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Endurance Specialty Holdings 10-K 2010 UNITED STATES
SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
FORM 10-K
for the fiscal year ended December 31, 2009,
or
for the transition period from to
Commission file number 1-31599
ENDURANCE SPECIALTY HOLDINGS LTD.
(Exact name of registrant as specified in its charter)
Wellesley House
90 Pitts Bay Road Pembroke HM 08, Bermuda (Address of principal executive offices, including postal code) Registrant’s telephone number, including area code: (441) 278-0400 Securities registered pursuant to Section 12(b) of the Securities Exchange Act of 1934:
Securities registered pursuant to Section 12(g) of the Securities Exchange Act of 1934: None
Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act of 1933. Yes þ No o
Indicate by check mark whether the registrant is not required to file reports pursuant to Section
13 or Section 15(d) of the Securities Exchange Act of 1934 Yes o No þ
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 periods 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 (§ 232.405 of this chapter) 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is
not contained herein, and will not be contained, to the best of the registrant’s knowledge, in the
definitive proxy or information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or
a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in
Rule 12b-2 of the Securities Exchange Act of 1934. (Check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Securities Exchange Act of 1934). Yes o No þ
The aggregate market value of the ordinary shares held by non-affiliates of the registrant, as of
June 30, 2009, was $1,298,931,790.
As of February 24, 2010, 53,957,605 ordinary shares were outstanding.
Certain portions of the registrant’s definitive proxy statement relating to its 2010 annual general
meeting of shareholders are incorporated by reference into Part III of this report.
PART I
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS Some of the statements under “Item 1. Business,” “Item 7. Management’s Discussion and Analysis
of Financial Condition and Results of Operations” and elsewhere in this Annual Report on Form 10-K
may include forward-looking statements within the meaning of the Private Securities Litigation
Reform Act of 1995 (“PLRSA”). The PLRSA provides a “safe harbor” for forward-looking statements.
These forward-looking statements reflect our current views with respect to future events and
financial performance. Such statements include forward-looking statements with respect to us in
general and the insurance and reinsurance sectors specifically, and as to both underwriting and
investment matters. Statements which include the words “expect,” “intend,” “plan,” “believe,”
“project,” “anticipate,” “seek,” “will,” and similar statements of a future or forward-looking
nature identify forward-looking statements for purposes of the PLSRA or otherwise.
All forward-looking statements address matters that involve risks and uncertainties.
Accordingly, there are or will be important factors that could cause actual results to differ
materially from those indicated in such statements. We believe that these factors include, but are
not limited to, the following:
The foregoing review of important factors should not be construed as exhaustive and should be
read in conjunction with the other cautionary statements that are included in this Annual Report on
Form 10-K, including the risk factors set forth in Item 1A. We undertake no obligation to publicly
update or review any forward-looking statement, whether as a result of new information, future
developments or otherwise.
Overview
Endurance Holdings is a holding company domiciled in Bermuda. Through our operating
subsidiaries based in Bermuda, the United States and the United Kingdom, we focus on underwriting
specialty lines of personal and commercial property and casualty insurance and reinsurance on a
global basis. We define specialty lines as those lines of insurance and reinsurance that require
dedicated, specialized underwriting skills and resources in order to be profitably underwritten.
Our portfolio of specialty lines of business is organized into two business segments — Insurance
and Reinsurance.
We began operations on December 17, 2001 after Endurance Bermuda completed a private placement
of $1.2 billion of its equity securities. On March 5, 2003, Endurance Holdings completed the
initial public offering of its ordinary shares. Endurance Holdings’ seven wholly-owned operating
subsidiaries as of December 31, 2009 are as follows:
3
Endurance Holdings and its wholly-owned subsidiaries are collectively referred to in this
discussion as “we” or the “Company”. Endurance Holdings’ ordinary shares are traded on the New
York Stock Exchange under the symbol “ENH”.
Business Strategy
Our goal is to leverage our competitive strengths and successfully execute our strategy in
order to generate a superior long-term return on capital and become the best specialty insurer and
reinsurer in the world.
The key elements of our strategy are:
4
Business Segments
The Company currently has two business segments — Insurance and Reinsurance. Financial data
relating to our two segments is included in Item 7 — Management’s Discussion and Analysis of
Financial Condition and Results of Operations and in our Audited Consolidated Financial Statements
and related notes presented under Item 8 — Financial Statements and Supplementary Data.
Our two business segments and the related gross and net premiums written for the years ended
December 31, 2009, 2008 and 2007 are as follows:
Insurance
Our Insurance segment is comprised of six lines of business: agriculture, professional lines,
casualty, property, healthcare liability and workers’ compensation. Gross and net premiums written for the lines of
business in the Insurance segment for the years ended December 31, 2009, 2008 and 2007 are as
follows:
5
From our Bermuda office, we provide casualty, healthcare liability and professional lines
insurance. From our United States offices, we provide agriculture, professional lines, casualty,
property, healthcare liability, and workers’ compensation. As of February 2009, we ceased writing
workers’ compensation business in our United States offices and ceased offering property insurance coverage from our London office. A
description of each of these lines of business follows:
Agriculture. Our agriculture insurance business focuses on traditional multiple peril crop
insurance, crop hail, livestock risk protection and other agriculture risk management products, all
offered through independent agents.
Professional Lines. Our professional lines insurance business includes directors’ and
officers’ liability, errors and omissions, employment practices liability, environmental liability
and pension trust liability insurance and includes both non-profit and for-profit entities
representing a wide range of industry groups.
Casualty. Our casualty insurance line of business provides third party liability insurance
for a wide range of industry groups. Our excess casualty clients are typically Fortune 1000
companies with sophisticated risk management practices who generally retain large portions of their
own risk and purchase large insurance limits. In addition, we write casualty insurance that
targets middle market companies at lower attachment points for real estate, manufacturing,
chemicals, financial, utilities, telecommunications, construction and other industries.
Property. Our property insurance line of business is comprised of insured properties with
sufficiently large values to require multiple insurers and reinsurers to accommodate their
insurance capacity needs. The properties insured are generally of a commercial nature and are
spread across a variety of industries, such as real estate, retail, manufacturing, chemicals,
financial services, utilities, telecommunications, construction, civil engineering and
municipalities/institutions.
Healthcare Liability. Our healthcare liability line of business is focused on excess hospital
medical professional liability insurance. Our Bermuda operation focuses on institutional
healthcare providers such as large, stand-alone hospitals, multi-hospital systems, university
teaching hospitals and integrated specialty hospitals. Our U.S.-based operations offer excess
coverage to small to medium sized stand-alone hospitals and other healthcare organizations.
Together, our Bermuda and U.S. based healthcare practices offer a comprehensive excess coverage
approach to the healthcare industry.
Workers’ Compensation. Our workers’ compensation insurance line was primarily focused on niche
markets in the U.S. Our target clients were small accounts written through local producers
utilizing innovative technology and web-based systems to provide exceptional service to our
clients. To support this business, we entered into a strategic relationship with a seasoned and
experienced specialist in the California workers’ compensation insurance market. As of February
2009, the Company ceased underwriting California workers’ compensation insurance business.
Reinsurance
Our Reinsurance segment is comprised of five lines of business: catastrophe, casualty,
property, aerospace and marine and surety and other specialty. Gross and net premiums written for
the lines of business in the Reinsurance segment for the years ended December 31, 2009, 2008 and
2007 are as follows:
6
From our Bermuda office, we provide casualty, property, catastrophe and aerospace reinsurance.
From our United States offices, we provide casualty, property, agriculture, marine, surety and
other specialty reinsurance. From our London office, we provide casualty, property, marine,
agriculture and personal accident reinsurance. From our Zurich and Singapore branches, we provide property, casualty and marine reinsurance.
A description of these lines of business follows:
Catastrophe. Our catastrophe reinsurance line of business reinsures catastrophic perils for
ceding companies on a treaty basis for primarily property and
workers’ compensation business. The
principal perils reinsured in our catastrophe reinsurance business include natural perils such as
hurricanes, typhoons, earthquakes, floods, tornados, hail and fire and certain man-made perils such
as industrial events and terrorism.
Casualty. Our casualty reinsurance line of business reinsures third party liability exposures
from ceding companies on a treaty basis such as automobile liability, professional liability,
directors’ and officers’ liability, umbrella liability and workers’ compensation.
Property. Property reinsurance reinsures individual property insurance policies issued by our
ceding company clients including both personal lines and commercial exposures (principally covering
buildings, structures, equipment, contents and time element coverages on a treaty basis). Loss
exposures in this line include the perils of fire, explosion, collapse, riot, vandalism, wind,
tornado, flood and earthquake. We underwrite our property reinsurance line of business on both a
proportional and excess of loss basis.
Aerospace and Marine. Our aerospace line of business is comprised primarily of the
reinsurance of aviation and space businesses. The aviation business includes hull, aircraft
liability and aircraft products coverages. The space business includes satellite launch and
in-orbit coverage.
Our marine line of business consists of the reinsurance of bluewater hull, brownwater hull and
cargo insurance business. Our marine reinsurance is underwritten on a proportional and
non-proportional basis.
Surety and Other Specialty. We provide surety reinsurance for contract and commercial surety
as well as for the fidelity line of business on both a proportional and excess of loss basis. This
business line also includes agriculture reinsurance comprised of risks associated with the
production of food and fiber on a global basis as well as traditional treaty, proportional and
aggregate stop loss reinsurance for primary insurance companies writing multiple peril, hail and
named peril covers, as well as custom risk transfer mechanisms for agricultural dependent
industries with exposure to crop yield or price. Our remaining business in this line represents a
variety of contracts, such as personal accident and terrorism, which are underwritten utilizing the
expertise of our senior underwriting staff.
Please see the Audited Consolidated Financial Statements’ Note 9 — “Segment Reporting” for
additional information about our business segments and the geographic distribution of our gross
premiums written for the last three fiscal years.
Distribution
The majority of our business is obtained directly by the Company or through the use of
independent agents, primarily for the agriculture line of our Insurance segment. We are also a
broker-market participant and conduct a portion of our business through insurance and reinsurance
brokers around the world. The brokerage distribution channel provides us with access to an
efficient, variable cost, and global distribution system without the significant time and expense
which would be incurred in creating wholly-owned distribution networks for certain lines of
business.
7
For the year ended December 31, 2009, Marsh & McLennan Companies, Inc. was the largest
broker distributor in our Insurance segment, and Aon Benfield was the largest broker distributor in our
Reinsurance segment. A breakdown of our distribution by broker and by business segment for the
years ended December 31, 2009, 2008 and 2007 is provided in the tables below:
Insurance
Reinsurance
Claims Management
Under the direction of our Chief Claims Officer, claims are managed by our experienced,
technical claims teams working closely with each of our operating subsidiaries. Our claims staff
reviews initial loss reports, administers claims databases, generates appropriate responses to
claims reports, identifies and handles coverage issues, determines whether further investigation is
required and where appropriate, retains outside claims counsel, establishes case reserves, pays
claims, manages salvage and subrogation and notifies reinsurers. In addition, our claims staff
conducts significant audits of our insurance company clients throughout the year, evaluating claims
handling abilities, reserve philosophies, loss notification processes and overall quality of our
clients’ performance.
Upon receipt, claims notices are recorded by the claims staff within our underwriting,
financial and claims systems. When the Company is notified of insured losses or discovers
potential losses as part of its claims audits, claims personnel record a case reserve as
appropriate for the estimated amount of the exposure at that time. The estimate reflects the
judgment of claims personnel based on general reserving practices, the experience and knowledge of
such personnel regarding the nature of the specific claim and, where appropriate, advice of
counsel. Reserves are also established to provide for the estimated expense of settling claims,
including legal and other fees and the general expenses of administering the claims adjustment
process.
Reserve for Losses and Loss Expenses
We are required by applicable insurance laws and regulations and accounting principles
generally accepted in the United States (“U.S. GAAP”) to establish reserves for losses and loss
expenses that arise from our business. These reserves are balance sheet liabilities representing
estimates of future amounts required to pay losses and loss expenses for insured or reinsured
claims which have occurred at or before the balance sheet date, whether already known to us or not
yet reported. It is our policy to establish these losses and loss expense reserves after
evaluating all information known to us as of the date they are reported.
8
We use statistical and actuarial methods to reasonably estimate ultimate expected losses and
loss expenses. The period of time from the reporting of a loss to us and the settlement of our
liability may be several years. During this period, additional facts and trends will be revealed.
As these factors become apparent, reserves will be adjusted, sometimes requiring an increase in our
overall reserves, and at other times requiring a reallocation of incurred but not reported reserves
to specific case reserves.
Reserves for losses and loss expenses are based in part upon the estimation of losses
resulting from catastrophic events. Estimation of losses from catastrophic events is inherently
difficult because of the infrequency and severity of large catastrophes. Therefore, we utilize
commercially available models, as well as historical reinsurance industry property catastrophe
claims experience to supplement our own historical claims experience, for purposes of evaluating
future trends and providing an estimate of ultimate claims costs.
To assist us in establishing appropriate reserves for losses and loss expenses, we analyze a
significant amount of insurance industry information with respect to the pricing environment and
loss settlement patterns. In combination with our individual pricing analyses, this industry
information is used to guide our loss and loss expense estimates. These estimates are reviewed
regularly, and adjustments, if any, are recorded in earnings in the periods in which they are
determined.
While management believes it has made a reasonable estimate of ultimate losses, the ultimate
claims experience may not be as reliably predicted as may be the case with other insurance and
reinsurance operations, and there can be no assurance that our future losses and loss expenses will
not exceed our current total reserves.
Enterprise Risk Management
We have developed a strong risk management culture within the Company through the
establishment of various processes and controls focused on the Company’s risk exposures. Our
enterprise risk management (“ERM”) activities are critical to the organization’s senior management,
business units and Board of Directors. The goals of our ERM framework that drive our corporate
strategy are as follows:
In order to meet our ERM goals, the Company has established risk tolerances applicable to all
areas of our business. It is our corporate objective to limit the risk of a significant loss on an
economic basis from a one-in-one-hundred year series of catastrophic events to no more than 25% of
our shareholders’ equity. We define “economic basis” as premiums plus net investment income less
incurred losses and loss expenses, acquisition expenses and general and administrative expenses.
On a group basis, we monitor our:
In addition, we have developed processes, models and a detailed internal control structure to
specifically address our risk exposures. The Company’s primary risk exposure areas are as follows:
underwriting risk, including certain key underwriting risks associated with the pricing and
exposure evaluation process; catastrophe correlation/aggregation risk; the risk embedded in the
loss reserve estimation process; investment risk; and operational risk. The following sections
more specifically address our method and procedures for addressing and managing our underwriting,
catastrophe, loss reserving, investment and operational risks.
9
Underwriting Risk Management
Internal underwriting controls are established by our Chief Executive Officer and Chief
Underwriting Officer. Underwriting authority is delegated to the managers of our lines of business
in each business segment and to underwriters in accordance with prudent practice and an
understanding of each underwriter’s capabilities. Detailed letters of underwriting authority are
issued to each of our underwriters. These letters contain our operating guidelines, a description
of the analytic process to be followed, referral requirements broken down by sources of business,
terms and conditions, situations, limits capacity and annual premium for any one contract. Our
return on capital guidelines are attached to each letter as an exhibit and are stated in terms of
maximum combined ratio targets, excluding our general and administrative expenses, and minimum
return on risk based capital by line of business. Our return on capital guidelines is regularly
reviewed by our Chief Underwriting Officer and our Chief Risk Officer/Chief Actuary to reflect
changes in market conditions, interest rates, capital requirements and market-expected returns. In
addition, oversight of underwriting and risk management is provided by our Board of Directors and
its Risk and Underwriting Committees through regular reviews of the Company’s risk profile. For a
further discussion on the role of our Board of Directors in the Company’s risk management, see “The
Role of the Board of Directors in Risk Management” below.
We have a disciplined approach to underwriting and risk management that relies heavily upon
the collective underwriting expertise of our management and staff. This expertise is in turn
guided by the following underwriting principles:
Before we review any program proposal, we consider the appropriateness of the client,
including the quality of its management and its risk management strategy. In addition, we require
each program to include significant information on the nature of the perils to be included and
detailed aggregate information as to the location or locations of the risks covered. We further
request information on the client’s loss history for the perils being insured or reinsured,
together with relevant underwriting considerations. If a program meets the preceding underwriting
criteria, we then evaluate the proposal in terms of its risk/reward profile to assess the adequacy
of the proposed pricing and its potential impact on our overall return on capital as well as our
corporate risk objectives.
We have fully integrated our internal actuarial staff into the underwriting and decision
making process. We use in-depth actuarial and risk analyses to evaluate contracts prior to
authorization. In addition to internal actuaries and risk professionals, we make use of outside
consultants as necessary to develop appropriate analyses for pricing.
Separate from our natural catastrophe exposed businesses, we underwrite and accept casualty
and specialty insurance and reinsurance business. We apply the same standards with respect to
actuarial and risk analysis to these businesses using commercial data and models licensed from
various professional service firms. As with our natural catastrophe exposed businesses, we seek to
identify those casualty and specialty exposures that are most likely to be simultaneously
influenced by significant events. These exposures are then jointly tracked to ensure that we do
not develop an excessive accumulation of exposure to that particular type of event.
In addition to the above technical and analytical practices, our underwriters use a variety of
means, including specific contract terms, to manage our exposure to loss. These include occurrence
limits, aggregate limits, reinstatement provisions and loss ratio caps. Additionally, our
underwriters use appropriate exclusions, terms and conditions to further eliminate particular risks
or exposures that our underwriting team deems to be outside of the intent of the coverage we are
willing to offer. Our Bermuda underwriting location provides us with a particular advantage for
certain lines of business because there are no regulatory limitations upon our use of coverage
restrictions in insurance policies.
In certain cases, the risks assumed by the Company are partially reinsured with third party
reinsurers. Reinsurance ceded varies by segment and line of business based on a number of factors,
including market conditions. The benefits of ceding risks include reducing exposure on individual
risks, protecting against catastrophic risks, maintaining acceptable capital ratios, enabling the
writing of additional business and ensuring our insurance businesses are of sufficient size to be
considered a lead market for their products. Reinsurance ceded does not legally discharge the
Company from its liabilities to the original policyholder in respect of the risk being reinsured.
See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”
and Note 6 — “Reinsurance” in the Notes to the Consolidated Financial Statements of the Company.
Catastrophe Risk Management
To achieve our catastrophe risk management objectives, we utilize a variety of proprietary and
commercially available tools to quantify and monitor the various risks we accept as a company.
We have licensed catastrophe modeling software from the principal modeling firms, including
EQE, RMS and AIR. These software tools use exposure data provided by our insureds and ceding
company clients to simulate catastrophic losses. We take an active role in the evaluation of these
commercial catastrophe models, providing feedback to the modeling companies to improve the efficiencies of these models. We also
supplement the model output in certain territories with the results of our proprietary models. We
use modeling not just for the underwriting of individual transactions but also to optimize the
total return and risk of our underwriting portfolio. We have high standards for the quality and
levels of detailed exposure data provided by our clients and have an expressed preference for data
at the zip code or postal code level or finer. Data provided at more summary levels, such as
counties or CRESTA zones, is conservatively modeled and surcharged for increased uncertainty. We
require significant amounts of data from our clients and decline business in which we feel the data
provided is insufficient to make an appropriate analysis. Our commitment to detailed exposure data
has precluded significant involvement as a retrocessionaire in the current market.
10
Data output from the software described above is incorporated in our proprietary models. Our
proprietary systems include those for modeling risks associated with property catastrophe,
healthcare liability, aerospace and marine, agriculture, property and workers’ compensation
business, various casualty and specialty pricing models as well as our proprietary portfolio risk
management and capital allocation models. These systems allow us to monitor our pricing and risk
on a contract by contract basis in each of our segments and business lines.
Data output from both our licensed and proprietary software models is used to estimate the
amount of premium that is required to pay the long-term expected losses under the proposed
contracts. The data output is also used to estimate correlation between both new business and our
existing portfolio. The degree of correlation is used to estimate the incremental capital required
to support our participation on each proposed risk, allowing us to calculate a return on consumed
capital. Finally, the data output is used to monitor and control our cumulative exposure to
individual perils across all of our businesses.
Our pricing of catastrophe reinsurance contracts is based on a combination of modeled loss
estimates, actual ceding company loss history, surcharges for potential unmodeled exposures, fixed
and variable expense estimates and profit requirements. The profit requirements are based on
incremental capital usage estimates described above and on our required return on consumed capital.
Loss Reserving Risk Management
Establishing reserves for losses and loss expenses, in particular reserves for the Company’s
long-tail lines of business, constitutes a significant risk for the Company. Loss reserves do not
represent an exact calculation of liability, but instead are estimates of what the Company expects
the ultimate settlement and administration of claims will cost. To the extent the Company
determines that actual losses and loss expenses exceed the loss reserves recorded in our financial
statements, the Company will be required to immediately increase its reserve for losses and loss
expenses which in turn could cause a material reduction in the Company’s profitability and capital.
The Company manages the risk inherent in estimating the Company’s reserves for losses and loss
expenses in a variety of ways. First, the Company underwrites a balanced and diversified portfolio
of business, which reduces the Company’s susceptibility to reserving errors that may be associated
with any one line or type of business. In 2009, the Company’s largest single line of business
represented 28.3% of the gross premiums written by the Company. Second, where loss development
uncertainty exists, the Company makes select use of the purchase of reinsurance to reduce the
Company’s exposure to such loss development uncertainty, in particular in our insurance lines of
business. Third, the Company incorporates uncertainty in loss trends into its underwriting pricing
process. Finally, in its reinsurance business, the Company conducts active, regular audits of its
ceding company clients with the intent of identifying quickly and thoroughly exposures assumed by
the Company.
The Company’s reserving process also serves to mitigate the risk associated with the Company’s
loss and loss expense reserve estimates. The Company seeks to base its loss reserve estimates upon
actuarial and statistical projections derived from the most recently available data, as well as
current information on future trends in claims severity and frequency, judicial theories of
liability and other factors. The Company continually refines both its loss reserve estimates and
the means by which its loss reserve estimates are derived, incorporating an ongoing process of
developing loss experience, reported claims and claims settlements.
11
Investment Risk Management
Investment risk encompasses the risk of loss in our investment portfolio potentially caused by
the adverse impact on our invested assets from fluctuations in interest rates, equity prices,
credit spreads, foreign currency rates and other market changes.
The Company manages its investment risks through both a system of limits and a strategy to
optimize the interaction of risks and opportunities. To ensure diversification of the Company’s
investment portfolio and avoid aggregation of risks, limits on asset types, economic sector
exposure, industry exposure and individual security exposure are placed on our investment
portfolio, and monitored on an ongoing basis. The Company manages its
interest rate risk through an asset liability strategy that involves the selection of
investments with appropriate characteristics, such as duration, yield, currency and liquidity that
are tailored to the anticipated cash outflow characteristics of our liabilities and the anticipated
interest rate environment. The Company manages foreign currency risk by seeking to match the
Company’s liabilities under insurance and reinsurance policies that are payable in foreign
currencies with assets including cash and investments that are denominated in such currencies. In
order to limit the Company’s exposure to credit risk, the Company’s investment policy is to invest
in debt instruments of high credit quality issuers and to limit the amount of credit exposure with
respect to particular ratings categories and any one issuer. The Company has limited its exposure
to any single corporate issuer to 0.60% or less of its fixed income investments, which includes
fixed maturity investments, short-term investments and preferred equity securities, as of December
31, 2009.
The Company uses a number of capital-at-risk models, which include volatility-scenario based
measures, value-at-risk (“VaR”) and credit impairment calculations to evaluate its investment
portfolio risk. Volatility scenario-based measures are used in order to stress test the portfolio
for expected changes in specific market scenarios. VaR is a probabilistic method of measuring the
potential loss in portfolio value over a given time period and for a given distribution of
historical returns. Portfolio risk, as measured by VaR, is affected by four primary risk factors:
asset concentration, asset volatility, asset correlation and systematic risk. For a one year
period over 95% of the time, assuming the risks taken into account in the VaR model perform per
their historical tendencies, the investment portfolio loss for a year period was expected to be
less than or equal to 4.5% at December 31, 2009. The Company adjusts its scenarios for a variety
of extremes as well as expected outcomes. Management continuously evaluates the applicability and
relevance of the models used and makes adjustments as necessary to reflect actual market conditions
and performance over time.
Operational Risk Management
Operational risk represents the risk of loss as a result of inadequate or failed internal
processes, system failures, human error or external events. Operational risks include, for example,
employee or third party fraud, business interruptions, inaccurate processing of transactions,
information technology failures, the loss of key employees without appropriate successors, and
non-compliance with reporting obligations.
The Company seeks to mitigate operational risks through the application of strong process
controls throughout our business. Key process controls include underwriting authority letters,
underwriting referral protocols, claims procedures guidelines, Sarbanes-Oxley procedures,
information technology procedures, the disaster recovery plan and the business continuity plan. The
Company’s internal audit department and operational audit personnel rigorously test the Company’s
various process controls on a regular basis.
The use by the Company of the services of unaffiliated third parties exposes the Company to
heightened operational risks, including the risk of information technology and physical security
breaches, fraud, non-compliance with laws and regulations or internal guidelines and inadequate
service. The Company mitigates the operational risk posed by the use of third party vendors by
verifying, among other items, a potential third party vendor’s financial stability, ability to
provide ongoing service, business continuity planning and its business reputation. The Company also
allocates appropriate resources to monitor any significant third party relationships.
Role of the Board of Directors in Risk Management
The Company’s Board of Directors has administered its risk oversight of the Company through
quarterly joint meetings of the Audit Committee and Underwriting Committee members with members of
senior management, including representatives from the Actuarial, Claims, Finance, Internal Audit,
Investment, Legal and Underwriting functions within the organization. The Audit Committee and
Underwriting Committee members reviewed with senior management the Company’s enterprise risk
management framework as set out above.
The Audit Committee and Underwriting Committee members have reviewed with management the
methods utilized by the Company to identify and quantify risks associated with the Company’s
business and operations and the Company’s established risk tolerances. In particular, the Audit
Committee and Underwriting Committee members have monitored the Company’s capital position relative
to internal standards and the requirements of the Company’s regulators and rating agencies and the
Company’s liquidity relative to internal standards, established based upon a series of stress cash
outflow scenarios.
In November of 2009, the Board of Directors formalized the quarterly meetings of the members
of the Audit Committee and Underwriting Committee through the creation of the Risk Committee of the
Board of Directors.
12
Investments
We follow an investment strategy designed to preserve book value growth and generate
appropriate risk adjusted returns while providing sufficient liquidity to meet the needs of the
Company. The portfolio is designed to diversify risks, including interest rate, credit and
structure risks. Our investment portfolio is managed by our Chief Investment Officer and a team of
investment professionals. Our investment team is experienced in direct portfolio management, asset
allocation, managing external investment manager relationships, risk management and auditing and
accounting. Our investment team uses specialized analytical tools to evaluate risk and opportunity
to facilitate an opportunity focused and risk integrated approach to investing consistent with the
requirements of the Company’s investment policy. We utilize external portfolio managers to oversee
most of the day-to-day activities of our investment portfolio, and our investment professionals
actively monitor our investment managers’ performance within the established investment policy of
the Company. During 2009, we also began managing a portion of our investment portfolio internally.
Our investment policy establishes authority for our investment activities and specifies risk
tolerances and minimum criteria on the overall credit quality and liquidity characteristics of the
portfolio. This includes limitations on the size of certain holdings as well as restrictions on
purchasing certain types of securities or investing in certain industries. Our investment managers
may be instructed to invest some of the investment portfolio in currencies other than U.S. dollars
based upon the business we have written, the currency in which our loss reserves are denominated or
regulatory requirements.
Our investment policy incorporates a traditional policy limit approach to each type of risk,
thus setting a maximum amount of capital that may be exposed at any one time to particular types of
securities and investment vehicles. We develop and maintain an investment risk profile, which estimates the maximum and expected levels of risk
relative to the Company’s shareholders’ equity that will be taken over a specified period. In
determining our investment decisions, we consider the impact of various catastrophic events on our
invested assets, particularly those to which our insurance and reinsurance portfolio may also be
exposed, in order to protect our financial position. The investment risk profile is reviewed by
the Investment Committee of the Company’s Board of Directors and is revised quarterly based on
market conditions and developing needs of the Company. In addition, as part of our risk management
processes, we maintain a watch list of securities that management considers to be at risk due to
industry and or company specific issues and or securities potentially subject to future
impairments. These securities are subjected to further internal analysis to evaluate their
underlying structures, credit characteristics and overall industry and security specific
fundamentals until they are sold, mature or it is deemed that further review is no longer
necessary.
In assessing the quality and risk associated with our investment portfolio, we utilize a
number of capital-at-risk models, which include volatility-scenario based measures and
value-at-risk calculations, to manage our aggregate investment risk exposures. Our capital-at-risk
models also include the assessment of risk capital undertaken by Standard & Poor’s (“S&P”) and A.M.
Best Company (“A.M. Best”). Volatility scenario-based measures are used in order to stress test
the portfolio for expected changes in specific market scenarios. We adjust our scenarios for a
variety of extreme as well as expected outcomes. Management continuously evaluates the
applicability and relevance of the models used and makes adjustments as necessary to reflect actual
market conditions and performance over time. In addition, management and the Board of Directors
regularly reviews investment strategy allocations, risk and capital allocations, expected returns
and expected return on capital.
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The following tables set forth the types of securities, amortized costs, fair values and
related gross unrealized gains and losses of our fixed income investments held as of December 31,
2009 and 2008:
Fixed Maturity Investments
U.S. Government and Agencies Securities. U.S. government and agencies securities are
comprised of bonds issued by the U.S. Treasury, the Federal Home Loan Bank, the Federal Home Loan
Mortgage Corporation (“FreddieMac”) and the Federal National Mortgage Association (“FannieMae”).
U.S. State and Municipal Securities. U.S. state and municipal securities are debt
securities issued by a state, municipality, or county, in order to finance its capital
expenditures. Municipal bonds are exempt from federal taxes and from most state and local taxes.
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Foreign Government Securities. Non U.S. government securities represent the fixed
income obligations of non-U.S. governmental entities.
Government
Guaranteed Corporate Securities. Goverment guaranteed corporate
securities represent corporate securities backed by the
full faith and credit of the sponsor country. In the U.S., government
guaranteed corporate securities were
issued under the Temporary Liquidity Guarantee Program (“TLGP”) program and issued with maturities
of up to three years.
Corporate Securities. Corporate securities are comprised of bonds issued by
corporations, primarily rated A-/A3 or higher and are diversified across a wide range of issuers
and industries. Corporate securities also include high yield securities comprised of bonds issued
by corporations rated below BBB-. The principal risk of corporate securities is the potential loss
of income and potential realized and unrealized principal losses due to insolvencies or
deteriorating credit. The largest corporate issuer in our portfolio represented less than 0.60%
of the fixed income investments at December 31, 2009. We had minimal realized credit related
losses during 2009.
Residential Mortgage-Backed Securities. The majority of the residential
mortgage-backed securities in our investment portfolio are FreddieMac and FannieMae. Our portfolio
has relatively low cash flow variability as compared to the overall mortgage market. The principal
risks inherent in holding agency residential mortgage-backed securities are prepayment and extension risks,
which will affect the timing of when cash flows will be received. Non-agency residential mortgage-backed
securities also have credit risk should losses on the underlying collateral exceed the credit
protection provided by subordinated tranches of mortgage-backed securities. Endurance has no
exposure to subprime mortgages, and Alt-A mortgages represented 1.2% of the fixed income
investments as of December 31, 2009.
Commercial Mortgage-Backed Securities. Our commercial mortgage-backed (“CMBS”)
portfolio is diversified both geographically and by the types of underlying properties. Our portfolio is primarily backed by
office buildings, retail, and multifamily loans. We have limited exposure to lodging and
industrial properties. The majority of our commercial mortgage-backed securities in the portfolio are in
the super senior tranche with average credit support in excess of 35%. The current risk in holding
CMBS is extension risk.
Asset-Backed Securities. Asset-backed securities are diversified both by type of
collateral and issuer. The majority of our asset-backed securities are AAA-rated bonds backed by
pools of automobile loan receivables and credit card receivables and other collateral originated by
a variety of financial institutions. The principal risks in holding asset-backed securities are
structural and credit risks. Structural risks include the security’s priority in the issuer’s
capital structure, the adequacy of and ability to realize proceeds from the collateral and the
potential for prepayments. Credit risks include performance of the underlying consumer or
corporate loans, which act as collateral to these securities.
Short-term Investments
Short-term investments are investments which mature within no more than one year or no less
than 90 days. The Company’s short-term investments generally consist of U.S. government and
agencies securities.
Preferred Equity Securities
The preferred equity securities in the Company’s portfolio are comprised of perpetual
preferred equity securities, which may remain outstanding indefinitely, if they are not called by
the issuer. Preferred equity securities generally pay a dividend at a fixed rate. Perpetual
preferred equity securities usually rank above common equity but below debt securities in an
issuer’s capital structure.
Insurance Enhancement
Within the categories of securities noted above, the Company holds insurance enhanced bonds
(corporate, asset-backed and municipal securities) of $35.7 million, which represent approximately
0.7% of our fixed income investments at December 31, 2009. The financial guarantors of the Company’s insurance enhanced
bonds at December 31, 2009 include Ambac Financial Group, Inc., Financial Guarantee Insurance
Company, National Public Finance Guarantee Corp. (formerly MBIA Insurance Corporation), Syncora
Holdings Ltd. and Assured Guaranty Municipal Corp. (formerly Financial Security Assurance Inc.).
The overall credit quality of the insured bond portfolio was an average rating of “Baa” from
Moody’s and “A” from Standard & Poor’s. The overall credit quality of the financial guarantors was
an average rating of “Caa” by Moody’s and “CC” by Standard & Poor’s. Our evaluation of risk for
insurance enhanced securities assumes we will gain no benefit from the guarantees.
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Investment Ratings
The investment ratings (provided by major rating agencies) for our fixed income investments
held as of December 31, 2009 and 2008 and the percentage of our total fixed income investments they
represented at such date were as follows:
The maturity distribution for our fixed income investments held as of December 31, 2009 and
2008 was as follows:
Other Investments
As of December 31, 2009, our Board of Directors had approved investments in alternative funds
at the time of commitment of capital of up to the lesser of (i) 15% of total shareholders’ equity,
or (ii) $350 million. This restriction does not apply to investments in high yield loan funds that
are classified as other investments. Our alternative funds and high yield loan funds (the “Funds”)
are included in other investments and consist largely of funds that investment in senior secured
bank debt and high yield securities, distressed debt, derivatives and equity long/short strategies.
As of December 31, 2009, our $351.4 million of other investments consisted of $251.8 million of
alternative investment funds and $99.6 million of high yield loan funds.
Our investment in the Funds is recorded on our balance sheet as other investments and is
accounted for under the equity method of accounting. Adjustments to the carrying value of these
investments are made based upon the net valuation criteria established by the managers of the
Funds, which in turn are established based upon the valuation criteria in the governing documents
of the Funds. Such valuations may differ significantly from the values that would have been used
had liquid markets existed for the shares or partnership interests of the Funds. Due to a delay in
the valuations reported by certain of the fund managers, our investments in certain alternative
funds are estimated based on the most recently available information including period end valuation
statements, period end estimates, or, in some cases, prior month or quarter valuation statements.
Investments in high yield loan funds are reported as of the current date. Many of the Funds are
subject to restrictions on redemptions and sales which are determined by the governing documents and
thereby limit our ability to liquidate these investments in the
short-term. Interest income, income distributions and realized and unrealized gains and
losses on our investments in the Funds are included in net investment income and totaled income of
$98.1 million for the year ended 2009.
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Investment Portfolio Management
We have engaged outside investment managers to provide us with investment advisory and
management services. Investment management fees, which vary depending on the amount of assets
under management, are offset against net investment income. Agreements with our investment
managers may be terminated by either party upon written notice.
Our investment returns for the years ended December 31, 2009, 2008 and 2007 were as follows:
During 2009, 2008 and 2007, the Company identified available for sale securities that were
considered to be other-than-temporarily impaired. During the second quarter of 2009, the Company
adopted new accounting guidance related to identifying whether an investment is considered to be
other than temporarily impaired, which is described in Note 2(d), “Summary of Significant
Accounting Policies—Investments,” of our Audited Consolidated Financial Statements for the year
ended December 31, 2009. As a result, the Company initially considered whether it intended to sell
or would be more likely than not required to sell the securities in an unrealized loss position at
December 31, 2009. The Company did not identify any such securities meeting these criteria. The
Company then performed various analysis and reviews, to determine whether the investments in an
unrealized loss position were other-than-temporarily impaired as a result of credit factors or
non-credit related factors. We identified certain securities that we believe will not recover
their amortized costs. As such, the Company recorded total other than temporary impairments of
$51.0 million of which $30.7 million related to non-credit factors and was included in other
comprehensive income (loss) and $20.3 million was related to credit factors and recognized in
earnings.
Securities Lending
The Company also participates in a securities lending program whereby fixed maturity
investments are loaned by the Company to third parties, primarily major brokerage firms and
commercial banks. The borrowers of the Company’s securities provide the Company with collateral,
typically cash, which the Company separately maintains. The Company invests such cash collateral
in other securities. In the first quarter of 2008, the Company restricted future investment of
cash collateral in its securities lending program to overnight repurchase agreements. Previously,
the Company allowed investments in U.S. Treasuries, securities of U.S. government agencies,
mortgage-backed securities, asset-backed securities and corporate fixed maturity securities. At
December 31, 2009, the cash collateral was invested in senior credit card and auto asset-backed
securities, bank notes, debentures and overnight repurchase agreements. Securities with an
estimated fair value of $65.7 million and $112.6 million were on loan under the program at December
31, 2009 and 2008, respectively. The Company was liable for cash collateral under the Company’s
control of $67.0 million and $115.6 million at December 31, 2009 and 2008, respectively. As of
December 31, 2009 and 2008, the fair value of the investments purchased with the cash collateral
received from the borrower was $66.9 million and $112.9 million. The investments purchased with
the cash collateral had an average
credit quality rating of “Aa2” by Moody’s and “AA” by Standard & Poor’s at December 31, 2009.
All securities on loan are issued on a term or overnight basis and are subject to daily recall at
the Company’s discretion.
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Ratings
Ratings have become an increasingly important factor in establishing the competitive position
of insurance and reinsurance companies. During 2009, S&P undertook a review of our ratings and
reaffirmed the financial strength rating of “A” (Strong), with a stable outlook for Endurance
Holdings and its operating subsidiaries. During 2009, A.M. Best also undertook a review of our
ratings and reaffirmed the Company’s financial strength rating of “A” (Excellent), with a stable
outlook for Endurance Holdings and its operating subsidiaries. Endurance Holdings and certain of
its operating subsidiaries maintain a Moody’s rating of A2, with a stable outlook.
The objective of S&P’s, A.M. Best’s and Moody’s rating systems is to provide an opinion of an
insurer’s or reinsurer’s financial strength and ability to meet ongoing obligations to its
policyholders. These ratings reflect S&P’s, A.M. Best’s and Moody’s opinions of our
capitalization, performance and management, and are not applicable to our securities and are not a
recommendation to buy, sell or hold such securities.
S&P maintains a letter rating system ranging from “AAA” (Extremely Strong) to “R” (Under
Regulatory Supervision). Within these categories, “AAA” (Extremely Strong) is the highest,
followed by “AA+”, “AA” and “AA-” (Very Strong) and “A+”, “A” and “A-” (Strong). Publications of
S&P indicate that the “A+”, “A” and “A-” ratings are assigned to those companies that, in S&P’s
opinion, have demonstrated strong financial security characteristics, but are somewhat more likely
to be affected by adverse business conditions than are insurers with higher ratings. These ratings
may be changed, suspended, or withdrawn at the discretion of S&P. The rating “A” (Strong) by S&P is
the sixth highest of twenty-one rating levels.
A.M. Best maintains a letter scale rating system ranging from “A++” (Superior) to “F” (In
Liquidation), and includes 16 separate ratings categories. Within these categories, “A++”
(Superior) and “A+” (Superior) are the highest, followed by “A” (Excellent) and “A-” (Excellent).
Publications of A.M. Best indicate that the “A” and “A-” ratings are assigned to those companies
that, in A.M. Best’s opinion, have demonstrated an excellent ability to meet their obligations to
policyholders. These ratings are subject to periodic review by, and may be revised at the sole
discretion of, A.M. Best. The rating “A” (Excellent) by A.M. Best is the third highest of 16
rating levels.
Moody’s maintains a letter rating system ranging from “Aaa” to “C.” Within these categories,
“Aaa” is the highest, followed by “Aa” and “A.” Within each of these categories, ratings are
further broken down into “Aa1,” “Aa2” and “Aa3.” Ratings may be changed, suspended, or withdrawn
at the discretion of Moody’s. The rating “A2” by Moody’s is the sixth highest of twenty-one rating
levels.
Competition
The insurance and reinsurance industries are mature and highly competitive. Insurance and
reinsurance companies compete on the basis of many factors, including premium charges, general
reputation and perceived financial strength, the terms and conditions of the products offered,
ratings assigned by independent rating agencies, speed of claims payments, reputation and
experience in the particular risk to be underwritten, the jurisdictions where the reinsurer or
insurer is licensed or otherwise authorized, capacity and coverages offered and various other
factors. These factors operate at the individual market participant level and in the aggregate
across the insurance and reinsurance industry more generally. In addition, background economic
conditions and variations in the insurance and reinsurance buying practices of insureds and ceding
companies, by participant and in the aggregate, contribute to cyclical movements in rates, terms
and conditions and may impact industry aggregate financial results.
We compete in the Bermuda, U.S., London and international insurance and reinsurance markets
directly with numerous other parties, including established global insurance and reinsurance
companies, start-up insurance and reinsurance entities, as well as potential capital markets and
securitization structures aimed at managing catastrophe and other risks. Many of these entities
have significantly larger amounts of capital and more employees than we maintain and have
established long-term and continuing business relationships throughout the industry, which can be a
significant competitive advantage.
In our Insurance segment, where competition tends to be focused more on availability, service
and considerations other than price, we compete with insurers that provide property and casualty
based lines of insurance in each of our markets as follows:
North America — ACE Ltd. (“ACE”), American International Group (“AIG”), Arch Capital Group
Ltd. (“Arch”), Factory Mutual Insurance Company, RLI Corp., Axis Capital Holdings Group (“Axis”),
Zurich Financial Services Group (“Zurich”), XL Capital Ltd. (“XL”), Allied World Assurance Company
(“AWAC”) CNA Financial Corporation, Rural Community Insurance Company, Rain and Hail LLC, NAU Country Insurance
Company, Great American Insurance Company and Producers Agriculture Insurance Company.
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Europe — ACE, Allianz AG, Lloyd’s Syndicates, Royal & Sun Alliance Insurance Group Plc, Swiss
Reinsurance Company (“Swiss Re”) and Zurich.
Bermuda — ACE, AIG CAT Excess, XL, Zurich, AWAC, Arch, Chartis, and Ironshore, Inc.
In our Reinsurance segment, we compete in the global reinsurance marketplace and our main
competitors in North America, Europe, Asia and Bermuda include the following:
North America — General Re Corporation, Munchener Ruckversicherungs-Gesellschaft
Aktiengesellschaft (''Munich Re’’), Partner Reinsurance Company Ltd. (“Partner Re”), Swiss Re,
Transatlantic Reinsurance Company (“Transatlantic Re”).
Europe — Swiss Re, Axis, Hannover Ruckversicherungs-Aktiengesellschaft (“Hannover”), Munich
Re, Partner Re, SCOR Reinsurance Company (“SCOR”) and Transatlantic Re.
Asia — Swiss Re, Axis, Hannover, Munich Re, Partner Re, SCOR, Transatlantic Re, Everest
Reinsurance Co. and Odyssey Re Holdings Corp.
Bermuda
— ACE, Arch, Axis, Montpelier Re Holdings Ltd., Partner Re, Renaissance Reinsurance
Ltd. and XL.
In general, in 2009, we believe operating conditions continued to be competitive. In certain
catastrophe-exposed classes of property business, we experienced a pricing environment that was
flat to slightly up; however, for the remaining insurance and reinsurance lines of property and
casualty business, we experienced downward pricing driven largely by relatively high levels of
underwriting capacity and competition driven by distressed insurers. We continue to maintain our
adherence to underwriting standards by declining business when pricing, terms and conditions did
not meet our underwriting criteria.
In 2010, we believe the following three primary influences may affect the market for our
insurance and reinsurance products — the continuation of the global recession, increased pricing
competition in many of our markets, and a low interest rate environment. The United States and
other markets around the world have continued to experience unsettled economic conditions,
including increased unemployment, increased governmental regulation and continued uncertainty in
global financial markets. The reduction in economic activity is likely to lead to decreased demand
for insurance and reinsurance. This, combined with the substantial recovery of most of the
industry’s surplus position in 2009 and the impact of new market entrants, is likely to result in a
more competitive global insurance and reinsurance market in 2010. Potentially offsetting these
factors is the current low interest rate environment that will likely encourage more underwriting
discipline as there will be reduced investment earnings from underwriting cash flows. We believe
these three factors have and will continue to contribute to changes in market conditions within
both the reinsurance and insurance marketplaces.
Employees
As of February 22, 2010, we had 781 full-time employees. We believe that our employee
relations are satisfactory. None of our employees are subject to collective bargaining agreements.
Before investing in any of our securities, you should carefully consider the following risk
factors and all other information set forth in this Annual Report on Form 10-K. These risks could
materially affect our business, results of operations or financial condition and cause the trading
price of our securities to decline. You could lose all or part of your investment. The headings
used in this section are solely to aid the reader as to general categories of risks related to
investing in the Company. Many of the risk factors listed apply to more than one category or the
Company generally. Accordingly, the headings used in this section should not be construed as
limiting in any manner the general applicability of any of the risk factors included in this
section.
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Underwriting Risks
As a property, agriculture and catastrophe insurer and reinsurer, we are particularly vulnerable to
losses from catastrophes.
Our property, agriculture and catastrophe insurance and reinsurance lines expose us to claims
arising out of catastrophes. Catastrophes can be caused by various unpredictable events, including
earthquakes, hurricanes, hailstorms, droughts, severe weather, floods, fires, tornadoes, volcano
eruptions, explosions and other natural or man-made disasters. Many scientists believe that the
earth’s atmospheric and oceanic temperatures are increasing and that, in recent years, changing
climate conditions have increased the unpredictability, severity and frequency of natural disasters
in certain parts of the world.
The global geographic distribution of our business subjects us to catastrophe exposure for
natural events occurring in a number of areas throughout the world, including, but not limited to,
windstorms in the United Kingdom and continental Europe, hurricanes in Florida, the Gulf Coast and
the Atlantic coast regions of the United States, typhoons and earthquakes in Japan, earthquakes in
California and the New Madrid region of the United States and drought and flooding in the
Midwestern United States. From time to time, we may have greater exposures in one or more of these
geographic areas than our overall share of the worldwide market might suggest. Accordingly, when
and if catastrophes occur in these areas, we may experience relatively more severe negative results
from such events than our competitors may. In particular, the Company has historically had a
relatively large percentage of its coverage exposures concentrated in the states of California and
Florida.
In addition, changing climate conditions, primarily rising global temperatures, may be
increasing, or may in the future increase the frequency and severity of natural catastrophes,
including weather events, and may create new types of catastrophe losses. We expect that increases
in the values and concentrations of insured property will increase the severity of such occurrences
in the future. In the event that we experience catastrophe losses, there is a possibility that our
premiums will be inadequate to cover these risks. In addition, because accounting regulations do
not permit insurers and reinsurers to reserve for such catastrophic events until they occur, claims
from catastrophic events could cause substantial volatility in our financial results for any fiscal
quarter or year and could have a material adverse effect on our financial condition and results of
operations. Furthermore, the estimation of reserves related to hurricanes can be affected by the
inability to access portions of the affected areas, the complexity of factors contributing to the
losses, legal and regulatory uncertainties and the nature of the information available to establish
the reserves. Complex factors include but are not limited to: determining whether damage was caused
by flooding versus wind; evaluating general liability and pollution exposures; estimating
additional living expenses; the impact of demand surge; infrastructure disruption; fraud; the
effect of mold damage; business interruption costs; and reinsurance collectability. The timing of a
catastrophe’s occurrence, such as at or near the end of a reporting period, can also affect the
information available to us in estimating reserves for that reporting period. The estimates related
to catastrophes are adjusted as actual claims emerge and additional information becomes available.
Our ability to write new business also could be adversely impacted. Although we attempt to manage
our exposure to such events through the use of underwriting controls and the purchase of
third-party reinsurance, catastrophic events are inherently unpredictable and the actual nature of
such events when they occur could be more frequent or severe than contemplated in our pricing and
risk management expectations. As a result, the occurrence of one or more catastrophic events could
have a material adverse effect on our results of operations or financial condition. See “Item 1.
Business — Enterprise Risk Management — Underwriting Risk Management.”
As a property and casualty insurer and reinsurer, we could face losses from war, terrorism and
political unrest.
We may have substantial exposure to losses resulting from acts of war, acts of terrorism and
political instability. These risks are inherently unpredictable, although recent events may lead
to increased frequency and severity. It is difficult to predict their occurrence with statistical
certainty or to estimate the amount of loss an occurrence will generate. Accordingly, it is
possible that our loss reserves will be inadequate to cover these risks. We closely monitor the
amount and types of coverage we provide for terrorism risk under insurance policies and reinsurance
treaties. We often seek to exclude terrorism when we cannot reasonably evaluate the risk of loss
or charge an appropriate premium for such risk. Even in cases where we have deliberately sought to
exclude coverage, we may not be able to eliminate our exposure to terrorist acts, and thus it is
possible that these acts will have a material adverse effect on us.
The risks associated with property and casualty reinsurance underwriting could adversely affect us.
Because we participate in property and casualty reinsurance markets, the success of our
underwriting efforts depends, in part, upon the policies, procedures and expertise of the ceding
companies making the original underwriting decisions. We face the risk that these ceding companies
may fail to accurately assess the risks that
they assume initially, which, in turn, may lead us to inaccurately assess the risks we assume.
If we fail to establish and receive appropriate premium rates, we could face significant losses on
these contracts.
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The terms of the Federal Multiple Peril Crop Insurance Program may change and adversely impact us.
We currently participate in the U.S. Federal Multi Peril Crop
Insurance Program (“MPCI”) sponsored by the Risk Management Agency of the U.S. Department of
Agriculture. As a result of our acquisition of ARMtech in December of 2007, crop insurance
premiums, which are primarily driven by MPCI, have become an increasingly larger portion of our
business, totaling $572.1 million of gross premiums written in 2009, and representing 49.7% of the
total gross premiums written in our Insurance segment in 2009.
The RMA has currently proposed several changes to the Standard Reinsurance Agreement (“SRA”)
that, if ultimately adopted, could adversely affect the financial results of crop insurers such as
ARMtech, beginning in 2011. If the SRA is finalized as drafted, we would receive lower expense
reimbursements and would be likely to retain less of the underwriting profit we generate, which
could materially negatively impact the profitability of ARMtech.
Industry feedback to the draft of the SRA has to date not been positive and the RMA is
expected to circulate further drafts of the agreement before it becomes final. However, we cannot
predict what changes the final version will have, if any, and therefore what impact the changes
will have on our future profitability.
If actual renewals of our existing policies and contracts do not meet expectations, our gross
premiums written in future years and our future results of operations could be materially adversely
affected.
Our insurance policies and reinsurance contracts are generally for a one-year term. In our
financial forecasting process, we make assumptions about the renewal of our prior year’s policies
and contracts. If actual renewals do not meet expectations, our gross premiums written in future
years and our future results of operations could be materially adversely affected. This risk is
especially prevalent in the first quarter of each year when a large number of reinsurance contracts
are subject to renewal.
The development of our U.S.-based insurance operations is subject to increased risk from changing
market conditions.
Excess and surplus lines insurance is a substantial portion of the business written by our
U.S.-based insurance operations. Excess and surplus lines insurance covers risks that are
typically more complex and unusual than standard risks and require a high degree of specialized
underwriting. As a result, excess and surplus lines risks do not often fit the underwriting
criteria of standard insurance carriers. Our excess and surplus lines insurance business fills the
insurance needs of businesses with unique characteristics and is generally considered higher risk
than those in the standard market. If our underwriting staff inadequately judges and prices the
risks associated with the business underwritten in the excess and surplus lines market, our
financial results could be adversely impacted.
Further, the excess and surplus lines market is significantly affected by the conditions of
the property and casualty insurance market in general. This cyclicality can be more pronounced in
the excess and surplus market than in the standard insurance market. During times of hard market
conditions (when market conditions are more favorable to insurers), as rates increase and coverage
terms become more restrictive, business tends to move from the admitted market to the excess and
surplus lines market and growth in the excess and surplus market can be significantly more rapid
than growth in the standard insurance market. When soft market conditions are prevalent (when
market conditions are less favorable to insurers), standard insurance carriers tend to loosen
underwriting standards and expand market share by moving into business lines traditionally
characterized as excess and surplus lines, exacerbating the effect of rate decreases. If we fail
to manage the cyclical nature and volatility of the revenues and profit we generate in the excess
and surplus lines market, our financial results could be adversely impacted.
The failure of any of the loss limitation methods we employ could have a material adverse effect on
our financial condition or on our results of operations.
We seek to limit our loss exposure by writing many of our insurance and reinsurance contracts
on an excess of loss basis, adhering to maximum limitations on policies written in defined
geographical zones, limiting program size for each client, establishing per risk and per occurrence
limitations for each event and following prudent underwriting guidelines for each program written.
In the case of proportional treaties, we seek per occurrence limitations or loss ratio caps to
limit the impact of losses from any one event. Most of our direct liability insurance policies
include maximum aggregate limitations. We also seek to limit our loss exposure through geographic
diversification. Geographic zone limitations involve significant underwriting judgments, including
the determination of the area of the zones and whether a policy falls within particular zone
limits. Disputes relating to coverage and choice of legal forum may also arise. As a result,
various provisions of our policies, such as limitations or exclusions from coverage or choice of
forum, may not be enforceable in the manner we intend and
some or all of our other loss limitation methods may prove to be ineffective. Underwriting is
a matter of judgment, involving important assumptions about matters that are inherently
unpredictable and beyond our control, and for which historical experience and probability analysis
may not provide sufficient guidance. One or more future catastrophic or other events could result
in claims that substantially exceed our expectations, which could have a material adverse effect on
our financial condition and our results of operations, possibly to the extent of eliminating our
shareholders’ equity.
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We may be unable to purchase reinsurance and our net income could be reduced or we could incur a
net loss in the event of an unusual loss experience.
We purchase reinsurance if it is deemed prudent from a risk mitigation perspective or if it is
expected to have a favorable cost/benefit relationship relative to our retained risk portfolio.
Changes in the availability and cost of reinsurance, which are subject to market conditions that
are outside of our control, may reduce to some extent our ability to use reinsurance to balance
exposures across our reinsurance or insurance operations. Accordingly, we may not be able to
obtain our desired amounts of reinsurance. In addition, even if we are able to obtain such
reinsurance, we may not be able to negotiate terms that we deem appropriate or acceptable or obtain
such reinsurance from entities with satisfactory creditworthiness.
We are also subject to credit risk with respect to our reinsurers because the transfer of risk
to a reinsurer does not relieve us of our liability to our clients. Many reinsurance companies
have been negatively affected by deteriorating financial and economic conditions, including
unprecedented financial market disruption. A number of these companies, including those with which
we conduct business, have been downgraded or have been placed on negative outlook by various rating
agencies. In addition, reinsurers may be unwilling to pay us even though they are able to do so.
The failure of one or more of the our reinsurers to honor their obligations to us in a timely
fashion would impact our cash flow and reduce our net income and, depending upon the amount of
reinsurance we have purchased, could cause us to incur a significant loss.
A decline in our financial strength ratings could affect our standing among brokers and customers
and cause our premiums and earnings to decrease.
Ratings have become an increasingly important factor in establishing the competitive position
of insurance and reinsurance companies. We currently maintain an A.M. Best financial strength
rating of “A” (Excellent) with a stable outlook and an S&P financial strength rating of “A”
(Strong) with a stable outlook. Because all of our ratings are subject to continual review, the
retention of these ratings cannot be assured. If our ratings are reduced from their current level
by A.M. Best or S&P, our competitive position in the insurance and reinsurance industry would
suffer. Such a downgrade may have a material negative impact on our ability to expand our
insurance and reinsurance portfolio and renew our existing insurance and reinsurance policies and
agreements, require us to establish trusts or post letters of credit for ceding company clients,
and could trigger provisions allowing some ceding company clients to terminate their reinsurance
contracts with us on terms disadvantageous to us. In addition, a downgrade of our A.M. Best rating
below “B++” (two levels below our current rating) would constitute an event of default under our
bank credit facility. Each of the effects of a downgrade of our financial strength rating
described above could make it more expensive or otherwise difficult for us to compete in certain
business segments in which we would otherwise desire to operate. If this were to occur, we could
suffer a material and adverse effect on our financial position and results of operations, and the
market price for our securities, including any ordinary shares, could be materially and adversely
affected.
In light of the difficulties experienced recently by many financial institutions, including
our competitors in the insurance industry, we believe it is possible that rating agencies may
heighten the level of scrutiny they apply when analyzing companies in our industry, may increase
the frequency and scope of their reviews, may request additional information from the companies
that they rate (including additional information regarding the valuation of investment securities
held), and may adjust upward the capital and other requirements employed in their models for
maintenance of certain rating levels.
We cannot predict what actions rating agencies may take, or what actions we may take in
response to the actions of rating agencies, which could adversely affect our business. As with
other companies in the financial services industry, our ratings could be downgraded at any time and
without any notice.
Profitability may be adversely impacted by inflation.
The effects of inflation could cause the cost of claims from catastrophes or other events to
rise in the future. Our reserve for losses and loss expenses includes assumptions about future
payments for settlement of claims and claims handling expenses, such as medical treatments and
litigation costs. To the extent inflation causes these costs
to increase above reserves established for these claims, we will be required to increase our
loss reserves with a corresponding reduction in our net income in the period in which the
deficiency is identified.
22
Adverse changes to the economy in the countries in which we operate could lower the demand for our
insurance and reinsurance products and could have a materially adverse effect on the profitability
of our operations.
Factors such as consumer spending, business investment, government spending, the volatility
and strength of the capital markets, and inflation all affect the business and economic environment
and, indirectly, the amount and profitability of our business. In an economic downturn
characterized by higher unemployment, lower family income, lower corporate earnings, lower business
investment and lower consumer spending, the demand for insurance products could be adversely
affected. Adverse changes in the economy could potentially lead our customers to have less need
for insurance coverage, to cancel existing insurance policies, modify coverage or to not renew with
us, and our premium revenue could be adversely affected. Challenging economic conditions also may
impair the ability of our customers to pay premiums as they come due.
Since we depend on a few brokers for a large portion of our revenues, loss of business provided by
any one of them could adversely affect us.
We market our insurance and reinsurance worldwide through insurance and reinsurance brokers.
In the year ended December 31, 2009, our top three brokers represented approximately 45.9% of our
gross premiums written. See “Item 1. Business — Distribution.” Loss of all or a substantial
portion of the business provided by one or more of these brokers could have a material adverse
effect on our business.
Our reliance on brokers subjects us to their credit risk.
In accordance with industry practice, we frequently pay amounts owed on claims under our
insurance or reinsurance contracts to brokers, and these brokers, in turn, pay these amounts to the
clients that have purchased insurance or reinsurance from us. If a broker fails to make such a
payment, in a significant majority of business that we write, it is highly likely that we will be
liable to the client for the deficiency because of local laws or contractual obligations
notwithstanding the broker’s obligation to make such payment. Likewise, when the client pays
premiums for these policies to brokers for payment over to us, these premiums are considered to
have been paid and, in most cases, the client will no longer be liable to us for those amounts,
whether or not we have actually received the premiums. Consequently, we assume a degree of credit
risk associated with brokers around the world with respect to most of our insurance and reinsurance
business. To date we have not experienced any losses related to such credit risks.
The effects of emerging claim and coverage issues on our business are uncertain.
As industry practices and legal, judicial, social and other environmental conditions change,
unexpected and unintended issues related to claims and coverage may emerge. These issues may
adversely affect our business by either broadening coverage beyond our underwriting intent or by
increasing the number or size of claims. In some instances, these changes may not become apparent
until some time after we have issued insurance policies or reinsurance contracts that are affected by the
changes. As a result, the full extent of liability under our
insurance policies or reinsurance contracts
may not be known for many years after a policy or contract is issued.
Recent examples of emerging claims and coverage issues include:
The effects of these and other unforeseen emerging claim and coverage issues are extremely
hard to predict and could harm our business.
23
We operate in a highly competitive environment which could adversely impact our operating margins.
The insurance and reinsurance industries are highly competitive. We compete with major U.S.
and non-U.S. insurers and reinsurers, including other Bermuda-based insurers and reinsurers. For
information regarding competition in each of our business segments, see “Item 1. Business —
Business Segments.” Many of our competitors have greater financial, marketing and management
resources. A number of newly organized, Bermuda-based insurance and reinsurance entities compete
in the same market segments in which we operate. In addition, we may not be aware of other
companies that may be planning to enter the segments of the insurance and reinsurance market in
which we operate or of existing companies that may be planning to raise additional capital.
Increasing competition could result in fewer submissions, lower premium rates and less favorable
policy terms and conditions, which could have a material adverse impact on our growth and
profitability.
Further, insurance/risk-linked securities and derivative and other non-traditional risk
transfer mechanisms and vehicles are being developed and offered by other parties, including
non-insurance company entities, which could impact the demand for traditional insurance or
reinsurance. A number of new, proposed or potential industry or legislative developments could
further increase competition in our industry. New competition from these developments could cause
the demand for insurance or reinsurance to fall or the expense of customer acquisition and
retention to increase, either of which could have a material adverse affect on our growth and
profitability.
The historical cyclicality of the property and casualty reinsurance industry may cause fluctuations
in our results.
Historically, property and casualty insurers and reinsurers have experienced significant
fluctuations in operating results due to competition, frequency of occurrence or severity of
catastrophic events, levels of capacity, general economic conditions and other factors. Demand for
insurance and reinsurance is influenced significantly by prevailing general economic conditions
and, in the case of reinsurance, the underwriting results of primary property and casualty
insurers. The supply of insurance and reinsurance is related to prevailing prices, the levels of
insured losses and the levels of industry surplus which, in turn, may fluctuate in response to
changes in rates of return on investments being earned in the insurance and reinsurance industry.
As a result, the insurance and reinsurance business historically has been a cyclical industry
characterized by periods of intense price competition due to excessive underwriting capacity as
well as periods when shortages of capacity permitted favorable premium levels. The recovery in the
industry’s surplus position in 2009 and the growth of new market entrants since 2005 has increased
the supply of insurance and reinsurance and has caused insurance and reinsurance prices in many of
the markets in which we participate to decrease.
Investment Risks
We are exposed to significant financial and capital markets risk, including changes in interest
rates, credit spreads, and foreign currency exchange rates, which may adversely affect our results
of operations, financial condition or liquidity.
We are exposed to significant financial and capital markets risk, including changes in
interest rates, credit spreads, equity prices, real estate markets, foreign currency exchange
rates, market volatility, the performance of the economy in general, the performance of the
specific issuers included in our portfolio and other factors outside our control.
Our exposure to interest rate risk relates primarily to the market price and cash flow
variability associated with changes in interest rates. A rise in interest rates, in the absence of
other countervailing changes, will increase the net unrealized loss position of our investment
portfolio. In the event that our estimate of our liability-cash flow profile is inaccurate, we may
be forced to liquidate investments prior to maturity at a loss in order to cover the liability.
Although we take measures to manage the economic risks of investing in a changing interest rate
environment, we may not be able to mitigate the interest rate risk of our assets relative to our
liabilities, which could have a material adverse effect on our consolidated results of operations,
financial condition or liquidity.
Our exposure to credit spreads primarily relates to market price and cash flow variability
associated with changes in credit spreads. If issuer credit spreads widen or increase
significantly over an extended period of time, it may result in a net unrealized loss position of
our investment portfolio. If credit spreads tighten significantly, it will reduce net investment
income associated with new purchases of fixed maturities. In addition, a reduction in market
liquidity has made it difficult to value certain of our securities as trading has become less
frequent. As such, valuations may include assumptions or estimates that may be more susceptible to
significant period-to-period changes, which could have a material adverse effect on our
consolidated results of operations, financial condition or liquidity.
24
Our primary foreign currency exchange risks are related to net income from foreign operations,
non-U.S. dollar denominated investments, and investments in foreign subsidiaries. In general, the
weakening of foreign currencies versus the U.S. dollar will unfavorably affect net income from
foreign operations, the value of non-U.S. dollar denominated investments, and investments in
foreign subsidiaries. Our primary foreign currency exchange risks are described more fully under
“We may be adversely affected by foreign currency fluctuations.”
A portion of our investment portfolio is allocated to alternative investments which we expect
to have different risk characteristics than our investments in traditional fixed maturity
securities and short-term investments, which in turn could result in a material adverse change to
our investment performance, and accordingly adversely affect our financial results.
A portion of our investment portfolio is allocated to alternative investments which we expect
to have different risk characteristics than our investments in traditional fixed income
investments. Our alternative investments include investments in funds which invest in senior
secured bank debt and high yield securities, distressed debt, derivatives and equity long/short
strategies and constituted approximately 5.9% of the carrying value of our cash and invested assets
as of December 31, 2009. The amount and timing of net investment income from such alternative
funds tends to be uneven as a result of the performance of the underlying investments. The timing
of distributions from the funds, which depends on particular events relating to the underlying
investments, as well as the funds’ schedules for making distributions and their needs for cash, can
be difficult to predict. As of December 31, 2009, we are committed to potential future capital
calls in the aggregate amount of approximately $1.7 million. As a result, the amount of net
investment income that we record from these investments can vary substantially from quarter to
quarter. Many of the investments are subject to restrictions on redemptions and sales which are
determined by the documents governing those investments and limit our ability to liquidate these
investments in the short-term. These investments expose us to market risks including interest rate
risk, foreign currency risk, equity price risk and credit risk. In addition, we typically do not
hold the underlying securities of these investments in our custody accounts. As a result, we
generally do not have the ability to quantify the risks associated with these investments in the
same manner for which we have for our fixed income investments. The performance of these
investments is also dependent on the individual investment managers and their investment
strategies. It is possible that the investment managers will leave and/or the investment
strategies will become ineffective. Any of the foregoing could result in a material adverse change
to our investment performance, and accordingly adversely affect our financial results.
Losses due to defaults by others, including issuers of investment securities (which include
structured securities such as commercial mortgage-backed securities and residential mortgage-backed
securities or other high yielding bonds), reinsurance counterparties or third party investment
managers could adversely affect the value of our investments, results of operations, financial
condition or cash flows.
Issuers or borrowers whose securities or loans we hold, customers, reinsurers, clearing
agents, exchanges, clearing houses and other financial intermediaries and guarantors may default on
the principal and interest they owe to us due to bankruptcy, insolvency, lack of liquidity, adverse
economic conditions, operational failure, fraud or other reasons. We are also subject to the risk
that the underlying collateral within loan-backed securities, including mortgage-backed and
asset-backed securities, may default on principal and interest payments causing an adverse change
in cash flows paid to us. At December 31, 2009, the fixed income investments of $5.1 billion in
our investment portfolio represented 85.3% of our total cash and invested assets. The occurrence
of a major economic downturn, acts of corporate malfeasance, widening risk spreads, or other events
that adversely impact the issuers, guarantors or underlying collateral of these securities could
cause the value of our fixed income investments and our net income to decline and the default rate
of the fixed maturity securities in our investment portfolio to increase. A ratings downgrade
affecting issuers or guarantors of particular securities, or similar trends that could worsen the
credit quality of issuers, such as the corporate issuers of securities in our investment portfolio,
could also have a similar effect. With economic uncertainty, credit quality of issuers or
guarantors could be adversely affected. Similarly, a ratings downgrade affecting a loan-backed
security we hold could indicate the credit quality of that security has deteriorated. Any event
reducing the value of these securities other than on a temporary basis could have a material
adverse effect on our business, results of operations and financial condition. Levels of write down
or impairment are impacted by our assessment of whether the Company
has made a decision to sell or is more than likely required to sell securities which
have declined in value and whether such declines in the
securities’ value below amortized cost are
due to credit related factors.
We have also engaged third party investment managers to provide us with investment advisory
and management services. It is possible that the investment strategies employed by these third
party investment managers may become ineffective or that such managers will fail to follow our
investment guidelines, which could result in a material adverse change to our investment
performance, and accordingly adversely affect our financial results.
25
Our participation in a securities lending program subjects us to potential liquidity and other
risks.
We participate in a securities lending program whereby securities, including fixed income
investments, are loaned by us to third parties. We retain all economic interest in the securities
we lend, retain the earnings and cash flows associated with the loaned securities and receive a fee
from the borrower for the temporary use of the securities. We require collateral in the form of
cash, government securities and letters of credit at a rate of 102% — 105% of the market value of
the loaned securities. We invest such collateral in other securities, primarily overnight
repurchase agreements.
Returns of loaned securities by the third parties would require us to return the collateral
associated with such loaned securities. In addition, in some cases, the maturity of the securities
held as invested collateral (i.e., securities that we have purchased with collateral received from
the third parties) may exceed the term of the related securities on loan and the market value may
fall below the amount received as collateral and invested. If we are required to return
significant amounts of collateral on short notice, and we are forced to sell securities to meet the
return obligation, we may have difficulty selling such collateral that is invested in securities in
a timely manner, be forced to sell securities in a volatile or illiquid market for less than we
otherwise would have been able to realize under normal market conditions, or both. In addition,
under stressful capital market and economic conditions, liquidity broadly deteriorates, which may
further restrict our ability to sell securities.
Our valuation of fixed maturity investments, short-term investments and preferred equity securities
may include methodologies, estimations and assumptions, which are subject to differing
interpretations, and could result in changes to investment valuations that may materially adversely
affect our results of operations or financial condition
Fixed maturity investments, which are reported at fair value on the consolidated balance
sheet, represented the majority of our total cash and invested assets. We have categorized these
securities as well as our short-term investments and preferred equity securities into a three-level
hierarchy, based on the priority of the inputs to the respective valuation technique. 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). An asset or
liability’s classification within the fair value hierarchy is based on the lowest level of
significant input to its valuation. The inputs for each level are defined as follows:
The Company uses quoted values and other data provided by nationally recognized independent
pricing sources as inputs into its process for determining fair values of its fixed income
investments. Independent pricing services and brokers obtain market quotations and actual
transaction prices for securities that have quoted prices in active markets. Each source has its
own proprietary method for determining the fair value of securities. As such, prices provided by
independent pricing services and independent broker quotes can vary widely, even for the same
security. The Company obtains multiple prices for its securities where available. To validate the
techniques or models used by pricing sources, the Company’s review process includes, but is not
limited to the following:
Based on the above review, the Company will challenge any prices for a security or portfolio
which are considered not to be representative of fair value. Please see Note 4 to the Company’s
Audited Consolidated Financial Statements for a more detailed discussion on the percentage and
types of securities held in each level.
26
The Company obtains market quotations and actual transaction prices for securities that have
quoted prices in active markets. Each source has its own proprietary method for determining the
fair value of securities that are not actively traded. In general, these methods involve the use of
“matrix pricing” in which the independent pricing source uses observable market inputs including,
but not limited to, investment yields, credit risks and spreads, benchmarking of like securities,
broker-dealer quotes, reported trades and sector groupings to determine a reasonable fair market
value. In addition, pricing vendors use model processes, such as an Option Adjusted Spread model,
to develop prepayment and interest rate scenarios. The Option Adjusted Spread model is commonly
used to estimate fair value for securities such as mortgage-backed and asset-backed securities. In
certain circumstances, when fair market values are unavailable from these independent pricing
sources, quotes are obtained directly from broker-dealers who are active in the corresponding
markets. The fair value estimates are made at a specific point in time, based on available market
information and judgments about financial instruments, including estimates of the timing and
amounts of expected future cash flows and the credit standing of the issuer or counterparty. The
use of different methodologies and assumptions may have a material effect on the estimated fair
value amounts. Such quotes are subject to the validation procedures noted above.
During periods of market disruption including periods of significantly rising or high interest
rates, rapidly widening credit spreads or illiquidity, it may be difficult to value certain of our
securities, for example mortgage-backed securities, if trading becomes less frequent or market
data becomes less observable. In addition, there may be certain asset classes that were in active
markets with significant observable data that become illiquid. In such cases, more securities may
fall to Level 3 and thus require more subjectivity and management judgment. As such, valuations
may include inputs and assumptions that are less observable or require greater estimation as well
as valuation methods, which are more sophisticated or require greater estimation thereby resulting
in values which may differ materially from the value at which the investments may be ultimately
sold. Further, rapidly changing and unprecedented credit and equity market conditions could
materially impact the valuation of securities as reported within our consolidated financial
statements and the period-to-period changes in value could vary significantly. Decreases in value
may have a material adverse effect on our results of operations or financial condition.
The determination of the other-than-temporary impairments taken on our investments is highly
subjective and could materially impact our financial position or results of operations.
The determination of the amount of other-than-temporary impairments taken on our investments varies
by investment type and is based upon our periodic evaluation and assessment of known and inherent
risks associated with the respective asset class. Such evaluations and assessments are revised as
conditions change and new information becomes available. Management updates its evaluations
regularly and reflects impairments in operations as such evaluations are revised. There can be no
assurance that our management has accurately assessed the level of impairments taken in our
consolidated financial statements. Furthermore, additional impairments may need to be taken in the future,
which could materially impact our financial position or results of operations. Historical trends
may not be indicative of future impairments.
Some of our investments are relatively illiquid and are in asset classes that may experience
significant market valuation fluctuations.
We hold certain investments that may lack liquidity, such as our alternative investments. If
we require significant amounts of cash on short notice in excess of normal cash requirements or are
required to post or return collateral in connection with our investment portfolio or securities
lending activities, we may have difficulty selling these investments in a timely manner, be forced
to sell them for less than we otherwise would have been able to realize, or both.
The reported value of our relatively illiquid types of investments and, at times, our high
quality, generally liquid asset classes, do not necessarily reflect the lowest current market price
for the asset. If we were forced to sell certain of our assets in the current market, there can be
no assurance that we will be able to sell them for the prices at which we have recorded them, and
we may be forced to sell them at significantly lower prices.
Our investment liquidity and investment performance may affect our financial assets and ability to
conduct business.
We derive a significant portion of our income from our invested assets. As a result, our
operating results depend in part on the performance of our investment portfolio, which consists
primarily of fixed maturity investments. Our income derived from our invested assets (including
net realized gains (losses) on investment sales and net impairment losses recognised in earnings)
was $270.3 million for the year ended December 31, 2009. Our operating results are subject to a
variety of investment risks, including risks relating to general economic conditions, market
volatility, interest rate fluctuations, liquidity risk and credit and default risk. In addition,
we are subject to pre-payment or reinvestment risk as well as restrictions on redemptions or sale
of certain of our investments.
27
With respect to our liabilities, we strive to structure our investments in a manner that
recognizes their cash flow profile and our potential liquidity needs. In that regard, we attempt
to correlate the maturity and duration of our investment portfolio to our liability profile.
However, if our liquidity needs or liability profile unexpectedly changes, we may not be successful
in continuing to structure our investment portfolio in that manner. The market value of our fixed
income investments will be subject to fluctuations depending on changes in various factors,
including prevailing interest rates. To the extent that we are unsuccessful in correlating our
investment portfolio with our liabilities, we may be forced to liquidate our investments at times
and prices that are not optimal, which could have a material adverse effect on the performance of
our investment portfolio.
Interest rates are highly sensitive to many factors, including governmental monetary policies,
domestic and international economic and political conditions and other factors beyond our control.
Although we take measures to attempt to manage the risks of investing in a changing interest rate
environment, we may not be able to mitigate interest rate sensitivity effectively. Our mitigation
efforts include maintaining a high quality portfolio with a relatively short duration to reduce the
effect of interest rate changes on book value. A significant portion of the investment portfolio
matures each year, allowing for reinvestment at current market rates. The portfolio is actively
managed, and trades are made to balance our exposure to interest rates. However, a significant
increase in interest rates would be expected to have a material adverse effect on our book value.
Liquidity and Capital Risks
Our holding company structure and certain regulatory and other constraints affect our ability to
pay dividends and make other payments.
Endurance Holdings is a holding company and, as such, has no substantial operations of its
own. Dividends and other permitted distributions from our operating subsidiaries are expected to
be Endurance Holdings’ primary source of funds to meet ongoing cash requirements, including debt
service payments and other expenses, and to pay dividends, if any, to shareholders. Bermuda law
and regulations, including, but not limited to, Bermuda insurance regulations, restrict the
declaration and payment of dividends and the making of distributions by Endurance Bermuda unless
certain regulatory requirements are met. The inability of Endurance Bermuda to pay dividends in an
amount sufficient to enable Endurance Holdings to meet its cash requirements at the holding company
level could have a material adverse effect on its operations. In addition, Endurance Holdings’
U.S. and U.K. operating subsidiaries are subject to significant regulatory restrictions limiting
their ability to declare and pay dividends. We therefore do not expect to receive material
dividends from these operating subsidiaries for the foreseeable future.
Endurance Holdings is subject to Bermuda regulatory constraints that will affect its ability
to pay dividends on its ordinary shares, class A shares and 7.75% Non-Cumulative Preferred Shares,
Series A (the “Series A Preferred Shares”), and make other payments. Under the Bermuda Companies
Act 1981, as amended (the “Companies Act”), Endurance Holdings may declare or pay a dividend or
make a distribution out of retained earnings or contributed surplus only if it has reasonable
grounds for believing that it is, or would after the payment be, able to pay its liabilities as
they become due and if the realizable value of its assets would thereby not be less than the
aggregate of its liabilities and issued share capital and share premium accounts. In addition, the
terms of our credit facility prohibit Endurance Holdings from declaring or paying any dividends if
a default or event of default has occurred and is continuing at the time of such declaration or
payment or would result from such declaration or payment. In addition, the terms of the Series A
Preferred Shares prohibit the declaration or payment of dividends on our ordinary shares unless
dividends on the Series A Preferred Shares have been declared and paid. Preference shares,
including the Series A Preferred Shares, may also not be redeemed if as a result of the redemption,
our issued share capital would be reduced below the minimum capital specified in the memorandum of
association of Endurance Holdings. For a discussion of the legal limitations on our subsidiaries’
ability to pay dividends to Endurance Holdings and of Endurance Holdings to pay dividends to its
shareholders, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results
of Operations — Liquidity and Capital Resources.”
We could incur substantial losses and reduced liquidity if one of the financial institutions we use
in our operations, including those institutions that participate in our credit facility and the
counterparty to our $150 million variable delivery equity forward, fails.
We have exposure to counterparties in many different industries and routinely execute
transactions with counterparties in the financial services industry, including brokers and dealers,
commercial banks, investment banks, hedge funds and other investment funds and other institutions.
Many of these transactions expose us to credit risk in the event of default of our counterparty.
In addition, with respect to secured transactions, our credit risk may be exacerbated when the
collateral held by us cannot be realized or is liquidated at prices not sufficient to recover the
full amount of the obligation. Due to the uncertainty associated with casualty business, current
reinsurance recoverables are subject to the credit risk of the reinsurers.
28
We maintain cash balances, including restricted cash held in premium trust accounts,
significantly in excess of the FDIC insurance limits at various depository institutions. We also
maintain cash balances in foreign banks and institutions and rely upon funding commitments from
several banks and financial institutions that participate in our credit facility. In addition, a
financial institution is the counterparty in our variable delivery equity forward sale agreement
that provides us with up to $150 million of additional liquidity. If one or more of these
financial institutions were to fail, our ability to access cash balances, draw down on our credit
facility or receive funds from our variable delivery equity forward sale might be temporarily or
permanently limited, which could have a material adverse effect on our results of operations,
financial condition or cash flows.
The cost of reinsurance security arrangements may materially impact our margins.
As a Bermuda reinsurer, Endurance Bermuda is required to post collateral security with respect
to reinsurance liabilities it assumes from ceding insurers domiciled in the U.S. The posting of
collateral security is generally required in order for U.S. ceding companies to obtain credit on
their U.S. statutory financial statements with respect to reinsurance liabilities ceded to
unlicensed or unaccredited reinsurers, such as Endurance Bermuda. Under applicable statutory
provisions, the security arrangements may be in the form of letters of credit, reinsurance trusts
maintained by third-party trustees or funds-withheld arrangements whereby the trusteed assets are
held by the ceding company. Endurance Bermuda has the ability to issue up to $1.175 billion in
letters of credit under our letter of credit and revolving credit facility that expires on May 8,
2012. If this facility is not sufficient or if the Company is unable to renew this facility or is
unable to arrange for other types of security on commercially acceptable terms, the ability of
Endurance Bermuda to provide reinsurance to U.S.-based clients may be severely limited.
Security arrangements may subject our assets to security interests and/or require that a
portion of our assets be pledged to, or otherwise held by, third parties. Although the investment
income derived from our assets while held in trust typically accrues to our benefit, the investment
of these assets is governed by the investment regulations of the state of domicile of the ceding
insurer, which may be more restrictive than the investment regulations applicable to us under
Bermuda law. The restrictions may result in lower investment yields on these assets, which could
have a material adverse effect on our profitability.
Adverse capital and credit market conditions may significantly affect our ability to meet liquidity
needs, access to capital and cost of capital.
The capital and credit markets have been experiencing extreme volatility and disruption for
more than twelve months. Recently, the volatility and disruption have reached unprecedented levels.
In some cases, the markets have exerted downward pressure on availability of liquidity and credit
capacity for certain issuers.
Our future capital requirements depend on many factors, including our ability to write new
business successfully, to establish premium rates and reserves at levels sufficient to cover
losses, and to maintain our current rating agency ratings. We need liquidity to pay our operating
expenses and without sufficient liquidity, we will be forced to curtail our operations, and our
business will suffer. The principal sources of our liquidity are our invested assets. Sources of
liquidity in normal markets also include a variety of short- and long-term instruments, including
repurchase agreements, commercial paper, medium- and long-term debt, junior subordinated debt
securities, capital securities and shareholders’ equity.
In the event current resources do not satisfy our needs, we may have to seek additional
financing. The availability of additional financing will depend on a variety of factors such as
market conditions, the general availability of credit, the volume of trading activities, the
overall availability of credit to the financial services industry, our credit ratings and credit
capacity, as well as the possibility that customers or lenders could develop a negative perception
of our long- or short-term financial prospects if we incur large investment losses or if the level
of our business activity decreases due to a market downturn. Similarly, our access to funds may be
impaired if regulatory authorities or rating agencies take negative actions against us. Our
internal sources of liquidity may prove to be insufficient, and in such case, we may not be able to
successfully obtain additional financing on favorable terms, or at all.
Disruptions, uncertainty or volatility in the capital and credit markets may also limit our
access to capital required to operate our business, most significantly our insurance operations.
Such market conditions may limit our ability to replace, in a timely manner, maturing liabilities;
satisfy statutory capital requirements; generate fee income and market-related revenue to meet
liquidity needs; and access the capital necessary to grow our business. As such, we may be forced
to delay raising capital, issue shorter tenor securities than we prefer, or bear an unattractive
cost of capital which could decrease our profitability and significantly reduce our financial
flexibility. Any equity or debt financing, if available at all, may be on terms that are not
favorable to us. In the case of equity financings, dilution to our shareholders could result, and
in any case such securities may have rights, preferences and privileges that are senior to those of
our already outstanding securities. In the case of debt financings, our credit spreads have
widened since we previously issued debt securities, which could lead to higher interest costs on new
debt. Our results of operations, financial condition, cash flows and statutory capital position
could be materially adversely affected by disruptions in the financial markets and an inability to
obtain adequate capital.
29
Our failure to comply with restrictive covenants contained in the indentures governing our senior
notes or our current or future credit facility could trigger prepayment obligations, which could
adversely affect our business, financial condition and results of operations.
The indentures governing our senior notes contain covenants that impose restrictions on us and
certain of our subsidiaries with respect to, among other things, the incurrence of liens and the
disposition of capital stock of these subsidiaries. In addition, our credit facility requires us
and/or certain of our subsidiaries to comply with certain covenants, including the maintenance of a
minimum consolidated net tangible worth and restrictions on the payment of dividends. Our failure
to comply with these covenants could result in an event of default under the indentures or our
credit facility, which, if not cured or waived, could result in us being required to repay the
notes or any amounts outstanding under the credit facility prior to maturity. As a result, our
business, financial condition and results of operations could be adversely affected.
Legal and Regulatory Risks
Recent or future legislation may decrease the demand for our property catastrophe reinsurance
products and adversely affect our business and results of operations.
It is also possible that U.S states, particularly those with Atlantic or Gulf Coast exposures,
may enact new or expanded legislation establishing further state involvement in providing or
governing the insurance or reinsurance of catastrophe exposed risks, or may otherwise enact
legislation, which would further diminish aggregate private market demand for our products.
Alternatively, legislation adversely impacting the private markets could be enacted on a regional
or at the federal level. Moreover, we believe that numerous modeled potential catastrophes could
exceed the actual or politically acceptable bonded capacity of one or more of the catatrophe funds
established by U.S. states, which could lead either to a severe dislocation or the necessity of
Federal intervention in the markets of one or more of those states, either of which would adversely
impact the private insurance and reinsurance industry.
The regulatory system under which we operate, and potential changes thereto, could have a material
adverse effect on our business.
Our insurance and reinsurance subsidiaries may not be able to obtain or maintain necessary
licenses, permits, authorizations or accreditations, or may be able to do so only at great cost.
In addition, we may not be able to comply fully with, or obtain appropriate exemptions from, the
wide variety of laws and regulations applicable to insurance or reinsurance companies or holding
companies. Failure to comply with or to obtain appropriate exemptions under any applicable laws
could result in restrictions on our ability to do business in one or more of the jurisdictions in
which we operate and fines and other sanctions, which could have a material adverse effect on our
business. The laws and regulations under which we operate, such as the regulations governing our
insurance rates and forms, the U.S. multiple peril crop insurance program and the purchase of
reinsurance by property insurers in Florida, could be revised in a manner materially adverse to the
manner in which we conduct our business.
In addition, the insurance and reinsurance regulatory framework continues to be subject to
increased scrutiny in many jurisdictions, including the U.S. and various states within the U.S. If
our Bermuda insurance or reinsurance operations become subject to the insurance laws of any state
in the U.S., we could face inquiries or challenges to the future operations of these companies.
Although surplus lines business is generally less regulated than the admitted market, the
regulation of surplus lines insurance may undergo changes in the future. Federal and/or state
measures may be introduced and promulgated that could result in increased oversight and regulation
of surplus lines insurance. Additionally, some recent and pending cases in Florida and California
courts have raised potentially significant questions regarding surplus lines insurance in those
states such as whether surplus lines insurers will be subject to policy form content, filing and
approval requirements or additional taxes. These cases also could foreshadow more extensive
oversight of surplus lines insurance by other jurisdictions.
Endurance American and Endurance Risk Solutions write insurance on an admitted basis within
the U.S. and are subject to extensive regulation under state statutes which confer regulatory,
supervisory and administrative powers on state insurance commissioners. Such regulation generally
is designed to protect policyholders rather than investors or shareholders of the insurer.
Our current or future business strategy could cause one or more of our currently unregulated
non-insurance subsidiaries to become subject to some form of regulation. Any failure to comply with
applicable laws could result
in the imposition of significant restrictions on our ability to do business, and could also
result in fines and other sanctions, any or all of which could adversely affect our financial
results and operations.
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We could be required to allocate considerable time and resources to comply with any new or
additional regulatory requirements and any such requirements may impact the operations of our
insurance non-insurance subsidiaries and ultimately could impact our financial condition as well.
In addition, we could be adversely affected if a regulatory authority believed we had failed to
comply with applicable law or regulation.
Operational Risks
Changes in current accounting practices and future pronouncements may materially impact our
reported financial results.
Unanticipated developments in accounting practices may require us to incur considerable
additional expenses to comply with such developments, particularly if it is required to prepare
information relating to prior periods for comparative purposes or to apply the new requirements
retroactively. The impact of changes in current accounting practices and future pronouncements
cannot be predicted but may affect the calculation of net income, net equity, and other relevant
financial statement line items. For example, the current proposal for the convergence of U.S. GAAP
with International Financial Reporting Standards (IFRS) would require the Company to prepare
financial statements in accordance with IFRS for the year ended December 31, 2014, including
comparative information also prepared under IFRS for the two previous years. Also, recent guidance
and ongoing projects put in place by standard setters globally have indicated a possible move away
from the current insurance accounting models toward more “fair value” based models which could
introduce significant volatility in the earnings of insurance industry participants.
Our results of operations may fluctuate significantly from period to period and may not be
indicative of our long-term prospects.
Our results of operations may fluctuate significantly from period to period. These
fluctuations result from a variety of factors, including the seasonality of the reinsurance and
insurance business, the volume and mix of reinsurance and insurance products that we write, loss
experience on our reinsurance and insurance liabilities, the performance of our investment
portfolio and our ability to assess and integrate our risk management strategy effectively. In
particular, we seek to underwrite products and make investments to achieve long-term results. As a
result, our short-term results of operations may not be indicative of our long-term prospects.
If actual claims exceed our reserve for losses and loss expenses, our financial condition and
results of operations could be adversely affected.
Our success depends upon our ability to accurately assess the risks associated with the
businesses that we insure or reinsure. We establish loss reserves to cover our estimated liability
for the payment of all losses and loss expenses incurred with respect to premiums earned on the
policies that we write. Loss reserves do not represent an exact calculation of liability. Rather,
loss reserves are estimates of what we expect the ultimate settlement and administration of claims
will cost. These estimates are based upon actuarial and statistical projections and on our
assessment of currently available data, as well as estimates of future trends in claims severity
and frequency, judicial theories of liability and other factors. Loss reserve estimates are
refined continually in an ongoing process as experience develops and claims are reported and
settled. Establishing an appropriate level of loss reserves is an inherently uncertain process.
Moreover, these uncertainties are greater for companies like us than for those with a longer
operating history because we do not yet have an extensive loss history. Because of this
uncertainty, it is possible that our reserves at any given time will prove inadequate.
To the extent we determine that actual losses and loss expenses exceed our expectations and
loss reserves recorded in our financial statements, we will be required to increase our reserve for
losses and loss expenses. This could cause a material reduction in our profitability and capital.
We may be adversely affected by foreign currency fluctuations.
We have made a significant investment in the capitalization of Endurance U.K., which is
denominated in British Sterling. In addition, we enter into reinsurance and insurance contracts
where we are obligated to pay losses in currencies other than U.S. dollars. For the year ended
December 31, 2009, approximately 9.1% of our gross premiums were written in currencies other than
the U.S. dollar. A portion of our cash and cash equivalents, investments and loss reserves are
also denominated in non-U.S. currencies. The majority of our operating foreign currency assets and
liabilities are denominated in Euros, British Sterling, Canadian Dollars, Japanese Yen and
Australian Dollars. We may, from time to time, experience losses from fluctuations in the values
of these and other non-U.S. currencies, which could have a material adverse affect on our results
of operations.
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We periodically buy and sell currencies or investment securities denominated in non-U.S.
dollars in an attempt to match our non-U.S. dollar assets to our related non-U.S. dollar
liabilities. We have no currency hedges in place; however, as part of our matching strategy, we
consider the use of hedges when we become aware of probable significant losses that will be paid in
non-U.S. currencies. However, it is possible that we will not successfully match our exposures or
structure the hedges to effectively manage these risks.
Acquisitions or strategic investments that we made or may make could turn out to be unsuccessful.
As part of our strategy, we have pursued and may continue to pursue growth through
acquisitions and/or strategic investments in new businesses. The negotiation of potential
acquisitions or strategic investments as well as the integration of an acquired business or new
personnel could result in a substantial diversion of management resources. Successful integration
will depend on, among other things, our ability to effectively integrate acquired businesses or new
personnel into our existing risk management techniques, our ability to effectively manage any
regulatory issues created by our entry into new markets and geographic locations, our ability to
retain key personnel and other operational and economic factors. There can be no assurance that
the integration of acquired business or new personnel will be successful or that the business
acquired will prove to be profitable or sustainable. The failure to integrate successfully or to
manage the challenges presented by the integration process may adversely impact our financial
results. Acquisitions could involve numerous additional risks such as potential losses from
unanticipated litigation or levels of claims and inability to generate sufficient revenue to offset
acquisition costs.
Our ability to manage our growth through acquisitions or strategic investments will depend, in
part, on our success in addressing these risks. Any failure by us to effectively implement our
acquisitions or strategic investment strategies could have a material adverse effect on our
business, financial condition or results of operations.
Operational risks, including systems or human failures, are inherent in business, including ours.
We are subject to operational risks including fraud, employee errors, failure to document
transactions properly or to obtain proper internal authorization, failure to comply with regulatory
requirements or obligations under our agreements, information technology failures, or external
events. Losses from these risks may occur from time to time and may be significant. As our business
and operations grow more complex, we are exposed to more risk in these areas.
Our modeling, underwriting and information technology systems are critical to our success.
Moreover, our proprietary technology and application systems have been an important part of our
underwriting strategy and our ability to compete successfully. We have also licensed certain
systems and data from third parties. We cannot be certain that we will have access to these, or
comparable, service providers, or that our information technology or application systems will
continue to operate as intended. While we have implemented disaster recovery and other business
continuity plans, a defect or failure in our internal controls or information technology systems
could result in reduced or delayed revenue growth, higher than expected losses, management
distraction, or harm to our reputation. We believe appropriate controls and mitigation procedures
are in place to prevent significant risk of defect in our internal controls and information
technology systems, but internal controls provide only reasonable, not absolute, assurance as to
the absence of errors or irregularities and any ineffectiveness of such controls and procedures
could have a material adverse effect on our business.
Since we are dependent on key executives, the loss of any of these executives or our inability to
retain other key personnel could adversely affect our business.
Our success substantially depends upon our ability to attract and retain qualified employees
and upon the ability of our senior management and other key employees to implement our business
strategy. We believe there are only a limited number of available qualified executives in the
business lines in which we compete. We rely substantially upon the services of Kenneth J.
LeStrange, our Chief Executive Officer, President and Chairman of the Board of Directors, Michael
J. McGuire, our Chief Financial Officer, Michael E. Angelina, our Chief Actuary and Chief Risk
Officer, David S. Cash, our Chief Underwriting Officer, Michael P. Fujii, the President and Chief
Executive Officer of our worldwide insurance operations and William M. Jewett, the President and
Chief Executive Officer of our worldwide reinsurance operations. On February 17, 2010, Mr.
LeStrange notified the Company’s Board of Directors that he would retire from his role as President
and Chief Executive Officer of the Company effective as of March 1, 2010 and that he would continue
in the role of Chairman of the Board of the Company until March 2, 2011. Upon Mr. LeStrange’s
retirement, Mr. Cash will become the Company’s Chief Executive Officer and Mr. Jewett will become
the Company’s President.
We believe we have been successful in attracting and retaining key
personnel since our inception. The loss of any of their services or the services of other members
of our management team or the inability to attract and retain other talented personnel could impede
the further implementation of our business strategy, which could have a material adverse effect on
our business. We do not currently maintain key man life insurance policies with respect to any of
our employees.
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Our business could be adversely affected by Bermuda employment restrictions.
We will need to continue to hire employees to work in Bermuda. Under Bermuda law,
non-Bermudians (other than spouses of Bermudians) may not engage in any gainful occupation in
Bermuda without an appropriate governmental work permit. Work permits may be granted or extended
by the Bermuda government upon showing that, after proper public advertisement in most cases, no
Bermudian (or spouse of a Bermudian) is available who meets the minimum standard requirements for
the advertised position. Current Bermuda law limits the duration of work permits to six years,
with certain exemptions for key employees. All of our 49 Bermuda-based professional employees who
require work permits, including Messrs. LeStrange, McGuire, Angelina, Fuji and Jewett have been
granted permits by the Bermuda government. The terms of such permits usually range from three to
five years at the time of grant depending on the individual. It is possible that we could lose the
services of one or more of our key employees if we are unable to obtain or renew their work
permits, which could have a material adverse effect on our business.
Corporate Risks
There are provisions in our charter documents that may reduce or increase the voting rights of our
ordinary shares.
The bye-laws of Endurance Holdings generally provide that any shareholder owning, directly,
indirectly or, in the case of any U.S. person, by attribution, outstanding ordinary shares
possessing more than 9.5% of the aggregate voting power of our ordinary shares will have their
voting rights reduced so that they may not exercise more than 9.5% of the voting rights conferred
by our ordinary shares. Under these provisions, certain shareholders may have their voting rights
limited to less than one vote per share, while other shareholders may have voting rights in excess
of one vote per share. Moreover, these provisions could have the effect of reducing the votes of
certain shareholders who would not otherwise be subject to the 9.5% limitation by virtue of their
direct share ownership. The bye-laws of Endurance Holdings provide that shareholders will be
notified of their voting interests prior to any vote to be taken by the shareholders.
As a result of any reallocation of votes, your voting rights might increase above 5% of the
aggregate voting power of the outstanding ordinary shares, thereby possibly resulting in your
becoming a reporting person subject to Schedule 13D or 13G filing requirements under the Securities
Exchange Act of 1934, as amended (the “Exchange Act”). In addition, the reallocation of your votes
could result in your becoming subject to filing requirements under Section 16 of the Exchange Act.
We also have the authority to request information from any shareholder for the purpose of
determining whether a shareholder’s voting rights are to be reallocated pursuant to the bye-laws.
If a shareholder fails to respond to a request for information from us or submits incomplete or
inaccurate information (after a reasonable cure period) in response to a request, we may, in our
reasonable discretion, reduce or eliminate the shareholder’s voting rights.
Provisions of Endurance Holdings’ bye-laws may restrict the ability to transfer shares of Endurance
Holdings.
Endurance Holdings’ Board of Directors may decline to register a transfer of any ordinary
shares if the relevant instrument of transfer (if any) is in favor of five persons or more jointly
or is not properly executed, the transferred shares are not fully paid shares or if the transferor
fails to comply with all applicable laws and regulations governing the transfer.
A shareholder may be required to sell its shares of Endurance.
The bye-laws of Endurance Holdings provide that we have the option, but not the obligation, to
require a shareholder to sell its ordinary shares for their fair market value to us, to other
shareholders or to third parties if we determine, based on the written advice of legal counsel,
that failure to exercise our option would result in non-de minimis adverse tax, legal or regulatory
consequences to us or certain U.S. persons as to which the shares held by such shareholder
constitute controlled shares. In the latter case, our right to require a shareholder to sell its
ordinary shares to us will be limited to the purchase of a number of ordinary shares that will
permit avoidance of those adverse tax consequences.
A shareholder may be required to indemnify us for any tax liability that results from the acts of
that shareholder.
The bye-laws of Endurance Holdings provide certain protections against adverse tax
consequences to us resulting from laws that apply to the shareholders of Endurance Holdings. If a
shareholder’s death or non-payment of any tax or duty payable by the shareholder, or any other act
or thing involving the shareholder, causes any adverse tax consequences to us, (i) the shareholder
(or his executor or administrator) is required to indemnify us
against any tax liability that we incur as a result, (ii) we will have a lien on any dividends
or any other distributions payable to the shareholder by us to the extent of the tax liability and
(iii) if any amounts not covered by our lien on dividends and distributions are owed to us by the
shareholder as a result of our tax liability, we have the right to refuse to register any transfer
of the shareholder’s shares.
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There are regulatory limitations on the ownership and transfer of our ordinary shares.
The Financial Services and Markets Act (“FSMA”) regulates the acquisition of control of any
U.K. insurance company authorized under FSMA. Any company or individual that (together with its or
his associates) directly or indirectly acquires 10% or more of the shares of a U.K. authorized
insurance company or its parent company, or is entitled to exercise or control the exercise of 10%
or more of the voting power in such authorized insurance company or its parent company, would be
considered to have acquired control for the purposes of FSMA, as would a person who had significant
influence over the management of such authorized insurance company or its parent company by virtue
of his shareholding or voting power in either. A purchaser of more than 10% of our ordinary shares
would therefore be considered to have acquired control of Endurance U.K. Under the FSMA, any
person proposing to acquire control over a U.K. authorized insurance company must notify the FSA of
his intention to do so and obtain the FSA’s prior approval. The FSA would then have three months
to consider that person’s application to acquire control. In considering whether to approve such
application, the FSA must be satisfied both that the acquirer is a fit and proper person to have
such control and that the interests of consumers would not be threatened by such acquisition of
control. Failure to make the relevant prior application would constitute a criminal offense.
State laws in the United States also require prior notices or regulatory agency approval of
changes in control of an insurer or its holding company. The insurance laws of the domiciliary
state provide that no corporation or other person except an authorized insurer may acquire control
of a domestic insurance or reinsurance company unless it has given notice to such company and
obtained prior written approval of the domiciliary state insurance commissioner. Any purchaser of
10% or more of our ordinary shares could become subject to such regulations and could be required
to file certain notices and reports with the insurance commissioners of the domiciliary states of
our operating companies.
U.S. persons who own our ordinary shares may have more difficulty in protecting their interests
than U.S. persons who are shareholders of a U.S. corporation.
The Companies Act, which applies to Endurance Holdings and Endurance Bermuda, differs in
certain material respects from laws generally applicable to U.S. corporations and their
shareholders. These differences include the manner in which directors must disclose transactions
in which they have an interest, the rights of shareholders to bring class action and derivative
lawsuits and the scope of indemnification available to directors and officers.
Anti-takeover provisions in our bye-laws could impede an attempt to replace or remove our
directors, which could diminish the value of our ordinary shares.
Endurance Holdings’ bye-laws contain provisions that may entrench directors and make it more
difficult for shareholders to replace directors even if the shareholders consider it beneficial to
do so. In addition, these provisions could delay or prevent a change of control that a shareholder
might consider favorable. For example, these provisions may prevent a shareholder from receiving
the benefit from any premium over the market price of our ordinary shares offered by a bidder in a
potential takeover. Even in the absence of an attempt to effect a change in management or a
takeover attempt, these provisions may adversely affect the prevailing market price of our ordinary
shares if they are viewed as discouraging changes in management and takeover attempts in the
future.
It may be difficult to enforce service of process and enforcement of judgments against us and our
officers and directors.
Endurance Holdings is a Bermuda company and certain of its officers and directors are
residents of jurisdictions outside the United States. A substantial portion of its assets and its
officers and directors, at any one time, are or may be located in jurisdictions outside the United
States. It may be difficult for investors to effect service of process within the United States on
our directors and officers who reside outside the United States or to enforce against us or our
directors and officers judgments of U.S. courts predicated upon civil liability provisions of the
U.S. federal securities laws.
We
have been advised by Appleby, our Bermuda counsel, that there is no
treaty in force between the United States and Bermuda providing for the reciprocal recognition and
enforcement of judgments in civil and commercial matters. As a result, whether a United States
judgment would be enforceable in Bermuda against us or our directors and officers depends on
whether the U.S. court that entered the judgment is
recognized by the Bermuda court as having jurisdiction over us or our directors and officers,
as determined by reference to Bermuda conflict of law rules.
34
In addition to and irrespective of jurisdictional issues, the Bermuda courts will not enforce
a United States federal securities law that is either penal or contrary to public policy. It is
the advice of Appleby that an action brought pursuant to a public or penal law, the purpose of
which is the enforcement of a sanction, power or right at the instance of the state in its
sovereign capacity, will not be entertained by a Bermuda court. Certain remedies available under
the laws of U.S. jurisdictions, including certain remedies under U.S. federal securities laws,
would not be available under Bermuda law or enforceable in a Bermuda court, as they would be
contrary to Bermuda public policy. Further, no claim may be brought in Bermuda against us or our
directors and officers in the first instance for violation of U.S. federal securities laws because
these laws have no extraterritorial jurisdiction under Bermuda law and do not have force of law in
Bermuda. A Bermuda court may, however, impose civil liability on us or our directors and officers
if the facts alleged in a complaint constitute or give rise to a cause of action under Bermuda law.
Taxation Risks
We may become subject to taxes in Bermuda after March 28, 2016, which may have a material adverse
effect on our financial condition.
The Bermuda Minister of Finance, under the Exempted Undertakings Tax Protection Act 1966, as
amended, of Bermuda, has given Endurance Holdings and Endurance Bermuda an assurance that if any
legislation is enacted in Bermuda that would “impose tax computed on profits or income or computed
on any capital asset, gain or appreciation, or any tax in the nature of estate duty or inheritance
tax, then the imposition” any such tax will not be applicable to Endurance Holdings, Endurance
Bermuda or any of their respective operations, shares, debentures or other obligations until March
28, 2016. Given the limited duration of the Minister of Finance’s assurance, however, it is
possible that after March 28, 2016 we may be subject to Bermuda taxes.
We and our subsidiaries may be subject to U.S. tax which may have a material adverse effect on our
financial condition and results of operations.
Endurance Holdings and Endurance Bermuda are Bermuda companies and Endurance U.K. is an
English company. Endurance Holdings, Endurance Bermuda and Endurance U.K. each intend to operate
in such a manner that none of these companies will be deemed to be engaged in the conduct of a
trade or business within the United States. Nevertheless, because definitive identification of
activities which constitute being engaged in a trade or business in the United States is not
provided by the Code, regulations or court decisions, the Internal Revenue Service (“IRS”) might
successfully contend that any of Endurance Holdings, Endurance Bermuda and/or Endurance U.K. are/is
engaged in a trade or business in the United States. If Endurance Holdings, Endurance Bermuda
and/or Endurance U.K. were engaged in a trade or business in the United States, and if Endurance
U.K. or Endurance Bermuda were to qualify for benefits under the applicable income tax treaty with
the United States, but such trade or business were attributable to a “permanent establishment” in
the United States (or in the case of Endurance Bermuda, with respect to investment income, arguably
even if such income were not attributable to a “permanent establishment”), Endurance Holdings,
Endurance U.K. and/or Endurance Bermuda would be subject to U.S. federal income tax at regular
corporate rates on the income that is effectively connected with the U.S. trade or business, plus
an additional 30% “branch profits” tax in certain circumstances, in which case our financial
condition and results of operations and your investment could be materially adversely affected.
Holders of Endurance Holdings’ ordinary shares or Series A Preferred Shares who own 10% or more of
our voting power may be subject to taxation under the “controlled foreign corporation” (“CFC”)
rules.
Certain “10% U.S. Shareholders” of a foreign corporation that is considered a “controlled
foreign corporation” (a “CFC”) for U.S. federal income tax purposes must include in gross income
such 10% U.S. shareholder’s pro rata share of the CFC’s “subpart F income,” even if the subpart F
income is not distributed. See “Material Tax Considerations — Certain United States Federal
Income Tax Considerations — United States Taxation of Holders of Ordinary Shares and Series A
Preferred Shares — Shareholders Who Are U.S. Persons — Classification of Endurance Holdings,
Endurance U.K. or Endurance Bermuda as a Controlled Foreign Corporation.” Due to the dispersion of
Endurance Holdings’ share ownership among holders, its bye-law provisions that impose limitations
on the concentration of voting power of its shares entitled to vote and authorize Endurance
Holdings to purchase such shares under certain circumstances, and other factors, no U.S. Person
that owns shares in Endurance Holdings directly or indirectly through foreign entities should be
subject to treatment as a 10% U.S. Shareholder of a CFC. It is possible, however, that the IRS
could challenge the effectiveness of these provisions and that a court could sustain such a
challenge. Accordingly, investors should consult their tax advisors regarding the application of
the CFC rules to an investment in Endurance Holdings.
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U.S. Persons who hold ordinary shares or Series A Preferred Shares may be subject to U.S. income
taxation on their pro rata share of our “related party insurance income” (“RPII”).
The CFC rules apply to certain insurance and reinsurance companies that earn RPII. If the
RPII rules were to apply to Endurance U.K. or Endurance Bermuda, a U.S. Person who owns ordinary
shares or Series A Preferred Shares of Endurance Holdings directly or indirectly through foreign
entities on the last day of the taxable year would be required to include in its income for U.S.
federal income tax purposes the shareholder’s pro rata share of Endurance U.K.’s or Endurance
Bermuda’s RPII for the entire taxable year, determined as if such RPII were distributed
proportionately to such U.S. shareholders at that date regardless of whether such income is
distributed. In addition, any RPII that is includible in the income of a U.S. tax-exempt
organization would be treated as unrelated business taxable income. Although Endurance U.K. and
Endurance Bermuda intend to generally operate in a manner so as to qualify for certain exceptions
to the RPII rules, there can be no assurance that these exceptions will be available. Accordingly,
there can be no assurance that U.S. Persons who own ordinary shares or Series A Preferred Shares
will not be required to recognize gross income inclusions attributable to RPII. See “Material Tax
Considerations — Certain United States Federal Income Tax Considerations — United States Taxation
of Holders of Ordinary Shares and Series A Preferred Shares — Shareholders Who Are U.S. Persons —
RPII Companies; RPII Exceptions.”
The RPII rules provide that if a shareholder who is a U.S. Person disposes of shares in a
foreign insurance corporation that has RPII and in which U.S. Persons collectively own 25% or more
of the shares, any gain from the disposition will generally be treated as ordinary income to the
extent of the shareholder’s share of the corporation’s undistributed earnings and profits that were
accumulated during the period that the shareholder owned the shares (whether or not such earnings
and profits are attributable to RPII). In addition, such a shareholder will be required to comply
with certain reporting requirements, regardless of the amount of shares owned by the shareholder.
These rules should not apply to dispositions of ordinary shares or Series A Preferred Shares
because Endurance Holdings will not itself be directly engaged in the insurance business. The RPII
provisions, however, have not been interpreted by the courts or the U.S. Treasury Department, and
regulations interpreting the RPII provisions of the Code exist only in proposed form. Accordingly,
the IRS might interpret the proposed regulations in a different manner and the applicable proposed
regulations may be promulgated in final form in a manner that would cause these rules to apply to
dispositions of our ordinary shares and Series A Preferred Shares. See “Material Tax
Considerations — Certain United States Federal Income Tax Considerations — United States Taxation
of Holders of Ordinary Shares and Series A Preferred Shares — Shareholders Who Are U.S. Persons
— Disposition of Ordinary Shares and Series A Preferred Shares; Uncertainty as to the Application
of RPII.”
U.S. Persons who hold ordinary shares or Series A Preferred Shares will be subject to adverse tax
consequences if we are considered a “passive foreign investment company” (a “PFIC”) for U.S.
federal income tax purposes.
We believe that we should not be considered a PFIC for U.S. federal income purposes for the
year ended December 31, 2009. Moreover, we do not expect to conduct our activities in a manner
that would cause us to become a PFIC in the future. However, there can be no assurance that the
IRS will not challenge this position or that a court will not sustain such challenge. Accordingly,
it is possible that we could be deemed a PFIC by the IRS or a court for the 2009 year or any future
year. If we were considered a PFIC, it could have material adverse tax consequences for an investor
that is subject to U.S. federal income taxation, including subjecting the investor to a greater tax
liability than might otherwise apply or subjecting the investor to tax on amounts in advance of
when tax would otherwise be imposed. Moreover, proposed legislation, if enacted, would impose an
annual reporting requirement on certain shareholders of a PFIC. There are currently no regulations
regarding the application of the PFIC provisions to an insurance company. New regulations or
pronouncements interpreting or clarifying these rules may be forthcoming. We cannot predict what
impact, if any, such guidance would have on a shareholder that is subject to U.S. federal income
taxation. See “Material Tax Considerations — Certain United States Federal Income Tax
Considerations — United States Taxation of Holders of Ordinary Shares and Series A Preferred
Shares — Shareholders Who Are U.S. Persons — Passive Foreign Investment Companies.”
Changes to U.S. Tax Legislation could have an adverse impact on us or our shareholders
Congress and the Administration have discussed from time-to-time proposals intended to
eliminate certain perceived tax advantages of companies (including insurance companies) that have
legal domiciles outside the United States but have certain U.S. connections. In particular,
President Obama’s budget for fiscal year 2011 includes proposals that would deny a U.S. non-life
insurance company a deduction for certain excess non-taxed reinsurance premiums paid to affiliates,
defer interest deductions related to certain foreign source income and prevent avoidance of
dividend withholding under certain circumstance. Congress has also introduced similar legislation,
as well as other proposals relating to tax-haven jurisdictions, cross-border transactions,
intangible products, and a proposal that would treat a foreign corporation that is primarily
managed and controlled in the United States as a U.S. corporation
for U.S. federal income tax purposes. We cannot be certain if, when or in what form such
legislation may be enacted and whether such legislation, if enacted, would have retroactive effect.
Enactment of some versions of such legislation as well as other changes in U.S. tax laws,
regulations and interpretations of such legislation or tax law changes to address these issues
could adversely affect the results of our operations and financial condition and could have a
material adverse effect on our business, financial condition or results of operations.
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The Organization for Economic Cooperation and Development (“OECD”) and the European Union are
considering measures that might increase our taxes and reduce our net income.
The OECD has published reports and launched a global dialogue among member and non-member
countries on measures to limit harmful tax competition. These measures are largely directed at
counteracting the effects of preferential tax regimes in countries around the world. In the OECD’s
report dated April 18, 2002 and updated as of June 2004 and November 2005 via a “Global Forum,”
Bermuda was not listed as an uncooperative tax haven jurisdiction because it had previously
committed to eliminate harmful tax practices and to embrace international tax standards for
transparency, exchange of information and the elimination of any aspects of the regimes for
financial and other services that attract business with no substantial domestic activity. Bermuda
was included in the most recently revised OECD white list with other countries that have
substantially implemented the OECD’s international tax standards. We are not able to predict what
changes will arise from the commitment or whether such changes will subject us to additional taxes.
REGULATORY MATTERS
General
The business of insurance and reinsurance is regulated in most countries, although the degree
and type of regulation varies significantly from one jurisdiction to another. Reinsurers are
generally subject to less direct regulation than primary insurers.
Bermuda
The Insurance Act 1978 of Bermuda and related regulations, as amended (the “Insurance Act”),
regulates the insurance business of Endurance Bermuda and provides that no person may carry on any
insurance business in or from within Bermuda unless registered as an insurer by the Bermuda
Monetary Authority (“BMA”) under the Insurance Act. Endurance Bermuda is registered as a Class 4
insurer by the BMA. As a holding company, Endurance Holdings is not subject to Bermuda insurance
regulations. Insurance, as well as reinsurance, is regulated under the Insurance Act. The BMA, in
deciding whether to grant registration, has broad discretion to act as it thinks fit in the public
interest. The BMA is required by the Insurance Act to determine whether the applicant is a fit and
proper body to be engaged in the insurance business and, in particular, whether (a) it has
fulfilled the minimum criteria with respect to the body corporate, (b) it has, or has available to
it, adequate knowledge and expertise to operate an insurance business and (c) the premises intended
to be used in the business are adequate for the conduct of the business. The continued
registration of an applicant as an insurer is subject to it complying with the terms of its
registration and such other conditions as the BMA may impose from time to time.
An Insurance Advisory Committee appointed by the Bermuda Minister of Finance (the “Minister”)
advises the BMA on matters connected with the discharge of the BMA’s functions. Sub-committees of
the Insurance Advisory Committee supervise and review the law and practice of insurance in Bermuda,
including reviews of accounting and administrative procedures. The day-to-day supervision of
insurers is the responsibility of the BMA.
The Insurance Act also imposes on Bermuda insurance companies solvency and liquidity standards
and auditing and reporting requirements and grants the BMA powers to supervise, investigate,
require information and the production of documents and intervene in the affairs of insurance
companies. Certain significant aspects of the Bermuda insurance regulatory framework are set forth
below.
In July 2008, the Insurance Amendment Act 2008 (the “Amendment Act”) was promulgated, which
among other things, created a new supervisory framework for Bermuda insurers by establishing new
risk-based regulatory capital adequacy and solvency margin requirements. The implementation of the
new supervisory framework is to occur in phases, and has commenced with Class 4 insurers and will
be extended to certain commercial Class 3, Class 3A and Class 3B insurers. Under the new regulatory
framework ushered in by the Amendment Act on December 31, 2008, the BMA promulgated the Insurance
(Prudential Standards) (Class 4 Solvency Requirement) Order 2008 (the “Order”) which, inter alia,
mandates that a Class 4 insurer’s Enhanced Capital Requirement (“ECR”) be calculated by either (a)
the model set out in Schedule 1 to the Order or (b) an internal capital model which the BMA has
approved for use for this purpose. More information on the ECR and the new risk-based regulatory
capital adequacy and solvency margin regime introduced under the Amendment Act can be found in the section
entitled “Enhanced Capital Requirement, Minimum Solvency Margin and Restrictions on Dividends and
Distributions”.
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On December 11, 2008, the Bermuda House of Assembly approved amendments to Bermuda’s existing
insurance regulations (the “Regulations”). The amended Regulations, which came into effect on
December 31, 2008, compliment and in certain respects, are consequential to the changes instituted
under the Amendment Act.
The BMA utilizes a risk based approach when it comes to licensing and supervising insurance
companies in Bermuda. As part of the BMA’s risk based system, an assessment of the inherent risks
within each particular class of insurer is utilized in the first instance to determine the
limitations and specific requirements which may be imposed. Thereafter, the BMA keeps its analysis
of relative risk within individual institutions under review on an ongoing basis, including through
the scrutiny of regular audited statutory financial statements, and, as appropriate, meeting with
senior management during onsite visits. The initial meetings with senior management and any
proposed onsite visit will primarily focus upon companies that are licensed as Class 3, Class 3A,
Class 3B and Class 4 insurers. The BMA has also recently adopted guidance notes, or the Guidance
Notes, in order to ensure those operating in Bermuda have a good understanding of the nature of the
requirements of, and the BMA’s approach in implementing, the Insurance Act.
Classification of Insurers
The Insurance Act distinguishes between insurers carrying on long-term business and insurers
carrying on general business. There are six classifications of insurers carrying on general
business, with Class 4 insurers subject to the strictest regulation. Endurance Bermuda, which is
incorporated to carry on general insurance and reinsurance business, is registered as a Class 4
insurer in Bermuda and is regulated as such under the Insurance Act. Endurance Bermuda is not
licensed to carry on long-term business.
Cancellation of Insurer’s Registration
An insurer’s registration may be canceled by the Supervisor of Insurance of the BMA on certain
grounds specified in the Insurance Act, including failure of the insurer to comply with its
obligations under the Insurance Act or if, in the opinion of the BMA after consultation with the
Insurance Advisory Committee, the insurer has not been carrying on business in accordance with
sound insurance principles.
Principal Representative
An insurer is required to maintain a principal office in Bermuda and to appoint and maintain a
principal representative in Bermuda. For the purpose of the Insurance Act, Endurance Bermuda’s
principal office is its executive offices in Pembroke, Bermuda. Michael J. McGuire has been
appointed by the Board of Directors as Endurance Bermuda’s principal representative and has been
approved by the BMA. Without a reason acceptable to the BMA, an insurer may not terminate the
appointment of its principal representative, and the principal representative may not cease to act
as such, unless 30 days’ notice in writing to BMA is given of the intention to do so. A principal
representative shall forthwith notify the BMA, in such a manner as it may direct, (a) on his
reaching a view that there is a likelihood of the insurer for which he acts becoming insolvent, for
instance the failure by the insurer to comply substantially with a condition imposed upon the
insurer by the BMA relating to a solvency margin or liquidity or other ratio would be a reportable
“event”; (b) on its coming to his knowledge, or his having reason to believe, that an event to
which the applicable section of the Insurance Act applies has occurred, under the Amendment Act
these events now include (i) circumstances where a Class 4 insurer undergoes a material change to
the nature of the business it underwrites; and (ii) a significant loss which is likely to render
the insurer unable to comply with its ECR. Within 14 days of such notification, the principal
representative shall furnish the BMA with a report in writing setting out all the particulars of
the case that are available to him.
Independent Approved Auditor
Every registered insurer must appoint an independent auditor who will audit and report
annually on the statutory financial statements and the statutory financial return of the insurer,
both of which, in the case of Endurance Bermuda, are required to be filed annually with the BMA.
Endurance Bermuda’s independent auditor must be approved by the BMA and may be the same person or
firm that audits Endurance Holdings’ consolidated financial statements and reports for presentation
to its shareholders.
Loss Reserve Specialist
As a registered Class 4 insurer, Endurance Bermuda is required to submit an opinion of its
approved loss reserve specialist with its statutory financial return in respect of its losses and
loss expenses provisions. The loss reserve specialist, who will normally be a qualified casualty
actuary, must be approved by the BMA. Michael E.
Angelina, Chief Actuary and Chief Risk Officer for the Company, has been appointed by our
Board of Directors and has been approved by the BMA to act as Endurance Bermuda’s loss reserve
specialist.
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Statutory and GAAP Financial Statements
An insurer must prepare annual statutory financial statements. The Insurance Act prescribes
rules for the preparation and substance of these statutory financial statements (which include, in
statutory form, a balance sheet, an income statement, a statement of capital and surplus and notes
thereto). The insurer is required to give detailed information and analyses regarding premiums,
claims, reinsurance and investments. The Amendment Act and amended Regulations have introduced a
new accounts regime applicable to Class 4 insurers, including (i) a distinct methodology and new
format to be applied when preparing and reporting the statutory balance sheet and statutory income
statements for Class 4 insurers and (ii) accompanying explanatory notes to be added and
instructions affecting each statutory statement. The most significant aspect of the amended
regulations in relation to the statutory balance sheet of Class 4 insurers is the reporting
obligation to detail, on a line-by-line basis, specific asset and liability classes, as well as the
requirement to identify and distinguish between what is or is not attributable to affiliates of the
Class 4 insurer.
With effect from December 31, 2008, Class 4 insurers are required to prepare and file with the
BMA audited annual financial statements prepared in accordance with GAAP (that applies in Bermuda,
U.K., U.S., or such other GAAP as the BMA may recognize) or International Financial Reporting
Standards (“IFRS”). These statements are to be submitted within four months from the end of the
financial year to which they relate or, if the Class 4 insurer makes an application to the BMA,
such longer period as may be allowed by the BMA but no longer than seven months from the end of the
financial year to which they relate. The BMA will publish each such Class 4 insurer’s GAAP or IFRS
audited financial statements.
The statutory financial statements are not prepared in accordance with U.S. GAAP and are
distinct from the financial statements prepared for presentation to the insurer’s shareholders
under the Companies Act, which financial statements, in the case of the Company, will be prepared
in accordance with U.S. GAAP. As a general business insurer, Endurance Bermuda is required to
submit the annual statutory financial statements as part of the annual statutory financial return.
The statutory financial statements and the statutory financial return do not form part of the
public records maintained by BMA.
In addition to statutory financial statements, Class 4 insureds are required to file audited
GAAP financial statements with the BMA to be published publicly. The audited GAAP financial
statements are to be filed with the annual statutory financial return.
Annual Statutory Financial Return
Endurance Bermuda is required to file with the BMA a statutory financial return no later than
four months after its financial year end (unless specifically extended upon application to the
BMA). The statutory financial return for a Class 4 insurer includes, among other matters, a report
of the approved independent auditor on the statutory financial statements of the insurer, solvency
certificates, the statutory financial statements, the opinion of the loss reserve specialist and a
schedule of reinsurance ceded. The solvency certificates must be signed by the principal
representative and at least two directors of the insurer certifying that the minimum solvency
margin has been met and whether the insurer complied with the conditions attached to its
certificate of registration. The independent auditor is required to state whether, in its opinion,
it was reasonable for the directors to make these certifications and whether the declaration of the
statutory ratios complies with the requirements of the Insurance Act. If an insurer’s accounts
have been audited for any purpose other than compliance with the Insurance Act, a statement to that
effect must be filed with the statutory financial return.
Enhanced Capital Requirement, Minimum Solvency Margin and Restrictions on Dividends and
Distributions
The new risk-based regulatory capital adequacy and solvency margin regime introduced under the
Amendment Act, which came into effect on December 31, 2008, provides a risk-based capital model as
a tool to assist the BMA both in measuring risk and in determining appropriate levels of
capitalization termed the Bermuda Solvency Capital Requirement (“BSCR”). BSCR employs a standard
mathematical model that correlates the risk underwritten by Bermuda insurers to the capital that is
dedicated to their business. The framework that has been developed and is set out in the Order,
published on December 31, 2008, applies a standard measurement format to the risk associated with
an insurer’s assets, liabilities and premiums, including a formula to take account of the
catastrophe risk exposure.
Where the insurer believes that its own internal model for measuring risk and determining
appropriate levels of capital better reflects the inherent risk of its business, it may make
application to the BMA for approval to use its internal capital model in substitution for the BSCR
model. The BMA may approve an insurer’s internal model
provided certain conditions have been established and may revoke approval of an internal model
in the event that the conditions are no longer met or where it feels that the revocation is
appropriate. The BMA will review the internal model regularly to confirm that the model continues
to meet the conditions.
39
In order to minimise the risk of a shortfall in capital arising from an unexpected adverse
deviation and in moving towards the implementation of a risk-based capital approach, the BMA seeks
that insurers operate at or above a threshold capital level (termed the Target Capital Level
(“TCL”)), which exceeds the BSCR or approved internal model minimum amounts.
The Amendment Act also introduced prudential standards in relation to the ECR and Capital and
Solvency Return (“CSR”). The ECR is determined using the BSCR or an approved internal model,
provided that at all times the ECR must be an amount equal to, or exceeding the minimum margin of
solvency. The CSR is the return setting out the insurers risk management practises and other
information used by the insurer to calculate its approved internal model ECR.
The new capital requirements require Class 4 insurers to hold available statutory capital and
surplus equal to or exceeding ECR and set TCL at 120% of ECR. The BMA also has a degree of
discretion enabling it to impose ECR on insurers in particular cases, for instance where an insurer
falls below the TCL. In those cases, the new risk-based capital model should be supplemented by a
requirement for the affected insurers to conduct certain stress and scenario testing in order to
assess their potential vulnerability to defined extreme events. Where the results of scenario and
stress testing indicated potential capital vulnerability, the BMA would be able to require a higher
solvency ‘cushion’ by increasing the 120% TCL figure. In circumstances where an insurer has failed
to comply with an ECR given by the BMA in respect of that insurer, such insurer is prohibited from
declaring or paying any dividends until the failure is rectified and the insurer is obliged to (i)
provide the BMA, within fourteen days of the failure, with a written report as to why the failure
occurred and remedial steps to be taken; and (ii) within forty-five days of the failure to provide
the BMA with unaudited interim financial statements. In addition, the unaudited interim finanical
statements must be accompanied by the opinion of the loss reserve specialist, a general business
solvency certificate in respect of the unaudited financials and a CSR reflecting an ECR prepared
using post-failure data.
Underlying the new risk-based solvency capital regime described above is the minimum solvency
margin test set out in the Insurance Returns and Solvency Amendment Regulations 1980 (as amended).
While it must calculate its ECR annually by reference to either the BSCR or an approved internal
model, a Class 4 insurer such as Endurance Bermuda must also ensure that, at all times, its ECR is
at least equal to the minimum solvency margin for a Class 4 insurer in respect of its general
business, which is the greater of:
In addition, under the Insurance Act, Class 4 insurers are prohibited from declaring or paying
any dividends of more than 25% of its total statutory capital and surplus, as shown on its previous
financial year statutory balance sheet, unless at least seven days before payment of the dividends
it files with the BMA an affidavit that it will continue to meet its required solvency margins.
Endurance Bermuda as a Class 4 insurer must obtain the BMA’s prior approval before reducing its
total statutory capital, as shown on its previous financial year statutory balance sheet, by 15% or
more.
Furthermore, under the Companies Act, Endurance Holdings and Endurance Bermuda may only
declare or pay a dividend if Endurance Holdings or Endurance Bermuda, as the case may be, has no
reasonable grounds for believing that it is, or would after the payment be, unable to pay its
liabilities as they become due, or if the realizable value of its assets would not be less than the
aggregate of its liabilities and its issued share capital and share premium accounts.
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Minimum Liquidity Ratio
The Insurance Act provides a minimum liquidity ratio for general business insurers, like
Endurance Bermuda. An insurer engaged in general business is required to maintain the value of its
relevant assets at not less than 75% of the amount of its relevant liabilities. Relevant assets
include, but are not limited to, cash and time deposits, quoted investments, unquoted bonds and
debentures, first liens on real estate, investment income due and accrued, accounts and premiums
receivable, reinsurance balances receivable and funds held by ceding reinsurers. There are certain
categories of assets which, unless specifically permitted by the BMA, do not automatically qualify
as relevant assets, such as unquoted equity securities, investments in and advances to affiliates
and real estate and collateral loans. The relevant liabilities are total general business
insurance reserves and total other liabilities less deferred income tax and sundry liabilities (by
interpretation, those not specifically defined), letters of credit and guarantees.
Supervision, Investigation and Intervention
The BMA may appoint an inspector with extensive powers to investigate the affairs of Endurance
Bermuda if the BMA believes that such an investigation is in the best interests of its
policyholders or persons who may become policyholders. In order to verify or supplement
information otherwise provided to the BMA, the BMA may direct Endurance Bermuda to produce
documents or information relating to matters connected with its business. In addition, the BMA has
the power to require the production of documents from any person who appears to be in possession of
such documents. Further, the BMA has the power, in respect of a person registered under the
Insurance Act, to appoint a professional person to prepare a report on any aspect of any matter
about which the BMA has required or could require information. If it appears to the BMA to be
desirable in the interests of the clients of a person registered under the Insurance Act, the BMA
may also exercise these powers in relation to any company which is or has at any relevant time been
(a) a parent company, subsidiary company or related company of that registered person, (b) a
subsidiary company of a parent company of that registered person, (c) a parent company of a
subsidiary company of that registered person or (d) a company in the case of which a shareholder
controller of that registered person, either alone or with any associate or associates, holds 50
percent or more of the shares or is entitled to exercise, or control the exercise, of more than 50
percent of the voting power at a general meeting.
If it appears to the BMA that there is a risk of Endurance Bermuda becoming insolvent, or that
Endurance Bermuda is in breach of the Insurance Act or any conditions imposed upon its
registration, the BMA may, among other things, direct Endurance Bermuda (i) not to effect further
contracts of insurance, or any contract of insurance of a specified description; (ii) to limit the
aggregate of the premiums to be written by it during a specified period beginning not earlier than
28 days after the direction is given; (iii) not to vary any contract of insurance in force when the
direction is given, if the effect of the variation would be to increase the liabilities of the
insurer; (iv) not to make any investment of a specified class; (v) before the expiration of a
specified period (or such longer period as the BMA may allow) to realize any existing investment of
a specified class; (vi) not to declare or pay any dividends or any other distributions, or to
restrict the making of such payments to such extent as the BMA thinks fit; (vii) not to enter into
any specified transaction with any specified person or persons of a specified class; (viii) to
provide such written particulars relating to the financial circumstances of the insurer as the BMA
thinks fit; and (ix) to obtain the opinion of a loss reserve specialist with respect to general
business, or an actuarial opinion with respect to long-term business, and to submit it to the BMA
within a specified time.
Disclosure of Information
In addition to powers under the Insurance Act to investigate the affairs of an insurer, the
BMA may require certain information from an insurer (or certain other persons) to be produced to
them. Further, the BMA has been given powers to assist other regulatory authorities, including
foreign insurance regulatory authorities, with their investigations involving insurance and
reinsurance companies in Bermuda but subject to restrictions. For example, the BMA must be
satisfied that the assistance being requested is in connection with the discharge of regulatory
responsibilities of the foreign regulatory authority. Further, the BMA must consider whether
cooperation is in the public interest. The grounds for disclosure are limited and the Insurance
Act provides sanctions for breach of the statutory duty of confidentiality.
Under the Companies Act, the Minister has been given powers to assist a foreign regulatory
authority which has requested assistance in connection with enquiries being carried out by it in
the performance of its regulatory functions. The Minister’s powers include requiring a person to
furnish him with information, to produce documents to him, to attend and answer questions and to
give assistance in connection with enquiries. The Minister must be satisfied that the assistance
requested by the foreign regulatory authority is for the purpose of its regulatory functions and
that the request is in relation to information in Bermuda which a person has in his possession or
under his
control. The Minister must consider, among other things, whether it is in the public interest
to give the information sought.
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Bermuda Guidance Notes
The BMA has issued Guidance Notes on the application of the Insurance Act in respect of the
duties, requirements and standards to be complied with by persons registered under the Insurance
Act or otherwise regulated under it and the procedures and sound principles to be observed by such
persons and by auditors, principal representatives and loss reserve specialists. In March 2005,
the BMA issued the Guidance Notes through its web site at www.bma.bm, which provides guidance on,
among other things, the roles of the principal representative, approved auditor, and approved
actuary and corporate governance for Bermuda insurers. The BMA has stated that the Guidance Notes
should be understood as reflecting the minimum standard that the BMA expects insurers such as
Endurance Bermuda and other relevant parties to observe at all times.
Controller Notification
Each shareholder or prospective shareholder will be responsible for notifying the BMA in
writing within 45 days of his becoming a controller, directly or indirectly, of 10%, 20%, 33% or
50% of Endurance Holdings and Endurance Bermuda. The BMA may serve a notice of objection on any
controller of Endurance Bermuda if it appears to the BMA that the person is no longer fit and
proper to be such a controller. Endurance Bermuda will be responsible for giving written notice to
the BMA of the fact that any person has become or ceases to be 10%, 20%, 33% or 50% controller of
Endurance Bermuda. The Notice has to be given within 45 days of Endurance Bermuda becoming aware
of the relevant facts.
Endurance Bermuda is also required to notify the BMA in writing in the event of any person
ceasing to be a controller, a controller being a managing director, chief executive or other person
in accordance with whose directions or instructions the directors of Endurance Bermuda are
accustomed to act, including any person who holds, or is entitled to exercise, 10% or more of the
voting shares or voting power or is able to exercise a significant influence over the management of
Endurance Bermuda.
Bermuda Statement of Principles
In June 2007, the BMA pursuant to section 2A of the Insurance Act introduced the Principles.
The Principles relate to the BMA’s decisions on whether to register an entity, to cancel the
registration of a registered entity, to impose conditions upon a registration, or to give certain
directions to a registered entity. These Principles are of general application and seek to take
account of the wide diversity of registered entities that may be licensed under the Insurance Act,
as well as relevant institutional and market developments.
Code of Conduct
The BMA proposes to implement a Code of Conduct which will address the standards, duties and
requirements that a registered person’s (which includes an insurer) internal policies and
procedures must provide for in relation to matters such as corporate governance, risk assessment,
risk and investment management, insurance activities and market conduct. The BMA will take into
account whether a relevant insurer such as Endurance Bermuda complies with the Code of Conduct and
as such is indeed conducting its business in a prudent manner as required under the Insurance Act.
The BMA has published its proposed approach to the implementation of the Code of Conduct for
registered persons on its website at www.bma.bm.
Certain Other Bermuda Law Considerations
Endurance Holdings and Endurance Bermuda will each also need to comply with the provisions of
the Companies Act regulating the payment of dividends and making of distributions from contributed
surplus. A company is prohibited from declaring or paying a dividend, or making a distribution out
of contributed surplus, if there are reasonable grounds for believing that: (a) the Company is, or
would after the payment be, unable to pay its liabilities as they become due; or (b) the realizable
value of the Company’s assets would thereby be less than the aggregate of its liabilities and its
issued share capital and share premium accounts.
Although Endurance Bermuda is incorporated in Bermuda, it is classified as a non-resident of
Bermuda for exchange control purposes by the BMA. Pursuant to its non-resident status, Endurance
Bermuda may engage in transactions in currencies other than Bermuda dollars and there are no
restrictions on its ability to transfer funds (other than funds denominated in Bermuda dollars) in
and out of Bermuda or to pay dividends to United States residents who are holders of its ordinary
shares.
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Under Bermuda law, exempted companies are companies formed for the purpose of conducting
business outside Bermuda from a principal place of business in Bermuda. As “exempted” companies,
Endurance Holdings
and Endurance Bermuda may not, without the express authorization of the Bermuda legislature or
under a license or consent granted by the Minister, participate in certain business transactions,
including: (1) the acquisition or holding of land in Bermuda (except that held by way of lease or
tenancy agreement which is required for its business and held for a term not exceeding 50 years, or
which is used to provide accommodation or recreational facilities for its officers and employees
and held with the consent of the Minister, for a term not exceeding 21 years); (2) the taking of
mortgages on land in Bermuda to secure an amount in excess of $50,000; (3) to acquire any bonds or
debentures secured on any land in Bermuda except bonds or debentures issued by the Government of
Bermuda or a public authority or (4) the carrying on of business of any kind for which it is not
licensed in Bermuda, except in certain limited circumstances such as doing business with another
exempted undertaking in furtherance of Endurance Holdings’ business or Endurance Bermuda’s business
(as the case may be) carried on outside Bermuda. Endurance Bermuda is a licensed insurer in
Bermuda, and so may carry on activities from Bermuda that are related to and in support of its
insurance business.
Securities may be offered or sold in Bermuda only in compliance with the provisions of the
Investment Business Act 2003, and Exchange Control Act 1972, and related regulations of Bermuda
which regulate the sale of securities in Bermuda. In addition, specific permission is required
from the BMA, pursuant to the provisions of the Exchange Control Act 1972 and related regulations,
for all issuances and transfers of securities of Bermuda companies, other than in cases where the
BMA has granted a general permission. The BMA, in its policy dated June 1, 2005, provides that
where any equity securities, which would include our ordinary shares, of a Bermuda company are
listed on an appointed stock exchange (the New York Stock Exchange is deemed to be an appointed
stock exchange under Bermuda law), general permission is given for the issue and subsequent
transfer of any securities of a company from and/or to a non-resident, for as long as any equity
securities of the company remain so listed.
Notwithstanding the above general permission, the BMA has granted us permission to, subject to
our ordinary or voting shares being listed on an appointed stock exchange, issue, grant, create,
sell and transfer any of our shares, stock, bonds, notes (other than promissory notes), debentures,
debenture stock, units under a unit trust scheme, shares in an oil royalty, options, warrants,
coupons, rights and depository receipts, collectively, the “Securities”, to and among persons who
are either resident or non-resident of Bermuda for exchange control purposes, whether or not the
Securities (excluding, for the avoidance of doubt, our ordinary or voting shares) are listed on an
appointed stock exchange.
The Bermuda government actively encourages foreign investment in “exempted” entities like
Endurance Holdings and Endurance Bermuda that are based in Bermuda, but do not operate in
competition with local businesses. As well as having no restrictions on the degree of foreign
ownership, Endurance Holdings and Endurance Bermuda are not currently subject to taxes computed on
profits or income or computed on any capital asset, gain or appreciation, or any tax in the nature
of estate duty or inheritance tax or to any foreign exchange controls in Bermuda. See “Material
Tax Considerations — Certain Bermuda Tax Considerations.”
Under Bermuda law, non-Bermudians (other than spouses of Bermudians or Permanent Resident Card
(“PRC”) Holders) may not engage in any gainful occupation in Bermuda without a work permit issued
by the Department of Immigration. Work permits may be granted or extended by the Bermuda
Government upon showing that, after proper public advertisement in most cases, no Bermudian (or
spouse of a Bermudian or PRC Holder) is available who meets the minimum standard requirements for
the advertised position. In April 2001, the Bermuda Government announced a policy that places
six-year term limits on individuals’ work, with certain exemptions for key employees.
U.K. Regulation
General
On December 1, 2001, the Financial Services Authority (“FSA”) assumed its full powers and
responsibilities as the single statutory regulator responsible for regulating the financial
services industry in respect of the carrying on of regulated activities (including deposit taking,
insurance, investment management and most other financial services business by way of business in
the U.K.), with the purpose of maintaining confidence in the U.K. financial system, providing
public understanding of the system, securing the proper degree of protection for consumers and
helping to reduce financial crime. It is a criminal offense for any person to carry on a regulated
activity in the U.K. unless that person is authorized by the FSA and has been granted permission to
carry on that regulated activity or falls under an exemption.
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Insurance business (which includes reinsurance business) is authorized and supervised by the
FSA. Insurance business in the United Kingdom is divided between two main categories: long-term
insurance (which is primarily investment-related) and general insurance. It is not possible for an
insurance company to be authorized in both long-term and general insurance business. These two categories are both divided into
“classes” (for example: permanent health and pension fund management are two classes of long-term
insurance; damage to property and motor vehicle liability are two classes of general insurance).
Under the Financial Services and Markets Act 2000 (the “FSMA”), effecting or carrying out contracts
of insurance, within a class of general or long-term insurance, by way of business in the United
Kingdom, constitutes a regulated activity requiring individual authorization. An authorized
insurance company must have permission for each class of insurance business it intends to write.
Endurance U.K. has received authorization from the FSA to effect and carry out in the United
Kingdom contracts of insurance in all classes of general business (limited in the case of credit
and surety to reinsurance only) except legal expenses and assistance business. On January 14,
2005, as a result of the implementation by the United Kingdom Government of the Insurance Mediation
Directive (2002/92/EC) various additional activities, which had previously been unregulated, fell
within the scope of FSA regulation.
Endurance U.K. has accordingly received authorization from the FSA to conduct the following
additional regulated activities: arranging (bringing about) deals in investments and making
arrangements with a view to transactions in investments. In both cases, those activities are
restricted to non-investment insurance contracts. Endurance U.K. is also authorized to accept
deposits (limited to accepting deposits in the course of carrying on insurance business for which
it holds permission).
As an authorized insurer in the United Kingdom, Endurance U.K. would be able to operate
throughout the E.U., subject to certain regulatory requirements of the FSA and in some cases,
certain local regulatory requirements. An insurance company with FSA authorization to write
insurance business in the United Kingdom can seek consent from the FSA to allow it to provide
cross-border services in other member states of the E.U. As an alternative, FSA consent may be
obtained to establish a branch office within another member state.
As an FSA authorized insurer, the insurance and reinsurance businesses of Endurance U.K. are
subject to close supervision by the FSA. The FSA has implemented specific requirements for senior
management arrangements, systems and controls of insurance and reinsurance companies under its
jurisdiction, which place a strong emphasis on risk identification and management in relation to
the prudential regulation of insurance and reinsurance business in the United Kingdom.
In December 2004, the FSA prompted a market initiative in the United Kingdom insurance
industry to resolve perceived problems resulting from contract uncertainty, which may exist where
the full terms and conditions of a contract of insurance or reinsurance are not established at or
before the time when the contract comes into force. The FSA’s stated preferred outcome was that a
market solution should be produced which met the regulator’s main concerns, which were that
policyholders should know precisely what protection they have bought; and that insurers, reinsurers
and brokers should have a clearer view, at the time of inception of a contract of the relevant
legal, fiduciary, operational and underwriting risks to which they are subject. On January 24,
2007, the FSA announced that the insurance industry had met the challenge laid down by the
regulator to achieve a solution to contract certainty in the United Kingdom. Accordingly, the
current publicly stated position of the FSA is that it does not, at present, intend to propose new
rules to address the contract certainty issue. However, the FSA also stated that contract
certainty would continue to be a supervisory priority in 2008 and that, in those cases where it
believes that firms have fallen behind the rest of the market in reducing the number of contracts
that do not meet the market’s contract certainty standards, it would consider regulatory action to
address this, though no enforcement action has been taken in this regard to date. This action
might include increases in required regulatory capital or the commencement of enforcement action.
In December 2007, the FSA published its new Insurance Conduct of Business sourcebook (“ICOBS”)
which sets out the standards of the requirements for general insurance firms on how they deal with
their customers. The new general insurance regime came into effect on January 6, 2008.
Supervision
The FSA carries out the prudential supervision of insurance companies through a variety of
methods, including the collection of information from statistical returns, review of accountants’
reports, visits to insurance companies and regular formal interviews.
The FSA has adopted a risk-based approach to the supervision of insurance companies. Under
this approach the FSA performs a formal risk assessment of insurance companies or groups carrying
on business in the U.K. periodically, which varies in length according to the risk profile of the
insurer. The FSA performs the risk assessment by analyzing information which it receives during
the normal course of its supervision, such as regular prudential returns on the financial position
of the insurance company, or which it acquires through a series of meetings with senior management
of the insurance company. After each risk assessment, the FSA will inform the
insurer of its views on the insurer’s risk profile. This will include details of any remedial
action that the FSA requires and the likely consequences if this action is not taken.
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Solvency Requirements
The FSA’s General Prudential Sourcebook and Prudential Sourcebook for Insurers (together, the
“Prudential Sourcebooks”) require that insurance companies maintain a margin of solvency at all
times in respect of any general insurance undertaken by the insurance company, the calculation of
which in any particular case depends on the type and amount of insurance business a company writes.
The method of calculation of the solvency margin is set out in the Prudential Sourcebooks, and for
these purposes, all insurer’s assets and liabilities are subject to specific valuation rules which
are set out in the Prudential Sourcebooks. Failure to maintain the required solvency margin is one
of the grounds on which wide powers of intervention conferred upon the FSA may be exercised. For
financial years ending on or after January 1, 2004, the calculation of the required margin of
solvency has been amended as a result of the implementation of the E.U. Solvency I Directives. In
respect of liability business accepted, 150% of the actual premiums written and claims incurred
must be included in the calculation, which has had the effect of increasing the required minimum
margin of solvency of Endurance U.K. Endurance U.K. continuously monitors its solvency capital
position and maintains capital in excess of the required minimum margin of solvency. Each
insurance company writing various classes of business is also required by the Prudential
Sourcebooks to maintain equalization provisions calculated in accordance with the provisions of the
Prudential Sourcebook for Insurers.
Insurers are required to calculate an Enhanced Capital Requirement (“ECR”) in addition to
their required minimum solvency margin and to report it to the FSA (though the ECR is not part of
the formal capital requirements under the Prudential Sourcebooks). This represents a more
risk-based calculation than the statutory solvency margin requirements derived from the E.U.
Directives. There is also a requirement for insurers to maintain financial resources which are
adequate, both as to amount and quality, to ensure that there is no significant risk that its
liabilities cannot be met as they come due. In order to carry out the assessment as to the
necessary financial resources that are required, an insurer is required to identify the major
sources of risk to its ability to meet its liabilities as they come due, and to carry out stress
and scenario tests to identify an appropriate range of realistic adverse scenarios in which the
risk crystallizes and to estimate the financial resources needed in each of the circumstances and
events identified. In addition, the FSA gives individual capital guidance (“ICG”) regularly to
insurers and reinsurers following receipt of individual capital assessments, prepared by firms
themselves. The FSA’s guidance may be that a company should hold more or less than its then
current level of regulatory capital, or that the company’s regulatory capital should remain
unaltered. Endurance U.K. has submitted an individual capital assessment solvency calculation to
the FSA and has agreed with the FSA the bases and methodology for this calculation. This
calculation is used along with other tools by the FSA to help establish the ICG. Endurance U.K. is
currently calculating the ECR for December 31, 2009. Should Endurance U.K. not meet this test,
additional capital may be required.
In addition, an insurer (other than a pure reinsurer) that is part of a group, is required to
perform and submit to the FSA a solvency margin calculation return in respect of its ultimate
parent undertaking, in accordance with the FSA’s rules. This return is not part of an insurer’s
own solvency return and hence will not be publicly available. Although there is no requirement for
the parent undertaking solvency calculation to show a positive result, the FSA may take action
where it considers that the solvency of the insurance company is or may be jeopardized due to the
group solvency position. Further, an insurer is required to report in its annual returns to the
FSA all material related party transactions (e.g., intra group reinsurance, whose value is more
than 5% of the insurer’s general insurance business amount).
The European Commission, jointly with Member States, is carrying out a fundamental review of
the regulatory capital and supervisory regime of the insurance industry (the Solvency II project).
Its objective is to establish a solvency system that is better matched to the true risks of
insurers enabling supervisors to protect policyholders’ interests as effectively as possible and in
accordance with common principles across the EU. Endurance U.K. is monitoring the ongoing
consultation and legislative steps following adopton of the Solvency II Framework Directive (the
“Solvency II Directive”) in May 2009. The legislation implementing the final version of the
Solvency II Directive is required to take effect in the U.K. and the other E.U. member states on
October 31, 2012, and will replace the current solvency requirements described above. The FSA has
commenced a program of preparatory work and supervisory visits to insurers, in order to identify
the actions which it considers that insurers should now undertake in anticipation of the
implementation of the Solvency II Directive. Endurance UK is fully co-operating with the FSA in
this respect.
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Restrictions on Dividend Payments
U.K. company law prohibits Endurance U.K. from declaring a dividend to its shareholders unless
it has “profits available for distribution.” The determination of whether a company has profits
available for distribution is
based on its accumulated realized profits less its accumulated realized losses. While the
United Kingdom insurance regulatory laws impose no statutory restrictions on a general insurer’s
ability to declare a dividend, the FSA strictly controls the maintenance of each insurance
company’s solvency margin within its jurisdiction. The FSA’s rules require Endurance U.K. to
notify the FSA of any proposed or actual payment of a dividend. Any such payment or proposal could
result in regulatory intervention. In addition, the FSA requires authorized insurance companies to
notify the FSA in advance of any significant dividend payment.
Reporting Requirements
U.K. insurance companies must prepare their financial statements under the Companies Act of
1985 (as amended), which requires the filing with Companies House of audited financial statements
and related reports. In addition, U.K. insurance companies are required to file with the FSA
regulatory returns, which include a revenue account, a profit and loss account and a balance sheet
in prescribed forms. Under the Interim Prudential Sourcebook for Insurers, audited regulatory
returns must be filed with the FSA within two months and 15 days (or three months where the
delivery of the return is made electronically).
Supervision of Management
The FSA closely supervises the management of insurance companies through the approved persons
regime, by which any appointment of persons to perform certain specified “controlled functions”
within a regulated entity, must be approved by the FSA.
Change of Control
The Financial Services and Markets Act (the “FSMA”) regulates the acquisition of control of
any U.K. insurance company authorized under the FSMA. Any company or individual that (together
with any person acting in concert with it or him) directly or indirectly acquires 10% or more of
the shares in a U.K. authorized insurance company or its parent company, or is entitled to exercise
or control the exercise of 10% or more of the voting power in such authorized insurance company or
its parent company, would be considered to have acquired control for the purposes of the relevant
legislation, as would a person who had significant influence over the management of such authorized
insurance company or its parent company by virtue of his shareholding or voting power in either. A
purchaser of 10% or more of the ordinary shares would therefore be considered to have acquired
control of Endurance U.K.
Under the FSMA (as amended by the E.U. Acquisitions Directive), any person proposing to
acquire control over a U.K. authorized insurance company must give prior notification to the FSA of
his intention to do so together with certain prescribed information. The FSA then has 60 working
days to make a decision following its acknowledgement of the application. The duration of this
period may be stopped by the FSA once, to request further information, for a maximum of 20 days (30
days for non-EU applicants). Although the FSA may make further information requests, this does not
“stop the clock”, meaning that the FSA has a maximum of 82 working days to consider an application
from an EU applicant (92 for a non-EU applicant). The FSA may only object to a particular
acquisition on the basis of certain specified “assessment criteria” relating to the reputation and
financial soundness of the acquirer, the reputation and experience of those who will direct the
regulated business, compliance with prudential requirement and any suspicion of money laundering or
terrorist financing. In addition to these requirements, the U.K. insurer itself is obliged to
notify the FSA if it is aware of the proposed acquisition, and may be subject to regulatory
enforcement action if it fails to do so.
Intervention and Enforcement
The FSA has extensive powers to intervene in the affairs of an authorized person, culminating
in the ultimate sanction of the removal of authorization to carry on a regulated activity. FSMA
imposes on the FSA statutory obligations to monitor compliance with the requirements imposed by
FSMA, and to enforce the provisions of FSMA related rules made by the FSA. The FSA has power,
among other things, to enforce and take disciplinary measures in respect of breaches of both the
Prudential Sourcebooks and breaches of the conduct of business rules generally applicable to
authorized persons. The FSA also has the power to prosecute criminal offences arising under FSMA,
and to prosecute insider dealing under Part V of the Criminal Justice Act of 1993, and breaches of
money laundering regulations. The FSA’s stated policy is to pursue criminal prosecution in all
appropriate cases.
Passporting
European Union directives allow Endurance U.K. to conduct business in European Union states
other than the United Kingdom in compliance with the scope of permission granted these companies by
the FSA without the necessity of additional licensing or authorization in other European Union
jurisdictions. This ability to operate in other jurisdictions of the European Union on the basis
of home state authorization and supervision is sometimes referred to as passporting. Insurers may
operate outside their home member state either on a services basis or on an
establishment basis. Operating on a services basis means that the Company conducts permitted
businesses in the host state without having a physical presence there, while operating on an
establishment basis means the Company has a branch or physical presence in the host state.
46
In both cases, a company remains subject to regulation by its home regulator, and not by local
regulatory authorities, although the Company nonetheless may have to comply with certain local
rules reserved to the “host state” (the state into which the services are being provided or in
which the branch is being established). In addition to European Union member states, Norway,
Iceland and Liechtenstein (members of the broader European Economic Area) are jurisdictions in
which this passporting framework applies.
U.S. Regulation
Endurance U.S. Reinsurance was organized under the laws of New York on September 5, 2002. On
December 18, 2002, Endurance U.S. Reinsurance received a license to write certain lines of
insurance and reinsurance business from the New York State Insurance Department. On August 1,
2005, Endurance U.S. Reinsurance acquired Endurance American Specialty Insurance Company, a
Delaware insurance company, which transacts business on a surplus lines basis. On June 5, 2006,
Endurance U.S. Reinsurance acquired Endurance American Insurance Company, a Delaware insurance
company, which transacts business on an admitted basis. On June 8, 2007, Endurance U.S.
Reinsurance acquired Endurance Risk Solutions Assurance Co., an Ohio insurance company that was
subsequently redomesticated to Delaware, which transacts business on a surplus lines basis. On
December 7, 2007, Endurance U.S. Holdings Corp. acquired American Agri-Business Insurance Company
and ARMtech Insurance Services, Inc., each a Texas company. On January 30, 2008, Endurance U.S.
Reinsurance completed its redomestication from New York to Delaware and is currently regulated by
the Delaware Department of Insurance.
Insurance Holding Company Regulation of Endurance Holdings
Endurance Holdings and Endurance U.S. Holdings Corp., as parent companies of the Company’s
U.S. operating companies, are subject to the insurance holding company laws of the States of
Delaware and Texas, the states in which the Company’s U.S. operating subsidiaries are organized and
domiciled. These laws generally require, among other things, the insurance holding company and
each insurance company directly or indirectly owned by the holding company to register with the
insurance departments of their respective domiciliary states and to furnish annually financial and
other information about the operations of companies within the holding company system. Generally,
all material transactions among companies in the holding company system involving the Company’s
U.S. operating subsidiaries, including sales, loans, reinsurance agreements, service agreements,
dividend payments and certain transactions within the insurance holding company system must be fair
and, if material or of a specified category, require prior notice and approval or non-disapproval
by the insurance regulator of the state in which the involved U.S. operating subsidiary is
domiciled.
Changes of Control
Before a person can acquire control of a U.S. domestic insurer (or reinsurer), prior written
approval must be obtained from the insurance commissioner of the state where the insurer (or
reinsurer) is domiciled, or the acquiror must make a disclaimer of control filing with the
insurance department of such state and obtain approval thereon. Prior to granting approval of an
application to acquire control of a domestic insurer (or reinsurer), the domiciliary state
insurance commissioner will consider such factors as the financial strength of the proposed
acquiror, the integrity and management of the acquiror’s Board of Directors and executive officers,
the acquiror’s plans for the future operations of the domestic insurer and any anti-competitive
results that may arise from the consummation of the acquisition of control. Generally, state
insurance statutes provide that control over a domestic insurer is presumed to exist if any person,
directly or indirectly, owns, controls, holds with the power to vote, or holds proxies
representing, ten percent or more of the voting securities of the domestic insurer. Because a
person acquiring ten percent or more of Endurance Holdings’ ordinary shares would indirectly
acquire the same percentage of common stock of Endurance Holdings’ U.S. operating subsidiaries, the
U.S. insurance change of control laws will likely apply to such a transaction. These laws may
discourage potential acquisition proposals and may delay, deter or prevent a change of control of
Endurance Holdings, including through transactions, and in particular unsolicited transactions,
that some or all of the shareholders of Endurance Holdings might
consider to be desirable.
State Insurance Regulation of the Company’s U.S. Operating Subsidiaries
Other than bulk reinsurance arrangements, the terms and conditions of reinsurance agreements
between unaffiliated parties generally are not subject to regulation by any U.S. state insurance
department with respect to rates or policy terms unlike primary insurance agreements, the rates and
policy terms of which are generally closely regulated by state insurance departments. As a
practical matter, however, the rates charged by primary insurers do have an effect on the rates
that can be charged by reinsurers.
47
State insurance authorities have broad regulatory powers with respect to various aspects of
the business of Endurance U.S. Reinsurance, Endurance American, Endurance American Specialty,
Endurance Risk Solutions and ARMtech including: licensing to transact business, admittance of
assets to statutory surplus, regulating unfair trade and claims practices, establishing reserve
requirements and solvency standards (including risk-based capital standards), approval of policy
forms and dates, and regulating investments, dividends and transactions between an insurer and its
affiliates. With respect to direct insurance business, states may also regulate rates and forms
used by insurers admitted to transact business within a given state jurisdiction. State insurance
laws and regulations require each of Endurance U.S. Reinsurance, Endurance American, Endurance
American Specialty, Endurance Risk Solutions and ARMtech to file financial statements with insurance
departments everywhere it is licensed, authorized or accredited to conduct insurance business; and
the operations of Endurance U.S. Reinsurance, Endurance American, Endurance American Specialty,
Endurance Risk Solutions and ARMtech are subject to examination by those departments at any time.
Endurance U.S. Reinsurance, Endurance American, Endurance American Specialty, Endurance Risk
Solutions and ARMtech prepare statutory financial statements in accordance with statutory
accounting practices and procedures prescribed or permitted by these departments. State insurance
departments also conduct periodic examinations of the books and records, financial reporting,
policy filings and market conduct of insurance companies domiciled or authorized to transact
business in their states, generally once every three to five years. Examinations are generally
carried out in cooperation with the insurance departments of other states under guidelines
promulgated by the NAIC.
In general, such state regulation is for the protection of policyholders rather than
shareholders. Under Delaware and Texas insurance laws, Endurance U.S. Reinsurance, Endurance
American, Endurance American Specialty, Endurance Risk Solutions and ARMtech may only pay dividends
to their respective parent companies out of earned surplus. In Delaware and Texas, earned surplus
is defined as an amount equal to the unassigned funds of an insurer as set forth in the most recent
annual statement of the insurer submitted to the applicable state insurance regulator, including
all or part of the surplus arising from unrealized capital gains or revaluation of assets.
In addition, the ability of Endurance U.S. Reinsurance, Endurance American, Endurance American
Specialty, Endurance Risk Solutions and ARMtech to declare or pay any dividend, together with all
dividends declared or distributed by it within the preceding twelve months, exceeds the greater of:
will be subject to the prior approval of the applicable domestic state insurance regulator. Any
dividend paid by Endurance U.S. Reinsurance, Endurance American, Endurance American Specialty,
Endurance Risk Solutions and ARMtech must first be paid to its parent company. If the parent
company is also an insurer, as is the case with Endurance American, Endurance American Specialty
and Endurance Risk Solutions, the parent company or companies must also meet their own dividend
eligibility requirements set forth above in order to pass along any dividends received from
subsidiary insurance companies.
The dividend limitations imposed by Delaware and Texas insurance laws are based on the
statutory financial results of the Company’s U.S. operating subsidiaries determined by using
statutory accounting practices which differ in certain respects from accounting principles used in
financial statements prepared in conformity with U.S. GAAP. The significant differences relate to
deferred acquisition expenses, deferred income taxes, required investment reserves, reserve
calculation assumptions and surplus notes. At December 31, 2009, of the Company’s U.S. operating
subsidiaries, only Endurance Risk Solutions and ARMtech had earned surplus, and therefore, only
Endurance Risk Solutions and ARMtech could declare or distribute dividends in 2009 without prior
regulatory approval.
While the federal government does not directly regulate the insurance business (other than for
flood, nuclear and reinsurance of losses from terrorism), federal legislation and administrative
policies can affect the insurance industry. The federal government has also undertaken initiatives
in several areas that may impact the insurance industry including tort reform, corporate governance
and the taxation of insurance companies. In addition, legislation has been introduced from time to
time in recent years that, if enacted, could result in the federal government assuming a more
direct role in the regulation of the insurance industry, primarily as respects federal licensing in
lieu of state licensing.
48
Risk-Based Capital Regulations
The insurance laws of Delaware and Texas require that insurers report their risk-based capital
(“RBC”) based on a formula calculated by applying factors to various asset, premium and reserve
items. The formula takes into account the risk characteristics of the insurer, including asset
risk, insurance risk, interest rate risk and business risk. The state insurance departments of
Delaware and Texas use the formula only as an early warning regulatory tool to identify possibly
inadequately capitalized insurers for purposes of initiating regulatory action, and not as a means
to rank insurers generally. Insurance laws impose broad confidentiality requirements on those
engaged in the insurance business (including insurers, agents, brokers and others) and on the state
insurance departments as to the use and publication of RBC data. The insurance departments of
Delaware and Texas have explicit regulatory authority to require various actions by, or take
various actions against, insurers whose total adjusted capital does not exceed certain RBC levels.
Statutory Accounting Practices
Statutory accounting practices, or “SAP,” are a basis of accounting developed to assist U.S.
insurance regulators in monitoring and regulating the solvency of insurance companies. It is
primarily concerned with measuring an insurer’s surplus to policyholders. Accordingly, statutory
accounting focuses on valuing assets and liabilities of insurers at financial reporting dates in
accordance with appropriate insurance law and regulatory provisions applicable in each insurer’s
domiciliary state.
U.S. GAAP concerns an insurer’s solvency, but it also concerns other financial measurements, such
as income and cash flows. Accordingly, U.S. GAAP gives more consideration to appropriate matching
of revenue andexpenses and accounting for management’s stewardship of assets than does SAP. As a
direct result, different assets and liabilities and different amounts of assets and liabilities
will be reflected in financial statements prepared in accordance with U.S. GAAP as opposed to SAP.
Statutory accounting practices established by the NAIC and adopted, in part, by the Delaware
and Texas insurance regulators, determine, among other things, the amount of statutory surplus and
statutory net income of Endurance Holdings’ U.S. insurance company subsidiaries and thus determine,
in part, the amount of funds they have available to pay dividends to their respective parent
companies.
Operations of Endurance U.K. and Endurance Bermuda
Endurance U.K. and Endurance Bermuda are not admitted to do business in any state in the
United States. Insurance laws of each state of the United States and of many other countries
restrict or prohibit the sale of insurance and reinsurance within their jurisdictions by
non-admitted alien insurers and reinsurers such as Endurance U.K. and Endurance Bermuda.
In addition to the regulatory requirements imposed by the jurisdictions in which they are
licensed, reinsurers’ business operations are affected by regulatory requirements in various states
of the United States governing “credit for reinsurance” which are imposed on their ceding
companies. In general, a ceding company that obtains reinsurance from a reinsurer that is
licensed, accredited or approved by the jurisdiction or state in which the reinsurer files
statutory financial statements is permitted to reflect in its statutory financial statements a
credit in an aggregate amount equal to the liability for unearned premiums (which are that portion
of written premiums which applies to the remaining portion of the policy period) and loss reserves
and loss expense reserves ceded to the reinsurer. As stated above, Endurance U.K. and Endurance
Bermuda are not licensed, accredited or approved in any state in the United States. The great
majority of states, however, permit a credit to statutory surplus resulting from reinsurance
obtained from a non-licensed or non-accredited reinsurer to be offset to the extent that the
reinsurer provides a letter of credit or other acceptable security arrangement. A few states do
not allow credit for reinsurance ceded to non-licensed or non-accredited reinsurers except in
certain limited circumstances and others impose additional requirements that make it difficult to
become accredited.
We do not believe that Endurance U.K. and Endurance Bermuda are in violation of insurance laws
of any jurisdiction in the United States. There can be no assurance however, that inquiries or
challenges to Endurance U.K.’s or Endurance Bermuda’s insurance or reinsurance activities will not
be raised in the future.
Switzerland
In 2008, Endurance Bermuda established a branch in Zurich, Switzerland named Endurance
Specialty Insurance Ltd. Pembroke (Bermuda) Zurich Branch. The Swiss Financial Regulator does not
impose additional regulation upon a branch of an authorized reinsurer. On January 1, 2009, the
Federal Act on the Swiss Financial Market Supervisory Authority (“FINMA”), which the Swiss
Parliament approved in June 2007, went into full legal force. The effect of the Act was to merge
three bodies — the Federal Office of Private Insurance, the Swiss Federal
Banking Commission and the Anti-Money Laundering Control Authority — into FINMA. Until their
merger and incorporation into FINMA, these three authorities retained responsibility for their own
areas of activity.
49
Singapore
In 2008, Endurance Specialty Insurance Ltd., Singapore Branch received regulatory approval
from the Monetary Authority of Singapore to operate as a branch insurer of Endurance Bermuda in
Singapore to transact insurance and reinsurance domestically and internationally. The branch is
regulated by the Monetary Authority of Singapore pursuant to The Insurance Act. Endurance Specialty
Insurance Ltd., Singapore Branch is also registered by the Accounting and Corporate Regulatory
Authority (“ACRA”) as a foreign company in Singapore and is regulated by ACRA pursuant to The
Companies Act.
MATERIAL TAX CONSIDERATIONS
Certain Bermuda Tax Considerations
Currently, there is no Bermuda income, corporation or profits tax, withholding tax, capital
gains tax, capital transfer tax, estate duty or inheritance tax payable by us or our shareholders,
other than shareholders ordinarily resident in Bermuda, if any. Currently, there is no Bermuda
withholding or other tax on principal interest or dividends paid to holders of the ordinary shares
or Series A Preferred Shares, other than holders ordinarily resident in Bermuda, if any. There can
be no assurance that we or our shareholders will not be subject to any such tax in the future.
Endurance Bermuda has received written assurance dated December 7, 2001 and Endurance Holdings
has received written assurance dated July 18, 2002 from the Minister of Finance under the Exempted
Undertakings Tax Protection Act 1966 of Bermuda, as amended, that if there is enacted in Bermuda
any legislation imposing tax computed on profits or income, or computed on any capital asset, gain
or appreciation, or any tax in the nature of estate duty or inheritance tax, then the imposition of
that tax would not be applicable to Endurance Bermuda or Endurance Holdings or to any of their
respective operations, shares, debentures or obligations until March 28, 2016; provided, that the
assurance is subject to the condition that it will not be construed to prevent the application of
such tax to people ordinarily resident in Bermuda, or to prevent the application of any taxes
payable by Endurance Bermuda or Endurance Holdings in respect of real property or leasehold
interests in Bermuda held by them. To date, the Ministry of Finance has given no indication that
the Ministry: (i) would not extend the term of the assurance beyond 2016; or (ii) would allow the
term of the assurance to expire; or (iii) would change the tax treatment afforded to exempted
companies either before or after 2016.
Certain United Kingdom Tax Considerations
Endurance U.K. is a company incorporated under the laws of England and is resident in the
United Kingdom for United Kingdom corporation tax purposes and will be subject to United Kingdom
corporation tax on its worldwide profits. The current rate of United Kingdom corporation tax is
generally 28% on profits of whatever description. Currently, no United Kingdom withholding tax
applies to dividends paid by Endurance U.K.
Certain United States Federal Income Tax Considerations
The following discussion is a summary of certain U.S. federal income tax considerations
relating to Endurance Holdings and its operating subsidiaries in Bermuda, the United States and the
United Kingdom and the ownership of our ordinary shares and Series A Preferred Shares.
This summary is based upon the Code, the regulations promulgated thereunder, rulings and other
administrative pronouncements issued by the IRS, judicial decisions, the tax treaty between the
United States and Bermuda (the “Bermuda Treaty”) and the tax treaty between the United States and
the United Kingdom (the “U.K. Treaty”), all as currently in effect, and all of which are subject to
differing interpretations or to change, possibly with retroactive effect. No assurance can be
given that the IRS would assert, or that a court would not sustain a position contrary to any of
the tax consequences described below. No advance ruling has been or will be sought from the IRS
regarding any matter discussed in this Annual Report on Form 10-K. This summary is for general
information only, and does not purport to discuss all aspects of U.S. federal income taxation that
may be important to a particular investor in light of such investor’s investment or tax
circumstances, or to investors subject to special tax rules, such as tax-exempt organizations,
dealers in securities, banks, insurance companies, persons that hold ordinary shares or Series A
Preferred Shares that are a hedge or that are hedged against interest rate or insurance risks or
that are part of a straddle or conversion transaction, or persons whose functional currency is not
the U.S. dollar. This summary assumes that an investor will hold our ordinary shares and Series A
Preferred Shares as capital assets, which
generally means as property held for investment. Investors should consult their tax advisors
concerning the consequences, in their particular circumstances, of the ownership of ordinary shares
and Series A Preferred Shares under U.S. federal, state, local and other tax laws.
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For U.S. federal income tax purposes and for purposes of the following discussion, a “U.S.
Person” means (i) an individual citizen or resident of the United States, (ii) a corporation, or
other entity treated as a corporation for U.S. federal income tax purposes, or a partnership, or
other entity treated as a partnership for U.S federal income tax purposes, in each case created or
organized in the United States or under the laws of the United States or of any of its political
subdivisions, (iii) an estate the income of which is subject to U.S. federal income tax without
regard to its source or (iv) a trust if either (a) a court within the United States is able to
exercise primary supervision over the administration of the trust and one or more U.S. Persons have
the authority to control all substantial decisions of the trust or (b) the trust has a valid
election in effect to be treated as a U.S. Person for U.S. federal income tax purposes. A
“Non-U.S. Person” is a nonresident alien individual, or a corporation, estate or trust that is not
a U.S. person.
If a partnership owns ordinary shares or Series A Preferred Shares, the tax treatment of a
partner will generally depend upon the status of the partner and the activities of the partnership.
If you are a partner of a partnership that owns ordinary shares or Series A Preferred Shares, you
should consult your tax advisor.
United States Taxation of Endurance Holdings and its Operating Subsidiaries
We intend to operate Endurance Holdings and its non-U.S. subsidiaries in such a manner that
they will not be considered to be conducting business within the United States for purposes of U.S.
federal income taxation. Whether business is being conducted in the United States is an inherently
factual determination. Because the Code, regulations and court decisions fail to identify
definitively activities that constitute being engaged in a trade or business in the United States,
there can be no assurance that the IRS will not contend successfully that Endurance Holdings,
Endurance Bermuda and/or Endurance U.K. are or will be engaged in a trade or business in the United
States. A foreign corporation deemed to be so engaged would be subject to U.S. federal income tax
(at a current maximum rate of 35%), as well as a 30% branch profits tax in certain circumstances,
on its income which is treated as effectively connected with the conduct of that trade or business
unless the corporation is entitled to relief under the permanent establishment provision of an
applicable tax treaty, as discussed below. Such income tax, if imposed, would be based on
effectively connected income computed in a manner generally analogous to that applied to the income
of a U.S. corporation, except that a foreign corporation is entitled to deductions and credits only
if it timely files a U.S. federal income tax return. Endurance Holdings, Endurance Bermuda and
Endurance U.K. intend to file protective U.S. federal income tax returns on a timely basis in order
to preserve the right to claim income tax deductions and credits if it is ever determined that they
are subject to U.S. federal income tax.
If Endurance Bermuda is entitled to the benefits under the Bermuda Treaty, it will not be
subject to U.S. federal income tax on any income found to be effectively connected with a U.S.
trade or business unless that trade or business is conducted through a permanent establishment in
the United States. Whether business is being conducted in the United States through a permanent
establishment is an inherently factual determination. Endurance Bermuda intends to conduct its
activities so as not to have a permanent establishment in the United States, although there can be
no assurance that it will achieve this result. An insurance enterprise resident in Bermuda
generally will be entitled to the benefits of the Bermuda Treaty if (i) more than 50% of its shares
are owned beneficially, directly or indirectly, by individual residents of the United States or
Bermuda or U.S. citizens and (ii) its income is not used in substantial part, directly or
indirectly, to make disproportionate distributions to, or to meet certain liabilities of, persons
who are neither residents of either the United States or Bermuda nor U.S. citizens.
Foreign insurance companies that conduct an insurance business within the United States must
maintain a certain minimum amount of effectively connected net investment income, determined in
accordance with a formula that depends, in part, on the amount of U.S. risk insured or reinsured by
such companies. If Endurance Bermuda is considered to be engaged in the conduct of an insurance
business in the United States and it is not entitled to the benefits of the Bermuda Treaty, either
because it fails to satisfy one of the limitations on Bermuda Treaty benefits described above or
because Endurance Bermuda is considered to have a U.S. permanent establishment, a significant
portion of Endurance Bermuda’s premium and investment income could be subject to U.S. federal
income tax. In addition, while the Bermuda Treaty clearly applies to premium income, it is not
clear whether it applies to other income, such as investment income. Consequently, if Endurance
Bermuda is considered to be engaged in the conduct of an insurance business in the United States
and is entitled to the benefits of the Bermuda Treaty, but the Bermuda Treaty is interpreted so as
not to apply to investment income, a significant portion of Endurance Bermuda’s investment income
could be subject to U.S. federal income tax even if Endurance Bermuda does not maintain a permanent
establishment in the United States.
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Under the U.K. Treaty, Endurance U.K., if entitled to the benefits of the U.K. Treaty, will
not be subject to U.S. federal income tax on any income found to be effectively connected with a
U.S. trade or business unless that
trade or business is conducted through a permanent establishment in the United States.
Endurance U.K. intends to conduct its activities in a manner so that it does not have a permanent
establishment in the United States, although we cannot predict whether we will achieve this result.
Endurance U.K. will be entitled to the benefits of the U.K. Treaty if (i) during at least half of
the days in the relevant taxable period, at least 50% of Endurance U.K.’s stock is beneficially
owned, directly or indirectly, by citizens or residents of the United States and the United
Kingdom, and less than 50% of Endurance U.K.’s gross income for the relevant taxable period is paid
or accrued, directly or indirectly, to persons who are not U.S. or U.K. residents in the form of
payments that are deductible for purposes of U.K. taxation or (ii) with respect to specific items
of income, profit or gain derived from the United States, if such income, profit or gain is
considered to be derived in connection with, or incidental to, Endurance U.K.’s business conducted
in the United Kingdom.
Foreign corporations not engaged in a trade or business in the United States are nonetheless
subject to U.S. withholding tax at a rate of 30% of the gross amount of certain “fixed or
determinable annual or periodical gains, profits and income” derived from sources within the United
States (such as dividends and certain interest on investments), subject to reduction by applicable
treaties.
The United States also imposes an excise tax on insurance and reinsurance premiums paid to
foreign insurers or reinsurers with respect to risks located in the United States. The rate of tax
applicable to premiums paid to Endurance Bermuda is 4% for casualty insurance premiums and 1% for
reinsurance premiums. The excise tax will not apply to premiums paid to Endurance U.K. if
Endurance U.K. is entitled to the benefits of the U.K. Treaty, and certain other requirements are
met.
Endurance U.S. Reinsurance, Endurance American, Endurance American Specialty and Endurance
Risk Solutions are Delaware corporations and ARMtech is a Texas corporation. Each will be subject
to taxation in the United States at regular corporate rates. Dividends paid by Endurance U.S.
Holdings Corp. to Endurance Bermuda will be subject to U.S. withholding tax at the rate of 30%.
United States Taxation of Holders of Ordinary Shares and Series A Preferred Shares
Shareholders Who Are U.S. Persons
Dividends. Distributions with respect to ordinary shares and Series A Preferred Shares
(including the payment of additional amounts, in the case of the Series A Preferred Shares) will be
treated as ordinary dividend income to the extent of Endurance Holdings’ current or accumulated
earnings and profits as determined for U.S. federal income tax purposes, subject to the discussion
below relating to the potential application of the “controlled foreign corporation,” “related
person insurance income” and “passive foreign investment company” rules. These dividends should
constitute “qualified dividend income” as defined in Section 1(h)(11)(B) of the Code and, thus,
should be entitled to the maximum marginal preferential federal income tax rate of 15% applicable
to “qualified dividends” received before January 1, 2011 by certain shareholders (such as
individuals), provided that certain holding period requirements are satisfied and certain other
conditions are met, and provided further that we are not considered a PFIC. This preferential tax
rate is subject to increase for dividends paid after such date.
Distributions with respect to Endurance Holdings’ ordinary shares and Series A Preferred
Shares will not be eligible for the dividends-received deduction allowed to U.S. corporations under
the Code. The amount of any distribution that exceeds Endurance Holdings’current and accumulated
earnings and profits first will be treated as a tax free return of capital; reducing a holder’s tax
basis in the ordinary shares or Series A Preferred Shares with regard to which the distribution was
made and any amount in excess of such tax basis will be treated as gain from the sale or exchange
of such holder’s shares.
Classification of Endurance Holdings, Endurance U.K. or Endurance Bermuda as a Controlled
Foreign Corporation. Each “10% U.S. Shareholder” of a foreign corporation that is a controlled
foreign corporation (“CFC”) for an uninterrupted period of 30 days or more during a taxable year,
and who owns shares in the CFC directly or indirectly through foreign entities, in such corporation
on the last day, in such year, in which such corporation is a CFC must include in its gross income
for U.S. federal income tax purposes its pro rata share of the CFC’s “subpart F income,” even if
the subpart F income is not distributed. A foreign corporation is considered a CFC if “10% U.S.
Shareholders” own (directly, indirectly through foreign entities or constructively pursuant to the
application of certain constructive ownership rules) more than 50% of the total combined voting
power of all classes of voting stock of such foreign corporation, or the total value of all stock
of such corporation. A 10% U.S. Shareholder is a U.S. Person who owns at least 10% of the total
combined voting power of all classes of stock entitled to vote of the foreign corporation. The
Series A Preferred Shares should not be considered voting stock for purposes of determining whether
a U.S. Person would be a “10% U.S. Shareholder” unless and until there exists a Nonpayment Event
which triggers the Series A Preferred Shareholders’ right to elect two additional directors to the
Board of Directors of Endurance Holdings. In such case, the Series A Preferred Shares should
be treated as voting stock for as long as such right continues.
52
For purposes of taking into account insurance income, a CFC also includes a foreign
corporation in which more than 25% of the total combined voting power of all classes of stock (or
more than 25% of the total value of the stock) is owned (directly, indirectly through foreign
entities or constructively pursuant to the application of certain constructive ownership rules) by
10% U.S. Shareholders, on any day during the taxable year of such corporation, if the gross amount
of premiums or other consideration for the reinsurance or the issuing of insurance contracts
exceeds 75% of the gross amount of all premiums or other consideration in respect of all risks.
Due to the anticipated dispersion of Endurance Holdings’ share ownership among holders, its bye-law
provisions that impose limitations on the concentration of voting power of any shares that are
entitled to vote and authorize the board to repurchase such shares under certain circumstances and
other factors, no U.S. Person that owns shares in Endurance Holdings directly or indirectly through
foreign entities should be subject to treatment as a 10% U.S. Shareholder of a CFC. There can be
no assurance, however, that the IRS will not challenge the effectiveness of these provisions for
purposes of preventing 10% U.S. Shareholder status and that a court will not sustain such
challenge.
RPII Companies. The CFC rules also apply to certain insurance companies that earn “related person
insurance income” (“RPII”). If the RPII rules were to apply to Endurance U.K. or Endurance
Bermuda, a U.S. Person who owns ordinary shares or Series A Preferred shares of Endurance Holdings,
directly or indirectly through foreign entities on the last day of the company’s taxable year would
be required to include in its gross income for U.S. federal income tax purposes its pro rata share
of Endurance U.K.’s or Endurance Bermuda’s RPII for the entire taxable year, regardless of whether
such RPII is distributed. For purposes of the RPII rules, Endurance U.K. or Endurance Bermuda will
be treated as a CFC if “RPII Shareholders” collectively own directly, indirectly through foreign
entities or by application of the constructive ownership rules 25% or more of the stock of
Endurance U.K. or Endurance Bermuda by vote or value. RPII is defined as any “insurance income”
attributable to policies of insurance or reinsurance with respect to which the person (directly or
indirectly) insured is a “RPII Shareholder” of the foreign corporation or a “related person” to
such RPII Shareholder. In general, and subject to certain limitations, “insurance income” is
income (including premium and investment income) attributable to the issuing of any insurance or
reinsurance contract which would be taxed under the portions of the Code relating to insurance
companies if the income were the income of a domestic insurance company.
A “RPII Shareholder” is any U.S. Person who owns, directly or indirectly through foreign
entities, any amount (rather than stock possessing 10% or more of the total combined voting power)
of Endurance U.K.’s or Endurance Bermuda’s stock, and “related person” means someone who controls
or is controlled by the RPII Shareholder or someone who is controlled by the same person or persons
which control the RPII Shareholder. “Control” is measured by either more than 50% in value or more
than 50% in voting power of stock, applying constructive ownership principles. A corporation’s
pension plan is ordinarily not a “related person” with respect to the corporation unless the
pension plan owns, directly or indirectly through the application of constructive ownership rules,
more than 50%, measured by vote or value, of the stock of the corporation.
RPII Exceptions. The special RPII rules do not apply if (i) direct or indirect insureds and
persons related to such insureds, whether or not U.S. Persons, own, directly or indirectly, less
than 20% of the voting power and less than 20% of the value of the stock of Endurance U.K. or
Endurance Bermuda, as applicable (the “20% Ownership Exception”), (ii) RPII, determined on a gross
basis, is less than 20% of Endurance U.K.’s or Endurance Bermuda’s gross insurance income for the
taxable year, as applicable (the “20% Gross Income Exception”), (iii) Endurance U.K. or Endurance
Bermuda elects to be taxed on its RPII as if the RPII were effectively connected with the conduct
of a U.S. trade or business and to waive all treaty benefits with respect to RPII and meets certain
other requirements or (iv) Endurance U.K. or Endurance Bermuda elects to be treated as a U.S.
corporation. Endurance Bermuda and Endurance U.K. intend to operate in a manner that is intended
to ensure that each qualifies for the 20% Gross Income Exception. It is possible that neither
Endurance Bermuda nor Endurance U.K. will be successful in qualifying under this exception.
If none of these exceptions applies, each U.S. Person who owns shares in Endurance Holdings
(and therefore, indirectly in Endurance U.K. and Endurance Bermuda) on the last day of Endurance
Holdings’ taxable year, will be required to include in its gross income for U.S. federal income tax
purposes its share of RPII of Endurance U.K. and/or Endurance Bermuda for the entire taxable year.
This inclusion will be determined as if such RPII were distributed proportionately only to such
U.S. Persons holding shares in Endurance Holdings at that date. The inclusion will be limited to
the current-year earnings and profits of Endurance U.K. or Endurance Bermuda, as applicable,
reduced by the shareholder’s pro rata share, if any, of certain prior year deficits in earnings and
profits.
Basis Adjustments. A RPII Shareholder’s tax basis in its Endurance Holdings ordinary shares
or Series A Preferred Shares, as the case may be, will be increased by the amount of any RPII that
the shareholder includes in
income. Any distributions made by Endurance Holdings out of previously taxed RPII income will
be exempt from further tax in the hands of the RPII Shareholder. The RPII Shareholder’s tax basis
in its Endurance Holdings shares will be reduced by the amount of any distributions that are
excluded from income under this rule.
53
Uncertainty as to Application of RPII. Regulations interpreting the RPII provisions of the
Code exist only in proposed form. It is not certain whether these regulations will be adopted in
their proposed form or what changes might ultimately be made or whether any such changes, as well
as any interpretation or application of the RPII rules by the IRS, the courts or otherwise, might
have retroactive effect. Accordingly, the meaning of the RPII provisions and their application to
Endurance U.K. and Endurance Bermuda is uncertain. These provisions include the grant of authority
to the U.S. Treasury to prescribe “such regulations as may be necessary to carry out the purposes
of this subsection, including regulations preventing the avoidance of this subsection through cross
insurance arrangements or otherwise.” In addition, there can be no assurance that the IRS will not
challenge any determinations by Endurance U.K. or Endurance Bermuda as to the amount, if any, of
RPII that should be includible in income or that the amounts of the RPII inclusions will not be
subject to adjustment based upon subsequent IRS examination. Prospective investors should consult
their tax advisors as to the effects of these uncertainties.
Information Reporting. Under certain circumstances, U.S. Persons owning stock in a foreign
corporation are required to file IRS Form 5471 with their U.S. federal income tax returns.
Generally, information reporting on IRS Form 5471 is required with respect to (i) a person who is
treated as a RPII Shareholder, (ii) a 10% U.S. Shareholder of a foreign corporation that is a CFC
for an uninterrupted period of 30 days or more during any tax year of the foreign corporation, and
who owned the stock on the last of that year and (iii) under certain circumstances, a U.S. Person
who acquires stock in a foreign corporation, and as a result thereof owns 10% or more of the voting
power or value of such foreign corporation, whether or not such foreign corporation is a CFC. For
any taxable year in which Endurance Holdings determines that gross RPII constitutes 20% or more of
Endurance U.K.’s or Endurance Bermuda’s gross insurance income and the 20% Ownership Exception does
not apply, Endurance Holdings intends to mail to all U.S. Persons registered as holders of its
ordinary shares and Series A Preferred Shares IRS Form 5471, completed with information from
Endurance Holdings, for attachment to the U.S. federal income tax returns of such shareholders. A
tax-exempt organization that is treated as a 10% U.S. Shareholder or a RPII Shareholder also must
file IRS Form 5471 in the circumstances described above. Failure to file IRS Form 5471 may result
in penalties.
Tax-Exempt Shareholders. Tax-exempt entities will be required to treat certain subpart F
insurance income, including RPII that is includible in income by the tax-exempt entity as unrelated
business taxable income.
Dispositions of Ordinary Shares and Series A Preferred Shares. Subject to the discussion
below relating to the redemption of Series A Preferred Shares or the potential application of Code
Section 1248 or the “PFIC” rules, any gain or loss realized by a U.S. Person on the sale or other
disposition of ordinary shares or Series A Preferred Shares will be subject to U.S. federal income
taxation as capital gain or loss in an amount equal to the difference between the amount realized
upon such sale or exchange and such person’s tax basis in the shares. If the holding period for
these shares exceeds one year at the time of the disposition, any gain will be subject to tax at a
current maximum marginal tax rate of 15% for individuals (subject to increase in 2011 without any
Congressional action) and 35% for corporations. Moreover, gain, if any, generally will be U.S.
source gain and generally will constitute “passive income” for foreign tax credit limitation
purposes.
Code Section 1248 provides that if a U.S. Person sells or exchanges stock in a foreign
corporation and such person owned directly, indirectly through certain foreign entities or
constructively 10% or more of the voting power of the corporation at any time during the five-year
period ending on the date of disposition when the corporation was a CFC, any gain from the sale or
exchange of the shares will be treated as ordinary income to the extent of the CFC’s earnings and
profits (determined under U.S. federal income tax principles) during the period that the
shareholder held the shares and while the corporation was a CFC (with certain adjustments). A 10%
U.S. Shareholder may in certain circumstances be required to report a disposition of shares of a
CFC by attaching IRS Form 5471 to the U.S. federal income tax or information return that it would
normally file for the taxable year in which the disposition occurs. For these purposes, the Series
A Preferred Shares should not be considered as having voting power unless and until there exists a
Nonpayment Event which triggers the Series A Preferred Shareholders’ right to elect two additional
directors to the Board of Directors of Endurance Holdings. In such case, the Series A Preferred
Shares should be treated as voting stock for as long as such right continues.
Code Section 1248 also applies to the sale or exchange of shares in a foreign corporation if
the foreign corporation would be treated as a CFC for RPII purposes and would be taxed as an
insurance company if it were a domestic corporation, regardless of whether the shareholder is a 10%
U.S. Shareholder or whether the 20% Gross Income Exception or the 20% Ownership Exception applies.
Regulations do not specifically address whether or how Code Section 1248 would apply to
dispositions of shares of stock in a foreign corporation that is not a CFC and does not directly
engage in the insurance business, but has a subsidiary that is a CFC and that would be taxed as an
insurance company if it were a domestic corporation. The Company believes, however, that the
application of Code Section 1248 under the RPII rules should not apply to the disposition of
ordinary shares or Series A Preferred Shares because Endurance Holdings is not directly engaged in
the insurance business. There can be no assurance, however, that the IRS will not interpret the
regulations in a contrary manner or that the U.S. Treasury Department will not amend the
regulations to provide that these rules will apply to dispositions of our ordinary shares and
Series A Preferred Shares. Prospective investors should consult their tax advisors regarding the
effects of these rules on a disposition of our shares.
54
Redemption of Series A Preferred Shares. Subject to the discussion herein relating to the
application of the RPII and PFIC rules, under Section 302 of the Code, a redemption of the Series A
Preferred Shares will be treated as a dividend to the extent of our current and accumulated
earnings and profits, unless such redemption satisfies the tests set forth under Section 302(b) of
the Code, which would treat the redemption as a sale or exchange subject to taxation as described
above under “Dispositions of Ordinary Shares and Series A Preferred Shares.” A redemption will be
treated as a sale or exchange if: (i) it is “substantially disproportionate,” (ii) constitutes a
“complete termination of the holder’s stock interest” in us, or (iii) is “not essentially
equivalent to a dividend”, each within the meaning of Section 302(b) of the Code. In determining
whether any of these tests are satisfied, shares considered to be owned by a U.S. Person by reason
of certain constructive ownership rules set forth in the Code, as well as shares actually owned,
must generally be taken into account. Because the determination as to whether any of the
alternative tests of Section 302(b) of the Code is satisfied with respect to a particular holder of
the Series A Preferred Shares will depend on the facts and circumstances as of the time the
determination is made, U.S. shareholders should consult their tax advisors, at such time, to
determine their tax treatment in light of their particular circumstances.
Passive Foreign Investment Companies. In general, a foreign corporation will be a PFIC during
a given year if (i) 75% or more of its gross income constitutes “passive income” or (ii) 50% or
more of its assets produce passive income.
If Endurance Holdings were characterized as a PFIC during a given year, U.S. Persons owning
ordinary shares or Series A Preferred Shares would be subject to a penalty tax at the time of the
sale at a gain of, or receipt of an “excess distribution” with respect to, their shares, unless
such shareholders made a “qualified electing fund election” or “mark-to-market” election.
Moreover, Congress has introduced legislation that if enacted would impose an annual reporting
requirement on PFIC shareholders. It is uncertain that Endurance Holdings would be able to provide
its shareholders with the information necessary for a U.S. Person to make the elections and unclear
what type of information would be required to be included in an annual report if the proposed
legislation were adopted. In general, a shareholder receives an “excess distribution” if the
amount of the distribution is more than 125% of the average distribution with respect to the shares
during the three preceding taxable years (or shorter period during which the taxpayer held the
shares). In general, the penalty tax is equivalent to an interest charge on taxes that are deemed
due during the period the shareholder owned the shares, computed by assuming that the excess
distribution or gain (in the case of a sale) with respect to the shares was taxed in equal portions
at the highest applicable tax rate on ordinary income throughout the shareholder’s period of
ownership. The interest charge is equal to the applicable rate imposed on underpayments of U.S.
federal income tax for such period.
For the above purposes, passive income generally includes interest, dividends, annuities and
other investment income. The PFIC statutory provisions, however, contain an express exception for
income derived in the active conduct of an insurance business by a corporation which is
predominantly engaged in an insurance business.
This exception is intended to ensure that income derived by a bona fide insurance company is
not treated as passive income, except to the extent such income is attributable to financial
reserves in excess of the reasonable needs of the insurance business. Endurance Holdings expects
for purposes of the PFIC rules that each of Endurance U.K. and Endurance Bermuda will be
predominantly engaged in an insurance business and is unlikely to have financial reserves in excess
of the reasonable needs of its insurance business. Accordingly, neither expects to be treated as a
PFIC for U.S. federal income tax purposes. There can be no assurances, however, that this will be
the case. The PFIC statutory provisions contain a look-through rule stating that, for purposes of
determining whether a foreign corporation is a PFIC, such foreign corporation shall be treated as
if it received “directly its proportionate share of the income . . .” and as if it “held its
proportionate share of the assets . . .” of any other corporation in which it owns at least 25% by
value of the shares. While no explicit guidance is provided by the statutory language, under this
look-through rule Endurance Holdings should be deemed to own the assets and to have received the
income of its insurance subsidiaries directly for purposes of determining whether it qualifies for
the insurance exception. Consequently, Endurance Holdings does not expect to be treated as a PFIC
for U.S. federal income tax purposes. This interpretation of the look-through rule is consistent
with the legislative intention generally to exclude bona fide insurance companies from the
application of PFIC provision. There can be no assurance, however, that the IRS will
not challenge this position or that a court will not sustain such challenge. Prospective
investors should consult their tax advisor as to the effects of the PFIC rules.
55
Other. Except as discussed below with respect to backup withholding, dividends paid by
Endurance Holdings will not be subject to U.S. withholding tax.
Information Reporting and Backup Withholding. Information returns may be filed with the IRS
in connection with payments of dividends with respect to our ordinary shares or Series A Preferred
Shares and the proceeds from a sale or other disposition of the shares unless the shareholder
establishes an exemption from the information reporting rules. A U.S. Person holding our ordinary
shares or Series A Preferred Shares that does not establish such an exemption may be subject to
U.S. backup withholding tax on these payments if the holder fails to provide its taxpayer
identification number or otherwise comply with the backup withholding rules. The amount of any
backup withholding from a payment to a U.S. Person will be allowed as a credit against the U.S.
Person’s U.S. federal income tax liability and may entitle such person to a refund, provided that
the required information is furnished to the IRS.
Shareholders Who Are Non-U.S. Persons
Dividends and Disposition. In general (and subject to the discussion below under “Information
Reporting and Backup Withholding”), a Non-U.S. Person will not be subject to U.S. federal income or
withholding tax with respect to payments of dividends on, or gain upon the disposition of, our
ordinary shares or Series A Preferred Shares unless (i) the dividends or gain is effectively
connected with the conduct by the Non-U.S. Person of a trade or business in the United States or
(ii) in the case of gain upon the disposition of shares, the Non-U.S. Person is an individual who
is present in the United States for 183 days or more in the taxable year and certain other
conditions are met. Nonresident alien individuals will not be subject to U.S. estate tax with
respect to our ordinary shares or Series A Preferred Shares.
Dividends or gain that is effectively connected with the conduct by a Non-U.S. Person of a
trade or business in the United States generally will be subject to regular U.S. federal income tax
in the same manner as if it were realized by a U.S. Person. In addition, if such Non-US. Person is
a non-US. corporation, such dividends or gain may be subject to a branch profits tax at a rate of
30% (or such lower rate as is provided by an applicable income tax treaty).
Information Reporting and Backup Withholding. If our ordinary shares or Series A Preferred
Shares are held by a Non-U.S. Person through a non-U.S. (and non-U.S. related) broker or financial
institution, information reporting and backup withholding generally would not be required.
Information reporting, and possibly backup withholding, may apply if the shares are held by a
Non-U.S. Person through a U.S. (or U.S. related) broker or financial institution and the Non-U.S.
Person fails to provide appropriate information. Non-U.S. Persons should consult their tax
advisors concerning the application of the information reporting and backup withholding rules.
AVAILABLE INFORMATION
General information about us, including our Corporate Governance Guidelines, Code of Business
Conduct and Ethics and the charters for the Audit, Compensation, Investment, Nominating and
Corporate Governance and Underwriting Committees of our Board of Directors, can be found on our
website. Our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on
Form 8-K, as well as any amendments and exhibits to those reports, are available free of charge
through our website as soon as reasonably practicable after we file them with, or furnish them to,
the United States Securities and Exchange Commission (the “SEC”). Any of the above referenced
documents can also be obtained in print, free of charge, by contacting the Secretary at Endurance
Specialty Holdings Ltd., Wellesley House, 90 Pitts Bay Road, Pembroke HM08, Bermuda. Information
on our website is not incorporated into this Form 10-K or our other securities filings and is not a
part of these filings.
The Company had no outstanding, unresolved comments from the SEC staff at December 31, 2009.
The Company leases office space in Pembroke, Bermuda where the Company’s principal executive
office is located. Additionally, the Company and its subsidiaries lease office space in the United
States, the United Kingdom, Switzerland and Singapore sufficient for the operation of its Insurance
and Reinsurance segments. We
renew and enter into new leases in the ordinary course of business. For further discussion of
our leasing commitments at December 31, 2009, please see Note 11 — “Commitments and Contingencies”
of our Audited Consolidated Financial Statements.
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We are party to various legal proceedings generally arising in the normal course of our
business. While any proceeding contains an element of uncertainty, we do not believe that the
eventual outcome of any litigation or arbitration proceeding to which we are presently a party
could have a material adverse effect on our financial condition or business. Pursuant to our
insurance and reinsurance agreements, disputes are generally required to be finally settled by
arbitration.
Not Applicable.
PART II
Market Information
Our ordinary shares are publicly traded on the New York Stock Exchange (“NYSE”) under the
symbol “ENH.” The following table sets forth, for the fiscal quarters and periods indicated, the
high and low sale price per ordinary share as reported on the NYSE for the two most recent fiscal
years:
Number of Holders of Ordinary Shares
The approximate number of record holders of our ordinary shares as of February 24, 2010 was
133, not including beneficial owners of shares registered in nominee or street name.
Dividends
We paid a quarterly dividend of $0.25 per ordinary share in each of the four quarters of 2009
and 2008. Our Board of Directors reviews our ordinary share dividend each quarter. Among the
factors considered by the Board of Directors in determining the amount of each dividend are the
results of operations and the capital requirements, growth and other characteristics of our
businesses. The declaration and payment of future dividends is also subject to certain legal,
regulatory and other restrictions.
Endurance Holdings is a holding company and has no direct operations. The ability of
Endurance Holdings to pay dividends or distributions depends almost exclusively on the ability of
its subsidiaries to pay dividends to Endurance Holdings. Under Bermuda law, Endurance Bermuda may
not declare or pay a dividend if there are reasonable grounds for believing that Endurance Bermuda
is, or would after the payment be, unable to pay its liabilities as they become due, or the
realizable value of Endurance Bermuda’s assets would thereby be less than the aggregate of its
liabilities and its issued share capital and share premium accounts. Further, Endurance Bermuda,
as a regulated insurance company in Bermuda, is subject to additional regulatory restrictions on
the payment of dividends or other distributions. As of December 31, 2009, the maximum amount of
distributions that Endurance Bermuda could pay to Endurance Holdings under applicable insurance and
Companies Act regulations without prior regulatory approval was approximately $610 million. During
2009, Endurance U.K. was precluded by regulatory
restrictions from declaring or distributing dividends. Endurance U.K. is currently completing
statutory income (loss) statements for the year ended December 31, 2009. The Company does not
expect Endurance U.K. to have material dividend capacity in 2009. As of December 31, 2009,
Endurance U.S. Reinsurance, Endurance American, and Endurance American Specialty did not have
earned surplus and thus were precluded from dividend distributions in 2010 without prior regulatory
approval. As of December 31, 2009, Endurance Risk Solutions and ARMtech (with notice to the Texas
Department of Insurance) could pay $3.8 million and $2.6 million of dividends, respectively,
without prior regulatory approval.
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Our credit facilities prohibit Endurance Holdings from declaring or paying any dividends if a
default or event of default has occurred and is continuing at the time of such declaration or
payment or would result from such declaration or payment. In addition, the terms of our Series A
Preferred Shares prohibit dividends from being declared or paid on ordinary shares unless the full
dividends for the latest completed dividend period on all outstanding Series A Preferred Shares
have been declared and paid.
For a description of working capital restrictions and other limitations upon the payment of
dividends, see “Item 1. Business — Regulatory Matters,” “Item 7. Management’s Discussion and
Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources,” “Item
8. Financial Statements and Supplementary Data” and Note 17 to the Company’s Audited Consolidated
Financial Statements.
Recent Sales of Unregistered Securities
None.
Purchase of Equity Securities by Issuer and Affiliated Purchasers
ISSUER PURCHASES OF EQUITY SECURITIES
Performance Graph
The following performance graph and related information shall not be deemed to be “soliciting
material” or to be “filed” with the Securities and Exchange Commission, nor shall such information
be incorporated by reference into any future filing under the Securities Act of 1933 or Securities
Exchange Act of 1934, each as amended, except to the extent that the Company specifically
incorporates it by reference into such filing.
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The graph below illustrates the cumulative 5-year shareholder return, including reinvestment
of dividends, of the Company’s ordinary shares, compared with such return for the (i) Standard &
Poor’s (“S&P”) 500 Composite Stock Price Index and (ii) S&P Property & Casualty Industry Group
Stock Price Index, in each case measured
during the period from December 31, 2004 to December 31, 2009. During this period, the
cumulative total return on the Company’s ordinary shares was 26.5%, the cumulative total return for
the S&P 500 Composite Stock Price Index was 2.1% and the cumulative total return for the S&P
Property & Casualty Industry Group Stock Price Index was -11.4%.
The following table sets forth our selected consolidated financial information for the years
ended and as of the dates indicated. As described in Note 1 to our Audited Consolidated Financial
Statements included elsewhere in this Annual Report on Form 10-K, our Audited Consolidated
Financial Statements include the accounts of Endurance Holdings, Endurance Bermuda, Endurance U.K.,
Endurance U.S. Reinsurance, Endurance American, Endurance American Specialty, Endurance Risk
Solutions and ARMtech.
We derived the following selected consolidated financial information for the years ended
December 31, 2009, 2008, 2007, 2006 and 2005 from our Audited Consolidated Financial Statements and
related notes. These historical results are not necessarily indicative of results to be expected
from any future period.
You should read the following selected consolidated financial information along with the
information contained in this Annual Report on Form 10-K, including ''Item 7. Management’s
Discussion and Analysis of Financial Condition and Results of Operations’’ and the Audited
Consolidated Financial Statements and related notes included elsewhere in this Annual Report on
Form 10-K.
59
60
The following discussion and analysis of the Company’s financial condition and results of
operations should be read in conjunction with the Company’s consolidated financial statements and
related notes included elsewhere in this Annual Report.
Some of the information contained in this discussion and analysis or set forth elsewhere in
this Annual Report, including information with respect to the Company’s plans and strategy for its
business, includes forward-looking statements that involve risk and uncertainties. Please see the
“Cautionary Statement Regarding Forward-Looking Statements” in this Annual Report on Form 10-K for
more information on factors that could cause actual results to differ materially from the results
described in or implied by any forward-looking statements contained in this discussion and
analysis. You should review the “Risk Factors” set forth in this Annual Report on Form 10-K for a
discussion of important factors that could cause actual results to differ materially from the
results described in or implied by the forward-looking statements contained herein.
Executive Overview
Endurance Specialty Holdings Ltd. (“Endurance Holdings”) was organized as a Bermuda holding
company on June 27, 2002. Endurance Holdings has seven wholly-owned operating subsidiaries:
Endurance Holdings and its wholly-owned subsidiaries are collectively referred to in this
discussion and analysis as the “Company”.
The Company writes specialty lines of property and casualty insurance and reinsurance on a
global basis and seeks to create a portfolio of specialty lines of business that are profitable and
have limited correlation with one another. The Company’s portfolio of specialty lines of business
is organized into two business segments, Insurance and Reinsurance.
In the Insurance segment, the Company writes
agriculture, professional lines, casualty, property, healthcare
liability and workers’ compensation insurance. In the Reinsurance segment, the
Company writes catastrophe, casualty, property, aerospace and marine and surety and other specialty
reinsurance.
The Company’s Insurance and Reinsurance segments both include property related coverages which
provide insurance or reinsurance of an insurable interest in tangible property for property loss,
damage or loss of use. In addition, the Company’s Insurance and Reinsurance segments include
various casualty insurance and reinsurance coverages, which are primarily concerned with the losses
caused by injuries to third parties, i.e., not the insured, or to property owned by third parties
and the legal liability imposed on the insured resulting from such injuries.
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Business and Accounting Factors
The Company’s results of operations are affected by the following business and accounting
factors:
Revenues. The Company derives its revenues primarily from premiums from its insurance
policies and reinsurance contracts. The premiums the Company charges for the risks assumed are
priced based on many assumptions and are a function of the amount and type of policies and
contracts the Company writes as well as prevailing market prices, and in the case of agricultural
insurance contracts, federally mandated pricing. The Company prices these risks before its
ultimate costs are known, which may extend many years into the future.
The Company’s revenues also include income generated from its investment portfolio. The
Company’s investment portfolio is comprised of fixed maturity investments, short-term investments
and preferred equity securities that are held as available for sale and other inestments that are
accounted for under the equity method of accounting. In accordance with accounting principles
generally accepted in the United States (“U.S. GAAP”), the available for sale investments are
carried at fair market value and unrealized gains and losses on the Company’s investments are
generally excluded from earnings. These unrealized gains and losses are included on the Company’s
balance sheet in accumulated other comprehensive income (loss) as a separate component of
shareholders’ equity. If unrealized losses are considered to be other-than-temporarily impaired due
to credit related factors, such losses are included in earnings as a realized loss. For other
investments, the Company increases or decreases the value of these investments for the Company’s
share of income or loss, less dividends, which is included in net investment income.
Expenses. The Company’s expenses consist primarily of losses and loss expenses, acquisition
expenses, interest expense, amortization of intangible assets and general and administrative
expenses. Losses and loss expenses are estimated by management and reflect its best estimate of
ultimate losses and loss adjustment costs arising during the current reporting period and revisions
of prior period estimates. The Company records losses and loss expenses based on an actuarial
analysis of the estimated losses the Company expects to be reported on policies and contracts
written. The ultimate losses and loss expenses will depend on the actual costs to settle claims.
Acquisition expenses consist principally of commissions and brokerage expenses that are typically a
percentage of the premiums on insurance policies or reinsurance contracts written. General and
administrative expenses consist primarily of personnel expenses and general operating expenses.
Marketplace Conditions and Trends. In general, at the end of 2009, we believe operating
conditions continued to be competitive. In certain catastrophe-exposed classes of property and
some casualty business, we experienced a pricing environment that was
flat to slightly up;
however, for the remaining insurance and reinsurance lines of property and casualty business, we
experienced downward pricing driven largely by relatively high levels of underwriting capacity and
competition driven by several distressed or aggressive competitors. We continued to maintain our
adherence to underwriting standards by declining business when pricing, terms and conditions did
not meet our underwriting criteria.
In 2010, we believe the following three primary influences may affect the market for our
insurance and reinsurance products — the continuation of the global recession, increased pricing
competition in many of our markets, and a low interest rate environment. The United States and
other markets around the world have continued to experience unsettled economic conditions,
including increasing unemployment, increased governmental regulation and continued uncertainty in
global financial markets. The reduction in economic activity is likely to lead to decreased demand
for insurance and reinsurance. This, combined with the substantial recovery of most of the
industry’s surplus position in 2009 and the impact of new market entrants, is likely to result in a
more competitive global insurance and reinsurance market in 2010. Potentially offsetting these
factors is the current low interest rate environment that will likely encourage more underwriting
discipline as there will be reduced investment earnings from underwriting cash flows. We believe
these three factors have and will continue to contribute to changes in market conditions within
both the reinsurance and insurance marketplaces.
At this time, the Company cannot predict with any reasonable certainty whether and to what
extent current marketplace conditions and trends will persist in the future.
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Critical Accounting Estimates
The Company’s consolidated financial statements contain certain amounts that are inherently
subjective in nature and require management to make assumptions and best estimates to determine the
reported values and related disclosures. Management considers an accounting estimate to be
critical if:
If factors such as those described in the “Risk Factors” section in this Annual Report on Form
10-K cause actual events or results to differ materially from management’s underlying assumptions
or estimates, there could be a material adverse effect on the Company’s results of operations and
financial condition and liquidity.
Management believes that the following critical accounting policies affect significant
estimates used in the preparation of its consolidated financial statements.
Premiums. The Company’s insurance premiums are earned pro rata over the terms of the
applicable risk period specified in the insurance policy. The Company’s insurance policies are
written on a losses occurring or claims made basis during the term of the policy. Generally, the
Company receives a fixed premium which is identified in the policy and is recorded on the inception
date of the contract or when premiums are determinable and earned evenly over the policy term. This
premium will only adjust if the underlying insured basis adjusts. Accordingly, we monitor the
underlying insured basis and record additional or return premiums in the period in which amounts
are reasonably determinable. Insurance premiums written accounted for
approximately 57%, 63%, and 42% of the
Company’s gross premiums written during the years ended December 31, 2009, 2008, and 2007,
respectively.
The Company’s reinsurance premiums are earned in proportion to the amount of reinsurance
protection provided over the terms of the applicable risk period established in the reinsurance
contract. Reinsurance contracts written on a losses occurring basis cover losses which occur during
the term of the reinsurance contract, typically 12 months. Accordingly, the Company earns the
premium on a losses occurring reinsurance contract evenly over the reinsurance contract term.
Losses occurring reinsurance contracts accounted for approximately 21%, 19%, and 32% of the
Company’s gross premiums written during the years ended December 31, 2009, 2008, and 2007,
respectively. Reinsurance contracts written on a policies attaching basis cover losses from the
underlying insurance policies incepting during the terms of the reinsurance contracts. Losses under
a policies attaching reinsurance contract may occur after the end date of the reinsurance contract,
so long as they are losses from policies which began during the reinsurance contract period. The
Company typically earns the premiums for policies attaching reinsurance contracts over a 24 month
period in proportion to the amount of reinsurance protection provided to reflect the extension of
the risk period past the term of the contract and the varying levels of reinsurance protection
provided during the reinsurance contract period. Policies attaching reinsurance contracts accounted
for approximately 22%, 18%, and 26% of the Company’s gross premiums written during the years ended
December 31, 2009, 2008, and 2007, respectively.
In addition to determining the applicable risk period, the Company’s estimate of its
reinsurance premiums written is based on the type of reinsurance contracts underwritten. For excess
of loss reinsurance contracts, the deposit premium, as defined in the contract, is generally
considered to be the best estimate of the reinsurance contract’s written premium at inception. The
Company earns reinstatement premiums upon the occurrence of a loss under the reinsurance contract.
Reinstatement premiums are calculated in accordance with the contract terms based upon the ultimate
loss estimate associated with each contract. Excess of loss reinsurance contracts accounted for
approximately 23%, 23%, and 31% of the Company’s gross premiums written during the years ended
December 31, 2009, 2008, and 2007, respectively. For proportional reinsurance contracts, the
Company estimates premiums, commissions and related expenses based on broker and ceding company
estimates. In addition to ceding company estimates, the Company also utilizes its judgment in
establishing proportional reinsurance contract premium estimates after considering the following
factors:
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Proportional reinsurance contracts accounted for approximately 20%, 14%, and 27% of the Company’s
gross premiums written during the years ended December 31, 2009, 2008, and 2007, respectively.
Premiums on the Company’s excess of loss and proportional reinsurance contracts are estimated
by management at the time the business is underwritten. Accordingly, this is the amount the Company
records as written premium in the period the contracts incept. As actual premiums are reported by
the ceding companies, management evaluates the appropriateness of the original premium estimates
and any adjustment to these estimates is recorded in the period in which it becomes known. The
Company has not historically experienced material adjustments to its initial premium estimates for
its excess of loss reinsurance contracts. For proportional contracts, as is customary in the
reinsurance market, there is a time lag from the point when premium and related commission and
expense activity is recorded by a ceding company to the point when such information is reported by
the ceding company to the Company, either directly or through a reinsurance intermediary. This time
lag can vary from one to several months or calendar quarters. In addition, uncertainty in premium
estimates arises due to changes in renewal rates or rate of new business acceptances by the cedant
insurance companies and changes in the rates being charged by cedants. Changes to original premium
estimates for proportional contracts could be material and such adjustments may directly and
significantly impact earnings in the period they are determined because the subject premium may be
fully or substantially earned.
The Company’s limited historical experience has shown that estimated premiums from
proportional contracts have varied and have been adjusted by up to approximately 10%, although
larger variations, both positive and negative, are possible as a result of changes in one or more
of the premium assumptions as noted above. A 10% variation in the Company’s proportional premiums
receivable, net as of December 31, 2009, after considering the related expected losses and loss
expenses, acquisition expenses and taxes, would result in an impact of approximately $2.1 million
on the Company’s net income.
The following summarizes the Company’s net proportional premium estimates within premiums
receivable, net on the Company’s Audited Consolidated Balance Sheet as of December 31, 2009 and
2008:
Reserve for Losses and Loss Expenses. The Company’s reserve for losses and loss expenses
includes case reserves and reserves for losses incurred but not reported (referred to as “IBNR
reserves”). Case reserves are established for losses that have been reported to us, but not yet
paid. IBNR reserves represent the estimated ultimate cost of events or conditions that have not
been reported to or specifically identified by the Company, but have occurred. Case reserves and
IBNR reserves are established by management based on reports from reinsurance intermediaries,
ceding companies and insureds and consultations with independent legal counsel. In addition, IBNR
reserves are established by management based on reported losses and loss expenses and actuarially
determined estimates of ultimate losses and loss expenses.
Under U.S. GAAP, the Company is not permitted to establish loss reserves until the occurrence
of an actual loss event. Once such an event occurs, the Company establishes reserves based upon
estimates of total losses incurred by the ceding companies or insureds as a result of the event,
its estimate of the potential losses incurred, and its estimate of the portion of such loss the
Company has insured or reinsured. As a result, only loss reserves applicable to losses incurred up
to the financial statement date may be recorded, with no allowance for the provision of a
contingency reserve to account for expected future losses. Losses arising from future events will
be estimated and recognized at the time the loss is incurred and could be substantial. See
''Reserve for Losses and Loss Expenses’’ below for further discussion.
The Company’s loss and loss expense reserves are reviewed regularly, and adjustments, if any,
are reflected in earnings in the period in which they become known. The establishment of new loss
and loss expense reserves or the adjustment of previously recorded loss and loss expense reserves
could result in significant positive or negative changes to the Company’s financial condition for
any particular period. While we believe that we have made a reasonable estimate of loss and loss
expense reserves, the ultimate loss experience may not be as reliably predicted as may be the case
with other insurance and reinsurance operations, and it is possible that losses and loss expenses
will be higher or lower than the total reserve for losses and loss expenses recorded by the
Company.
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Information Used in Determining the Reserve for Losses and Loss Expenses. In order to
estimate the Company’s reserve for losses and loss expenses, management uses information either
developed from internal or independent external sources, or pricing information created by the
Company or provided to the Company by insureds and brokers at the time individual contracts and
policies are bound. In addition, we use commercially available risk analysis models, contract by
contract review by our underwriting teams and, to a limited extent, overall market share
assumptions to estimate our loss and loss expense reserves related to specific loss events.
Actuarial Methods Used to Estimate Loss and Loss Expense Reserves. When the applicable
information has been obtained, the Company uses a variety of actuarial methods to estimate the
ultimate losses and loss expenses incurred by the Company in connection with business it has
underwritten and thus, the applicable reserve for losses and loss expenses. One actuarial method
used by the Company to estimate its reserve for losses and loss expenses is the expected loss ratio
approach, which is based on expected results independent of current loss reporting activity. This
approach is typically used for immature loss periods (i.e., the current accident year). Another
actuarial method used by the Company is known as the Bornhuetter-Ferguson method. The
Bornhuetter-Ferguson method uses an initial loss estimate (expected loss technique) for each
underwriting quarter by business line and type of contract. The portion of the initial loss
estimate that is the IBNR reserve is then reduced in each subsequent quarter by the losses reported
for that business segment during that quarter. Over time, the IBNR reserve will be reduced and
will be replaced with the actual losses reported to the Company or, if losses do not develop as
expected, reserves for those losses are reduced with the amounts by which reserves are reduced then
reflected in net income (loss). Management uses these multiple actuarial methods, supplemented
with its own professional judgment, to establish its best estimate of reserves for losses and loss
expenses.
The information gathered by the Company and the actuarial analyses performed on the gathered
information is used to develop individual point estimates of carried loss and loss expense reserves
for each of the Company’s business segments and underlying lines of business. These individual point
estimates are then aggregated along with actual losses reported to reach the total reserve for
losses and loss expenses carried in the Company’s consolidated financial statements. All of the
Company’s loss reserving is currently performed on a point estimate basis. The Company does not
utilize range estimation in its loss reserving process.
Since inception, the Company has used reserving methods that are commonly applied when limited
loss development experience exists. In order to capture the key dynamics of loss development and
expected volatility that may arise within the disclosed amounts for the reserve for losses and loss
expenses, the key lines of business within each business segment are aggregated based on their
potential expected length of loss emergence. The period over which loss emergence occurs is
typically referred to as the tail. The Company has classified its lines of business as either
having a “short,” “long” or “other” tail pattern. As the Company has accumulated its own loss
reserve history, it has determined it is more appropriate to incorporate the Company’s actual loss
experience. As of 2006, the Company determined that its own loss development history in relation
to its short tail and other lines of business had reached a level of maturity sufficient to provide
a credible basis on which to estimate its reserve for losses and loss expenses related to these
lines of buinsess. As such, the Company’s actual reporting patterns were considered when
determining the reserve for losses and loss expenses in the short tail and other lines of business
in its Reinsurance and Insurance segments for the year ended December 31, 2009. The Company
continues to utilize industry loss and development patterns in the establishment of loss and loss
expense reserves for its long tail and certain other lines of business in both its Insurance and
Reinsurance segments.
Significant Assumptions Employed in the Estimation of Loss and Loss Expense Reserves. The
most significant assumptions used as of December 31, 2009 to estimate the reserve for losses and
loss expenses within the Company’s Insurance and Reinsurance segments are as follows:
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The above four assumptions most significantly influence the Company’s determination of initial
expected loss ratios and expected loss reporting patterns that are the key inputs which impact
potential variability in the estimate of the reserve for losses and loss expenses and are
applicable to each of the Company’s business segments. While there can be no assurance that any of
the above assumptions will prove to be correct, we believe that these assumptions represent a
realistic and appropriate basis for estimating the reserve for losses and loss expenses.
Factors Creating Uncertainty in the Estimation of the Reserve for Losses and Loss Expenses.
While management does not at this time include an explicit or implicit provision for uncertainty in
its reserve for losses and loss expenses, certain of the Company’s business lines are by their
nature subject to additional uncertainties, including the Company’s casualty, property,
catastrophe, aerospace and surety and other specialty lines in the Reinsurance segment and the
Company’s casualty and professional lines in the Insurance segment, which are discussed in detail
below. In addition, the Company’s Reinsurance segment is subject to additional factors which add
to the uncertainty of estimating loss and loss expense reserves. Time lags in the reporting of
losses can also introduce further ambiguity to the process of estimating loss and loss expense
reserves.
The aspects of the Company’s casualty line in the Reinsurance segment and the casualty and
professional lines in the Insurance segment that complicate the process of estimating loss reseves
include the lack of long-term historical data for losses of the same type intended to be covered by
the policies and contracts written by the Company and the expectation that a portion of losses in
excess of the Company’s attachment levels in many of its contracts will be low in frequency and
high in severity, limiting the usefulness of claims experience of other insurers and reinsurers for
similar claims. In addition, the portion of the Company’s casualty line in its Insurance segment
which is underwritten in Bermuda includes policy forms that vary from more traditional policy
forms. The primary difference in the casualty policy form used by Endurance Bermuda from more
traditional policy forms relates to the coverage being provided on an occurrence reported basis
instead of the typical occurrence or claims-made basis used in traditional policy forms. The
occurrence reported policy forms typically cover occurrences causing unexpected and unintended
personal injury or property damage to third parties arising from events or
conditions that commence at or subsequent to an inception date, and prior to the expiration of
the policy provided that proper notice is given during the term of the policy or the discovery
period.
The inherent uncertainty of estimating the Company’s loss and loss expense reserves for its
Reinsurance segment increases principally due to:
In order to verify the accuracy and completeness of the information provided to the Company by its
ceding company counterparties, the Company’s underwriters, actuaries, accounting and claims
personnel perform underwriting and claims reviews of the Company’s ceding companies. Any material
findings are communicated to the ceding companies and utilized in the establishment or revision of
the Company’s case reserves and related IBNR reserve. On occasion, these reviews reveal that the
ceding company’s reported losses and loss expenses do not comport with the terms of the contract
with the Company. In such events, the Company strives to resolve the outstanding differences in an
amicable fashion. The large majority of such differences are resolved in this manner. In the
infrequent instance where an amicable solution is not feasible, the Company’s policy is to
vigorously defend its position in litigation or arbitration. As of December 31, 2009, the Company
was not involved in any material claims litigation or arbitration proceedings.
Due to the large volume of potential transactions that must be recorded in the insurance and
reinsurance industry, backlogs in the recording of the Company’s business activities can also
impair the accuracy of its loss and loss expense reserve estimates. As of December 31, 2009, there
were no significant backlogs related to the processing of policy or contract information in the
Company’s Insurance or Reinsurance segments.
The Company assumes in its loss and loss expense reserving process that, on average, the time
periods between the recording of expected losses and the reporting of actual losses are predictable
when measured in the aggregate and over time. The time period over which all losses are expected
to be reported to the Company varies significantly by line of business. This period can range from
a few quarters for some lines, such as catastrophe, to many years for some casualty lines of
business. For the Company’s Reinsurance business segment, due to ceding company and reinsurance
intermediary reporting frequency, the time period is generally longer than for its Insurance
segment, resulting in a reliance by the Company for a longer period of time on its actuarial
estimates of loss and loss expense reserves. To the extent that actual reported losses are
reported more quickly than expected, the Company may adjust upward its estimate of ultimate loss
and to the extent that actual reported losses are reported more slowly than expected, the Company
may reduce its estimate of ultimate loss.
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Potential Volatility in the Reserve for Losses and Loss Expenses. In addition to the factors
creating uncertainty in the Company’s estimate of loss and loss expense reserves, the Company’s
estimated reserve for losses and loss expenses can change over time because of unexpected changes
in the external environment. Potential changing external factors include:
The Company’s estimates of reserves for losses and loss expenses can also change over time
because of changes in internal company operations, such as:
Due to the inherent complexity of the assumptions used in establishing the Company’s loss and
loss expense reserve estimates, final claim settlements made by the Company may vary significantly
from the present estimates, particularly when those settlements may not occur until well into the
future. For an illustration of the effect of a 10% change in the Company’s two key inputs used in
determining its loss and loss expense reserves — the expected loss ratio and the expected loss
reporting pattern — please see “Reserve for Losses and Loss Expenses” below.
Investments. The Company currently classifies all of its fixed income investments, which
consist of fixed maturity investments, short-term investments and preferred equity securities, as
“available for sale” and, accordingly, they are carried at estimated fair value, with related net
unrealized gains or losses excluded from earnings and included in shareholders’ equity as a
component of accumulated other comprehensive income (loss). The Company determines the fair value of its
fixed income investments in accordance with current accounting guidance, which defines fair value
and establishes a fair value hierarchy based on inputs to the various valuation techniques used for
each fair value measurement. The use of valuation techniques for any given investment requires a
significant amount of judgment and consideration of factors specific to the underlying investment.
Fair value measurements determined by the Company seek to maximize observable inputs and minimize
the use of unobservable inputs. Current accounting guidance establishes three levels as follows:
Level 1: Unadjusted quoted prices in active markets for identical assets or liabilities.
Level 2: Quoted prices for similar assets in markets that are active, quoted prices for
identical or similar assets in markets that are not active or inputs that are observable
either directly or indirectly. Level 2 inputs include quoted prices for similar assets or
liabilities other than quoted prices in Level 1; quoted prices in markets that are not
active; or other inputs that are observable or can be derived principally from or
corroborated by observable market data for substantially the full term of the assets or
liabilities.
Level 3: Unobservable inputs that are supported by little or no market activity and are
significant to the fair value of the assets or liabilities. Unobservable inputs reflect the
Company’s own views about the assumptions that market participants would use in pricing the
asset or liability. Level 3 assets and liabilities include financial instruments whose
values are determined using pricing models, discounted cash flow methodologies, or similar
techniques, as well as instruments for which the determination of fair value requires
significant management judgment or estimation.
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The Company determines the estimated fair value of each individual security utilizing the
highest level inputs available.
The Company uses quoted values and other data provided by nationally recognized independent
pricing sources as inputs into its process for determining fair values of its fixed income
investments. The Company obtains multiple prices for its securities where available. Pricing
sources used in pricing the Company’s fixed income investments at December 31, 2009 were as
follows:
Pricing Services and Index Providers. Pricing services, including index providers, provide
pricing for less-complex, liquid securities based on market quotations in active markets. For
securities that do not trade on a listed exchange, these pricing services may use a matrix pricing
consisting of observable market inputs to estimate the fair value of a security. These observable
market inputs include: reported trades, benchmark yields, broker/dealer quotes, issuer spreads,
two-sided markets, benchmark securities, bids, offers, reference data, and industry and economic
factors. Additionally, pricing services may use a valuation model such as an option adjusted
spread model commonly used for estimating fair values of mortgage-backed and asset-backed
securities. At December 31, 2009, the Company has not adjusted any pricing provided by independent
pricing services and index providers and have classified all such securities as Level 2.
Broker/Dealers. Generally, the Company obtains quotes directly from broker/dealers who are
active in the corresponding markets when prices are unavailable from independent pricing services
or index providers. Broker/dealer quotes may also be used if the pricing from pricing services or
index providers is not reflective of current market levels, as detected by our pricing control
tolerance procedures. Generally, broker/dealers value securities through their trading desks based
on observable market inputs. Their pricing methodologies include mapping securities based on trade
data, bids or offers, observed spreads and performance on newly issued securities. They may also
establish pricing through observing secondary trading of similar securities. Quotes from
broker/dealers are all non-binding. At December 31, 2009, the Company has not adjusted any pricing
provided by broker/dealers and has classified all such securities as Level 2.
As described above, independent pricing services, index providers and broker/dealers have
their own method for determining the fair value of securities. As such, prices provided by
independent pricing services, index providers and independent broker quotes can vary widely, even
for the same security, and may have a material effect on the estimated fair values of the Company’s
securities. If the Company determines that there has been a significant decrease in the volume and
level of trading activity for the securities in relation to the normal market activity for such
security (or similar securities), then transactions or quoted prices may not accurately reflect
fair value and, if there is evidence that the transaction for the security is not orderly, the
Company may place less weight on the transaction price as an indicator of fair value. To validate
the techniques or models used by pricing sources, the Company’s review process includes, but is not
limited to:
Based on the above review, the Company will challenge any prices for a security, which are not
considered representative of fair value.
The Company’s available for sale investments are comprised of a variety of different
securities, which are grouped based on the valuation technique and inputs used in their valuation.
The valuation of current issue U.S. government securities is generally based on Level 1 inputs,
which use the market approach valuation technique. The valuation of the Company’s other available
for sale investments, including non-current U.S. government and agency securities, U.S. state,
municipal and foreign government securities, government guaranteed
and other corporate debt, U.S. agency and non-agency residential
and commercial mortgage-backed securities, asset-backed securities, short-term investments and
preferred equity securities generally incorporate significant Level 2 inputs using the market and
income approach techniques. Level 3 includes any available for sale investments that use
unobservable inputs, which will vary from period to period.
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For mortgage-backed and other asset-backed debt securities, fair value includes estimates
regarding prepayment assumptions, which are based on current market conditions. Amortized cost in
relation to these securities is calculated using a constant effective yield based on anticipated
prepayments and the estimated economic life of the security. When actual prepayments differ
significantly from anticipated prepayments, the effective yield is recalculated to reflect actual
payments to date. For the majority of these securities, changes in estimated yield are recorded on
a retrospective basis, resulting in future cash flows determining current book value.
Other than Temporary Impairment. Following a determination of fair value, the Company reviews
its fixed income investments to determine whether any declines in the fair value below the
amortized cost basis of its fixed income investments are other-than-temporary. If the Company
determines that a decision to sell the security has been made or that it is more likely than not
that the Company will be required to sell the security, the Company deems the security to be
other-than-temporarily impaired and writes down the value to fair value, thereby establishing a new
cost basis. The amount of the write-down is recognized in earnings as an other-than-temporary
impairment (“OTTI”) loss.
For the remaining fixed income investments in an unrealized loss position for which a
decision to sell has not been made and it is more likely that the Company will not be required to
sell, the Company performs additional reviews to determine whether the investment will recover its
amortized cost. Analysis and reviews
performed to determine if the amortized cost of the Company’s fixed income investments is
likely to be recovered include the following actions, among others, depending on the type of
security being reviewed or tested:
If the amortized cost of the Company’s fixed income investments is, based upon the judgment
of management, unlikely to be recovered, the Company writes down the investment by the amount
representing the credit related portion of the decline in value, thereby establishing a new cost
basis. The amount of the write-down is recognized in earnings as an OTTI loss. The new cost basis
is not changed for subsequent recoveries in fair value.
To the extent the Company determines that the amortized cost of the Company’s fixed income
investments is likely to be recovered and related to other factors (such as interest rates, market
conditions, etc.) and not due to credit related factors, that remaining non-credit portion of the
unrealized loss is recorded as a part of accumulated other
comprehensive income (loss) in the
shareholders’ equity section of the Company’s balance sheet.
Prior to April 1, 2009, the Company assessed securities for declines in value that were
considered to be other-than-temporary through the consideration of several factors
including (i) the time period in which there has been a significant decline in value, (ii)
the expected maturity of the investment, (iii) the significance of the decline, (iv) an
analysis of the liquidity, business prospects and overall financial condition of the
issuer, and (v) the Company’s intent and ability to hold the investment for a period of
time sufficient for the value to recover. If the decline in fair value was determined to
be other-than-temporary, the cost of the security was written down to fair value and the
amount was included in net impairment losses recognized in earnings in the Consolidated
Statements of Income and Comprehensive Income (Loss).
Other Investments. Other investments are accounted for using the equity method of accounting
whereby the initial investment is recorded at cost. Other investments consist largely of
alternative and high yield loan funds that investment in senior secured bank debt and high yield
securities, distressed debt, derivatives and equity long/short strategies The carrying value of
these investments are increased or decreased to reflect the Company’s share of income or loss,
which is included in net investment income, and are decreased for dividends. Due to the timing of
the delivery of the final valuations reported by the managers of certain of our alternative funds,
our investments in those alternative funds are estimated based on the most recently available
information including period end valuation statements, period end estimates, or, in some cases,
prior month or quarter valuation statements.
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Goodwill. The Company is required to make an annual assessment as to whether the value of the
Company’s goodwill asset is impaired. Impairment, which can be either partial or full, is based on
a fair value analysis by individual reporting unit. Based upon the Company’s assessment at the
reporting unit level, there was no impairment of its goodwill asset of $86.2 million as of December
31, 2009.
In making an assessment of the value of its goodwill, the Company uses both market based and
non-market based valuations. Assumptions underlying these valuations include forecasts of
discounted future cash flows and future profits in addition to an analysis of the Company’s stock
price relative to both its book value and its net income. Significant changes in the data
underlying these assumptions could result in an assessment of impairment of the Company’s goodwill
asset. In addition, if the current economic environment and/or the Company’s financial performance
were to deteriorate significantly, this could lead to an impairment of goodwill, the write-off of
which would be recorded against net income in the period such deterioration occurred. If a 5%
decline in the fair value of the reporting units occurred, this would not result in an impairment
of the goodwill asset at December 31, 2009.
Deferred Tax Assets. We provide for income taxes in accordance with the provisions of the
relevant accounting guidance on, “Accounting for Income Taxes” and “Accounting for Uncertain Tax
Positions”, for Endurance Reinsurance, Endurance American, Endurance American Specialty, Endurance
Risk Solutions, ARMtech and Endurance U.K., which are our subsidiaries operating in income tax
paying jurisdictions. Our deferred tax assets and liabilities primarily result from the net tax
effect of temporary differences between the amounts recorded in our Audited Consolidated Financial
Statements and the tax basis of our assets and liabilities. We determine deferred tax assets and
liabilities separately for each tax-paying component in each tax jurisdiction.
At each balance sheet date, management assesses the need to establish a valuation allowance
that reduces deferred tax assets when it is more likely than not that all, or some portion, of the
deferred tax asset will not
be realized. The valuation allowance is based on all available information including
projections of future taxable income from each tax-paying component in each tax jurisdiction and
available tax planning strategies. Estimates of future taxable income incorporate several
assumptions that may differ from actual experience. Differences in our assumptions and resulting
estimates could be material and have an adverse impact on our financial results of operations and
liquidity. Any such differences are recorded in the period in which they become known.
Reclassifications. Certain comparative information has been reclassified to conform to
current year presentation.
Recent Accounting Pronouncements. See note 2(p), “Summary of Significant Accounting
Policies—Recent Accounting Pronouncements,” of the notes accompanying our audited consolidated
financial statements.
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Results of Operations
Years Ended December 31, 2009, 2008 and 2007
The following is a discussion and analysis of the Company’s consolidated results of operations
for the years ended December 31, 2009, 2008 and 2007.
Premiums
Gross premiums written in 2009 were $2,021.5 million, a decrease of $225.0 million, or 10.0%,
compared to 2008 and an increase of $240.3 million, or 13.5% compared to 2007. Net premiums
written in 2009 were $1,606.1 million, a decrease of $178.2 million, or 10.0%, compared to 2008 and
an increase of $31.1 million,
or 2.0% compared to 2007. The change in net premiums written for 2009 compared to 2008 was
driven primarily by the following factors:
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The change in net premiums written for 2009 compared to 2007 was driven primarily by
the following:
Ceded premiums written by the Company decreased in 2009 compared to 2008 because of decreased
cessions to third party reinsurers associated with decreased gross premiums written, principally in
the agriculture line of business of the Insurance segment. The majority of premiums ceded by the
agriculture line of business were to the U.S. government through a federally sponsored crop
reinsurance program. Ceded premiums written increased in 2009 compared to 2007 due to the full
year impact of ARMtech on the agriculture line of the Insurance segment in 2009.
Net premiums earned decreased in 2009 compared to 2008 due to the decline in net premiums
written by the Insurance segment. Net premiums earned increased in 2009 compared to 2007
consistent with increases in net premiums written in the agriculture line of the Insurance segment
year over year. The following table provides the distribution of gross premiums written by the
geographic location in which the risk originated for the years ended December 31, 2009, 2008 and
2007:
Net Investment Income
Net investment income increased in 2009 compared to 2008 and 2007 principally due to net mark
to market gains on alternative investments and high yield loan funds, included in other
investments, of $98.1 million as compared to a loss of $111.6 million in 2008 and a gain of $21.3
million in 2007. Cash and cash equivalents and investments (including pending investment
settlements) have increased 11.5% from 2008 and 6.9% from 2007. The increase in cash and cash
equivalents and investments during 2009 resulted from increases in market valuations of investments
and positive net operating cash flows throughout 2009, partially offset by share repurchases.
Investment expenses, including investment management fees, for 2009 were $11.4 million compared to
$10.3 million in 2008, and compared to $9.5 million in 2007. The increase in investment expenses
resulted from a larger investment portfolio year over year and from increased monitoring activity
conducted throughout the year.
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The annualized net earned yield, total return of the investment portfolio for the years ended
December 31, 2009, 2008 and 2007 and market yield and portfolio duration as of December 31, 2009
and 2008 were as follows:
During 2009, the yield on the benchmark five year U.S. Treasury bond fluctuated within a 157
basis points range, with a high of 2.92% and a low of 1.35%. Investment grade corporate and agency
structured security spreads narrowed approximately 414 and 59 basis points, respectively, during
the year ended December 31, 2009. Trading activity in the Company’s portfolio included a reduction
of agency and non-agency residential mortgages, commercial mortgages, cash equivalents, foreign
government securities, and an increase in U.S. government guaranteed corporate securities and
corporate securities from prior periods and was aimed at selectively adding yield while continuing
to keep the portfolio short in duration and conservatively positioned. The duration of the fixed
income investments held at December 31, 2009 was largely consistent with 2008.
Net Realized Gains (Losses) on Investment Sales
Our investment portfolio is managed to generate attractive economic returns and income while
providing the Company with liquidity. Movements in financial markets and interest rates influence
the timing and recognition of net realized investment gains or losses as the portfolio is adjusted
and rebalanced. Proceeds from sales of investments classified as available for sale for the year
ended December 31, 2009 were $2,587.5 million compared to $3,142.8 million for the year ended
December 31, 2008. Net realized investment gains (losses) on investment sales for the years ended
December 31, 2009, 2008 and 2007 were as follows:
Net Impairment Losses Recognized in Earnings
During 2009, 2008 and 2007, the Company identified available for sale securities that were
considered to be other-than-temporarily impaired. During the second quarter of 2009, the Company
adopted new accounting guidance related to identifying whether an investment is considered to be
other than temporarily impaired, which is described in Note 2(d), “Summary of Significant
Accounting Policies—Investments,” of the notes accompanying our audited consolidated financial
statements. As a result, the Company initially considered whether it intended to sell or would be
more likely than not required to sell the securities in an unrealized loss position at December 31,
2009. The Company did not identify any such securities meeting these criteria. As such, the
Company performed various analysis and reviews, to determine whether the investments in an
unrealized loss position were other-than-temporarily impaired as a result of credit factors or
non-credit related factors. Other-than-temporary impairment losses recognized in earnings for the
years ended December 31, 2009, 2008 and 2007 were as follows:
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The $20.3 million of other-than-temporary impairment losses recognized by the Company in 2009
relating to specific credit events occurred primarily due to reductions in expected recovery values
on mortgage and asset-backed securities during the period, along with certain credit related
downgrades in corporate securities. For the years ended December 31, 2008 and 2007, the Company
recorded $82.1 and $17.3 million of OTTI losses in earnings, respectively. These amounts included
a portion related to credit losses and a portion related to non-credit factors. Non-credit related
factors included market and sector related factors such as limited liquidity and credit spread
widening.
As of December 31, 2009, the Company maintained an investment portfolio with an average credit
rating of AA+. The Company’s investment portfolio consists of both mortgage-backed and
asset-backed securities, which comprised 33.8% of total invested assets, including pending
securities transactions, fixed maturity investments, short-term investments, preferred equity
securities, cash and cash equivalents and other investments, at December 31, 2009. The Company,
along with its investment managers, monitors the nature and type of assets underlying these types
of securities. At December 31, 2009, the Company’s portfolio held no sub-prime mortgage exposure
and the Company’s Alt-A exposure represented 1.2% of the Company’s fixed income investments. Of the
Company’s Alt-A exposure, 81.0% are fixed rate securities.
Net Foreign Exchange Gains (Losses)
During 2009, the Company revalued its monetary assets and liabilities denominated in foreign
currencies, which resulted in net foreign exchange gains of $29.7 million compared to losses of
($53.7) million for 2008 and losses of ($8.0) million for 2007. The current year net foreign
exchange gains resulted from the strengthening of the U.K. pound sterling and weakening of the U.S.
dollar compared to other currencies. The Company had offsetting net unrealized foreign exchange
losses of $11.0 million (2008 — gains of $54.8 million, 2007 — gains of $10.8 million) from the
revaluation of its foreign currency invested assets included in the change in net unrealized
holding gains (losses) on investments within accumulated other comprehensive income (loss).
Net Losses and Loss Expenses
The Company’s reported net losses and loss expenses are characterized by various factors and
are significantly impacted by the occurrence or absence of catastrophic events and subsequent loss
emergence related to such events. For 2009, the Company’s net loss ratio benefited from the
absence of major catastrophes compared to 2008 which was adversely impacted by losses from
Hurricanes Gustav and Ike and severe weather and worse than expected growing conditions and lower
prices for major crops in the U.S., which adversely impacted the agriculture line of the Insurance
segment for 2008. The Company recorded losses, net of reinstatement premiums, related to
Hurricanes Gustav and Ike during 2008 of $148.0 million primarily in the Reinsurance segment.
Losses from Hurricanes Gustav and Ike added 8.9 percentage points to the Company’s net loss ratio
for 2008. The 2009 net loss ratio, however, included higher current accident year losses compared
to 2008 and 2007 primarily in the Company’s recently exited workers’ compensation insurance line,
reflecting the Company’s cautious view of current year loss reporting and deteriorating industry
trends as a result of legal and regulatory changes and potential claim cost changes.
During 2009, 2008 and 2007, the Company’s previously estimated ultimate losses for prior
accident years were reduced by $150.9 million, $156.5 million and $159.4 million, respectively, as
the loss emergence related to prior accident years was lower than expected, resulting in the
reserves held by the Company for those accident years being moderately redundant. The overall net
reduction in the Company’s estimated losses for prior accident years experienced in 2009 emerged in
the Company’s short tail, long tail and other lines of both the Insurance and Reinsurance segments.
The Company participates in lines of business where claims may not be reported for many years.
Accordingly, management does not believe that reported claims are the only valid means for
estimating ultimate obligations. Ultimate losses and loss expenses may differ materially from the amounts
recorded in the Company’s consolidated financial statements. These estimates are reviewed
regularly and, as experience develops and new information becomes known, the reserves are adjusted
as necessary. Reserve adjustments, if any, are recorded in earnings in the period in which they are determined.
The overall loss reserves were established by the Company’s actuaries and reflect management’s best
estimate of ultimate losses. See “Reserve for Losses and Loss Expenses” below for further
discussion.
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Acquisition Expenses
The Company’s acquisition expense ratio decreased in 2009 as compared to 2008 and 2007
primarily due to shifts in the earned premium mix, notably within the Insurance segment, partially
offset by higher profit commissions payable to ceding companies in the Reinsurance segment as a
result of improved performance and favorable loss emergence.
General and Administrative Expenses
The Company’s general and administrative expense ratio for 2009 increased as compared to 2008
and 2007 primarily due to above target incentive compensation expenses across the Company in 2009,
lower expense reimbursements in the agriculture line of the Insurance segment and from lower earned
premiums. At December 31, 2009, the Company had a total of 759 employees as compared to 781
employees at December 31, 2008 and 709 employees at December 31, 2007.
Net Income
The Company produced net income of $536.1 million in 2009 compared to $98.6 million in 2008
and $521.1 million in 2007. The increase in net income for 2009 compared to 2008 was primarily due
to a decline in losses and loss expenses as a result of the absence of significant catastrophe
events during 2009. In addition, the Company experienced growth in net investment income during
2009 specifically driven by increases in the value of the Company’s alternative investments and
high yield loan funds as well as the recognition of foreign exchange gains which were absent in
2008 and 2007.
Underwriting Results by Business Segment
The determination of the Company’s business segments is based on the manner in which
management monitors the performance of the Company’s underwriting operations. As a result, we
report two business segments — Insurance and Reinsurance.
Management measures the Company’s results on the basis of the combined ratio, which is
obtained by dividing the sum of the losses and loss expenses, acquisition expenses and general and
administrative expenses by net premiums earned. The Company’s historic combined ratios may not be
indicative of future underwriting performance. When purchased within a single line of business,
ceded reinsurance and recoveries are accounted for within that line of business. When purchased
across multiple lines of business, ceded reinsurance and recoveries are allocated to the lines of
business in proportion to the related risks assumed. The Company does not manage its assets by
business segment; accordingly, investment income and total assets are not allocated to the
individual business segments. General and administrative expenses incurred by business segments
are allocated directly. Remaining general and administrative expenses not directly incurred by the
segments are allocated primarily based on estimated consumption, headcount and other variables
deemed relevant to the allocation of such expenses. Ceded reinsurance and recoveries are recorded
within the segment to which they apply.
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Insurance
The following table summarizes the underwriting results and associated ratios for the
Company’s Insurance segment for the years ended December 31, 2009, 2008 and 2007.
Premiums. Net premiums written in the Insurance segment decreased in 2009 by 24.5%
compared to 2008 and increased 34.1% compared to 2007. Gross
and net premiums written for each line of business in the Insurance segment for the years ended
December 31, 2009, 2008 and 2007 were as follows:
The change in the Insurance business segment net premiums written in 2009 compared to 2008 was
driven by the following factors:
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The change in the Insurance business segment net premiums written in 2009 compared to 2007 was
driven by the full year impact of the Company’s acquisition of ARMtech, which was acquired in the
fourth
quarter of 2007. Partially offsetting this growth in 2009 compared to 2007, was the Company’s
exit from the California workers’ compensation and U.K. property insurance markets in the first
quarter of 2009 that contributed $273.0 million of net premiums written in 2007.
Ceded premiums written by the Company in the Insurance segment decreased in 2009 compared to
2008 because of decreased cessions to third party reinsurers associated with decreased gross
premiums written, principally in the agriculture line of business. The majority of premiums ceded
by the agriculture line of business were to the U.S. government through a federally sponsored crop
reinsurance program. Net premiums earned by the Company in the Insurance segment in 2009 decreased
compared to 2008 primarily due to declines in net premiums written during 2009. Net premiums
earned by the Company in the Insurance segment in 2009 increased compared to 2007 due to the
addition of ARMtech agriculture premiums written during 2009.
Net Losses and Loss Expenses. The net loss ratio in the Company’s Insurance segment in 2009
improved compared to 2008 primarily from improved loss experience in the agriculture line and
increased prior year favorable loss reserve development. During 2008, the Company’s agriculture
line was adversely impacted by significant declines in commodity prices for certain agricultural
products and severe weather that led to worse than expected growing conditions for major crops in
the U.S. The net loss ratio in the Company’s Insurance segment in 2009 was higher than the 2007
net loss ratio primarily due a shift in the mix of business toward the agriculture line of business
which has generally higher loss ratios than the other insurance lines of business. The net loss
ratio in the Company’s Insurance segment was adversely affected in 2009 due to higher current
accident and prior year loss ratios in the recently exited California workers’ compensation line
compared to 2008 and 2007 reflecting the Company’s cautious view of industry trends as a result of
legal and regulatory changes and potential claim cost changes.
The net loss ratio also benefited from higher favorable prior year loss reserve development
recorded for 2009 as compared to 2008 and 2007. Prior year loss reserves were reduced in 2009 by
$92.1 million as compared to reductions of $71.0 million and $80.4 million for the years ended
December 31, 2008 and 2007. Of the lines of business in the Company’s Insurance segment, the
short tail property, long tail healthcare liability and other agriculture lines experienced net
reductions in the Company’s estimated losses for prior accident years in 2009 as claims have not
materialized as originally estimated by the Company.
Acquisition Expenses. The Company’s acquisition expense ratio in the Insurance segment
decreased in 2009 as compared to 2008 and 2007 due to the reduction in worker’s compensation earned
premiums which had a higher commission expense structure than the remaining lines of the Insurance
segment.
General and Administrative Expenses. The Company’s general and administrative expense ratio
in the Insurance segment increased for 2009 compared to 2008 primarily due to reductions in third
party commissions and expense reimbursements offsets, primarily in the agriculture line as well as
higher incentive compensation expenses across the business compared to 2008. In addition, the
Company continued to make strategic employee additions in its agriculture and other U.S. specialty
insurance operations. The Company’s general and administrative expense ratio in the Insurance
segment decreased for 2009 compared to 2007 from the increases in agriculture premiums written and
earned for which general and administrative expenses were reduced by third party expense
reimbursements.
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Reinsurance
The following table summarizes the underwriting results and associated ratios for the
Company’s Reinsurance segment for the years ended December 31, 2009, 2008 and 2007.
Premiums. Net premiums written in the Reinsurance segment increased in 2009 by 7.7% over
2008 and decreased 15.4% over 2007. Gross and net premiums
written for each line of business in the Reinsurance segment for the years ended December 31, 2009,
2008 and 2007 were as follows:
The change in the Reinsurance business segment net premiums written during 2009 compared to
2008 and 2007 was driven by the following factors:
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Ceded premiums written by the Company in the Reinsurance segment was lower in 2009 compared to
2008 and 2007. During 2008, the Company’s $235 million multi-year, collateralized catastrophe
reinsurance protection purchased in 2006 expired.
Net premiums earned decreased in 2009 compared to 2008 and 2007 primarily due to a lag in
recognizing earned premium on business written in more recent periods.
Net Losses and Loss Expenses. The net loss ratio in the Company’s Reinsurance segment for
2009 decreased compared to 2008 and 2007 primarily as a result of the absence of significant
catastrophe activity. In 2008, the Company recorded combined losses, net of reinstatement
premiums, of approximately $148 million due to Hurricanes Gustav and Ike, which added 19.2
percentage points to the net loss ratio. In 2007, the net loss ratio was impacted by approximately
$40 million of net losses or 3.5 net loss ratio points due to European Windstorm Kyrill.
The Company experienced lower favorable loss reserve development from prior years in its
Reinsurance segment in 2009 compared to 2008 and 2007, with the majority of the current year
favorable loss reserve development emanating from this segment’s short tail catastrophe, property
and surety and other specialty lines of business. During 2009, 2008 and 2007, the Company’s
previously estimated ultimate losses for the Reinsurance segment for prior accident years were
reduced by $58.8 million, $85.5 million and $79.0 million, respectively. Favorable prior year loss
reserve development resulted as claims have not materialized as originally estimated by the
Company.
Acquisition Expenses. The Company’s acquisition expense ratio in the Reinsurance segment in
2009 was relatively consistent with 2008 and 2007.
General and Administrative Expenses. The general and administrative expense ratio experienced
by the Reinsurance segment in 2009 as compared to 2008 and 2007 increased as a result of higher
incentive compensation expenses and an increase in allocated corporate and service company expenses
against lower net premiums earned.
Significant Transaction
On December 7, 2007, Endurance Holdings’ U.S. based holding company acquired all outstanding
stock of ARMtech and its affiliates. The base purchase price was $120 million, plus additional
amounts as determined in accordance with the terms of the purchase agreement. The Company has paid
additional amounts of $22.7 million in settlement of its obligations under the purchase agreement
with ARMtech. ARMtech underwrites crop insurance primarily through the U.S. federally sponsored
Multiple Peril Crop Insurance Program. The Company recorded total goodwill and other intangible
assets of $45.2 million and $96.7 million, respectively, related to certain licenses, internally
developed software, non-compete agreements and customer relationships.
Liquidity and Capital Resources
Liquidity
Endurance Holdings is a holding company that does not have any significant operations or
assets other than its ownership of the shares of its direct and indirect subsidiaries, including
Endurance Bermuda, Endurance U.K., Endurance U.S. Reinsurance, Endurance American, Endurance
American Specialty, Endurance Risk Solutions and ARMtech. Endurance Holdings relies primarily on
dividends and other permitted distributions from its insurance subsidiaries to pay its operating
expenses, interest on debt and dividends, if any, on its common shares and Series A Preferred
Shares. There are restrictions on the payment of dividends by Endurance Bermuda, Endurance U.K.,
Endurance U.S. Reinsurance, Endurance American, Endurance American Specialty, Endurance Risk
Solutions and ARMtech to Endurance Holdings, which are described in more detail below.
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The ability of Endurance Bermuda to pay dividends is dependent on its ability to meet the
requirements of applicable Bermuda law and regulations. Under Bermuda law, Endurance Bermuda may
not declare or pay a dividend if there are reasonable grounds for believing that Endurance Bermuda
is, or would after the payment be, unable to pay its liabilities as they become due, or the
realizable value of Endurance Bermuda’s assets would thereby be less than the aggregate of its
liabilities and its issued share capital and share premium accounts. Further, Endurance Bermuda,
as a regulated insurance company in Bermuda, is subject to additional regulatory restrictions on
the payment of dividends or distributions. As of December 31, 2009, Endurance Bermuda could pay a
dividend or return additional paid-in capital totaling approximately $610 million without prior
regulatory approval based upon the Bermuda insurance and Companies Act regulations. In addition,
the Endurance Holdings has loaned Endurance Bermuda $300.0 million which is callable on demand.
Endurance U.S. Reinsurance, Endurance American, Endurance American Specialty and Endurance
Risk Solutions are subject to regulation by the State of Delaware Department of Insurance. ARMtech
is subject to regulation by the Texas Department of Insurance. Dividends for each U.S. operating
subsidiary are limited to the greater of 10% of policyholders’ surplus or statutory net income,
excluding realized capital gains. In addition, dividends may only be declared or distributed out
of earned surplus. At December 31, 2009, Endurance U.S. Reinsurance, Endurance American and
Endurance American Specialty did not have earned surplus; therefore, these companies are precluded
from declaring or distributing dividends during 2009 without the prior approval of the applicable
insurance regulator. At December 31, 2009, Endurance Risk Solutions and ARMtech (with notice to
the Texas Department of Insurance) could pay dividends of $3.8 million and $2.6 million,
respectively, without prior regulatory approval from the applicable regulators. In addition, any
dividends paid by Endurance American, Endurance American Specialty and Endurance Risk Solutions
would be subject to the dividend limitation of their respective parent insurance companies.
Under the jurisdiction of the United Kingdom’s Financial Services Authority (“FSA”), Endurance
U.K. must maintain a margin of solvency at all times, which is determined based on the type and
amount of insurance business written. The FSA regulatory requirements imposed no explicit
restrictions on Endurance U.K.’s ability to pay a dividend, but Endurance U.K. would have to notify
the FSA 28 days prior to any proposed dividend payment. Dividends may only be distributed from
profits available for distributions. At December 31, 2009, Endurance U.K. did not have profits
available for distributions.
Cash and Invested Assets.The Company’s aggregate invested assets, including fixed maturity
investments, short-term investments, preferred equity securities, other investments, cash and cash
equivalents and pending securities transactions, as of December 31, 2009 totaled $6.0 billion
compared to aggregate invested assets of $5.4 billion as of December 31, 2008. The increase in
invested assets since December 31, 2008 resulted from collections of premiums on insurance policies
and reinsurance contracts and investment income, offset in part by losses and loss expenses paid,
interest and dividends paid, acquisition expenses paid, reinsurance premiums paid, general and
administrative expenses paid, interest and dividends paid, and the repurchase of the Company’s
ordinary shares and realized losses in the investment portfolio.
As of December 31, 2009 and 2008, the Company had pledged cash and cash equivalents and fixed
maturity investments of $158.5 million and $147.9 million, respectively, in favor of certain ceding
companies to collateralize obligations. As of December 31, 2009 and 2008, the Company had also
pledged $664.0 million and $591.9 million of its cash and fixed maturity investments as required to
meet collateral obligations for $605.3 million and $550.8 million in letters of credit outstanding
under its credit facility, respectively. In addition, at December 31, 2009 and 2008, cash and
fixed maturity investments with fair values of $361.6 million and $234.8 million were on deposit
with U.S. state regulators, respectively, and cash and fixed maturity investments with fair values
of $12.4 million and $14.2 million were on deposit with Canadian regulators, respectively.
Cash flows from operating activities on a consolidated basis are provided by premiums
collected and investment income, offset by loss and loss expense payments and other general and
administrative expenses. Consolidated cash provided by operating activities for the years ended
December 31, 2009, 2008 and 2007 was $471.9 million, $479.4 million, and $480.5 million,
respectively.
Variable Delivery Forward. On September 11, 2007, Endurance Holdings consummated a variable
delivery equity forward sale arrangement under which Endurance Holdings is entitled to sell
ordinary shares to an affiliate of Deutsche Bank Securities, Inc. (the “forward counterparty”) for
proceeds of approximately $150 million pursuant to a prospectus supplement to the Shelf
Registration Statement on Form S-3ASR (Registration No. 333-130464) filed with the U.S. Securities
and Exchange Commission on September 12, 2007. Under the terms of the forward sale agreement,
Endurance Holdings will sell an aggregate of between 2,984,772 and
4,786,827 ordinary shares to the forward counterparty, subject to Endurance Holdings’ right to
cash settle or net share settle all or a portion of such agreement.
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Endurance Holdings did not receive any proceeds from the sale of the ordinary shares by the
forward counterparty, but Endurance Holdings will receive proceeds upon any prepayment, and may
receive proceeds upon settlement of the forward sale agreement. Subject to Endurance Holdings’
right to elect cash or net share settlement of, or to terminate early, all or a portion of the
forward sale agreement, the forward sale agreement will be physically settled by delivery of the
requisite number of Endurance Holdings’ ordinary shares beginning July 20, 2010. The forward
counterparty will pay Endurance Holdings approximately $150 million upon settlement of the forward
sale agreement. The number of Endurance Holdings’ ordinary shares to be delivered to the forward
counterparty varies depending upon the price of Endurance Holdings’ ordinary shares over a forty
trading-day period beginning July 15, 2010 subject to an aggregate maximum of 4,786,827 and an
aggregate minimum of 2,984,772 ordinary shares.
Endurance Holdings may accelerate settlement of or elect early termination with respect to,
all or a portion of the forward sale agreement. The forward counterparty may elect early
termination of the forward sale agreement upon the occurrence of certain events and the number of
ordinary shares deliverable upon settlement of the forward sale agreement may be adjusted depending
on the amount of dividends paid by Endurance Holdings or the occurrence of certain events.
Credit Facility. On May 8, 2007, Endurance Holdings amended its existing credit facility
among Endurance Holdings, various designated subsidiary borrowers, various lending institutions and
JPMorgan Chase Bank, N.A. as Administrative Agent to, among other things, increase the size of the
facility to $1,175 million from $925 million and to extend the maturity of the facility to May 8,
2012 (the “Credit Agreement”). On July 18, 2007, the Company entered into the First Amendment to
the Credit Agreement, to, among other things, modify the restrictive covenants in the Credit
Agreement to permit the Company to pay dividends on its preferred equity securities following the
occurrence of certain defaults as defined pursuant to the terms of the Credit Agreement. As
amended, the credit facility is referred to as the ''2007 Credit Facility.’’
The full amount of the 2007 Credit Facility is available for revolving credit borrowings and
for the issuance of letters of credit. The proceeds of the facility may be used for general
corporate and working capital purposes, to finance potential acquisitions and for the repurchase of
Endurance Holdings’ outstanding publicly or privately issued securities. So long as the Company is
not in default under the terms of the facility, the Company may request that the size of the
facility be increased by $500 million, provided that no participating lender is obligated to
increase its commitments under the facility.
Up to $675 million of borrowings or letter of credit issuances under the 2007 Credit Facility
may be collateralized by a portion of the investment portfolio of such subsidiary borrowing under
the facility. The facility allows for the issuance of up to $200 million in multicurrency letters
of credit and up to $300 million of fronted letters of credit that may also be multicurrency
letters of credit. Endurance Holdings guarantees the obligations of its subsidiaries that are
parties to the 2007 Credit Facility.
The interest rate for revolving loans under the 2007 Credit Facility is either (i) the higher
of (a) the Federal Funds Effective Rate plus 0.5% and (b) the prime commercial lending rate of
JPMorgan Chase Bank or (ii) LIBOR, plus a fee ranging from 0.165% to 0.375% depending on the
Company’s leverage ratio and if the loan is collateralized or uncollateralized. For letters of
credit issued on a collateralized basis, the Company is required to pay a fee ranging from 0.165%
to 0.29% on the daily stated amount of such letters of credit. For letters of credit issued on an
uncollateralized basis, the Company is required to pay a fee ranging from 0.275% to 0.375% on the
daily stated amount of such letters of credit. In addition, the 2007 Credit Facility requires the
Company to pay to the lenders a facility fee and a utilization fee.
The 2007 Credit Facility requires the Company’s compliance with certain customary restrictive
covenants. These include certain financial covenants, such as maintaining a leverage ratio (no
greater than 0.35:1.00 at any time) and a consolidated tangible net worth (no less than $1.4
billion at any time). In addition, each of the Company’s regulated insurance subsidiaries that
have a claims paying rating from A.M. Best must maintain a rating of at least B++ at all times.
The terms of the facility generally restrict the declaration or payment of dividends on the
Company’s common shares if the Company is already in default or the payment or declaration would
cause a default under the terms of the credit facility.
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The 2007 Credit Facility also contains customary event of default provisions, including
failure to pay principal or interest under the facility, insolvency of the Company, a change in
control of the Company, a breach of the Company’s representations or covenants in the facility or a
default by the Company under its other indebtedness. Upon the occurrence of an event of default
under the 2007 Credit Facility, the lenders can terminate their commitments under the revolving
credit facility, require repayment of any outstanding revolving loans, give notice of termination
of any outstanding letters of credit in accordance with their terms, require the delivery of cash
collateral for outstanding letters of credit and foreclose on any security held by the lenders
under the 2007 Credit Facility.
Commitments
At December 31, 2009, letters of credit totaling $605.3 million were outstanding, $200.0
million face value of 6.15% Senior Notes were outstanding and $250.0 million face value of 7%
Senior Notes (the “7% Senior Notes”) were outstanding.
The Company’s contractual obligations as of December 31, 2009 are summarized as follows:
These estimated obligations noted in the table above will be funded through operating cash
flows and existing cash and investments.
Capital Resources
Variable Delivery Forward. On September 11, 2007, Endurance Holdings consummated a variable
delivery equity forward sale arrangement as described above under the section entitled “Liquidity
and Capital Resources.”
Credit Facility. On May 8, 2007, Endurance Holdings amended its existing credit facility
among Endurance Holdings, various designated subsidiary borrowers, various lending institutions and
JPMorgan Chase Bank, N.A. as Administrative Agent to, as described above under the section entitled
“Liquidity and Capital Resources.”
The Company had outstanding as of December 31, 2009 and 2008 $605.3 million and $635.5
million, respectively, of letters of credit under the 2007 Credit Facility. The Company did not
have any revolving loans outstanding under the 2007 Credit Facility as of December 31, 2009. The
Company was in compliance with all covenants contained in the 2007 Credit Facility as of December
31, 2009.
Senior Indebtedness. On October 17, 2005, Endurance Holdings issued $200 million principal
amount of 6.15% Senior Notes. The 6.15% Senior Notes were offered by the underwriters at a price
of 99.639% of their principal amount, providing an effective yield to investors of 6.199%, and,
unless previously redeemed, will mature on October 15, 2015. Endurance Holdings used net proceeds
from the offering to repay the $143.5 million revolving loan then outstanding under the credit
facility as well as to provide additional capital to its subsidiaries and for other general
corporate purposes.
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On July 15, 2004, the Company issued $250 million principal amount of 7% Senior Notes. The 7%
Senior Notes were offered by the underwriters at a price of 99.108% of their principal amount,
providing an effective yield to investors of 7.072%, and, unless previously redeemed, will mature
on July 15, 2034.
The 6.15% Senior Notes and the 7% Senior Notes (collectively, the “Senior Notes”) are senior
unsecured obligations of Endurance Holdings and rank equally with all of Endurance Holdings’
existing and future unsecured and unsubordinated debt. The Senior Notes are also effectively
junior to claims of creditors of Endurance Holdings’ subsidiaries, including policyholders, trade
creditors, debt holders, and taxing authorities.
The indentures governing the Senior Notes contain customary covenants and events of default
for senior unsecured indebtedness, including events of default for non-payment of principal or
interest, breaches of covenants, insolvency of the Company or a default by the Company under other
outstanding indebtedness.
At December 31, 2009, the carrying value of the Senior Notes stood at $447.4 million while the
fair value as determined by quoted market valuation was $439.1 million. The Company was in
compliance with all covenants contained within the indentures governing the Senior Notes as of
December 31, 2009.
Given that the Company’s Senior Notes and the 2007 Credit Facility contain cross default
provisions, the risk exists that the holders of the Senior Notes and the lenders under the credit
facility may declare such debt due and payable, which could result in an acceleration of all debt
due under both the Senior Notes and the 2007 Credit Facility. If this were to occur, the Company
may not have liquid funds sufficient to repay any or all of such indebtedness.
Preferred Shares. On October 10, 2005, Endurance Holdings issued 8,000,000 shares of its
7.75% Non-Cumulative Preferred Shares, Series A (the “Series A Preferred Shares”). The Series A
Preferred Shares sold in the offering were registered under the Securities Act of 1933, as amended,
and are traded on the New York Stock Exchange. The Series A Preferred Shares were issued at a
price to the public of $25.00 per share. Endurance Holdings received net proceeds from this
offering of $193.5 million after expenses and underwriting discounts. The proceeds from this
offering were used to provide additional capital to Endurance Holdings’ subsidiaries and for other
general corporate purposes.
The Series A Preferred Shares have no stated maturity date and are redeemable in whole or in
part at the option of Endurance Holdings any time after December 15, 2015 at a redemption price of
$25.00 per share plus any declared and unpaid dividends, without accumulation of any undeclared
dividends. Endurance Holdings may redeem all but not less than all of the Series A Preferred
Shares before that date at a redemption price of $26.00 per share, plus any declared and unpaid
dividends, to the date of redemption, if Endurance Holdings is required to
submit a proposal to the holders of the Series A Preferred Shares concerning an amalgamation,
consolidation, merger, similar corporate transaction or change in Bermuda law.
Dividends on the Series A Preferred Shares, when, as and if declared by the Board of Directors
of Endurance Holdings or a duly authorized committee of the board, accrue and are payable on the
liquidation preference amount from the original issue date, quarterly in arrears on each dividend
payment date, at an annual rate of 7.75%. Dividends on the Series A Preferred Shares are not
cumulative.
Upon any voluntary or involuntary liquidation, dissolution or winding-up of Endurance
Holdings, holders of the Series A Preferred Shares and any parity shares are entitled to receive
out of Endurance Holdings’ assets available for distribution to shareholders, before any
distribution is made to holders of Endurance Holdings’ common equity securities, a liquidating
distribution in the amount of $25 per Series A Preferred Share plus any declared and unpaid
dividends, without accumulation of any undeclared dividends. Distributions will be made pro rata
as to the Series A Preferred Shares and any parity shares and only to the extent of Endurance
Holdings’ assets, if any, that are available after satisfaction of all liabilities to creditors.
In conjunction with the issuance by the Company of the Series A Preferred Shares, the Company
entered into a “Declaration of Covenant” for the benefit of the holders of the 7% Senior Notes.
The Covenant states that the Company will redeem its Series A Preferred Shares only if the total
redemption price is less than or equal to the proceeds Endurance Holdings or its subsidiaries have
received during the six months prior to the date of such redemption from the sale of certain
qualifying securities that, among other things, are, with limited exceptions, pari passu with or
junior to the Series A Preferred Shares upon the Company’s liquidation, dissolution or winding-up;
perpetual, or have a mandatory redemption or maturity date that is not less than sixty years after
the initial issuance of such securities; and provide for dividends or other income distributions
that are non-cumulative.
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Holders of the Series A Preferred Shares have no voting rights, except with respect to certain
fundamental changes in the terms of the Series A Preferred Shares and in the case of certain
dividend non-payments or as otherwise required by Bermuda law or Endurance Holdings’ bye-laws.
On an ongoing basis, the Company expects its internally generated funds, together with
borrowings available under the 2007 Credit Facility, capital generated from the exercise of the
Company’s variable delivery forward, offering and sale of its Senior Notes, Series A Preferred
Shares and ordinary shares, to be sufficient to operate its business. However, there can be no
assurance that the Company will not incur additional indebtedness or issue additional equity or
hybrid securities in order to implement its business strategy or pay claims.
Off-Balance Sheet Arrangements
Shackleton Re Limited (“Shackleton”), the entity from which Endurance Bermuda purchased $235
million of collateralized catastrophe reinsurance in 2006, is a variable interest entity. The final
component of the Company’s coverage under Shackleton expired as of July 31, 2008. The Company had
a variable interest in Shackleton but was not the primary beneficiary of Shackleton and therefore
was not required to consolidate Shackleton in its consolidated financial statements. Please see
“Ceded Reinsurance” section below for further details related to this transaction.
Currency and Foreign Exchange
The Company’s functional currencies are U.S. dollars for its U.S. and Bermuda operations and
British Sterling for its U.K. operations. The reporting currency for all entities is U.S. dollars.
The Company maintains a portion of its investments and liabilities in currencies other than the
U.S. dollar. The Company has made a significant investment in the capitalization of Endurance U.K.
Endurance U.K. is subject to the United Kingdom’s Financial Services Authority rules concerning
the matching of the currency of its assets to the currency of its liabilities. Depending on the
profile of Endurance U.K.’s liabilities, it may be required to hold some of its assets in
currencies corresponding to the currencies of its liabilities. The Company may, from time to time,
experience losses resulting from fluctuations in the values of foreign currencies, which could have
a material adverse effect on the Company’s results of operations.
Assets and liabilities of foreign operations whose functional currency is not the U.S. dollar
are translated at exchange rates in effect at the balance sheet date. Revenues and expenses of
such foreign operations are translated at average exchange rates during the year. The effect of
the translation adjustments for foreign operations is included in accumulated other comprehensive
income.
Other monetary assets and liabilities denominated in foreign currencies are revalued at the
exchange rates in effect at the balance sheet date with the resulting foreign exchange gains and
losses included in earnings. Revenues and expenses denominated in foreign currencies are translated
at the prevailing exchange rate on the transaction date.
Effects of Inflation
The effects of inflation could cause the severity of claims to rise in the future. The
Company’s estimates for losses and loss expenses include assumptions about future payments for
settlement of claims and claims handling expenses, such as medical treatments and litigation costs.
To the extent inflation causes these costs to increase above reserves established for these
claims, the Company will be required to increase the reserve for losses and loss expenses with a
corresponding reduction in its earnings in the period in which the deficiency is identified.
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Reserve for Losses and Loss Expenses
Reserving Process
The Company establishes loss and loss expense reserves to provide for the estimated costs of
paying claims under insurance policies and reinsurance contracts underwritten by the Company. These
reserves include estimates for both claims that have been reported and those that have been
incurred but not reported and include estimates of all expenses associated with processing and
settling these claims. Estimating the ultimate cost of future claims and claim adjustment expenses
is an uncertain and complex process. This estimation process is based largely on the assumption
that past developments are an appropriate predictor of future events and involves a variety of
actuarial techniques and judgments that analyze experience, trends and other relevant factors.
The Company’s reserving actuaries, who are independent of the Company’s business units, review
the Company’s loss and loss expense reserves on a quarterly basis for both current and prior
accident years using the most current claims data. These reserve reviews incorporate a variety of
actuarial methods and judgments, including the three most common methods of actuarial evaluation
used within the insurance industry, the Bornhuetter-Ferguson method, the expected loss ratio method
and the loss development method. One actuarial method used by the Company to estimate reserves for
losses and loss expenses is the expected loss ratio approach, which is based on expected results
independent of current loss reporting activity. This approach is typically used for immature loss
periods (i.e., the current accident year). The Bornhuetter-Ferguson method involves the
application of selected loss ratios to the Company’s earned premiums to determine estimates of
ultimate expected unpaid claims and claims expenses for each underwriting year. When the IBNR
reserves are added to the losses and loss expenses amounts with respect to claims that have been
reported to date, an estimated ultimate expected loss results. The Company believes that this
method provides a more stable estimate of IBNR reserves that is insulated from wide variations in
reported losses. In contrast, the loss development method extrapolates the current value of
reported losses to ultimate expected losses by using selected reporting patterns of losses over
time. The selected reporting patterns are based on historical information (organized into loss
development triangles) and are adjusted to reflect the changing characteristics of the book of
business written by the Company. The Company uses these multiple methods, supplemented with its own
actuarial and professional judgment, to establish its best estimate of loss and loss expense
reserves.
The estimate of the reserve for losses and loss expenses is reviewed each quarter by the
Company’s Loss Reserve Committee, consisting of the Company’s Chief Executive Officer, Chief
Financial Officer, Chief Actuary and representatives of various disciplines from within the
Company, such as claims, underwriting and legal.
Current Reserve for Losses and Loss Expenses
In order to capture the key dynamics of loss development and expected volatility that may
arise within the disclosed amounts for the reserve for losses and loss expenses, the key lines of
business within each business segment are aggregated based on their potential expected length of
loss emergence. The period over which loss emergence occurs is typically referred to as the tail.
The Company has classified its lines of business as either having a “short,” “long” or “other” tail
pattern. The Company views short tail business as that for which development typically emerges
within a period of several quarters while long tail business would emerge over many years. The
Company’s short tail lines of business in the Insurance segment includes property; long tail lines
of business include casualty, healthcare liability, workers’ compensation and professional lines.
The Company’s short tail lines of business in the Reinsurance segment include catastrophe,
property, marine, aerospace and surety while the long tail line of business is casualty related
business. Within the Company’s Reinsurance segment, the Company
writes certain specialty lines of business for which the loss emergence is considered unique
in nature and thus, has been included as “other” in the table below.
As more fully described under “Reserving Process” above, the Company incorporates a variety of
actuarial methods and judgments in its reserving process. Two key inputs in the various actuarial
methods employed by the Company are initial expected loss ratios and expected loss reporting
patterns. These key inputs impact the potential variability in the estimate of the reserve for
losses and loss expenses and are applicable to each of the Company’s business segments. The
Company’s loss and loss expense reserves consider and reflect, in part, deviations resulting from
differences between expected loss and actual loss reporting as well as judgments relating to the
weights applied to the reserve levels indicated by the actuarial methods. Expected loss reporting
patterns are based upon internal and external historical data and assumptions regarding claims
reporting trends over a period of time that extends beyond the Company’s own operating history.
Differences between actual reported losses and expected losses are anticipated to occur in any
individual period and such deviations may influence future initial expected loss ratios and/or
expected loss reporting patterns as the recent actual experience becomes part of the historical
data utilized as part of the ongoing reserve estimation process. The Company has demonstrated the
impact of changes in the speed of the loss reporting patterns, as well as changes in the expected
loss ratios, within the table under the heading “Potential Variability in Reserves for Losses and
Loss Expenses” beginning on page 90.
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Losses and loss expenses for the year ended December 31, 2009 are summarized as follows:
Losses and loss expenses for the year ended December 31, 2009 include $150.9 million in
favorable development of reserves relating to prior accident years. The favorable loss reserve
development experienced during the 2009 year benefited the Company’s 2009 reported loss ratio by
approximately 9.2 percentage points. The net reduction in estimated losses for prior accident years
reflects lower than expected loss emergence in the Company’s short tail, long tail and other lines
within both the Insurance and Reinsurance segments.
For the year ended December 31, 2009, the Company did not materially alter the two key inputs
it utilizes to establish its reserve for losses and loss expenses, initial expected loss ratios or
loss reporting patterns, for business related to prior years for the insurance and reinsurance
reserve categories as the variances in reported losses in 2009 for those reserve categories were
within the range of possible results anticipated by the Company.
Short Tail Insurance. The prior year favorable loss development in the short tail insurance
category was primarily as a result of lower than expected claims reported and favorable case
reserve development in the Company’s property line of business. As a result, the Company reduced
its estimated losses and loss expenses related to prior years in this reserve category during 2009.
Long Tail Insurance. The favorable loss emergence within the long tail insurance reserve
category was primarily due to lower than expected claims activity and favorable case settlement
within the healthcare liability line of business. During the latter part of the year the favorable
loss emergence in healthcare liability was partially offset by adverse loss development in the
recently exited workers’ compensation line of business resulting from the Company’s cautious view
of industry trends and potential claim cost changes due to medical inflation. In addition, the
Company also experienced adverse loss emergence related to credit crisis exposures within the
professional lines of business.
Other Insurance. The Company recorded favorable loss emergence within this reserve category
due to lower than anticipated claims settlements for the 2008 crop year in the agriculture line of
business recorded in the earlier part of 2009.
Short Tail Reinsurance. The Company recorded favorable loss emergence within this reserve
category primarily due to lower than expected claims activity and favorable case reserve
development within the catastrophe, surety and other specialty, and property lines of business and
the aerospace portion of the aerospace and marine line of business. The favorable emergence was
partially offset by unfavorable loss development within the marine portion of the aerospace and
marine line of business.
Long Tail Reinsurance. The Company recorded a modest amount of favorable loss emergence
within this reserve category during 2009. For the year the Company experienced favorable prior
period development within the direct casualty and professional laibility lines of business due to
lower than anticipated claim activity. This was offset to some degree by adverse development within
the treaty casualty line of business, primarily due to higher than expected reported loss activity
from prior years.
Other Reinsurance. Favorable loss emergence in the other reinsurance reserve category
was due to lower than expected loss activity within the agriculture, personal accident,
self-insured and special accounts lines
of business. The agriculture line of business contributed a significant amount to the
favorable development which resulted from lower than anticipated claim settlements for the 2008
crop year.
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Losses and loss expenses for the year ended December 31, 2008 are summarized as follows:
Losses and loss expenses for the year ended December 31, 2008 include $156.5 million in
favorable development of reserves relating to prior accident years. The favorable loss reserve
development experienced during the 2008 year benefited the Company’s 2008 reported loss ratio by
approximately 8.9 percentage points. The net reduction in estimated losses for prior accident years
reflects lower than expected loss emergence in the Company’s short tail, long tail and other lines
within both the Insurance and Reinsurance segments.
For the year ended December 31, 2008, the Company did not materially alter the two key inputs
it utilizes to establish its reserve for losses and loss expenses, initial expected loss ratios or
loss reporting patterns, for business related to prior years for the insurance and reinsurance
reserve categories as the variances in reported losses in 2008 for those reserve categories were
within the range of possible results anticipated by the Company.
Short Tail Insurance. The lower than expected losses and loss expenses related to prior years
in the short tail insurance category were primarily a result of favorable claims emergence in the
Company’s property line of business. As a result, the Company reduced its estimated losses and
loss expenses related to prior years in this reserve category during 2008.
Long Tail Insurance. Lower than expected claims activity within the healthcare liability line
of business resulted in a reduction in estimated losses and loss expenses related to prior years
for this reserve category. This favorable development was partially offset by unfavorable
development in the Company’s professional line of business.
Other Insurance. Lower than anticipated agriculture claims settlements for the 2007 crop year
resulted in a reduction in estimated losses and loss expenses for prior years within this reserve
category.
Short Tail Reinsurance. Favorable loss emergence in the short tail reinsurance reserve
category was due to lower than expected loss activity within the treaty catastrophe, treaty
property, surety and aerospace lines of business partially offset by higher than expected loss
activity within the Company’s marine line of business.
Long Tail Reinsurance. The lower than expected losses and loss expenses related to prior
years in the long tail reinsurance reserve category were principally due to favorable development
in the Company’s treaty casualty line of business.
Other Reinsurance. Favorable loss emergence in the other reinsurance reserve category was due
to lower than expected loss activity within the agriculture, personal accident, self-insured and
special accounts lines of business.
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Reserves for losses and loss expenses were comprised of the following at December 31, 2009:
Reserves for losses and loss expenses were comprised of the following at
December 31, 2008:
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Selected quarterly activity in the reserve for losses and loss expenses for the year ended
December 31, 2009 is summarized as follows:
The following table represents the development of GAAP balance sheet reserve for losses
and loss expenses, net of losses and loss expenses recoverable, for 2002 through December 31, 2009.
This table does not present accident or policy year development data. The top line of the table
shows the gross and net reserve for losses and loss expenses at the balance sheet date for each of
the indicated years. This represents the estimated amounts of gross and net losses and loss
expenses arising in the current year and all prior years that are unpaid at the balance sheet date,
including IBNR reserves. The table also shows the re-estimated amount of the previously recorded
reserve based on experience as of the end of each succeeding year. The estimate changes as more
information becomes known about the frequency and severity of claims for individual years. The
“cumulative redundancy” represents the aggregate change to date from the original estimate.
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The table also shows the cumulative paid amounts as of successive years with respect to the
reserve liability. All amounts reflect the conversion from the original currency of the underlying
business if not denominated in U.S. dollars. The data in the table has been restated using the
rate of exchange to U.S. dollars as of December 31, 2009. Information presented herein may differ
materially from that reported in the Company’s financial statements due to differences in foreign
currency exchange rates.
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