE estimates may vary considerably from
historical experience. Our estimates of ultimate losses and LAE are based upon the information we
have available at any given point in time and upon our assumptions derived from that information.
Every one percentage point difference in the ultimate settlement value of losses and LAE compared
to our estimate of reserves for losses and LAE as of March 31, 2010 will impact pre-tax income by
$47.4 million.
If a change were to occur in the frequency and severity of claims underlying our March 31,
2010 unpaid losses and LAE, the approximate change in pre-tax income would be as follows (in
millions):
Decrease in | ||||
Pre-tax | ||||
Income | ||||
1.0% unfavorable change |
$ | 47.4 | ||
2.5% unfavorable change |
118.4 | |||
5.0% unfavorable change |
236.9 |
Historically, our actual results have varied considerably in certain instances from our
estimates of losses and LAE because historical loss emergence trends have not been indicative of
future emergence for certain segments of our business. In this period, we experienced loss
emergence, resulting from a combination of claim frequency and severity of losses, greater than
expectations that were established based on a review of prior years loss emergence trends,
particularly for business written in the late 1990s and early 2000s. General liability and excess
workers compensation classes of business during these years were adversely impacted by the highly
competitive conditions in the industry at that time. These competitive conditions resulted in price
pressure and relatively broader coverage terms, thereby affecting the ability of standard actuarial
techniques to generate reliable estimates of ultimate loss. Similarly, directors and officers
professional liability lines were impacted by the increase in frequency and severity of claims
resulting from an increase in shareholder lawsuits against corporations and their officers and
directors, corporate bankruptcies and other financial and management improprieties in the late
1990s and early 2000s.
41
Table of Contents
The following table provides detail on net adverse (favorable) loss and LAE development
for prior years, by division, for the three months ended March 31, 2010 and 2009 (in millions):
Three Months Ended | ||||||||
March 31, | ||||||||
Division | 2010 | 2009 | ||||||
Americas |
$ | 2.9 | $ | (1.3 | ) | |||
EuroAsia |
0.1 | (4.8 | ) | |||||
London Market |
(4.3 | ) | (2.1 | ) | ||||
U.S. Insurance |
(3.6 | ) | (3.6 | ) | ||||
Total loss and LAE development |
$ | (4.9 | ) | $ | (11.8 | ) | ||
The Americas division reported a net increase in prior period loss estimates of
$2.9 million for the three months ended March 31, 2010, and a net decrease in prior period loss
estimates of $1.3 million for the three months ended March 31, 2009. The increase in prior period
loss estimates for the three months ended March 31, 2010 was principally attributable to loss
emergence greater than expectations in the period on property business. The decrease in prior
period loss estimates for the three months ended March 31, 2009 was principally attributable to
loss emergence lower than expectations in the period on miscellaneous property lines of business.
The EuroAsia division reported a net increase in prior period loss estimates of $0.1 million
for the three months ended March 31, 2010, and a net decrease in prior period loss estimates of
$4.8 million for the three months ended March 31, 2009. The decrease in prior period loss estimates
for the three months ended March 31, 2009 was driven by loss emergence lower than expectations in
the period on miscellaneous property lines of business.
The London Market division reported net decreases in prior period loss estimates of $4.3
million and $2.1 million for the three months ended March 31, 2010 and 2009, respectively. The
decrease in prior period loss estimates for the three months ended March 31, 2010 was principally
attributable to loss emergence lower than expectations in the period on liability and miscellaneous
property lines of business, partially offset by increased loss estimates due to loss emergence
greater than expectations in the period on medical malpractice business. The decrease in prior
period loss estimates for the three months ended March 31, 2009 resulted from loss emergence lower
than expectations in the period on liability business.
The U.S. Insurance division reported net decreases in prior period loss estimates of $3.6
million for both the three months ended March 31, 2010 and 2009. The decrease in prior period loss
estimates for the three months ended March 31, 2010 was principally due to loss emergence lower
than expectations in the period on miscellaneous liability business. The decrease in prior
period loss estimates for the three months ended March 31, 2009 was principally attributable to
loss emergence lower than expectations in the period on miscellaneous liability business.
Estimates of reserves for unpaid losses and LAE are contingent upon legislative,
regulatory, social, economic and legal events and trends that may or may not occur or develop in
the future, thereby affecting assumptions of claim frequency and severity. Examples of emerging
claim and coverage issues and trends in recent years that could affect reserve estimates include
developments in tort liability law, legislative attempts at asbestos liability reform, an increase
in shareholder derivative suits against corporations and their officers and directors, and
increasing governmental involvement in the insurance and reinsurance industry. The eventual outcome
of these events and trends may be different from the assumptions underlying our loss reserve
estimates. In the event that loss trends diverge from expected trends during the period, we adjust
our reserves to reflect the change in losses indicated by revised expected loss trends. On a
quarterly basis, we compare actual emergence of the total value of newly reported losses to the
total value of losses expected to be reported during the period and the cumulative value since the
date of our last reserve review. Variation in actual loss emergence from expectations may result in
a change in our estimate of losses and LAE reserves. Any adjustments
will be reflected in the periods in which they become known,
potentially resulting in adverse or favorable effects to our
financial results. Changes in expected claim payment rates, which
represent one component of losses and LAE
42
Table of Contents
emergence, may impact our liquidity and capital resources, as discussed below in Liquidity
and Capital Resources.
The following table summarizes, by type of reserve and division, the unpaid losses and LAE
reserves as of March 31, 2010 and December 31, 2009. Case reserves represent unpaid claim reports
provided by cedants and claims adjusters plus additional reserves determined by us. IBNR is the
estimate of unreported loss liabilities established by us.
As of March 31, 2010 | As of December 31, 2009 | |||||||||||||||||||||||
Case | Total | Case | Total | |||||||||||||||||||||
Reserves | IBNR | Reserves | Reserves | IBNR | Reserves | |||||||||||||||||||
(In millions) | ||||||||||||||||||||||||
Americas |
||||||||||||||||||||||||
Gross |
$ | 1,325.3 | $ | 1,487.4 | $ | 2,812.7 | $ | 1,369.2 | $ | 1,356.6 | $ | 2,725.8 | ||||||||||||
Ceded |
(171.7 | ) | (169.9 | ) | (341.6 | ) | (178.4 | ) | (120.2 | ) | (298.6 | ) | ||||||||||||
Net |
1,153.6 | 1,317.5 | 2,471.1 | 1,190.8 | 1,236.4 | 2,427.2 | ||||||||||||||||||
EuroAsia |
||||||||||||||||||||||||
Gross |
582.2 | 381.9 | 964.1 | 589.8 | 320.7 | 910.5 | ||||||||||||||||||
Ceded |
(32.0 | ) | (20.6 | ) | (52.6 | ) | (33.0 | ) | (2.6 | ) | (35.6 | ) | ||||||||||||
Net |
550.2 | 361.3 | 911.5 | 556.8 | 318.1 | 874.9 | ||||||||||||||||||
London Market |
||||||||||||||||||||||||
Gross |
416.4 | 675.4 | 1,091.8 | 387.6 | 707.2 | 1,094.8 | ||||||||||||||||||
Ceded |
(79.2 | ) | (174.9 | ) | (254.1 | ) | (67.1 | ) | (183.2 | ) | (250.3 | ) | ||||||||||||
Net |
337.2 | 500.5 | 837.7 | 320.5 | 524.0 | 844.5 | ||||||||||||||||||
U.S. Insurance |
||||||||||||||||||||||||
Gross |
237.7 | 530.7 | 768.4 | 255.2 | 521.5 | 776.7 | ||||||||||||||||||
Ceded |
(70.6 | ) | (180.6 | ) | (251.2 | ) | (81.9 | ) | (175.1 | ) | (257.0 | ) | ||||||||||||
Net |
167.1 | 350.1 | 517.2 | 173.3 | 346.4 | 519.7 | ||||||||||||||||||
Total |
||||||||||||||||||||||||
Gross |
2,561.6 | 3,075.4 | 5,637.0 | 2,601.8 | 2,906.0 | 5,507.8 | ||||||||||||||||||
Ceded |
(353.5 | ) | (546.0 | ) | (899.5 | ) | (360.4 | ) | (481.1 | ) | (841.5 | ) | ||||||||||||
Net |
$ | 2,208.1 | $ | 2,529.4 | $ | 4,737.5 | $ | 2,241.4 | $ | 2,424.9 | $ | 4,666.3 | ||||||||||||
The provision for IBNR in unpaid losses and LAE as of March 31, 2010 was $2,529.4 million. For
illustration purposes, a change in the expected loss ratio that increases the three months ended
March 31, 2010 calendar year loss ratio by 2.5 loss ratio points would increase IBNR by $11.4
million. A change in loss emergence trends that increases unpaid losses and LAE at March 31, 2010
by 2.5% would increase IBNR by $118.4 million.
We have exposure to asbestos, environmental pollution and other latent injury damage claims
resulting from contracts written by Clearwater prior to 1986. Exposure arises from reinsurance
contracts under which we assumed liabilities from ceding companies, on an indemnity or assumption
basis, primarily in connection with general liability insurance policies issued by such ceding
companies. Our estimate of the ultimate liability for these exposures includes case basis reserves
and a provision for IBNR claims. The provision for asbestos loss liabilities is established based
on an annual review of Company and external trends in reported loss and claim payments, with
monitoring of emerging experience on a quarterly basis.
43
Table of Contents
Estimation of ultimate asbestos and environmental liabilities is unusually complex due to
several factors resulting from the long period between exposure and manifestation of these claims.
This lag can complicate the identification of the sources of asbestos and environmental exposure,
the verification of coverage and the allocation of liability among insurers and reinsurers over
multiple years. This lag also exposes the claim settlement process to changes in underlying laws
and judicial interpretations. There continues to be substantial uncertainty regarding the ultimate
number of insureds with injuries resulting from these exposures.
In addition, other issues have emerged regarding asbestos exposure that have further impacted
the ability to estimate ultimate liabilities for this exposure. These issues include an
increasingly aggressive plaintiffs bar, an increased involvement of defendants with peripheral
exposure, the use of bankruptcy filings due to asbestos liabilities as an attempt to resolve these
liabilities to the disadvantage of insurers, the concentration of litigation in venues favorable to
plaintiffs, and the potential of asbestos litigation reform at the state or federal level.
We believe that these uncertainties and factors make projections of these exposures,
particularly asbestos, subject to less predictability relative to non-environmental and
non-asbestos exposures. Current estimates, as of March 31, 2010, of our asbestos and environmental
losses and LAE reserves, net of reinsurance, are $229.2 million and $23.6 million, respectively.
See Note 7 to the consolidated financial statements of this Form 10-Q for additional historical
information on losses and LAE reserves for these exposures.
We did not incur net losses and
LAE related to asbestos or environmental
claims for either of the three month periods ended March 31, 2010 or 2009.
Reinsurance and Retrocessions
We may purchase reinsurance to increase our aggregate premium capacity, to reduce and spread
the risk of loss on our insurance and reinsurance business and to limit our exposure to multiple
claims arising from a single occurrence. We are subject to accumulation risk with respect to
catastrophic events involving multiple contracts. To protect against this risk, we have purchased
catastrophe excess of loss reinsurance protection. The retention, the level of capacity purchased,
the geographical scope of the coverage and the costs vary from year to year. Specific reinsurance
protections are also placed to protect our insurance business outside of the United States.
We seek to limit our net after-tax probable maximum loss for a severe catastrophic event,
defined as an occurrence with a return period of 250 years, to no more than 20% of our statutory
surplus. There can be no assurances that we will not incur losses greater than 20% of our statutory
surplus from one or more catastrophic events due to the inherent uncertainties in (i) estimating
the frequency and severity of such events, (ii) the margin of error in making such determinations
resulting from potential inaccuracies and inadequacies in the data provided by clients and brokers,
(iii) the modeling techniques and the application of such techniques and (iv) the values of
securities in our investment portfolio, which may lead to volatility in our statutory surplus from
period to period.
When we purchase reinsurance protection, we cede to reinsurers a portion of our risks and pay
premiums based upon the risk and exposure of the policies subject to the reinsurance. Although the
reinsurer is liable to us for the reinsurance ceded, we retain the ultimate liability in the event
the reinsurer is unable to meet its obligations at some later date.
44
Table of Contents
Reinsurance recoverables are recorded as assets, based on our evaluation of the
retrocessionaires ability to meet their obligations under the agreements. Premiums written and
earned are stated net of reinsurance ceded in the consolidated statements of operations. Direct
insurance, reinsurance assumed, reinsurance ceded and net amounts for these items follow (in
millions):
Three Months Ended | ||||||||
March 31, | ||||||||
2010 | 2009 | |||||||
Premiums Written |
||||||||
Direct |
$ | 165.4 | $ | 166.8 | ||||
Add: assumed |
396.3 | 388.1 | ||||||
Less: ceded |
88.5 | 75.9 | ||||||
Net |
$ | 473.2 | $ | 479.0 | ||||
Premiums Earned |
||||||||
Direct |
$ | 181.9 | $ | 169.5 | ||||
Add: assumed |
357.5 | 365.8 | ||||||
Less: ceded |
82.3 | 65.3 | ||||||
Net |
$ | 457.1 | $ | 470.0 | ||||
The total amount of reinsurance recoverables on paid and unpaid losses as of March 31,
2010 and December 31, 2009 was $941.7 million and $912.0 million, respectively. We have established
a reserve for potentially uncollectible reinsurance recoverables based upon an evaluation of each
retrocessionaire and our assessment as to the collectability of individual balances. The reserve
for uncollectible recoverables as of March 31, 2010 and December 31, 2009, was $42.1 million and
$41.9 million, respectively, and has been netted against reinsurance recoverables on paid losses.
We have also established a reserve for potentially uncollectible insurance and assumed reinsurance
balances of $5.8 million and $5.5 million as of March 31, 2010 and December 31, 2009, respectively,
which has been netted against premiums receivable.
Results of Operations
Three Months Ended March 31, 2010 Compared to Three Months Ended March 31, 2009
Underwriting Results
Gross Premiums Written. Gross premiums written for the three months ended March 31,
2010 increased by $6.8 million, or 1.2%, to $561.7 million, compared to $554.9 million for the
three months ended March 31, 2009, as reflected in the following table (in millions):
Three Months Ended | ||||||||||||||||
March 31, | Change | |||||||||||||||
Division | 2010 | 2009 | $ | % | ||||||||||||
Americas |
$ | 197.7 | $ | 195.3 | $ | 2.4 | 1.2 | % | ||||||||
EuroAsia |
164.8 | 160.3 | 4.5 | 2.8 | ||||||||||||
London Market |
83.0 | 72.9 | 10.1 | 13.9 | ||||||||||||
U.S. Insurance |
116.2 | 126.4 | (10.2 | ) | (8.1 | ) | ||||||||||
Total gross premiums written |
$ | 561.7 | $ | 554.9 | $ | 6.8 | 1.2 | % | ||||||||
Total reinsurance gross premiums written for the three months ended March 31, 2010 were $396.3
million, compared to $388.1 million for the three months ended March 31, 2009, an increase of 2.1%.
Total insurance gross premiums written for the three months ended March 31, 2010, which include our
U.S. Insurance division
45
Table of Contents
and the insurance business underwritten by our London Market division, were $165.4 million,
compared to $166.8 million for the three months ended March 31, 2009, a decrease of 0.8%. For the
three months ended March 31, 2010, total reinsurance gross premiums written represented 70.6%
(69.9% in the three months ended March 31, 2009) of our business, while insurance represented the
remaining 29.4% (30.1% in the three months ended March 31, 2009) of our business.
Americas. Gross premiums written in the Americas division for the three months ended
March 31, 2010 were $197.7 million, an increase of $2.4 million, or 1.2%, compared to $195.3
million for the three months ended March 31, 2009. These amounts represented 35.2% of our gross
premiums written for both of the three month periods ended March 31, 2010 and 2009. Gross premiums
written across each geographic region of the Americas division were as follows (in millions):
Three Months Ended | ||||||||||||||||
March 31, | Change | |||||||||||||||
2010 | 2009 | $ | % | |||||||||||||
United States |
$ | 146.4 | $ | 149.8 | $ | (3.4 | ) | (2.3 | )% | |||||||
Latin America |
36.5 | 36.5 | | | ||||||||||||
Canada |
14.8 | 9.0 | 5.8 | 64.4 | ||||||||||||
Total gross premiums written |
$ | 197.7 | $ | 195.3 | $ | 2.4 | 1.2 | % | ||||||||
| United States The decrease in gross premiums written was primarily due to a decrease in casualty treaty business of $15.8 million, to $64.0 million, for the three months ended March 31, 2010, compared to $79.8 million for the three months ended March 31, 2009, and a decrease in casualty facultative business of $4.5 million, to $14.5 million, for the three months ended March 31, 2010, compared to $19.0 million for the three months ended March 31, 2009. These decreases were partially offset by an increase in property treaty business of $16.8 million, to $55.3 million, for the three months ended March 31, 2010, compared to $38.5 million for the three months ended March 31, 2009. | ||
| Canada The increase in gross premiums written was primarily due to increased volume from share increases on existing business, and new business written, in 2010. |
EuroAsia. Gross premiums written in the EuroAsia division for the three months ended
March 31, 2010 were $164.8 million, an increase of $4.5 million, or 2.8%, compared to $160.3
million for the three months ended March 31, 2009. These amounts represented 29.3% of our gross
premiums written for the three months ended March 31, 2010 and 28.9% in the corresponding period of
2009. The increase in gross premiums written was principally comprised of $13.4 million
attributable to the movement in foreign exchange rates. Excluding the effects of foreign exchange
rate movement, gross premiums would have decreased by $8.9 million.
London Market. Gross premiums written in the London Market division for the three
months ended March 31, 2010 were $83.0 million, an increase of $10.1 million, or 13.9%, compared to
$72.9 million for the three months ended March 31, 2009. These amounts represented 14.8% of our
gross premiums written for the three months ended March 31, 2010 and 13.1% for the three months
ended March 31, 2009. Gross premiums written across each unit of the London Market division were as
follows (in millions):
Three Months Ended | ||||||||||||||||
March 31, | Change | |||||||||||||||
2010 | 2009 | $ | % | |||||||||||||
London branch |
$ | 33.8 | $ | 32.5 | $ | 1.3 | 4.0 | % | ||||||||
Newline |
49.2 | 40.4 | 8.8 | 21.8 | ||||||||||||
Total gross premiums written |
$ | 83.0 | $ | 72.9 | $ | 10.1 | 13.9 | % | ||||||||
The increase in gross premiums written by the London branch was primarily attributable to
marine and aviation business, which increased by $1.8 million, or 22.2%. This increase was offset
by a decrease in casualty business of $0.5 million, or 16.1%, due to the non-renewal of business
not meeting our underwriting standards.
46
Table of Contents
The increase in gross premiums written by Newline was primarily attributable to increases in
liability lines/financial institution and motor business of $5.8 million and $6.0 million,
respectively. These amounts were offset by a decrease in medical professional liability business of
$3.0 million.
U.S. Insurance. Gross premiums written in the U.S. Insurance division for the three
months ended March 31, 2010 were $116.2 million, a decrease of $10.2 million, or 8.1%, compared to
$126.4 million for the three months ended March 31, 2009. These amounts represented 20.7% of our
gross premiums written for the three months ended March 31, 2010 and 22.8% for the three months
ended March 31, 2009. Gross premiums written by line of business were as follows (in millions):
Three Months Ended | ||||||||||||||||
March 31, | Change | |||||||||||||||
2010 | 2009 | $ | % | |||||||||||||
Professional liability |
$ | 30.7 | $ | 27.9 | $ | 2.8 | 10.0 | % | ||||||||
Specialty liability |
29.8 | 28.5 | 1.3 | 4.6 | ||||||||||||
Medical professional liability |
22.5 | 22.8 | (0.3 | ) | (1.3 | ) | ||||||||||
Property and package |
18.0 | 26.0 | (8.0 | ) | (30.8 | ) | ||||||||||
Commercial automobile |
13.5 | 16.6 | (3.1 | ) | (18.7 | ) | ||||||||||
Personal automobile |
1.7 | 4.6 | (2.9 | ) | (63.0 | ) | ||||||||||
Total gross premiums written |
$ | 116.2 | $ | 126.4 | $ | (10.2 | ) | (8.1 | )% | |||||||
The reduction in gross premiums written for the three months ended March 31, 2010 compared to
the three months ended March 31, 2009 principally relates to the declines in crop (in property and
package) and personal automobile books of business.
Ceded Premiums Written. Ceded premiums written for the three months ended March 31,
2010 increased by $12.6 million, or 16.6%, to $88.5 million (15.8% of gross premiums written), from
$75.9 million (13.7% of gross premiums written) for the three months ended March 31, 2009. The
increase in ceded premiums written was primarily related to an increase in reinsurance purchased
for our professional and medical professional liability business in the U.S. Insurance division and
reinstatement premiums related to the Chile earthquake.
Net Premiums Written. Net premiums written for the three months ended March 31, 2010
decreased by $5.8 million, or 1.2%, to $473.2 million, compared to $479.0 million for the three
months ended March 31, 2009. Net premiums written represent gross premiums written less ceded
premiums written.
Three Months Ended | ||||||||||||||||
March 31, | Change | |||||||||||||||
Division | 2010 | 2009 | $ | % | ||||||||||||
(In millions) | ||||||||||||||||
Americas |
$ | 183.4 | $ | 190.7 | $ | (7.3 | ) | (3.8) | % | |||||||
EuroAsia |
155.5 | 153.6 | 1.9 | 1.2 | ||||||||||||
London Market |
67.9 | 52.5 | 15.4 | 29.3 | ||||||||||||
U.S. Insurance |
66.4 | 82.2 | (15.8 | ) | (19.2 | ) | ||||||||||
Total net premiums written |
$ | 473.2 | $ | 479.0 | $ | (5.8 | ) | (1.2) | % | |||||||
Americas. Net premiums written in the Americas division for the three months ended
March 31, 2010 were $183.4 million, compared to $190.7 million for the 2009 period, a decrease of
3.8%. These amounts represented 38.8% of our net premiums written for the three months ended March
31, 2010 and 39.8% for the three months ended March 31, 2009. The net retention ratio, which
represents net premiums written as a percentage of gross premiums written, was 92.8% and 97.6% for
the three months ended March 31, 2010 and 2009, respectively.
47
Table of Contents
The decrease in net premiums written in the Americas division for the three months ended March
31, 2010 was primarily due to an increase in ceded premiums written related to reinstatement
premiums due to the losses from the Chile earthquake in Latin America.
EuroAsia. Net premiums written in the EuroAsia division for the three months ended
March 31, 2010 were $155.5 million, compared to $153.6 million for 2009, an increase of 1.2%. These
amounts represented 32.9% of our net premiums written for the three months ended March 31, 2010 and
32.1% for the three months ended March 31, 2009. The net retention ratio was 94.4% for the three
months ended March 31, 2010, compared to 95.8% for the three months ended March 31, 2009.
The increase in net premiums written consisted of an increase in gross premiums written of
$4.5 million and an increase in ceded premiums written of $2.6 million.
London Market. Net premiums written in the London Market division for the three
months ended March 31, 2010 were $67.9 million, compared to $52.5 million for 2009, an increase of
29.3%. These amounts represented 14.3% of our net premiums written for the three months ended March
31, 2010 and 11.0% for the three months ended March 31, 2009. The net retention ratio was 81.8% for
the three months ended March 31, 2010, compared to 72.0% for the three months ended March 31, 2009.
The increase in net premiums written consisted of an increase in gross premiums written of
$10.1 million, coupled with a decrease in ceded premiums written of $5.3 million.
U.S. Insurance. Net premiums written in the U.S. Insurance division for the three
months ended March 31, 2010 were $66.4 million, compared to $82.2 million for the three months
ended March 31, 2009, a decrease of 19.2%. These amounts represented 14.0% of our net premiums
written for the three months ended March 31, 2010 and 17.1% for the three months ended March 31,
2009. The net retention ratio was 57.1% for the three months ended March 31, 2010, compared to
65.0% for the three months ended March 31, 2009.
The decrease in net premiums written was due to a decrease in gross premiums written of $10.2
million, combined with a lower retention rate.
Net Premiums Earned. Net premiums earned for the three months ended March 31, 2010
decreased by $12.9 million, or 2.7%, to $457.1 million, from $470.0 million for the three months
ended March 31, 2009. Net premiums earned decreased by $18.5 million, or 9.5%, in the Americas
division, $0.4 million, or 0.3%, in the EuroAsia division, $7.1 million, or 8.7%, in the U.S.
Insurance division and increased by $13.1 million, or 24.2%, in the London Market division.
Losses and Loss Adjustment Expenses. Net losses and LAE incurred increased $58.3
million, or 18.4%, to $375.9 million for the three months ended March 31, 2010, from $317.6 million
for the three months ended March 31, 2009, as follows (in millions):
Three Months Ended | ||||||||||||||||
March 31, | Change | |||||||||||||||
2010 | 2009 | $ | % | |||||||||||||
Gross losses and LAE incurred |
$ | 508.3 | $ | 352.9 | $ | 155.4 | 44.0 | % | ||||||||
Less: ceded losses and LAE incurred |
132.4 | 35.3 | 97.1 | 275.1 | ||||||||||||
Net losses and LAE incurred |
$ | 375.9 | $ | 317.6 | $ | 58.3 | 18.4 | % | ||||||||
The increase in net losses and LAE incurred was principally related to an increase in current
year property catastrophe losses of $73.4 million, to $121.1 million for the three months ended
March 31, 2010, from $47.7 million for the three months
ended March 31, 2009. For the three months ended March 31, 2010, current year property catastrophe losses included $85.2
million related to the Chile earthquake and $17.6 million related to Windstorm Xynthia. For the
three months ended March 31, 2009, current year property catastrophe losses included $43.9 million
related to Windstorm Klaus. Losses and LAE for
the three months ended March 31, 2010 included a decrease in prior period losses of $4.9 million,
attributable to reduced loss estimates due to loss emergence lower than expectations in the period
on business written in the London Market and U.S. Insurance divisions, partially offset by
increased loss estimates due to loss emergence greater than
expectations in the period on business written in the
Americas division. Losses and LAE for the three months ended March 31, 2009 included a
48
Table of Contents
decrease in prior period losses of $11.8 million, attributable to reduced loss estimates due to
loss emergence lower than expectations in the period on business written in all divisions.
The
loss estimates for property catastrophe losses, such as the Chile earthquake and Windstorm
Xynthia, represent our best estimate based on the most recent information available. We used various
approaches in estimating our losses, including a detailed review of exposed contracts and
information from ceding companies. As additional information becomes available, including
information from ceding companies, actual losses may exceed our estimated losses, potentially
resulting in adverse effects to our financial results.
Ceded losses and LAE incurred increased $97.1 million, or 275.1%, to $132.4 million for the
three months ended March 31, 2010, from $35.3 million for the three months ended March 31, 2009.
This increase was principally attributable to increased loss cessions related to property
catastrophe events.
The loss and LAE ratio for the three months ended March 31, 2010 and 2009 and the percentage
point change for each of our divisions and in total are as follows:
Three Months Ended | Percentage | |||||||||||
March 31, | Point | |||||||||||
Division | 2010 | 2009 | Change | |||||||||
Americas |
105.4 | % | 60.1 | % | 45.3 | |||||||
EuroAsia |
69.7 | 80.1 | (10.4 | ) | ||||||||
London Market |
66.3 | 63.7 | 2.6 | |||||||||
U.S. Insurance |
64.9 | 66.8 | (1.9 | ) | ||||||||
Total loss and LAE ratio |
82.3 | % | 67.6 | % | 14.7 | |||||||
The following tables reflect total losses and LAE as reported for each division and include
the impact of catastrophe losses and prior period reserve development, expressed as a percentage of
net premiums earned (NPE), for the three months ended March 31, 2010 and 2009 (in millions):
Three Months Ended March 31, 2010
Americas | EuroAsia | London Market | U.S. Insurance | Total | ||||||||||||||||||||||||||||||||||||
% of | % of | % of | % of | % of | ||||||||||||||||||||||||||||||||||||
$ | NPE | $ | NPE | $ | NPE | $ | NPE | $ | NPE | |||||||||||||||||||||||||||||||
Total losses and LAE |
$ | 186.3 | 105.4 | % | $ | 96.1 | 69.7 | % | $ | 44.8 | 66.3 | % | $ | 48.7 | 64.9 | % | $ | 375.9 | 82.3 | % | ||||||||||||||||||||
Catastrophe losses: |
||||||||||||||||||||||||||||||||||||||||
2010 events: |
||||||||||||||||||||||||||||||||||||||||
Chile earthquake |
71.2 | 40.3 | 3.5 | 2.5 | 10.5 | 15.5 | | | 85.2 | 18.6 | ||||||||||||||||||||||||||||||
Windstorm Xynthia |
| | 17.5 | 12.7 | 0.1 | 0.1 | | | 17.6 | 3.9 | ||||||||||||||||||||||||||||||
Haiti earthquake |
6.7 | 3.8 | | | | | | | 6.7 | 1.5 | ||||||||||||||||||||||||||||||
Other 2010 events |
6.3 | 3.6 | 4.9 | 3.6 | 0.4 | 0.7 | | | 11.6 | 2.5 | ||||||||||||||||||||||||||||||
Total 2010 events |
84.2 | 47.7 | 25.9 | 18.8 | 11.0 | 16.3 | | | 121.1 | 26.5 | ||||||||||||||||||||||||||||||
Prior period events |
2.6 | 1.4 | 2.9 | 2.1 | (1.1 | ) | (1.7 | ) | | | 4.4 | 1.0 | ||||||||||||||||||||||||||||
Total
catastrophe losses |
$ | 86.8 | 49.1 | % | $ | 28.8 | 20.9 | % | $ | 9.9 | 14.6 | % | $ | | | % | $ | 125.5 | 27.5 | % | ||||||||||||||||||||
Prior period loss
development
including prior period
catastrophe losses |
$ | 2.9 | 1.6 | % | $ | 0.1 | 0.1 | % | $ | (4.3 | ) | (6.4 | )% | $ | (3.6 | ) | (4.8 | )% | $ | (4.9 | ) | (1.1 | )% | |||||||||||||||||
49
Table of Contents
Three Months Ended March 31, 2009
Americas | EuroAsia | London Market | U.S. Insurance | Total | ||||||||||||||||||||||||||||||||||||
% of | % of | % of | % of | % of | ||||||||||||||||||||||||||||||||||||
$ | NPE | $ | NPE | $ | NPE | $ | NPE | $ | NPE | |||||||||||||||||||||||||||||||
Total losses and LAE |
$ | 117.3 | 60.1 | % | $ | 110.7 | 80.1 | % | $ | 34.7 | 63.7 | % | $ | 54.9 | 66.8 | % | $ | 317.6 | 67.6 | % | ||||||||||||||||||||
Catastrophe losses: |
||||||||||||||||||||||||||||||||||||||||
2009 events: |
||||||||||||||||||||||||||||||||||||||||
Windstorm Klaus |
| | 43.9 | 31.8 | | | | | 43.9 | 9.3 | ||||||||||||||||||||||||||||||
Other 2009 events |
3.1 | 1.5 | 0.3 | 0.2 | 0.4 | 0.7 | | | 3.8 | 0.8 | ||||||||||||||||||||||||||||||
Total 2009 events |
3.1 | 1.5 | 44.2 | 32.0 | 0.4 | 0.7 | | | 47.7 | 10.1 | ||||||||||||||||||||||||||||||
Prior period events |
0.7 | 0.4 | 2.0 | 1.4 | 5.6 | 10.3 | 0.6 | 0.7 | 8.9 | 1.9 | ||||||||||||||||||||||||||||||
Total
catastrophe losses |
$ | 3.8 | 1.9 | % | $ | 46.2 | 33.4 | % | $ | 6.0 | 11.0 | % | $ | 0.6 | 0.7 | % | $ | 56.6 | 12.0 | % | ||||||||||||||||||||
Prior period loss development
including prior period
catastrophe losses |
$ | (1.3 | ) | (0.7 | )% | $ | (4.8 | ) | (3.5 | )% | $ | (2.1 | ) | (3.9 | )% | $ | (3.6 | ) | (4.4 | )% | $ | (11.8 | ) | (2.5 | )% | |||||||||||||||
Americas Division Losses and LAE increased $69.0 million, or 58.8%, to $186.3 million
for the three months ended March 31, 2010, from $117.3 million for the three months ended March 31,
2009. This resulted in a loss and LAE ratio of 105.4% for the three months ended March 31, 2010,
compared to 60.1% for the three months ended March 31, 2009. This increase in losses and LAE was
principally attributable to an increase in current year property catastrophe losses of $81.1
million, to $84.2 million for the three months ended March 31, 2010, from $3.1 million
for the three months ended March 31, 2009. Losses and LAE for the three months ended March 31,
2010 included current year property catastrophe losses of $84.2 million, with $71.2 million for the
Chile earthquake and $6.7 million for the Haiti earthquake, and an increase in prior period losses
of $2.9 million, principally due to loss emergence greater than expectations in the period on
property business. Losses and LAE for the three months ended March 31, 2009 included a decrease in
prior period losses of $1.3 million, principally due to loss emergence lower than expectations in
the period on miscellaneous property lines of business.
EuroAsia Division Losses and LAE decreased $14.6 million, or 13.2%, to $96.1 million for
the three months ended March 31, 2010, from $110.7 million for the three months ended March 31,
2009. This resulted in a loss and LAE ratio of 69.7% for the three months ended March 31, 2010,
compared to 80.1% for the three months ended March 31, 2009. This decrease in losses and LAE was
principally due to a decrease in current year property catastrophe losses of $18.3 million, to
$25.9 million for the three months ended March 31, 2010, from $44.2 million for the three months
ended March 31, 2009. Losses and LAE for the three months ended March 31, 2010 included current
year property catastrophe losses of $25.9 million, with $17.5 million for Windstorm Xynthia and
$3.5 million for the Chile earthquake. Losses and LAE for the three months ended March 31, 2009
included current year property catastrophe losses of $44.2 million, with $43.9 million for
Windstorm Klaus, and a decrease in prior period losses of $4.8 million, principally due to loss
emergence lower than expectations in the period on miscellaneous property lines of business.
London Market Division Losses and LAE increased $10.1 million, or 29.1%, to $44.8 million
for the three months ended March 31, 2010, from $34.7 million for the three months ended March 31,
2009. This resulted in a loss and LAE ratio of 66.3% for the three months ended March 31, 2010,
compared to 63.7% for the three months ended March 31, 2009. This increase in losses and LAE was
principally due to an increase in current year property catastrophe losses of $10.6 million, to $11.0
million for the three months ended March 31, 2010, from $0.4 million for the three months ended
March 31, 2009. Losses and LAE for the three months ended March 31, 2010 included current year
property catastrophe losses of $11.0 million, with $10.5 million for the Chile earthquake, and a
decrease in prior period losses of $4.3 million, principally attributable to loss emergence lower
than expectations in the period on liability and miscellaneous property lines of business,
partially offset by increased loss estimates due to loss emergence greater than expectations in the
period on medical malpractice business. Losses and LAE for the three months ended March 31, 2009
included a decrease in prior period losses of $2.1 million, principally due to loss emergence lower
than expectations in the period on liability business.
50
Table of Contents
U.S. Insurance Division Losses and LAE decreased $6.2 million, or 11.3%, to $48.7 million
for the three months ended March 31, 2010, from $54.9 million for the three months ended March 31,
2009. This resulted in a loss and LAE ratio of 64.9% for the three months ended March 31, 2010,
compared to 66.8% for the three months ended March 31, 2009. This decrease in losses and LAE was
principally due to a decline in loss exposure associated with a decline in net premiums earned of
$7.1 million, to $75.0 million for the three months ended March 31, 2010, from $82.1 million for
the three months ended March 31, 2009. Losses and LAE for the three months ended March 31, 2010
included a decrease in prior period losses of $3.6 million, principally attributable to loss
emergence lower than expectations in the period on miscellaneous liability business.
Losses and LAE for the three months ended March 31, 2009 included a decrease in prior period losses
of $3.6 million, principally due to loss emergence lower than expectations in the period on
miscellaneous liability business.
Acquisition Costs. Acquisition costs for the three months ended March 31, 2010 were
$89.0 million, a decrease of $4.0 million or 4.3%, compared to $93.0 million for the three months
ended March 31, 2009. The resulting acquisition expense ratio, expressed as a percentage of net
premiums earned, was 19.5% for the three months ended March 31, 2010, compared to 19.8% for the
three months ended March 31, 2009, a decrease of 0.3 points. The Americas and London Market
divisions acquisition expense ratios increased by 1.2 points and 0.2 points, respectively, for the
three months ended March 31, 2010 compared to the corresponding period in 2009. The EuroAsia and
U.S. Insurance divisions acquisition expense ratios both decreased by 1.5 points for the three
months ended March 31, 2010 compared to the corresponding period in 2009.
Other Underwriting Expenses. Other underwriting expenses for the three months ended March
31, 2010 were $51.0 million, compared to $43.1 million for the three months ended March 31, 2009.
The other underwriting expense ratio, expressed as a percentage of net premiums earned, was 11.2%
for the three months ended March 31, 2010, compared to 9.1% for the three months ended March 31,
2009. The increase in the other underwriting expense ratio was principally attributable to a
decrease in net premiums earned of $12.9 million, combined with an increase in other underwriting
expenses of $7.9 million.
The following table reflects the acquisition and other underwriting expenses, expressed as a
percentage of net premiums earned, for the three months ended March 31, 2010 and 2009 for each of
our divisions:
Three Months Ended | Percentage | |||||||||||
March 31, | Point | |||||||||||
Division | 2010 | 2009 | Change | |||||||||
Americas |
35.3 | % | 31.0 | % | 4.3 | |||||||
EuroAsia |
24.5 | 25.1 | (0.6 | ) | ||||||||
London Market |
27.4 | 28.3 | (0.9 | ) | ||||||||
U.S. Insurance |
34.1 | 31.0 | 3.1 | |||||||||
Total
acquisition
costs and other
underwriting
expense ratio |
30.6 | % | 28.9 | % | 1.7 | |||||||
51
Table of Contents
Our combined ratio was 112.9% for the three months ended March 31, 2010, compared to 96.5% for
the three months ended March 31, 2009. The following table reflects the combined ratio for the
three months ended March 31, 2010 and 2009 for each of our divisions:
Three Months Ended | Percentage | |||||||||||
March 31, | Point | |||||||||||
Division | 2010 | 2009 | Change | |||||||||
Americas |
140.7 | % | 91.1 | % | 49.6 | |||||||
EuroAsia |
94.2 | 105.2 | (11.0 | ) | ||||||||
London Market |
93.7 | 92.0 | 1.7 | |||||||||
U.S. Insurance |
99.0 | 97.8 | 1.2 | |||||||||
Total combined ratio |
112.9 | % | 96.5 | % | 16.4 | |||||||
Investment Results
Net Investment Income. Net investment income for the three months ended March 31, 2010
increased by $16.6 million, or 24.6%, to $84.1 million, from $67.5 million for the three months
ended March 31, 2009. Net investment income was comprised of gross investment income of $93.7
million less investment expenses of $9.6 million for the three months ended March 31, 2010,
compared to gross investment income of $72.7 million less investment expenses of $5.2 million for
the three months ended March 31, 2009. The increase in net investment income for the three months
ended March 31, 2010 was primarily attributable to the following:
| investment income from fixed income securities was $69.9 million for the three months ended March 31, 2010, an increase of $13.3 million, or 23.5%, compared to the three months ended March 31, 2009; | ||
| an increase in net investment income from other invested assets of $15.4 million for the three months ended March 31, 2010, compared to the three months ended March 31, 2009; offset by: | ||
| a decrease of $5.2 million, or 32.5%, in net investment income from equity investments for the three months ended March 31, 2010, compared to the three months ended March 31, 2009. Dividends on common stocks decreased $6.1 million, slightly offset by an increase in net income on common stocks, at equity, of $0.9 million; | ||
| an increase in investment expenses of $4.4 million for the three months ended March 31, 2010, compared to the three months ended March 31, 2009, which was primarily due to dividend expenses related to total return swaps; and | ||
| a decrease in net investment income from cash and short-term investments of $2.5 million, or 50.6%, for the three months ended March 31, 2010, compared to the three months ended March 31, 2009. |
Our total effective annualized yield on average invested assets, net of expense but before the
impact of interest expense from funds held balances, was 4.0% and 3.6% for the three months ended
March 31, 2010 and 2009, respectively. The total effective annualized yield on average invested
assets is calculated by dividing annual income by the annual average invested assets (computed
using average amortized cost for fixed income securities and average carrying value for all other
securities).
Net Realized Investment Gains/Losses. Net realized investment gains of $54.0 million for the
three months ended March 31, 2010 increased by $153.4 million, from net realized investment losses
of $99.4 million for the three months ended March 31, 2009. The increase in net realized investment
gains was principally due to the following:
| increased net realized investment gains on equity securities of $155.5 million, compared to $75.1 million in realized investment losses for the three months ended March 31, 2009; | ||
| an increase in net realized investment gains on fixed income securities of $75.6 million; |
52
Table of Contents
| a decrease in losses on other invested assets of $3.5 million; offset by: | ||
| a decrease in net realized investment gains on derivative securities of $67.8 million, primarily attributable to a decrease of $42.0 million on total return swaps, a decrease of $7.4 million on forward currency contracts, a decrease of $4.4 million on credit default swaps and a decrease of $14.0 million on other derivatives; | ||
| increased realized investment losses on preferred stock of $13.0 million; and | ||
| an increase in losses on short-term investments, cash and cash equivalents of $0.4 million. |
Net realized investment gains include other-than-temporary impairment losses in the amount of
$4.1 million, relating to fixed income securities of $2.9 million and equity securities of $1.2
million for the three months ended March 31, 2010. During the three months ended March 31, 2009,
net realized investment gains were reduced by other-than-temporary impairment losses in the amount
of $81.4 million, relating to equity securities of $78.3 million and fixed income securities of
$3.1 million. Other-than-temporary impairments reflect situations where the fair value was below
the cost of the securities, and the ability of the security to recover its value could not be
reasonably determined.
Other Results, Principally Holding Company and Income Taxes
Other Expenses, Net. Other expense, net, for the three months ended March 31, 2010 was $31.9
million, compared to $4.2 million for the three months ended March 31, 2009. The other expense is
principally comprised of foreign currency exchange gains and losses and the operating expenses of
our holding company, including audit related fees, corporate-related legal fees, consulting fees
and compensation expense. The $27.7 million increase for the three months ended March 31, 2010
compared to the comparable 2009 period was primarily related to $19.6 million of foreign exchange
related adjustments and $4.6 million of expense related to restricted equity value rights.
Interest Expense. We incurred interest expense related to our debt obligations of $7.5
million and $8.1 million for the three months ended March 31, 2010 and 2009, respectively. The
lower amount of interest expense in 2010 primarily resulted from the decrease in interest rates on
our Series A, B and C floating rate senior notes.
Federal and Foreign Income Tax Provision. Our federal and foreign income tax provision for
the three months ended March 31, 2010 increased by $24.1 million, to $2.0 million, compared to a
$22.1 million tax benefit for the three months ended March 31, 2009, resulting from increased
pre-tax income. Our effective tax rates were 5.0% and 79.2% for the three months ended March 31,
2010 and 2009, respectively.
Preferred Dividends and Purchases. We recorded preferred dividends related to our Series A
and Series B non-cumulative perpetual preferred shares of $1.3 million and $1.3 million for the
three months ended March 31, 2010 and 2009, respectively. During the three months ended March 31,
2009, Odyssey America purchased 704,737 shares of our Series B preferred stock, with a liquidation
preference of $17.2 million, for $9.2 million. The purchase of the Series B preferred shares
resulted in an increase in net income attributable to common shareholders of $8.0 million for the
three months ended March 31, 2009.
Liquidity and Capital Resources
Our shareholders equity increased by $163.9 million, or 4.6%, to $3,719.1 million as of March
31, 2010, from $3,555.2 million as of December 31, 2009, due to net income of $37.8 million, a
capital contribution from Fairfax of $14.5 million, and an increase in net unrealized appreciation
on securities of $102.5 million, and foreign currency translation adjustments of $10.4 million
(both components of accumulated other comprehensive income). Offsetting these increases were
dividends to our preferred shareholders of $1.3 million.
Odyssey Re Holdings Corp. is a holding company that does not have any significant operations
or assets other than its ownership of Odyssey America, and its principal sources of funds are cash
dividends and other permitted payments from its operating subsidiaries, primarily Odyssey America.
If our subsidiaries are unable to make payments to the holding company, or are able to pay only
limited amounts, we may be unable to pay
53
Table of Contents
dividends on our preferred shares or make payments on our
indebtedness. The payment of dividends by our
operating subsidiaries is subject to restrictions set forth in the insurance laws and
regulations of Connecticut, Delaware, New York and the United Kingdom. Holding company cash, cash
equivalents and short-term investments totaled $109.4 million as of March 31, 2010, compared to
$33.0 million as of December 31, 2009. The holding company has received dividends from Odyssey
America of $200.0 million through May 6, 2010 and $200.0 million for the year ended December 31,
2009. During the remainder of 2010, Odyssey America can pay dividends to the holding company of
$151.3 million without prior regulatory approval. Effective
May 1, 2010, we entered into a $300.0 million two-way revolving credit facility with
Fairfax, Inc. (a wholly-owned subsidiary of Fairfax, and the direct and indirect holder of 100% of
our common shares). Pursuant to the facility, either party may borrow up to $300.0 million from
the other party. Loans under the facility are unsecured and bear interest at a rate of 7.5% per
annum, payable quarterly, and the principal amount is payable on demand. Either party may
terminate the facility at any time upon demand, at which time all outstanding principal and unpaid
interest shall become due. On May 3, 2010, we loaned $200.0 million to Fairfax, Inc. under the
facility.
Odyssey Americas liquidity requirements are principally met by cash flows from operating
activities, which primarily result from collections of premiums, reinsurance recoverables and
investment income, net of paid losses, acquisition costs, income taxes and underwriting and
investment expenses. We seek to maintain sufficient liquidity to satisfy the timing of projected
claim payments and operating expenses. The estimate, timing and ultimate amount of actual claim
payments is inherently uncertain and will vary based on many factors including the frequency and
severity of losses across various lines of business. Claim payments can accelerate or increase due
to a variety of factors, including losses stemming from catastrophic events, which are typically
paid out in a short period of time, legal settlements or emerging claim issues. We estimate claim
payments, net of associated reinsurance recoveries, of approximately $1.3 billion during 2010. The
timing and certainty of associated reinsurance collections that may be due to us can add
uncertainty to our liquidity position to the extent amounts are not received on a timely basis. As
of March 31, 2010, our operating subsidiaries maintained cash and cash equivalents of $1.0 billion
and short-term investments of $201.6 million, which is readily available for expected claim
payments. In addition, our liquidity is enhanced through the collection of premiums on new business
written through the year. We believe our cash resources, together with readily marketable
securities, are sufficient to satisfy expected payment obligations, including any unexpected
acceleration or increase in claim payments, or timing differences in collecting reinsurance
recoverables.
Although the obligations of our reinsurers to make payments to us are based on specific
contract provisions, these amounts only become recoverable when we make a payment of the associated
loss amount, which may be several years, or in some cases decades, after the actual loss occurred.
Reinsurance recoverables on unpaid losses, which represent 95.5% of our total reinsurance
recoverables as of March 31, 2010, will not be due for collection until some time in the future,
and over this period of time, economic conditions and the operational performance of a particular
reinsurer may negatively impact its ability to meet its future obligations to us. We manage our
exposure by entering into reinsurance transactions with companies that have a strong capital
position and a favorable long term financial profile.
Our total reinsurance recoverable on paid losses as of March 31, 2010, net of the reserve for
uncollectible reinsurance, was $42.2 million. The top ten reinsurers measured on total reinsurance
recoverables represented $14.4 million, or 34.1%, of the total paid loss recoverable, of which $2.1
million is collateralized and the remaining $12.3 million is with highly rated companies. The
remaining $27.8 million recoverable on paid losses is with numerous companies, and no single
company has a balance greater than $5.4 million net of the reserve on uncollectible reinsurance.
Approximately $13.2 million of our total reinsurance paid recoverable is current billings, and
$29.0 million is over 120 days past due. The change in the economic conditions of any of our
retrocessionaires may impact their ability to meet their obligations and negatively impact our
liquidity.
Cash provided by operations was $44.8 million for the three months ended March 31, 2010,
compared to cash used in operations of $76.3 million for the three months ended March 31, 2009.
This reflects an increase in cash provided by operations of $121.1 million, or 158.7%, over the
three months ended March 31, 2009, due to the payment of income taxes in the first quarter of 2009
relating to realized investment gains on closed credit default and total return swap contracts in
the fourth quarter of 2008.
Total investments and cash amounted to $8.8 billion as of March 31, 2010, an increase of
$117.4 million compared to December 31, 2009. Our average invested assets were $8.8 billion for the
three months ended March 31, 2010, compared to $7.7 billion for the three months ended March 31,
2009. We anticipate that our cash and cash equivalents will continue to be reinvested on a basis
consistent with our long-term, value-oriented investment philosophy. Cash, cash equivalents and
short-term investments, excluding cash and cash
54
Table of Contents
equivalents held as collateral, represented 14.9%
and 15.1% of our total investments and cash, excluding cash and cash equivalents held as
collateral, as of March 31, 2010 and December 31, 2009, respectively. Total fixed income securities
were $5.0 billion as of March 31, 2010, compared to $4.9 billion as of December 31, 2009. As of
March 31, 2010, 59.6% of our fixed income portfolio was rated AAA, with 11.0% of securities
rated below investment grade. The duration of our investment portfolio, including short-term
investments, cash and cash equivalents, was 8.8 years.
Total investments and cash exclude amounts receivable for securities sold and amounts payable
for securities purchased, representing the timing between the trade date and settlement date of
securities sold and purchased. As of March 31, 2010 and December 31, 2009, we had receivables for
securities sold of $135.8 million and $77.9 million, respectively, which are included in other
assets, and payables for securities purchased of $4.1 million and $45.6 million, respectively,
which are included in other liabilities.
On November 28, 2006, we completed the private sale of $40.0 million aggregate principal
amount of floating rate senior debentures, series C due December 15, 2021 (the Series C Notes).
Interest on the Series C Notes accrues at a rate per annum equal to the three-month LIBOR, reset
quarterly, plus 2.50%, and is payable quarterly in arrears on March 15, June 15, September 15 and
December 15 of each year. We have the option to redeem the Series C Notes at par, plus accrued and
unpaid interest, in whole or in part on any interest payment date on or after December 15, 2011.
For the three months ended March 31, 2010 and 2009, the average annual interest rate on the Series
C Notes was 2.75% and 4.37%, respectively.
On February 22, 2006, we issued $100.0 million aggregate principal amount of floating rate
senior debentures, pursuant to a private placement. The net proceeds from the offering, after fees
and expenses, were $99.3 million. The debentures were sold in two tranches: $50.0 million of series
A, due March 15, 2021 (the Series A Notes), and $50.0 million of series B, due March 15, 2016
(the Series B Notes). Interest on each series of debentures is due quarterly in arrears on March
15, June 15, September 15 and December 15 of each year. The interest rate on each series of
debentures is equal to the three-month LIBOR, reset quarterly, plus 2.20%. The Series A Notes are
callable by us on any interest payment date on or after March 15, 2011 at their par value, plus
accrued and unpaid interest, and the Series B Notes are callable by us on any interest payment date
on or after March 15, 2009 at their par value, plus accrued and unpaid interest. For the three
months ended March 31, 2010 and 2009, the average annual interest rate on each series of notes was
2.45% and 4.07%, respectively.
In December 2008, we entered into interest rate swaps, with an aggregate notional value of
$140.0 million, to protect against adverse movements in interest rates. Under these swap contracts,
we receive a floating interest rate of three-month London Interbank Offer Rate (LIBOR) and pay a
fixed interest rate of 2.49% on the $140.0 million notional value of the contracts, for a five-year
period ending in December 2013.
During the second quarter of 2005, we issued $125.0 million aggregate principal amount of
senior notes due May 1, 2015. The issue was sold at a discount of $0.8 million, which is being
amortized over the life of the notes. Interest accrues on the senior notes at a fixed rate of
6.875% per annum, which is due semi-annually on May 1 and November 1.
During the fourth quarter of 2003, we issued $225.0 million aggregate principal amount of
senior notes due November 1, 2013. The issue was sold at a discount of $0.4 million, which is being
amortized over the life of the notes. Interest accrues on the senior notes at a fixed rate of 7.65%
per annum, which is due semi-annually on May 1 and November 1.
On July 13, 2007, we entered into a $200.0 million credit facility (the Credit Agreement)
with Wachovia Bank National Association (Wachovia), KeyBank National Association and a syndicate
of lenders. The original Credit Agreement provided for a five-year credit facility of $200.0
million, $100.0 million of which was available for direct, unsecured borrowings by us, and all of
which was available for the issuance of collateralized letters of credit to support our insurance
and reinsurance business. As of June 17, 2009, the Credit Agreement was amended to explicitly
permit us to pledge collateral to secure our obligations under swap agreements, subject to certain
financial limitations, in the event that such collateral is required by the counterparty or
counterparties. As of February 24, 2010, the Credit Agreement was amended (i) to reduce the size
of the facility to $100.0 million, removing the unsecured $100.0 million tranche, (ii) to remove
the previous limitation on dividends and other restricted payments that we may pay to our
shareholders during any fiscal year and (iii) to
55
Table of Contents
amend certain of the covenants and default
provisions, the minimum ratings requirement, and the pricing of the credit facility.
The amended Credit Agreement contains an option that permits us to request an increase in the
aggregate amount of the facility by an amount up to $50.0 million, to a maximum facility size of
$150.0 million. Following such a request, each lender has the right, but not the obligation, to
commit to all or a portion of the proposed increase. As of March 31, 2010, there was $33.7 million
outstanding under the Credit Agreement, all of which was in support of secured letters of credit.
During March 2009, we filed a shelf registration statement on Form S-3ASR with the SEC, which
became effective automatically upon filing. The registration statement provided for the offer and
sale by us, from time to time, of debt and equity securities. On February 9, 2010, we filed a
post-effective amendment to the Form S-3ASR to remove from registration the securities that
remained unsold as of such date.
We participate in Lloyds through our 100% ownership of Newline Syndicate (1218), for which we
provide 100% of the capacity. The results of Newline Syndicate (1218) are consolidated in our
financial statements. In support of Newline Syndicate (1218)s capacity at Lloyds, NCNL and
Odyssey America have pledged securities and cash with a fair value of $136.5 million and $123.8
million, respectively, as of March 31, 2010 in a deposit trust account in favor of the Society and
Council of Lloyds. These securities may be substituted with other securities at our discretion,
subject to approval by Lloyds. The securities are carried at fair value and are included in
investments and cash in our consolidated balance sheets. Interest earned on the securities is
included in investment income. The pledge of assets in support of Newline Syndicate (1218) provides
us with the ability to participate in writing business through Lloyds, which remains an important
part of our business. The pledged assets effectively secure the contingent obligations of Newline
Syndicate (1218) should it not meet its obligations. NCNL and Odyssey Americas contingent
liability to the Society and Council of Lloyds is limited to the aggregate amount of the pledged
assets. We have the ability to remove funds at Lloyds annually, subject to certain minimum amounts
required to support outstanding liabilities as determined under risk-based capital models and
approved by Lloyds. The funds used to support outstanding liabilities are adjusted annually and
our obligations to support these liabilities will continue until they are settled or the
liabilities are reinsured by a third party approved by Lloyds. We expect to continue to actively
operate Newline Syndicate (1218) and support its requirements at Lloyds. We believe that Newline
Syndicate (1218) maintains sufficient liquidity and financial resources to support its ultimate
liabilities and we do not anticipate that the pledged assets will be utilized.
On March 1, 2010, our Board of Directors declared quarterly dividends of $0.5078125 per share
on our 8.125% Series A preferred shares and $0.2186719 per share on our floating rate Series B
preferred shares. The total dividends of $1.3 million were paid on April 20, 2010 to Series A and
Series B preferred shareholders of record on March 31, 2010.
As described in Note 3 to our consolidated financial statements included in this Form 10-Q, as
of March 31, 2010, we held $48.5 million of investments, or approximately 0.6% of net assets and
liabilities measured at fair value, that are classified as Level 3 (which are financial instruments
for which the values are based on prices or valuation techniques that require inputs that are both
unobservable and significant to the overall fair value measurement and that reflect our own
assumptions about the methodology and valuation techniques that a market participant would use in
pricing the asset or liability). These Level 3 investments are valued using a discounted cash flow
model, including unobservable inputs that are supported by limited market-based activity. During
the three months ended March 31, 2010, we purchased $6.3 million of investments classified as Level
3. In addition, Level 3 investments with a value of $4.3 million were sold during the three months
ended March 31, 2010.
Healthcare Reform
In March 2010, President Obama signed into law the Patient Protection and Affordable Care Act
and the Health Care and Education Reconciliation Act of 2010 (collectively, the Act). The passage
of the Act has resulted in comprehensive health care reform legislation, the effects of which on
the U.S. economy could be as sweeping as those resulting from the passage of Medicare and Social
Security. The Act will expand health care coverage by providing the following:
| Medicaid eligibility for an estimated 16 million additional people; |
56
Table of Contents
| Insurance coverage for an estimate 16 million additional people through subsidiaries to purchase insurance through health care exchanges; | ||
| Dependent coverage through age 26; | ||
| No lifetime limits, or unreasonable annual limits, on insurance coverage; | ||
| Health insurance for certain individuals with preexisting conditions; and | ||
| A requirement that states maintain current eligibility levels for children in Medicaid and the Childrens Health Insurance Plan for a specified period. |
The changes to insurance coverage will be largely funded by fees and excise taxes charged to
entities in health-care-related industries, by excise taxes on high-cost group health plans
(commonly referred to as Cadillac plans and include those plans that have annual cost of benefits
in excess of $10,200 a year for individuals or $27,500 for families), by tax increases on
high-income individuals, and by reductions to Medicare scheduled payments.
Other provisions of the Act may impact the amount of deferred tax assets that companies are
allowed to recognize as a result of the elimination of the income tax deduction previously allowed
for Medicare Part D subsidiaries relating to retiree prescription drug coverage.
Although we have not completed our analysis of the impact of the Act on our financial position
and future operating results, we expect the impact to be minimal as (i) our group health plan is
not a Cadillac plan and (ii) the deduction taken in previous years relating to Medicare Part D
subsidies was not significant. With respect to healthcare business
underwritten by us, principally through our U.S. Insurance division,
it is too early to determine what impact the Act will have, if any, on our
underlying insurance and reinsurance businesses.
Financial Strength and Credit Ratings
We and our subsidiaries are assigned financial strength (insurance) and credit ratings from
internationally recognized rating agencies, which include A.M. Best Company, Inc. (A.M. Best),
Standard & Poors Ratings Services (Standard & Poors) and Moodys Investors Service (Moodys).
Financial strength ratings represent the opinions of the rating agencies of the financial strength
of a company and its capacity to meet the obligations of insurance and reinsurance contracts. The
rating agencies consider many factors in determining the financial strength rating of an insurance
or reinsurance company, including the relative level of statutory surplus necessary to support our
business operations.
These ratings are used by insurers, reinsurers and intermediaries as an important means of
assessing the financial strength and quality of reinsurers. A reduction in our financial strength
ratings could limit or prevent us from writing new reinsurance or insurance business. The financial
strength ratings of our principal operating subsidiaries are as follows:
A.M. Best | Standard & Poors | Moodys | ||||||||||
Odyssey America |
A (Excellent) | A- (Strong) | A3 (Good) | |||||||||
Hudson |
A (Excellent) | Not Rated | Not Rated | |||||||||
Hudson Specialty |
A (Excellent) | A- (Strong) | Not Rated |
Our senior unsecured debt is currently rated BBB- by Standard & Poors, Baa3 by Moodys
and bbb by A.M. Best. Our Series A and Series B preferred shares are currently rated BB by
Standard & Poors, Ba2 by Moodys and bb+ by A.M. Best.
Accounting Pronouncements
Recently Adopted
A description of recently adopted accounting pronouncements is provided in Note 1 to our
consolidated financial statements included in this Form 10-Q.
57
Table of Contents
Off-Balance Sheet Arrangements
We have off-balance sheet arrangements, including certain arrangements with affiliated
companies, that have financial implications. A description of these arrangements is provided in
Note 10 to our consolidated financial statements included in this Form 10-Q.
Forward Looking Statements
We have included in this Quarterly Report on Form 10-Q filing, and from time to time our
management may make, written or oral statements that may include forward-looking statements that
reflect our current views with respect to future events and financial performance. These
forward-looking statements relate to, among other things, our plans and objectives for future
operations. These forward-looking statements are subject to uncertainties and other factors that
could cause actual results to differ materially from such statements. These uncertainties and other
factors include, but are not limited to:
| a reduction in net income if our loss reserves are insufficient; | ||
| the occurrence of catastrophic events with a frequency or severity exceeding our estimates; | ||
| the lowering or loss of one or more of our financial or claims-paying ratings, including those of our subsidiaries; | ||
| an inability to realize our investment objectives; | ||
| a decrease in the level of demand for our reinsurance or insurance business, or increased competition in the industry; | ||
| emerging claim and coverage issues, which could expand our obligations beyond the amount we intend to underwrite; | ||
| ongoing legislative and regulatory developments that may disrupt our business or mandate changes in industry practices in a fashion that increases our costs or requires us to alter aspects of the way we conduct our business; | ||
| changes in economic conditions, including interest rate, currency, equity and credit conditions that could affect our investment portfolio; | ||
| a change in the requirements of one or more of our current or potential customers relating to counterparty financial strength, claims-paying ratings, or collateral requirements; | ||
| actions of our competitors, including industry consolidation, and increased competition from alternative sources of risk management products, such as the capital markets; | ||
| our 100% shareholders ability to determine the outcome of our corporate actions that require board or shareholder approval; | ||
| our ability to raise additional capital if it is required; | ||
| the availability of dividends from our reinsurance and insurance company subsidiaries; | ||
| the loss of services of any of our key employees; | ||
| our use of reinsurance brokers in contract negotiations and as cash settlement agents; | ||
| the failure of our reinsurers to honor their obligations to us; | ||
| the growth of our specialty insurance business and the development of our infrastructure to support this growth; |
58
Table of Contents
| operational and financial risks relating to our utilization of program managers, third-party administrators, and other vendors to support our specialty insurance operations; | ||
| the passage of federal or state legislation subjecting our business to additional supervision or regulation, including additional tax regulation, in the United States or other jurisdictions in which we operate; | ||
| our reliance on computer and data processing systems; and | ||
| acts of war, terrorism or political unrest. |
The words believe, anticipate, estimate, project, expect,
intend, will likely
result, will seek to or will continue and similar expressions or their negative or variations
identify forward-looking statements. We caution readers not to place undue reliance on these
forward-looking statements, which speak only as of the date on which they are made. Additional
information regarding these factors and others that could cause our actual results to differ
materially from our expectations is included in our Annual Report on Form 10-K filed with the
Securities and Exchange Commission on February 25, 2010. The information appearing under Risk
Factors in such Annual Report on Form 10-K is incorporated by reference into and made a part of
this Form 10-Q. Except as otherwise required by federal securities laws, we undertake no obligation
to publicly update or revise any forward-looking statements, whether as a result of new
information, future events or otherwise.
PART I Item 3. Quantitative and Qualitative Disclosures About Market Risk
Market Sensitive Instruments
The term market risk refers to the risk of loss arising from adverse changes in prices. We
believe that we are principally exposed to four types of market risk related to our investment
operations: interest rate risk, credit risk, equity price risk and foreign currency risk. Market
sensitive instruments discussed in this section principally relate to our fixed income securities
and common stocks carried at fair value, which are classified as available for sale. As of March
31, 2010, our total investments and cash of $8.8 billion include $5.0 billion of fixed income
securities that are subject primarily to interest rate risk and credit risk.
Interest Rate Risk
The following table displays the potential impact of fair value fluctuations on our fixed
income securities portfolio as of March 31, 2010 and December 31, 2009, based on parallel 200 basis
point shifts in interest rates up and down in 100 basis point increments. This analysis was
performed on each security individually.
As of March 31, 2010 | As of December 31, 2009 | |||||||||||||||||||||||
Fair Value | Fair Value | |||||||||||||||||||||||
of Fixed | of Fixed | |||||||||||||||||||||||
Income | Hypothetical | Hypothetical | Income | Hypothetical | Hypothetical | |||||||||||||||||||
Percent Change in Interest Rates | Portfolio | $ Change | % Change | Portfolio | $ Change | % Change | ||||||||||||||||||
(In millions) | ||||||||||||||||||||||||
200 basis point rise |
$ | 4,116.7 | $ | (849.8 | ) | (17.1) | % | $ | 4,098.4 | $ | (808.3 | ) | (16.5) | % | ||||||||||
100 basis point rise |
4,534.2 | (432.3 | ) | (8.7 | ) | 4,500.1 | (406.6 | ) | (8.3 | ) | ||||||||||||||
Base scenario |
4,966.5 | | | 4,906.7 | | | ||||||||||||||||||
100 basis point decline |
5,387.7 | 421.2 | 8.5 | 5,297.3 | 390.6 | 8.0 | ||||||||||||||||||
200 basis point decline |
5,846.8 | 880.3 | 17.7 | 5,717.1 | 810.4 | 16.5 |
The preceding table indicates an asymmetric fair value response to equivalent basis point
shifts, up and down, in interest rates. This is partially caused by the impact of bonds in our
portfolio that have put or call features, which reflect different dynamics in changing interest
rate environments than bonds without these features. In an increasing interest rate environment,
put features tend to limit losses in fair value by giving the holder the ability to put the bonds
back to the issuer for early maturity. In a declining interest rate environment, call features
tend to limit gains in fair value by giving the issuer the ability to call the bond, which limits
the gain
59
Table of Contents
in fair value. As the mix of bonds with puts and calls in our portfolio changes,
different asymmetric results in hypothetical fair values occur.
As of March 31, 2010, we had net unrealized gains of $985.9 million, before taxes, related to
our total investments and cash. This net amount was comprised of gross unrealized appreciation of
$1,002.6 million, offset by gross unrealized depreciation of $16.7 million, all of which are
related to fixed income securities and common stocks.
As of March 31, 2010, we were party to floating to fixed interest rate swap contracts with a
notional amount of $140.0 million. As of March 31, 2010, the fair value of these contracts is
reported in other liabilities at $2.0 million. Net realized investment losses on interest rate
swaps totaled $2.8 million for the three months ended March 31, 2010.
During 2008, we entered into Eurodollar futures contracts to manage our interest rate risk
with respect to certain investments. During the first quarter of 2009, we closed the futures
contracts. A futures contract is a variation of a forward currency contract, with some additional
features, such as a clearinghouse guarantee against credit losses, a daily settlement of gains and
losses, and trading on an organized electronic or floor trading facility. Futures contracts are
entered either long or short. We had entered into the long side, which agrees to buy the underlying
currency at the future date at the agreed-upon price.
Disclosure About Limitations of Interest Rate Sensitivity Analysis
Computations of the prospective effects of hypothetical interest rate changes are based on
numerous assumptions, including the maintenance of the existing level and composition of fixed
income security assets, and should not be relied on as indicative of future results.
Certain shortcomings are inherent in the method of analysis used in the computation of the
fair value of fixed rate instruments. Actual values may differ from those projections presented
should market conditions vary from assumptions used in the calculation of the fair value of
individual securities, including non-parallel shifts in the term structure of interest rates and a
change in individual issuer credit spreads.
Credit Risk
Credit risk is the risk that one party to a financial instrument fails to discharge an
obligation and thereby causes financial loss to another party. Our exposure to credit risk is
concentrated in investments and underwriting balances.
We have exposure to credit risk, primarily as a holder of fixed income securities. We control
this exposure by emphasizing investment grade ratings in the fixed income securities we purchase.
We also have exposure to credit risk associated with the collection of current and future amounts
owing from our reinsurers. We control this exposure by emphasizing reinsurers with financial
strength.
Our credit risk exposure, based upon carrying value, as of March 31, 2010 and December 31,
2009 (without taking into account amounts pledged as collateral for our benefit of $270.4 million
and $220.2 million as of March 31, 2010 and December 31, 2009, respectively) was comprised as
follows (in millions):
As of | As of | |||||||
March 31, | December 31, | |||||||
2010 | 2009 | |||||||
Fixed income securities |
$ | 4,966.5 | $ | 4,906.7 | ||||
Derivatives |
65.5 | 20.0 | ||||||
Cash, cash equivalents and short-term investments |
1,368.4 | 1,361.7 | ||||||
Premiums receivable |
436.9 | 473.9 | ||||||
Recoverable from reinsurers |
1,204.4 | 1,165.5 | ||||||
Total gross exposure |
$ | 8,041.7 | $ | 7,927.8 | ||||
60
Table of Contents
Our risk management strategy with respect to investments in debt instruments is to invest
primarily in securities of high credit quality issuers and to limit the amount of credit risk
exposure with respect to any one issuer. While we review third party ratings, we carry out our own
analysis and do not delegate the credit decision to rating agencies. We endeavor to limit credit
exposure by imposing fixed income portfolio limits on individual corporate issuers and limits based
on credit quality and may, from time to time, invest in credit default swaps, or other types of
derivatives, to further mitigate credit risk exposure.
The composition of the fair value of our fixed income securities portfolio as of the dates
indicated, classified according to the higher of each securitys respective Standard & Poors and
Moodys issuer credit ratings, is presented below (in millions):
As of March 31, 2010 | As of December 31, 2009 | |||||||||||||||
Fair | Fair | |||||||||||||||
Issuer Credit Rating | Value | % | Value | % | ||||||||||||
AAA/Aaa |
$ | 2,959.7 | 59.6 | % | $ | 3,034.4 | 61.9 | % | ||||||||
AA/Aa2 |
506.0 | 10.2 | 393.0 | 8.0 | ||||||||||||
A/A2 |
733.7 | 14.8 | 706.5 | 14.4 | ||||||||||||
BBB/Baa2 |
218.8 | 4.4 | 257.1 | 5.2 | ||||||||||||
BB/Ba2 |
146.0 | 2.9 | 143.3 | 2.9 | ||||||||||||
B/B2 |
100.7 | 2.0 | 87.5 | 1.8 | ||||||||||||
CCC/Caa or lower or not rated |
301.6 | 6.1 | 284.9 | 5.8 | ||||||||||||
Total |
$ | 4,966.5 | 100.0 | % | $ | 4,906.7 | 100.0 | % | ||||||||
As of March 31, 2010, 89.0% of our fixed income portfolio at fair value was rated investment
grade (as compared to 89.5% as of December 31, 2009), with 69.8% (primarily consisting of
government obligations) being rated AA/Aa2 or better (as compared to 69.9% as of December 31,
2009). As of March 31, 2010, holdings of fixed income securities in the ten issuers (excluding
federal governments) to which we had the greatest exposure was $1.7 billion, which was
approximately 18.8% of our total invested assets. The exposure to the largest single issuer of
corporate bonds held as of March 31, 2010 was $151.5 million, which was approximately 1.7% of our
total investment portfolio, or 4.1% of our total shareholders equity.
Our investment portfolio as of March 31, 2010 included $3.2 billion in U.S. taxable and tax
exempt state and municipal bonds, most of which were purchased during 2008, and of which
approximately $2.0 billion (61.4%) were fully insured by Berkshire Hathaway Assurance Corp.
(BHAC) for the payment of interest and principal in the event of issuer default; we believe that
the BHAC insurance significantly mitigates the credit risk associated with these bonds.
Our risk management objective is to mitigate the adverse change in the fair value of our
financial assets that would likely result in the event of significant defaults or other adverse
events in the U.S. credit markets. Beginning in 2003, we attempted to meet this objective by
purchasing credit default protection (credit default swaps) referenced to various issuers in the
banking, mortgage and insurance sectors of the financial services industry, which are
representative of the systemic financial risk, versus hedging specific assets. We chose this
approach because it was impossible to predict which of the hedged assets would be adversely
affected and to what degree. As a result, we did not specifically align hedged items with hedging
instruments.
Under a credit default swap, as the buyer, we agree to pay to a specific counterparty, at
specified periods, fixed premium amounts based on an agreed notional principal amount in exchange
for protection against default by the issuers of specified referenced debt securities. The credit
events, as defined by the respective credit default swap contracts, establishing the rights to
recover amounts from the counterparties are comprised of ISDA-standard credit events, which are:
bankruptcy, obligation acceleration, obligation default, failure to pay, repudiation/moratorium and
restructuring. As of March 31, 2010, all credit default swap contracts held by us have been
purchased from and entered into with either Citibank, N.A., Deutsche Bank AG or Barclays Bank PLC
as the counterparty, with positions on certain covered risks with more than one of these
counterparties.
61
Table of Contents
We obtain market derived fair values for our credit default swaps from third party providers,
principally broker-dealers. To validate broker-dealer credit default swap fair value quotations,
two reasonability tests are performed. First, we obtain credit default swap bid-spreads from
independent broker-dealers (non-counterparty broker-dealers). These spreads are entered as inputs
into a discounted cash flow model, which calculates a fair value that is compared for reasonability
to the counterparty broker-dealer provided fair values. The discounted cash flow model uses the
independently obtained credit default swap bid-spreads to calculate the present value of the
remaining protection payments using the appropriate currency-denominated swap curve, with
consideration given to various other parameters including single name bid-spread in basis points
and the remaining term to maturity of the credit default swap contract. Secondly, a comparison is
performed against recently transacted credit default swap values as provided by independent
broker-dealers, and to prices reflected in recent trades of identical financial instruments where
available.
The initial premium paid for each credit default swap contract is recorded as a
derivative asset and is subsequently adjusted for changes in the unrealized fair value of the
contract at each balance sheet date. As these contracts do not qualify for hedge accounting,
changes in
the unrealized fair value of the contract are recorded as net realized investment gains
(losses) on investments in our consolidated statements of operations and comprehensive income.
Sales of credit default swap contracts require us to reverse through net gains (losses) on
investments any previously recorded unrealized fair value changes since the inception of the
contract, and to record the actual amount of the final cash settlement. Derivative assets are
reported gross, on a contract-by-contract basis, and are recorded at fair value in other invested
assets in the consolidated balance sheet. The sale, expiration or early settlement of a credit
default swap will not result in a cash payment owed by us; rather, such an event can only result in
a cash payment by a third party purchaser of the contract, or the counterparty, to us. Accordingly,
there is no opportunity for netting of amounts owed in settlement. Cash receipts at the date of
sale of the credit default swaps are recorded as cash flows from investing activities arising from
net sales of assets and liabilities classified as held for trading.
62
Table of Contents
The total cost of the credit default swaps was $19.8 million and $20.6 million as of
March 31, 2010 and December 31, 2009, respectively, and the fair value was $8.7 million and $10.0
million, as of March 31, 2010 and December 31, 2009, respectively. The notional amount of the
credit default swaps was $1.2 billion and $1.3 billion as of March 31, 2010 and December 31, 2009,
respectively. The credit default swaps had net realized investment losses of $1.3 million and net
realized investment gains of $3.1 million for the three months ended March 31, 2010, and 2009,
respectively. The fair values of credit default swaps are subject to significant volatility given
potential differences in the perceived risk of default of the underlying issuers, movements in
credit spreads and the length of time to the contracts maturities. The fair value of the credit
default swaps may vary dramatically either up or down in short periods, and their ultimate value
may therefore only be known upon their disposition. Credit default swap transactions generally
settle in cash. As a result of the appreciation in the fair value of the credit default swaps,
counterparties to these transactions are required to place government securities as collateral,
pursuant to the swaps agreements. The fair value of this collateral as of March 31, 2010 was $0.9
million. As we fund all of our obligations relating to these contracts upon initiation of the
transaction, there are no requirements in these contracts for us to provide collateral.
The following tables summarize the effect of the credit default swap hedging instruments and
related hedged items on our historical financial position, results of operations and cash flows as
of and for the three months ended March 31, 2010 and 2009 (in millions):
As of and for the Three Months Ended March 31, 2010 | ||||||||||||||||||||||||
Effect on Pre-tax: | ||||||||||||||||||||||||
Exposure / | Other | Net Realized | Net Cash | |||||||||||||||||||||
Notional | Carrying | Comprehensive | Investment | Flow from | ||||||||||||||||||||
Value | Value | Income | Gains | Net Equity | Disposals | |||||||||||||||||||
Credit risk exposures: |
||||||||||||||||||||||||
Fixed income securities |
$ | 4,966.5 | $ | 4,966.5 | $ | 10.3 | $ | 54.5 | $ | 64.8 | $ | 16.6 | ||||||||||||
Derivatives other invested assets |
56.8 | 56.8 | | (11.7 | ) | (11.7 | ) | 0.2 | ||||||||||||||||
Cash, cash equivalents and
short-term investments |
1,368.4 | 1,368.4 | | (11.3 | ) | (11.3 | ) | (11.3 | ) | |||||||||||||||
Premiums receivable |
436.9 | 436.9 | | (0.3 | ) | (0.3 | ) | (0.3 | ) | |||||||||||||||
Reinsurance recoverable |
1,204.4 | 1,204.4 | | (0.3 | ) | (0.3 | ) | | ||||||||||||||||
Total credit risk exposure |
$ | 8,033.0 | $ | 8,033.0 | 10.3 | 30.9 | 41.2 | 5.2 | ||||||||||||||||
Hedging instruments: |
||||||||||||||||||||||||
Other invested assets: |
||||||||||||||||||||||||
Credit default swaps: |
||||||||||||||||||||||||
Banking |
$ | 317.7 | $ | 2.8 | | (0.3 | ) | (0.3 | ) | (0.8 | ) | |||||||||||||
Insurance |
843.3 | 5.9 | | (1.0 | ) | (1.0 | ) | | ||||||||||||||||
Total credit default swaps |
$ | 1,161.0 | $ | 8.7 | | (1.3 | ) | (1.3 | ) | (0.8 | ) | |||||||||||||
Net equity impact |
$ | 10.3 | $ | 29.6 | $ | 39.9 | $ | 4.4 | ||||||||||||||||
63
Table of Contents
As of and for the Three Months Ended March 31, 2009 | ||||||||||||||||||||||||
Effect on Pre-tax: | ||||||||||||||||||||||||
Exposure / | Other | Net Realized | Net Cash | |||||||||||||||||||||
Notional | Carrying | Comprehensive | Investment | Flow from | ||||||||||||||||||||
Value | Value | Loss | Losses | Net Equity | Disposals | |||||||||||||||||||
Credit risk exposures: |
||||||||||||||||||||||||
Fixed income securities |
$ | 4,258.8 | $ | 4,258.8 | $ | 110.5 | $ | (21.1 | ) | $ | 89.4 | $ | 3.1 | |||||||||||
Derivatives other invested assets |
40.3 | 40.3 | | 12.0 | 12.0 | (0.3 | ) | |||||||||||||||||
Cash, cash equivalents and
short-term
investments |
1,371.5 | 1,371.5 | 0.1 | (10.8 | ) | (10.7 | ) | (10.8 | ) | |||||||||||||||
Premiums receivable |
486.3 | 486.3 | | | | | ||||||||||||||||||
Reinsurance recoverable |
981.8 | 981.8 | | (0.8 | ) | (0.8 | ) | | ||||||||||||||||
Total credit risk exposure |
$ | 7,138.7 | $ | 7,138.7 | 110.6 | (20.7 | ) | 89.9 | (8.0 | ) | ||||||||||||||
Hedging instruments: |
||||||||||||||||||||||||
Other invested assets: |
||||||||||||||||||||||||
Credit default swaps: |
||||||||||||||||||||||||
Banking |
486.7 | 19.5 | | 9.0 | 9.0 | 7.7 | ||||||||||||||||||
Insurance |
843.8 | 29.0 | | (5.9 | ) | (5.9 | ) | 20.7 | ||||||||||||||||
Total credit default swaps |
$ | 1,330.5 | $ | 48.5 | | 3.1 | 3.1 | 28.4 | ||||||||||||||||
Net equity impact |
$ | 110.6 | $ | (17.6 | ) | $ | 93.0 | $ | 20.4 | |||||||||||||||
In the normal course of effecting our economic hedging strategy with respect to credit
risk, we expect that there may be periods where the notional value of the hedging instrument may
exceed or be less than the exposure item being hedged. This situation may arise when management
compensates for imperfect correlations between the hedging item and the hedge, due to the timing of
opportunities related to our ability to exit and enter hedged or hedging items at attractive prices
or when management desires to only partially hedge an exposure.
The fair values of credit default swap contracts are sensitive to individual issuer credit
default swap yield curves and current market spreads. The timing and amount of changes in fair
value of fixed income securities and underwriting balances are by their nature uncertain. As a
result of these data limitations and market uncertainties, it is not possible to estimate the
reasonably likely future impact of our economic hedging programs.
Our
holdings of credit default swap contracts have declined significantly in recent quarters
relative to prior years, largely as a result of significant sales in 2008. In the latter part of
2008, we revised the financial objectives of our hedging program by determining not to replace our
credit default swap hedge position as sales or expiries occurred, primarily based upon our judgment
that our exposure to elevated levels of credit risk had moderated, but also due to (i) the
significant increase in the cost of purchasing credit protection (reducing the attractiveness of
the credit default swap contract as a hedging instrument), (ii) improvement in our capital and
liquidity (having benefited significantly from, among other things,
$568.0 million in gains from
sales of credit default swaps realized since the beginning of 2007), and (iii) our judgment that
managing credit risk through means other than the use of derivatives was, given the market
environment, once again appropriate for mitigating our credit exposure arising from financial
assets. As a result, the effects that credit default swaps as hedging instruments may be expected
to have on our future financial position, liquidity and operating results may be expected to
diminish relative to the effects in recent years. We continue to evaluate the potential impact of
the volatility in the U.S. credit markets on our financial statements and may, if conditions
warrant, initiate new credit default swap contracts as a hedging mechanism in the future, although
there can be no assurance that we will do so, in an effort to achieve our continuing objective to
minimize the potential for loss of value of held assets where, in our view, an unusual or excessive
exposure exists.
The credit default swaps portfolio had an average term to expiration of 1.4 years as of March
31, 2010, a decrease from 1.5 years as of December 31, 2009.
As of March 31, 2010, our holdings of financial instruments without quoted prices, or
non-traded investments, included a collateral loan, which was fully impaired during 2005. We
periodically evaluate the
64
Table of Contents
carrying value of non-traded investments by reviewing the borrowers
current financial positions and the timeliness of their interest and principal payments.
Equity Price Risk
Our investment portfolio is managed with a long term, value-oriented investment philosophy
emphasizing downside protection. We have policies to limit and monitor our individual issuer
exposures and aggregate equity exposure. Aggregate exposure to single issuers and total equity
positions are monitored at the subsidiary level and in aggregate at the consolidated level.
During 2009, we increased our investments in equity securities as a result of the
opportunities presented by significant declines in valuations. These additions to our portfolio,
coupled with the significant appreciation in the value of the worldwide equity markets during 2009,
resulted in a significant increase in the value of our equity holdings and, thus, to the exposure
to increased loss potential should the equity markets again suffer a significant decline in value.
We continue to manage our exposure to market price fluctuations primarily through policies designed
to monitor and limit our individual issuer exposures and aggregate equity exposure. However, in
late September 2009, we also initiated U.S. equity index total return swap contracts,
which as of March 31, 2010 have a notional value of $856.1 million, to protect against potential
future broad market downturns. The collateral requirement related to entering the total return
swaps was $65.2 million as of March 31, 2010. These total return swap transactions terminate during
the third quarter of 2010. The equity index total return swaps, in the aggregate, were in a loss
position as of March 31, 2010, and are recorded in other liabilities. Changes in the fair values of
equity index total return swaps are recorded as realized gains or losses in the consolidated
statements of operations in the period in which they occur. As of both March 31, 2010 and December
31, 2009, we had aggregate equity holdings with fair value of $2.2 billion (common stocks of $2.1
billion plus preferred stock of $0.1 billion).
During
the first quarter of 2010, we purchased a common stock total return
swap, with a total notional value of $129.9 million, as a
replication of a long position in a
publicly-listed common stock. The collateral requirement related to
this swap, which terminates
in the first quarter of 2011, was $13.0 million as of March 31, 2010. The common stock total return
swap was in a loss position as of March 31, 2010, and is recorded in other
liabilities. Changes in the fair values of common stock total return swaps are recorded as realized
gains or losses in the consolidated statements of operations in the period in which they occur.
The following tables summarize the effect of equity risk hedging instruments and related
hedged items on our historical financial position, results of operations and cash flows as of and
for the three months ended March 31, 2010 and 2009 (in millions):
As of and for the Three Months Ended March 31, 2010 | ||||||||||||||||||||||||
Effect on Pre-tax: | ||||||||||||||||||||||||
Net Cash | ||||||||||||||||||||||||
Exposure / | Other | Net Realized | Flow Impact | |||||||||||||||||||||
Notional | Carrying | Comprehensive | Investment | from | ||||||||||||||||||||
Value | Value | Income | Gains | Net Equity | Disposals | |||||||||||||||||||
Equity risk exposures: |
||||||||||||||||||||||||
Preferred stocks |
$ | 69.4 | $ | 69.4 | $ | | $ | (13.2 | ) | $ | (13.2 | ) | $ | | ||||||||||
Common stocks, at fair value |
2,076.4 | 2,076.4 | 145.7 | 80.4 | 226.1 | 80.8 | ||||||||||||||||||
Other |
129.8 | (1.5 | ) | | (1.5 | ) | (1.5 | ) | | |||||||||||||||
Total equity exposure |
$ | 2,275.6 | $ | 2,144.3 | 145.7 | 65.7 | 211.4 | 80.8 | ||||||||||||||||
Hedging instruments: |
||||||||||||||||||||||||
Other invested assets: |
||||||||||||||||||||||||
Total return swaps |
$ | 856.1 | $ | 0.3 | | (40.5 | ) | (40.5 | ) | (37.6 | ) | |||||||||||||
Total equity hedging instruments |
$ | 856.1 | $ | 0.3 | | (40.5 | ) | (40.5 | ) | (37.6 | ) | |||||||||||||
Net equity impact |
$ | 145.7 | $ | 25.2 | $ | 170.9 | $ | 43.2 | ||||||||||||||||
65
Table of Contents
As of and for the Three Months Ended March 31, 2009 | ||||||||||||||||||||||||
Effect on Pre-tax: | ||||||||||||||||||||||||
Net Cash | ||||||||||||||||||||||||
Exposure / | Other | Net Realized | Flow Impact | |||||||||||||||||||||
Notional | Carrying | Comprehensive | Investment | from | ||||||||||||||||||||
Value | Value | Loss | Losses | Net Equity | Disposals | |||||||||||||||||||
Equity risk exposures: |
||||||||||||||||||||||||
Preferred stocks |
$ | 0.1 | $ | 0.1 | $ | 0.2 | $ | (0.2 | ) | $ | | $ | (1.1 | ) | ||||||||||
Common stocks, at fair value |
1,485.9 | 1,485.9 | (243.6 | ) | (75.1 | ) | (318.7 | ) | 3.2 | |||||||||||||||
Total equity exposure |
$ | 1,486.0 | $ | 1,486.0 | (243.4 | ) | (75.3 | ) | (318.7 | ) | 2.1 | |||||||||||||
Hedging instruments: |
||||||||||||||||||||||||
Other invested assets: |
||||||||||||||||||||||||
Total return swaps |
$ | | $ | | | | | | ||||||||||||||||
Total equity hedging instruments |
$ | | $ | | | | | | ||||||||||||||||
Net equity impact |
$ | (243.4 | ) | $ | (75.3 | ) | $ | (318.7 | ) | $ | 2.1 | |||||||||||||
In the normal course of effecting our economic hedging strategy with respect to equity
risk, we expect that there may be periods where the notional value of the hedging instrument may
exceed or be less than the exposure item being hedged. This situation may arise when management
compensates for imperfect correlations between the hedging item and the hedge, due to the timing of
opportunities related to our ability to exit and enter hedged or hedging items at attractive prices
or when management desires to only partially hedge an exposure.
The following table summarizes the potential impact of a 10% change in our equity and
equity-related holdings (including equity hedges where appropriate) on pre-tax other comprehensive
income (loss) and pre-tax net income for the three months ended March 31, 2010 and 2009. Certain
shortcomings are inherent in the method of analysis presented, as it is based on the assumptions
that the equity and equity-related holdings had increased/decreased by 10%, with all other
variables held constant, and that all the equity and equity-related instruments move according to a
one-to-one correlation with global equity markets.
Three Months Ended | Three Months Ended | |||||||||||||||
March 31, 2010 | March 31, 2009 | |||||||||||||||
Effect on Pre-tax: | ||||||||||||||||
Other | Other | |||||||||||||||
Comprehensive | Net | Comprehensive | Net | |||||||||||||
Change in global equity markets | Income | Income | Loss | Income | ||||||||||||
(In millions) | ||||||||||||||||
10% decrease |
$ | (214.6 | ) | $ | 85.6 | $ | (148.6 | ) | $ | | ||||||
10% increase |
214.6 | (85.6 | ) | 148.6 | |
Generally, a 10% decline in the global equity markets would result in a similar decrease in
the value of our equity investment holdings, resulting in decreases in our pre-tax other
comprehensive income, as the majority of our equity investment holdings are classified as available
for sale. Conversely, a 10% increase in global equity markets would generally result in a similar
increase in the value of our equity investment holdings, resulting in increases in our pre-tax
other comprehensive income. As the equity hedges held by us as of March 31, 2010 were all entered
into at the end of September 2009, and as there were no other equity hedges in our portfolio during
2009 prior to September, the effects of changes in the global equity markets for the three months
ended March 31, 2009 were not offset by any hedging activities.
As of March 31, 2010, our equity related holdings in the ten issuers to which we had the
greatest exposure totaled $1.5 billion, which was approximately
17.4% of our total invested assets.
The exposure to the largest single issuer of equity related holdings held as of March 31, 2010 was
$296.5 million, which was approximately 3.4% of our total invested assets, or 8.0% of our total
shareholders equity.
66
Table of Contents
Foreign Currency Risk
Through investment in securities denominated in foreign currencies, we are exposed to foreign
(i.e., non-U.S.) currency risk. Foreign currency exchange risk exists because changes in the
exchange rates of the underlying foreign currencies in which our investments are denominated affect
the fair values of these investments when they are converted to the U.S. dollar. As of both March
31, 2010 and December 31, 2009, our total exposure to foreign-denominated securities in U.S. dollar
terms was approximately $2.0 billion, or 22.3% and 22.6%, respectively, of our total investments
and cash. The primary foreign currency exposures were from securities denominated in Euros, which
represented 7.4% and 8.1% of our total investments and cash as of March 31, 2010 and December 31,
2009, respectively, the British pound, which represented 4.4% and 4.9% of our total investments and
cash as of March 31, 2010 and December 31, 2009, respectively, and the Canadian dollar, which
represented 4.4% and 4.0%, of our total investments and cash as of March 31, 2010 and December 31,
2009, respectively. As of March 31, 2010, the potential impact of a 10% decline in each of the
foreign exchange rates on the valuation of investment assets denominated in foreign currencies
would result in a $197.3 million decline in the fair value of our total investments and cash,
before taxes.
Through our international operations, we conduct our business in a variety of foreign
(non-U.S.) currencies, with the primary exposures being Euros, British pounds, and Canadian
dollars. Assets and liabilities denominated in foreign currencies are exposed to changes in
currency exchange rates to the extent that they do not offset each other resulting in a natural
hedge. Our reporting currency is the U.S. dollar, and exchange rate fluctuations relative to the
U.S. dollar may materially impact our results and financial condition. We manage this risk on a
macro basis by entering into forward currency contracts. As of March 31, 2010 and December 31,
2009, we were party to forward currency contracts with notional amounts of $512.0 million and
$416.3 million, respectively. As of March 31, 2010 and December 31, 2009, the fair value of these
contracts is reported in other liabilities at $34.8 million and $39.3 million, respectively. The
collateral requirement related to the forward currency contracts was $6.6 million as of March 31,
2010. As a result in the appreciation in the fair value of some of the forward currency contracts,
counterparties to these contracts are required to place government securities as collateral,
pursuant to the forward currency agreements. The fair value of this collateral as of March 31, 2010
was $2.4 million. Forward currency contracts had net realized investment gains of $4.6 million and
$12.0 million for the three months ended March 31, 2010 and 2009, respectively.
Investment Impairment Risk
On a quarterly basis, we review our investment portfolio for declines in value and
specifically consider securities with fair values that have declined to less than 80% of their cost
or amortized cost at the time of review. Declines in the fair value of investments that are
determined to be temporary are recorded as unrealized depreciation, net of tax, in accumulated
other comprehensive income. If we determine that a decline is other-than-temporary, the cost or
amortized cost of the investment will be written down to the fair value and a realized investment
loss will be recorded in our consolidated statements of operations.
In assessing the value of our debt and equity securities held as investments, and possible
impairments of such securities, we review (i) the issuers current financial position and
disclosures related thereto, (ii) general and specific market and industry developments, (iii) the
timely payment by the issuer of its principal, interest and other obligations, (iv) the outlook and
expected financial performance of the issuer, (v) current and historical valuation parameters for
the issuer and similar companies, (vi) relevant forecasts, analyses and recommendations by research
analysts, rating agencies and investment advisors, and (vii) other information we may consider
relevant. Generally, a change in the market or interest rate environment would not, of itself,
result in an impairment of an investment, but rather a temporary decline in value. In addition, we
consider our ability and intent to hold the security to recovery when evaluating possible
impairments.
Decisions regarding other-than-temporary impairments require an evaluation of facts and
circumstances at a specific time to determine if an other-than-temporary impairment exists. For our
available-for-sale fixed income securities, additional facts are evaluated to determine if the
other-than-temporary impairment is related to credit or other factors. For our available-for-sale
fixed income securities, should the facts and circumstances change, such that an
other-than-temporary impairment is considered appropriate, and additional factors determine that
the other-than-temporary impairment is related to credit, we will recognize the
impairment by reducing the cost or amortized cost of the investment to its fair value and
recording the loss in our consolidated
67
Table of Contents
statements of operations. When it is determined that an other-than-temporary impairment for
our available-for-sale fixed income securities exists that is related to other factors (e.g.,
interest rates and market conditions), we will recognize the impairment in other comprehensive
income, unless we anticipate that we will likely sell or be required to sell such securities, or
that such securities will mature, before the securities have recovered in value, in which case the
loss is recorded in our consolidated statement of operations. For our redeemable preferred stock at
fair value, should the facts and circumstances change such that an other-than-temporary impairment
is considered appropriate, we will recognize the impairment by reducing the cost of the investment
to its fair value and recording the loss in our consolidated statements of operations. Upon the
disposition of a security where an other-than-temporary impairment has been taken, we will record a
gain or loss based on the adjusted cost or carrying value of the investment.
Risks and uncertainties are inherent in our other-than-temporary decline in value assessment
methodology. Risks and uncertainties include, but are not limited to, incorrect or overly
optimistic assumptions about financial condition or liquidity, incorrect or overly optimistic
assumptions about future prospects, inadequacy of any underlying collateral, unfavorable changes in
economic or social conditions and unfavorable changes in interest rates.
The following tables reflect the fair value and gross unrealized depreciation of our fixed
income securities and common stock investments, aggregated by investment category and length of
time that individual securities have been in a continuous unrealized loss position, as of March 31,
2010 and December 31, 2009 (in millions):
Duration of Unrealized Loss | ||||||||||||||||||||||||||||||||||||
Less than 12 Months | Greater than 12 Months | Total | ||||||||||||||||||||||||||||||||||
Gross | Number | Gross | Number | Gross | Number | |||||||||||||||||||||||||||||||
Fair | Unrealized | of | Fair | Unrealized | of | Fair | Unrealized | of | ||||||||||||||||||||||||||||
Value | Depreciation | Securities | Value | Depreciation | Securities | Value | Depreciation | Securities | ||||||||||||||||||||||||||||
March 31, 2010 |
||||||||||||||||||||||||||||||||||||
Fixed income securities
investment grade: |
||||||||||||||||||||||||||||||||||||
United States government, government
agencies and authorities |
$ | 51.6 | $ | (2.8 | ) | 8 | $ | 8.7 | $ | (2.1 | ) | 1 | $ | 60.3 | $ | (4.9 | ) | 9 | ||||||||||||||||||
States, municipalities and political
subdivisions |
711.0 | (5.6 | ) | 11 | 1.1 | (0.1 | ) | 1 | 712.1 | (5.7 | ) | 12 | ||||||||||||||||||||||||
Foreign governments |
12.2 | (1.0 | ) | 1 | | | | 12.2 | (1.0 | ) | 1 | |||||||||||||||||||||||||
Total investment grade |
774.8 | (9.4 | ) | 20 | 9.8 | (2.2 | ) | 2 | 784.6 | (11.6 | ) | 22 | ||||||||||||||||||||||||
Fixed income securities non-investment
grade, corporate |
37.0 | (1.1 | ) | 2 | | | | 37.0 | (1.1 | ) | 2 | |||||||||||||||||||||||||
Total fixed income securities |
811.8 | (10.5 | ) | 22 | 9.8 | (2.2 | ) | 2 | 821.6 | (12.7 | ) | 24 | ||||||||||||||||||||||||
Common stocks, at fair value |
46.9 | (4.0 | ) | 4 | | | | 46.9 | (4.0 | ) | 4 | |||||||||||||||||||||||||
Total temporarily impaired
securities |
$ | 858.7 | $ | (14.5 | ) | 26 | $ | 9.8 | $ | (2.2 | ) | 2 | $ | 868.5 | $ | (16.7 | ) | 28 | ||||||||||||||||||
Duration of Unrealized Loss | ||||||||||||||||||||||||||||||||||||
Less than 12 Months | Greater than 12 Months | Total | ||||||||||||||||||||||||||||||||||
Gross | Number | Gross | Number | Gross | Number | |||||||||||||||||||||||||||||||
Fair | Unrealized | of | Fair | Unrealized | of | Fair | Unrealized | of | ||||||||||||||||||||||||||||
Value | Depreciation | Securities | Value | Depreciation | Securities | Value | Depreciation | Securities | ||||||||||||||||||||||||||||
December 31, 2009 |
||||||||||||||||||||||||||||||||||||
Fixed income securities
investment grade: |
||||||||||||||||||||||||||||||||||||
United States government, government
agencies and authorities |
$ | 62.2 | $ | (4.3 | ) | 9 | $ | | $ | | | $ | 62.2 | (4.3 | ) | 9 | ||||||||||||||||||||
States, municipalities and political
subdivisions |
572.0 | (39.3 | ) | 6 | 1.0 | (0.1 | ) | 1 | 573.0 | (39.4 | ) | 7 | ||||||||||||||||||||||||
Foreign governments |
| | | 8.5 | (0.1 | ) | 1 | 8.5 | (0.1 | ) | 1 | |||||||||||||||||||||||||
Corporate |
4.9 | (0.1 | ) | 1 | | | | 4.9 | (0.1 | ) | 1 | |||||||||||||||||||||||||
Total investment grade |
639.1 | (43.7 | ) | 16 | 9.5 | (0.2 | ) | 2 | 648.6 | (43.9 | ) | 18 | ||||||||||||||||||||||||
Fixed income securities non-investment
grade, corporate |
41.9 | | 3 | | | | 41.9 | | 3 | |||||||||||||||||||||||||||
Total fixed income securities |
681.0 | (43.7 | ) | 19 | 9.5 | (0.2 | ) | 2 | 690.5 | (43.9 | ) | 21 | ||||||||||||||||||||||||
Common stocks, at fair value |
36.2 | (3.9 | ) | 7 | | | | 36.2 | (3.9 | ) | 7 | |||||||||||||||||||||||||
Total temporarily impaired
securities |
$ | 717.2 | $ | (47.6 | ) | 26 | $ | 9.5 | $ | (0.2 | ) | 2 | $ | 726.7 | $ | (47.8 | ) | 28 | ||||||||||||||||||
68
Table of Contents
We believe the gross unrealized depreciation is temporary in nature and we have not
recorded a realized investment loss related to these securities. Given the size of our investment
portfolio and capital position, we believe it is likely that we will not be required to sell or
liquidate these securities before the fair value recovers the gross unrealized depreciation.
As an economic hedge against the potential adverse impact of changes in price levels in the
economy, we purchased inflation-linked derivative contracts referenced to inflation indices in the
geographic regions in which we operate. As of March 31, 2010 and December 31, 2009, we had 34 and
three inflation-linked derivative contracts, respectively, outstanding, with a carrying value in
the consolidated balance sheet of $55.2 million and $4.1 million, respectively, and a cost of $65.7
million and $4.0 million, respectively. The initial premium paid for inflation-linked derivative
contracts is recorded as a derivative asset and subsequently adjusted for changes in the unrealized
fair value of the contracts at each balance sheet date. Changes in the unrealized fair value of the
contracts are recorded as realized gains or losses on
investments in our consolidated statements of
operations with a corresponding adjustment to the carrying value of the
derivative asset. In the event of a sale, expiration or early settlement of one of our
inflation-linked derivative contracts, we would receive the fair value of that contract on the date
of the transaction. Our maximum potential cash loss is limited to the premiums paid to enter into
the derivative contracts. Pursuant to the agreements governing the inflation-linked derivatives,
counterparties to these transactions are contractually required to periodically deposit eligible
collateral for the benefit of us in support of the then-current fair value of the derivative
contracts. As of March 31, 2010, the fair value of this collateral was $39.1 million.
69
Table of Contents
PART I Item 4. Controls and Procedures
(a) | Evaluation of disclosure controls and procedures. Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this Quarterly Report. Based upon that evaluation, such officers have concluded that our disclosure controls and procedures are effective as of the end of such period. | ||
(b) | Changes in internal controls over financial reporting. There have been no changes during the period covered by this Quarterly Report in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. |
70
Table of Contents
PART II OTHER INFORMATION
PART II Item 1. Legal Proceedings
On February 8, 2007, we were added as a co-defendant in an amended and consolidated complaint
in an existing action against our then-majority (now 100%) shareholder, Fairfax, and certain of
Fairfaxs officers and directors, who included certain of our current and former directors. The
amended and consolidated complaint was filed in the United States District Court for the Southern
District of New York by the lead plaintiffs, who sought to represent a class of all purchasers and
acquirers of securities of Fairfax between May 21, 2003 and March 22, 2006, inclusive, and allege,
among other things, that the defendants violated U.S. federal securities laws by making material
misstatements or failing to disclose certain material information. The amended and consolidated
complaint sought, among other things, certification of the putative class, unspecified compensatory
damages, unspecified injunctive relief, reasonable costs and attorneys fees and other relief.
Motions to dismiss were argued before the Court in December 2007. On March 29, 2010, the Court
granted defendants motion to dismiss on the grounds that the Court lacked subject matter
jurisdiction over the case. The Court also denied plaintiffs request to move for leave to file a
second amended complaint.
In July 2006, Fairfax, our then-majority (now 100%) shareholder, filed a lawsuit in the
Superior Court, Morris County, New Jersey, seeking damages from a number of defendants who, the
complaint alleges, participated in a stock market manipulation scheme involving Fairfax shares, and
the complaint was subsequently amended to add additional allegations and two defendants. In January
2008, two of these defendants filed a counterclaim against Fairfax and a third-party complaint
against, among others, us and certain of our directors. Those counterclaims and third-party
claims were voluntarily withdrawn in March 2008. In September 2008, the same two defendants filed
an amended counterclaim against Fairfax, as well as third-party claims against certain Fairfax
executives, us and certain of our directors, Fairfaxs outside legal counsel and
PricewaterhouseCoopers. The complaint alleges, among other things, claims of racketeering,
intentional infliction of emotional distress, tortious interference with economic advantage and
other torts, and seeks unspecified compensatory and punitive damages
and other relief. We deny the allegations and intend to vigorously defend against these claims. In September 2008,
the Court granted a motion for summary judgment brought by two defendants, and dismissed Fairfaxs
claims against those defendants without prejudice. We have not yet responded to the
complaint, and the timing of that response has not been set. Discovery in this action is ongoing.
At this early stage of the proceedings, it is not possible to make any determination regarding the
likely outcome of this matter.
We and our subsidiaries are involved from time to time in ordinary litigation and arbitration
proceedings as part of our business operations; in managements opinion, the outcome of these
suits, individually or collectively, is not likely to result in judgments that would be material to
our financial condition or results of operations.
PART II Item 1A. Risk Factors
There have been no material changes to the risk factors as previously disclosed in our 2009
Annual Report Form 10-K filed with the SEC on February 25, 2010.
PART II Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
None.
PART II Item 3. Defaults Upon Senior Securities
None.
PART
II Item 4. (Removed and Reserved)
N/A
71
Table of Contents
PART II Item 5. Other Information
Effective
May 1, 2010, we entered into a $300 million two-way
revolving credit facility with Fairfax, Inc. (a wholly-owned subsidiary of
Fairfax, and the direct and indirect holder of 100% of the common shares of the Company), under which either party may borrow up to
$300.0 million from the other party. Loans under the facility are unsecured and bear interest at a
rate of 7.5% per annum, payable quarterly, and the principal amount is payable on demand. Either
party may terminate the facility at any time upon demand, at which time all outstanding principal
and unpaid interest shall become due. On May 3, 2010, we loaned $200.0 million to Fairfax,
Inc. under the facility. The foregoing summary of the two-way revolving credit facility is qualified in its entirety by
reference to the text of the revolving line of credit agreement, effective as of May 1, 2010, which
is filed as Exhibit 10.28 hereto.
72
Table of Contents
PART II Item 6. Exhibit Index
Number | Title of Exhibit | |
*10.28
|
Revolving Line of Credit Agreement, dated as of May 1, 2010, between Odyssey Re Holdings Corp. and Fairfax, Inc. | |
* 31.1
|
Certification of President and Chief Executive Officer pursuant to Rule 13a-15(e) or 15d-15(e), as enacted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
* 31.2
|
Certification of Executive Vice President and Chief Financial Officer pursuant to Rule 13a-15(e) or 15d-15(e), as enacted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
* 32.1
|
Certification of President and Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as enacted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
* 32.2
|
Certification of Executive Vice President and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as enacted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
99.1
|
Risk Factors (incorporated into Part II of this Form 10-Q by reference to Item 1A Risk Factors in the Registrants Annual Report on Form 10-K filed with the Securities and Exchange Commission on February 25, 2010). |
* | Filed herewith. |
73
Table of Contents
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.
Odyssey Re Holdings Corp. |
||||
Date: May 6, 2010 | By: | /s/ Andrew A. Barnard | ||
Name: | Andrew A. Barnard | |||
Title: | President and Chief Executive Officer | |||
Date: May 6, 2010 | By: | /s/ Jan Christiansen | ||
Name: | Jan Christiansen | |||
Title: | Executive Vice President and Chief Financial Officer |
|||
74