|
|
 | | | |
- close
- close
- close
- close
PartnerRe 10-Q 2010 Table of Contents
UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2010 OR
For the transition period from to . Commission file number 1-14536
PartnerRe Ltd. (Exact name of Registrant as specified in its charter)
90 Pitts Bay Road, Pembroke, HM08, Bermuda (Address of principal executive offices) (Zip Code) (441) 292-0888 (Registrant’s telephone number, including area code) Not Applicable (Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨ 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 x No ¨ Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x The number of the Registrant’s common shares (par value $1.00 per share) outstanding, net of treasury shares, as of August 2, 2010 was 75,590,936.
Table of ContentsINDEX TO FORM 10-Q
Table of ContentsPART I—FINANCIAL INFORMATION
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Shareholders of PartnerRe Ltd. We have reviewed the accompanying condensed consolidated balance sheet of PartnerRe Ltd. and subsidiaries (the “Company”) as of June 30, 2010, and the related condensed consolidated statements of operations and comprehensive income for the three-month and six-month periods ended June 30, 2010 and 2009, and of shareholders’ equity, and of cash flows for the six-month periods ended June 30, 2010 and 2009. These interim condensed consolidated financial statements are the responsibility of the Company’s management. We conducted our reviews in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion. Based on our reviews, we are not aware of any material modifications that should be made to such condensed consolidated interim financial statements for them to be in conformity with accounting principles generally accepted in the United States of America. We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of PartnerRe Ltd. and subsidiaries as of December 31, 2009 and the related consolidated statements of operations and comprehensive income, shareholders’ equity, and of cash flows for the year then ended (not presented herein); and in our report dated March 1, 2010, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 2009 is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.
Hamilton, Bermuda August 9, 2010
1
Table of ContentsUnaudited Condensed Consolidated Balance Sheets (Expressed in thousands of U.S. dollars, except parenthetical share and per share data)
See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.
2
Table of ContentsUnaudited Condensed Consolidated Statements of Operations and Comprehensive Income (Expressed in thousands of U.S. dollars, except share and per share data)
See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.
3
Table of ContentsUnaudited Condensed Consolidated Statements of Shareholders’ Equity (Expressed in thousands of U.S. dollars)
See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.
4
Table of ContentsUnaudited Condensed Consolidated Statements of Cash Flows (Expressed in thousands of U.S. dollars)
See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.
5
Table of ContentsNotes to Unaudited Condensed Consolidated Financial Statements 1. Organization PartnerRe Ltd. (the Company) provides reinsurance on a worldwide basis through its principal wholly-owned subsidiaries, including Partner Reinsurance Company Ltd., Partner Reinsurance Europe Limited, Partner Reinsurance Company of the U.S., PARIS RE SA and PARIS RE Switzerland AG. Risks reinsured include, but are not limited to, property, casualty, motor, agriculture, aviation/space, catastrophe, credit/surety, engineering, energy, marine, specialty property, specialty casualty, multiline and other lines, life/annuity and health and alternative risk products. The Company’s alternative risk products include weather and credit protection to financial, industrial and service companies on a worldwide basis. 2. Significant Accounting Policies The Company’s Unaudited Condensed Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States (U.S. GAAP) for interim financial information and with the instructions for Form 10-Q and Article 10 of Regulation S-X. The Unaudited Condensed Consolidated Financial Statements include the accounts of the Company and its subsidiaries. Intercompany accounts and transactions have been eliminated. The preparation of financial statements in conformity with U.S. GAAP requires Management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. While Management believes that the amounts included in the Unaudited Condensed Consolidated Financial Statements reflect its best estimates and assumptions, actual results could differ from those estimates. The Company’s principal estimates include:
In the opinion of Management, all adjustments (which include normal recurring adjustments) necessary for a fair presentation of results for the interim periods have been made. As the Company’s reinsurance operations are exposed to low-frequency, high-severity risk events, some of which are seasonal, results for certain interim periods may include unusually low loss experience, while results for other interim periods may include significant catastrophic losses. Consequently, the Company’s results for interim periods are not necessarily indicative of results for the full year. These Unaudited Condensed Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009. The following significant accounting policies were adopted by the Company during the six months ended June 30, 2010. The adoption of these policies did not have an impact on the Company’s consolidated shareholders’ equity or net income.
The Company is involved in the normal course of business with VIEs as a passive investor in certain asset-backed securities, other fixed maturity investments and limited partnerships, that are issued by third party VIEs. The Company’s maximum exposure to loss with respect to these investments is limited to the investment carrying amounts reported in the Company’s Unaudited Condensed Consolidated Balance Sheets and any unfunded commitments. The Company also has three indirect wholly-owned subsidiaries that are considered to be VIEs, which were utilized to issue the Company’s Senior Notes and Capital Efficient Notes (see Note 16 to Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009). The Company determined that it was not the primary beneficiary of any of these VIEs as of June 30, 2010.
6
Table of ContentsPartnerRe Ltd. Notes to Unaudited Condensed Consolidated Financial Statements—(Continued)
3. New Accounting Pronouncements In March 2010, the FASB issued new accounting guidance for embedded credit derivatives, which clarifies that only a credit derivative related to the subordination of one financial instrument to another is exempt from embedded derivative bifurcation requirements. As a result, entities that have contracts containing an embedded credit derivative feature in a form other than such subordination, may need to separately account for the embedded credit derivative feature. This guidance is effective for interim and annual periods beginning after June 15, 2010, with early adoption permitted. The adoption of this guidance will not have an impact on the Company’s consolidated shareholders’ equity or net income. In July 2010, the FASB issued new accounting guidance which requires companies to enhance the disclosures related to the credit quality of financing receivables and the allowances for credit losses. This guidance is effective for interim and annual periods ending on or after December 15, 2010. The Company is currently evaluating the impact of the adoption of this guidance on its disclosures. 4. Fair Value (a) Fair Value of Financial Instrument Assets The fair value hierarchy prioritizes the inputs to valuation techniques used to measure fair value by maximizing the use of observable inputs and minimizing the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are inputs that market participants would use in pricing an asset or liability based on market data obtained from sources independent of the Company. Unobservable inputs are inputs that reflect the Company’s assumptions about what market participants would use in pricing the asset or liability based on the best information available in the circumstances. The level in the hierarchy within which a given fair value measurement falls is determined based on the lowest level input that is significant to the measurement. The Company determines the appropriate level in the hierarchy for each financial instrument that it measures at fair value. In determining fair value, the Company uses various valuation approaches, including market, income and cost approaches. The hierarchy is broken down into three levels based on the reliability of inputs as follows:
The Company’s financial instruments that it measures at fair value using Level 1 inputs generally include: equities listed on a major exchange, exchange traded funds and exchange traded derivatives, such as futures and certain weather derivatives, that are actively traded.
The Company’s financial instruments that it measures at fair value using Level 2 inputs generally include: U.S. Treasury bonds; U.S. Government Sponsored Entities; Organization for Economic Co-operation and Development Sovereign Treasury bonds; investment grade and high yield corporate bonds; catastrophe bonds; mortgage-backed securities; asset-backed securities; foreign exchange forward contracts and over-the-counter derivatives such as foreign currency option contracts, equity put and call options, credit default swaps and interest rate swaps.
The Company’s financial instruments that it measures at fair value using Level 3 inputs generally include: unlisted equities including preference shares; unit trusts; inactively traded fixed maturities; real estate mutual fund investments; notes receivable and total return swaps.
7
Table of ContentsPartnerRe Ltd. Notes to Unaudited Condensed Consolidated Financial Statements—(Continued)
The Company’s financial instruments measured at fair value include investments classified as trading securities, certain other invested assets and the segregated investment portfolio underlying the funds held – directly managed account. At June 30, 2010 and December 31, 2009, the Company’s financial instruments measured at fair value were categorized between Levels 1, 2 and 3 as follows (in thousands of U.S. dollars):
During the three months and six months ended June 30, 2010, there were no significant transfers between Levels 1 and 2.
8
Table of ContentsPartnerRe Ltd. Notes to Unaudited Condensed Consolidated Financial Statements—(Continued)
At June 30, 2010 and December 31, 2009, the aggregate carrying amounts of items included in other invested assets that the Company did not measure at fair value were $252.9 million and $169.3 million, respectively, which primarily related to the Company’s investments that are accounted for using the cost method of accounting, equity method of accounting or investment company accounting. At June 30, 2010 and December 31, 2009, the aggregate carrying amounts of items included in the funds held – directly managed account that the Company did not measure at fair value were $116.7 million and $123.9 million, respectively, which primarily related to other assets and liabilities held by Colisée Re related to the underlying business, which are carried at cost (see Note 7 to the Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009). In addition to the investments underlying the funds held – directly managed account held at fair value of $1,685.3 million and $1,830.3 million at June 30, 2010 and December 31, 2009, respectively, the funds held – directly managed account included cash and cash equivalents, carried at fair value, of $51.5 million and $145.4 million, respectively, and accrued investment income of $21.8 million and $25.2 million, respectively. At June 30, 2010 and December 31, 2009, substantially all of the accrued investment income and the accrued investment income related to the investments underlying the funds held – directly managed account in the Unaudited Condensed Consolidated Balance Sheets related to investments for which the fair value option was elected.
9
Table of ContentsPartnerRe Ltd. Notes to Unaudited Condensed Consolidated Financial Statements—(Continued)
The following tables are reconciliations of the beginning and ending balances for all financial instruments measured at fair value using Level 3 inputs for the three months ended June 30, 2010 and 2009 (in thousands of U.S. dollars):
10
Table of ContentsPartnerRe Ltd. Notes to Unaudited Condensed Consolidated Financial Statements—(Continued)
The following tables are reconciliations of the beginning and ending balances for all financial instruments measured at fair value using Level 3 inputs for the six months ended June 30, 2010 and 2009 (in thousands of U.S. dollars):
During the six months ended June 30, 2010, certain fixed maturities with a fair value of $18 million were transferred from Level 3 into Level 2. The reclassifications to Level 2 consisted of municipal (included within U.S. government and agencies), corporate and student loans (included within asset-backed securities) fixed maturities. The transfers into Level 2 were due to the availability of quoted prices for similar assets in active markets used for valuation as of June 30, 2010, resulting from the continued recovery of the financial markets. In addition, during the six months ended June 30, 2010, certain derivatives with a fair value in a net liability position of $8 million were transferred out of Level 3 into Level 2 due to the availability of externally modeled quoted prices that use observable inputs.
11
Table of ContentsPartnerRe Ltd. Notes to Unaudited Condensed Consolidated Financial Statements—(Continued)
During the six months ended June 30, 2010, certain fixed maturities within the investments underlying the funds held – directly managed account with a fair value of $17 million were transferred from Level 2 into Level 3. The reclassification into Level 3 consisted of asset-backed securities and residential and commercial mortgage-backed securities. The transfers into Level 3 were the result of the lack of observable market inputs, leading the Company to apply inputs that were not directly observable. Changes in the fair value of the Company’s financial instruments subject to the fair value option during the three months and six months ended June 30, 2010 and 2009 were as follows (in thousands of U.S. dollars):
N/A: not applicable All of the above changes in fair value are included in the Unaudited Condensed Consolidated Statements of Operations under the caption Net realized and unrealized investment gains. The following methods and assumptions were used by the Company in estimating the fair value of each class of financial instrument recorded in the Unaudited Condensed Consolidated Balance Sheets. There have been no material changes in the Company’s valuation techniques during the periods presented. Fixed maturities and short-term investments Substantially all of the Company’s fixed maturities and short-term investments are categorized as Level 2 within the fair value hierarchy. The Company receives prices from independent pricing sources to measure the fair values of its fixed maturity investments. The independent pricing sources 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 that are not actively traded. In general, these methods involve the use of “matrix pricing” in which the independent pricing source applies the credit spread for a comparable security that has traded recently to the current yield curve to determine a reasonable fair value. The Company uses a pricing service ranking to consistently select the most appropriate pricing service in instances where it receives multiple quotes on the same security. When fair values are unavailable from these independent pricing sources, quotes are obtained directly from broker-dealers who are active in the corresponding markets. Most of the Company’s fixed maturities are priced from the pricing services or dealer quotes. The Company will typically not make adjustments to prices received from pricing services or dealer quotes; however, in instances where the quoted external price for a security uses significant unobservable inputs, the Company will categorize that security as Level 3. The Company’s inactively traded fixed maturities are classified as Level 3. For all fixed maturity investments, the bid price is used for estimating fair value. To validate prices, the Company compares the fair value estimates to its knowledge of the current market and will investigate prices that it considers not to be representative of fair value. The Company also reviews an internally generated fixed maturity price validation report which converts prices received for fixed maturity investments from the independent pricing sources and from broker-dealers quotes and plots option adjusted spreads (OAS) and duration on a sector and rating basis. The OAS is calculated using established algorithms developed by an independent risk analytics platform vendor. The OAS on the fixed maturity price validation report are compared for securities in a similar sector and having a similar rating, and outliers are identified and investigated for price reasonableness. In addition, the Company completes quantitative analyses to compare the performance of each fixed maturity investment portfolio to the performance of an appropriate benchmark, with significant differences identified and investigated. Equities The majority of the Company’s equities are categorized as Level 1 within the fair value hierarchy. In determining the fair value for equities and exchange traded funds categorized as Level 1, the Company uses prices received from independent pricing sources based on closing exchange prices. Equities categorized as Level 3 are generally mutual funds invested in securities other than the common stock of publicly traded companies, where the net asset value is not provided on a daily basis. To validate prices, the Company completes quantitative analyses to compare the performance of each equity investment portfolio to the performance of an appropriate benchmark, with significant differences identified and investigated.
12
Table of ContentsPartnerRe Ltd. Notes to Unaudited Condensed Consolidated Financial Statements—(Continued)
Other invested assets The Company’s exchange traded derivatives, such as futures, options and certain weather derivatives are categorized as Level 1 and foreign exchange forward contracts, foreign currency option contracts, equity put and call options, interest rate swaps, and credit default swaps are categorized as Level 2 within the fair value hierarchy. Included in the Company’s Level 3 categorization are unlisted equities including preference shares, unit trusts, credit linked notes, notes receivable and total return swaps. The Company will generally either (i) receive a price based on a manager’s or trustee’s valuation for the asset; or (ii) develop an internal discounted cash flow model to measure fair value. Where the Company receives prices from the manager or trustee, these prices are based on the manager’s or trustee’s estimate of fair value for the assets and are generally audited on an annual basis. Where the Company develops its own discounted cash flow models, the inputs will be specific to the asset in question, based on appropriate historical information, adjusted as necessary, and using appropriate discount rates. As part of the Company’s modeling to determine the fair value of an investment, the Company considers counterparty credit risk as an input to the model, however, the majority of the Company’s counterparties are highly rated institutions and the failure of any one counterparty would not have a significant impact on the Company’s financial statements. To validate prices, the Company will compare them to benchmarks, where appropriate, or to the business results generally within that asset class and specifically to those particular assets. In addition, the fair value measurements of all Level 3 investments are presented to, and peer reviewed by, an internal valuation committee that the Company has established. Funds held – directly managed The segregated investment portfolio underlying the funds held – directly managed account is comprised of fixed maturities, short-term investments and other invested assets which are fair valued on a basis consistent with the methods described above. Substantially all fixed maturities and short-term investments within the funds held – directly managed account are categorized as Level 2 within the fair value hierarchy. The other invested assets within the segregated investment portfolio underlying the funds held – directly managed account, which are categorized as Level 3 investments, are primarily real estate mutual fund investments carried at fair value. For the real estate mutual fund investments, the Company receives a price based on the real estate fund manager’s valuation for the asset and further adjusts the price, if necessary, based on appropriate current information on the real estate market. To validate prices within the segregated investment portfolio underlying the funds held – directly managed account, the Company utilizes the methods described above. (b) Fair Value of Financial Instrument Liabilities The methods and assumptions used by the Company in estimating the fair value of each class of financial instrument liability recorded in the Unaudited Condensed Consolidated Balance Sheet at June 30, 2010, for which the Company does not measure that instrument at fair value, did not change from December 31, 2009, except for the fair value of the capital efficient notes (CENts), which was based on quoted market prices. The fair value of the Senior Notes, issued on March 10, 2010, was based on quoted market prices (see Note 5). The carrying values and fair values of the financial instrument liabilities recorded in the Unaudited Condensed Consolidated Balance Sheets as of June 30, 2010 and December 31, 2009 were as follows (in thousands of U.S. dollars):
13
Table of ContentsPartnerRe Ltd. Notes to Unaudited Condensed Consolidated Financial Statements—(Continued)
5. Debt Related to Senior Notes On March 10, 2010, PartnerRe Finance B LLC (PartnerRe Finance B), an indirect wholly-owned subsidiary of the Company, issued $500.0 million aggregate principal amount of 5.500% Senior Notes (Senior Notes). The Senior Notes will mature on June 1, 2020 and may be redeemed at the option of the issuer, in whole or in part, at any time. Interest on the Senior Notes is payable semi-annually commencing on June 1, 2010 at an annual fixed rate of 5.500%, and cannot be deferred. The Senior Notes are ranked as senior unsecured obligations of PartnerRe Finance B. The Company has fully and unconditionally guaranteed all obligations of PartnerRe Finance B under the Senior Notes. The Company’s obligations under this guarantee are senior and unsecured and rank equally with all other senior unsecured indebtedness of the Company. The proceeds from the Senior Notes were used for general corporate purposes. Contemporaneously, PartnerRe U.S. Holdings, a wholly-owned subsidiary of the Company, issued a 5.500% promissory note, with a principal amount of $500.0 million to PartnerRe Finance B. Under the terms of the promissory note, PartnerRe U.S. Holdings promises to pay to PartnerRe Finance B the principal amount on June 1, 2020, unless previously paid. Interest on the promissory note is payable semi-annually commencing on June 1, 2010 at an annual fixed rate of 5.500%, and cannot be deferred. 6. Net Income per Share The reconciliation of basic and diluted net income per share is as follows (in thousands of U.S. dollars or shares, except per share amounts):
7. Derivatives The Company’s derivative instruments are recorded in the Unaudited Condensed Consolidated Balance Sheets at fair value, with changes in fair value mainly recognized in either net foreign exchange gains and losses or net realized and unrealized investment gains and losses in the Unaudited Condensed Consolidated Statements of Operations or accumulated other comprehensive income or loss in the Unaudited Condensed Consolidated Balance Sheets, depending on the nature of the derivative instrument. The Company’s objectives for holding or issuing these derivatives are as follows: Foreign Exchange Forward Contracts The Company utilizes foreign exchange forward contracts as part of its overall currency risk management and investment strategies. From time to time, the Company also utilizes foreign exchange forward contracts to hedge a portion of its net investment exposure resulting from the translation of its foreign subsidiaries and branches whose functional currency is other than the U.S. dollar. Foreign Currency Option Contracts and Futures Contracts The Company also utilizes foreign currency option contracts to mitigate foreign currency risk. The Company uses exchange traded treasury note futures contracts to manage portfolio duration and commodity and equity futures to hedge certain investments.
14
Table of ContentsPartnerRe Ltd. Notes to Unaudited Condensed Consolidated Financial Statements—(Continued)
Credit Default Swaps The Company purchases protection through credit default swaps to mitigate the risk associated with its underwriting operations, most notably in the credit/surety line, and to manage market exposures. The Company also assumes credit risk through credit default swaps to replicate investment positions. The original term of these credit default swaps is generally five years or less and there are no recourse provisions associated with these swaps. While the Company would be required to perform under exposure assumed through credit default swaps in the event of a default on the underlying issuer, no issuer was in default at June 30, 2010. The counterparties on the Company’s assumed credit default swaps are all highly rated financial institutions. Insurance-Linked Securities The Company has entered into various weather derivatives, weather futures and a longevity total return swap for which the underlying risks include parametric weather risks for the weather derivatives and weather futures, and longevity risk for the longevity total return swap. Total Return and Interest Rate Swaps and Interest Rate Derivatives The Company has entered into total return swaps referencing various project and principal finance obligations. The Company has also entered into interest rate swaps to mitigate interest rate risk on certain total return swaps and interest rate derivatives to mitigate exposure to interest rate volatility. The fair values and the related notional values of derivatives included in the Company’s Unaudited Condensed Consolidated Balance Sheets at June 30, 2010 and December 31, 2009 were as follows (in thousands of U.S. dollars):
The fair value of all derivatives at June 30, 2010 and December 31, 2009 is recorded in other invested assets in the Company’s Unaudited Condensed Consolidated Balance Sheets. The effective portion of net investment hedging derivatives recognized in accumulated other comprehensive income at December 31, 2009 was a loss of $66.3 million. The effective portion of interest rate derivatives recognized in accumulated other comprehensive income at December 31, 2009 was a gain of $6.4 million. There were no net investment hedges or interest rate derivatives outstanding at June 30, 2010. The gains and losses in the Unaudited Condensed Consolidated Statements of Operations for derivatives not designated as hedges for the three and six months ended June 30, 2010 and 2009 were as follows (in thousands of U.S. dollars):
15
Table of ContentsPartnerRe Ltd. Notes to Unaudited Condensed Consolidated Financial Statements—(Continued)
8. Off-Balance Sheet Arrangements On April 28, 2010, under the terms of the amendment to the forward sale agreement with the forward counterparty, the remaining $200 million forward sale agreement matured. Subsequent to maturity and commencing on April 28, 2010, there was a 40 day valuation period, whereby the Company could deliver up to 3.4 million common shares over the valuation period, subject to a minimum price per share of $59.05 and a maximum price per share of $84.15. As a result of the Company’s share price trading between the minimum and the maximum price per share during the valuation period, the Company did not deliver any common shares to the forward counterparty. See Off-Balance Sheet Arrangements in Notes 15 and 18 to Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009. 9. Credit Agreements In the normal course of its operations, the Company enters into agreements with financial institutions to obtain unsecured and secured credit facilities. These facilities are used primarily for the issuance of letters of credit, although a portion of these facilities may also be used for liquidity purposes. On May 14, 2010, the Company entered into an agreement to modify an existing credit facility with Credit Suisse AG. Under the terms of the agreement, this credit facility was increased from a $100 million unsecured credit facility to a $250 million combined credit facility, with the initial $100 million being unsecured and any utilization above that being secured. This credit facility matures on May 14, 2011, and can be extended automatically to May 14, 2012. See Note 21 to the Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009 for a discussion of the credit facilities available to the Company. 10. Commitments and Contingencies (a) Concentration of Credit Risk The Company’s investment portfolio is managed following prudent standards of diversification and a prudent investment philosophy. The Company is not exposed to any significant credit concentration risk on its investments, except for debt securities issued or guaranteed by the U.S. and other AAA rated sovereign governments. As of June 30, 2010, the Company’s fixed maturity investments included $787 million, or 11.1% of the Company’s total shareholders’ equity, of AAA rated debt securities issued by the government of France. As of December 31, 2009, the Company’s fixed maturity investments included $814 million, or 10.6% of the Company’s total shareholders’ equity, of AAA rated debt securities issued by the government of France. The Company keeps cash and cash equivalents in several banks and may keep up to $500 million, excluding custodial accounts, at any point in time in any one bank. See Note 19(a) to the Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009 for a complete description of the Company’s credit risks and the related credit risk management strategies and controls. (b) Employment Agreements In April 2010, as part of the Company’s integration of PARIS RE (Paris Re), the Company announced a voluntary termination plan (voluntary plan) available to certain eligible employees in France. During the three months and six months ended June 30, 2010, the Company recorded charges of $33.8 million and $35.2 million, respectively, related to the voluntary plan within other operating
16
Table of ContentsPartnerRe Ltd. Notes to Unaudited Condensed Consolidated Financial Statements—(Continued)
expenses. Employees participating in the voluntary plan have no compulsory notice periods, however, their expected leaving dates are over the next 18 months. Participating employees will continue to receive salary and other employment benefits until they leave the Company. The continuing salary and other employment benefits costs related to participating employees will be expensed as the employee provides service and remains with the Company. (c) Legal Proceedings Legal proceedings at June 30, 2010 have not changed significantly since December 31, 2009. See Note 19(e) to the Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009. 11. Segment Information The Company monitors the performance of its operations in three segments, Non-life, Life and Corporate and Other as described in Note 22 to the Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009. The Non-life segment is further divided into five sub-segments: U.S., Global (Non-U.S.) P&C, Global (Non-U.S.) Specialty, Catastrophe and Paris Re. Because the Company does not manage its assets by segment, net investment income is not allocated to the Non-life segment. However, because of the interest-sensitive nature of some of the Company’s Life products, net investment income is considered in Management’s assessment of the profitability of the Life segment. The following items are not considered in evaluating the results of the Non-life and Life segments: net realized and unrealized investment gains and losses, net realized gain on purchase of CENts, interest expense, amortization of intangible assets, net foreign exchange gains and losses, income tax expense or benefit and interest in earnings and losses of equity investments. Segment results are shown before consideration of intercompany transactions. Management measures results for the Non-life segment on the basis of the loss ratio, acquisition ratio, technical ratio, other operating expense ratio and combined ratio (defined below). Management measures results for the Non-life sub-segments on the basis of the loss ratio, acquisition ratio and technical ratio. Management measures results for the Life segment on the basis of the allocated underwriting result, which includes revenues from net premiums earned, other income or loss and allocated net investment income for Life, and expenses from life policy benefits, acquisition costs and other operating expenses.
17
Table of ContentsPartnerRe Ltd. Notes to Unaudited Condensed Consolidated Financial Statements—(Continued)
The following tables provide a summary of the segment revenues and results for the three months and six months ended June 30, 2010 and 2009 (in millions of U.S. dollars, except ratios): Segment Information For the three months ended June 30, 2010
18
Table of ContentsPartnerRe Ltd. Notes to Unaudited Condensed Consolidated Financial Statements—(Continued)
Segment Information For the three months ended June 30, 2009
19
Table of ContentsPartnerRe Ltd. Notes to Unaudited Condensed Consolidated Financial Statements—(Continued)
Segment Information For the six months ended June 30, 2010
20
Table of ContentsPartnerRe Ltd. Notes to Unaudited Condensed Consolidated Financial Statements—(Continued)
Segment Information For the six months ended June 30, 2009
21
Table of ContentsPartnerRe Ltd. Notes to Unaudited Condensed Consolidated Financial Statements—(Continued)
12. Subsequent Events On July 7, 2010, the Company agreed to sell its entire ownership of ChannelRe Holdings (ChannelRe), a Bermuda based non-publicly traded financial guaranty reinsurer, in consideration for cash of $9.7 million. Following the sale, the Company no longer has an ownership interest in ChannelRe and has no contractual obligations to provide capital or other financial support to ChannelRe. The carrying value of the Company’s investment in ChannelRe immediately prior to its sale was $nil, resulting in a realized gain on sale of $9.7 million, which the Company will record in its Consolidated Statements of Operations for the three months and nine months ended September 30, 2010 (see Note 24 to the Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009). On July 12, 2010, the Company repaid the $200 million remaining half of the original $400 million loan agreement with Citibank N.A. (see Note 15 to Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009). On July 12, 2010, the Company announced certain changes in its executive management group. Related to these changes, on July 28, 2010, the Company entered into a separation agreement with a member of executive management. As a result, the Company expects to recognize an additional pre-tax charge of approximately $10 million during the remainder of 2010. On July 16, 2010, the Company terminated its existing $660 million five-year syndicated unsecured credit facility, which had a maturity date of September 30, 2010, and entered into a new $750 million three-year syndicated unsecured credit facility. The new facility has the following terms: (i) a maturity date of July 16, 2013, (ii) a $250 million accordion feature, which enables the Company to potentially increase its available credit from $750 million to $1 billion, and (iii) a minimum consolidated tangible net worth requirement. The Company’s ability to increase its available credit to $1 billion is subject to the agreement of the credit facility participants, which may be limited. The Company’s breach of any of the covenants would result in an event of default, upon which the Company may be required to repay any outstanding borrowings and replace or cash collateralize letters of credit issued under these facilities. The new facility will predominantly be used for the issuance of letters of credit, although the Company and its subsidiaries have access to a revolving line of credit of up to $375 million as part of this facility.
22
Table of Contents
Executive Overview The Company is a leading global reinsurer, with a broadly diversified and balanced portfolio of traditional reinsurance risks and capital markets risks. Successful risk management is the foundation of the Company’s value proposition, with diversification of risks at the core of its risk management strategy. The Company’s ability to succeed in the risk assumption and management business is dependent on its ability to accurately analyze and quantify risk, to understand volatility and how risks aggregate or correlate, and to establish the appropriate capital requirements and absolute limits for the risks assumed. All risks are managed by the Company within an integrated framework of policies and processes that ensure the intelligent and consistent evaluation and valuation of risk, and ultimately provide an appropriate return to shareholders. The Company’s economic objective is to manage a portfolio of risks that will generate compound annual diluted book value per share growth of 10 percent and an average operating return on beginning shareholders’ equity of 13 percent over a reinsurance cycle. See Executive Overview—Key Financial Measures and Other Key Issues of Management in Item 7 of Part II of the Company’s Annual Report on Form 10-K for the year ended December 31, 2009. Risk Management A key challenge in the reinsurance industry is to create economic value through the intelligent assumption of reinsurance and capital markets and investment risk, but also to limit or mitigate those risks that can destroy tangible as well as intangible value. Management believes that every organization faces numerous risks that could threaten the successful achievement of a company’s goals and objectives. These include choice of strategy and markets, economic and business cycles, competition, changes in regulation, data quality and security, fraud, business interruption and management continuity; all factors which can be viewed as either strategic or operational risks that are common to any industry. See Risk Factors in Item 1A of Part I of the Company’s Annual Report on Form 10-K for the year ended December 31, 2009 and Risk Factors in Item 1A of Part II of the Company’s Quarterly Report on Form 10-Q for the three months ended March 31, 2010. In addition to these risks, the Company assumes risks and its results are primarily determined by how well the Company understands, prices and manages assumed risk. While many industries and companies start with a return goal and then attempt to shed risks that may derail that goal, the Company starts with a capital-based risk appetite and then looks for risks that meet its return targets within that framework. Management believes that this construct allows the Company to balance the cedants’ need for absolute certainty of claims payment with the shareholders’ need for an adequate return on their capital. See Executive Overview—Other Key Issues of Management—Risk Management in Item 7 of Part II of the Company’s Annual Report on Form 10-K for the year ended December 31, 2009 for a complete description of the Company’s risks, risk management framework and the related risk management strategies and controls. The Company manages assumed risk at a strategic level through diversification, risk appetite, and absolute limits. For each key risk, the Board approves a risk appetite that the Company defines as the percentage of economic capital the Company is willing to expose to economic loss with a modeled probability of occurring once every 15 years and once every 75 years. The Company manages its exposure to key risks such that the modeled economic loss at a 1 in 15 year and a 1 in 75 year return period are less than the economic capital the Company is willing to expose to the key risks at those return periods. The major risks to the Company’s balance sheet are typically due to events that Management refers to as shock losses. The Company defines a shock loss as an event that has the potential to materially impact economic value. The Company defines its economic value as the difference between the net present value of tangible assets and the net present value of liabilities, using appropriate risk discount rates, plus the unrecognized value of our Life portfolio. For traded assets, the calculated net present values are equivalent to market values. There are four areas of risk that the Company has currently identified as having the greatest potential for shock losses: catastrophe, reserving for casualty and other long-tail lines, equity and equity-like investment risk and longevity risk. The Company manages the risk of shock losses by setting risk appetite and limits, as described above and below, for each type of shock loss. The Company establishes limits to manage the absolute maximum foreseeable loss from any one event and considers the possibility that several shock losses could occur at one time, for example a major catastrophe event accompanied by a collapse in the equity markets. Management believes that the limits that it has placed on shock losses will allow the Company to continue writing business should such an event occur. See Executive Overview—Other Key Issues of Management—Risk Management in Item 7 of Part II of the Company’s Annual Report on Form 10-K for the year ended December 31, 2009 for a discussion of the Company’s exposure to catastrophe risk, casualty reserving risk and equity investment risk.
23
Table of ContentsDuring the three months ended March 31, 2010, Management identified longevity risk as the fourth area of risk having the potential for shock losses. Management considers longevity exposure to have a material accumulation potential and has established a limit to manage the risk of loss associated with this exposure. The Company defines longevity risk as the potential for increased actual and future expected annuity payments resulting from annuitants living longer than expected, or the expectation that annuitants will live longer in the future. Assuming longevity risk, through reinsurance or capital markets transactions, is part of the Company’s strategy of building a diversified portfolio of risks. While longevity risk is highly diversifying in relation to other risks in the Company’s portfolio (e.g. mortality products), longevity risk itself is a systemic risk with little opportunity to diversify within the risk class. Longevity risk accumulates across cedants, geographies, and over time because mortality trends can impact diverse populations in the same manner. Longevity risk can manifest slowly over time as experience proves annuitants are living longer than original expectations, or abruptly as in the case of a “miracle drug” that increases the life expectancy of all annuitants simultaneously. In order to determine a longevity limit metric for the purposes of risk accumulation, the Company examined extreme scenarios and measured its exposure to loss under those scenarios. Examples of these scenarios included, but were not limited to, immediate elimination of major causes of death and an extreme improvement scenario equivalent to the adverse result of every annuitant’s life expectancy increasing to approximately 100 years. The Company did not rely upon modeled losses to determine the limit metric, but did benchmark the scenario results against existing tests, scenarios and models. For risk accumulation purposes, the Company selected the most extreme scenario and added an additional margin for error. The Company selected a longevity limit of $2 billion. To measure utilization of the longevity limit (accumulation of longevity exposure), the Company accumulates the net present value of adverse loss resulting from the application of the selected extreme scenario and additional margin applied to every in-force longevity treaty and the notional value of any longevity insurance-linked security. Other risks such as interest rate risk and credit spread risk have the ability to impact results substantially and may result in volatility in results from period to period, but Management believes that by themselves, they are unlikely to represent a material downside threat to the Company’s long-term economic value. See Quantitative and Qualitative Disclosures about Market Risk in Item 3 of Part I of this report for additional disclosure on interest rate risk, credit spread risk, foreign currency risk, counterparty credit risk and equity price risk. The Company seeks to maintain a risk appetite moderately above the average of the reinsurance market because Management believes that this position offers the best potential for creating shareholder value at an acceptable risk level. The most profitable products generally present the most volatility and potential downside risk. Management believes that the Company’s actual risk profile is equal to or less than the average of the reinsurance market because of the level of diversification achieved in the portfolio, the strict adherence to risk appetite and limits, and the risk mitigation strategies employed. The limits and actual exposures of the Company for its major risks were as follows:
N/A: not applicable The risk appetite and modeled economic loss for the Company’s major risks were as follows:
24
Table of ContentsCritical Accounting Policies and Estimates Critical Accounting Policies and Estimates of the Company at June 30, 2010 have not changed materially compared to December 31, 2009. See Critical Accounting Policies and Estimates in Management’s Discussion and Analysis of Financial Condition and Results of Operations in Item 7 of Part II of the Company’s Annual Report on Form 10-K for the year ended December 31, 2009. The following discussion updates specific information related to the Company’s estimates for losses and loss expenses and life policy benefits and valuation of investments and funds held – directly managed, including certain derivative financial instruments. Losses and Loss Expenses and Life Policy Benefits Losses and Loss Expenses Because a significant amount of time can elapse between the assumption of risk, occurrence of a loss event, the reporting of the event to an insurance company (the primary company or the cedant), the subsequent reporting to the reinsurance company (the reinsurer) and the ultimate payment of the claim on the loss event by the reinsurer, the Company’s liability for unpaid losses and loss expenses (loss reserves) is based largely upon estimates. The Company categorizes loss reserves into three types of reserves: reported outstanding loss reserves (case reserves), additional case reserves (ACRs) and incurred but not reported (IBNR) reserves. The Company updates its estimates for each of the aforementioned categories on a quarterly basis using information received from its cedants. The Company also estimates the future unallocated loss adjustment expenses (ULAE) associated with the loss reserves and these form part of the Company’s loss adjustment expense reserves. The Company’s Non-life loss reserves for each category and sub-segment are reported in the table included later in this section. The amount of time that elapses before a claim is reported to the cedant and then subsequently reported to the reinsurer is commonly referred to in the industry as the reporting tail. For all lines, the Company’s objective is to estimate ultimate losses and loss expenses. Total loss reserves are then calculated by subtracting losses paid. Similarly, IBNR reserves are calculated by subtraction of case reserves and ACRs from total loss reserves. The Company analyzes its ultimate losses and loss expenses after consideration of the loss experience of various reserving cells. The Company assigns treaties to reserving cells and allocates losses from the treaty to the reserving cell. The reserving cells are selected in order to ensure that the underlying treaties have homogeneous loss development characteristics (e.g., reporting tail) but are large enough to make estimation of trends credible. The selection of reserving cells is reviewed annually and changes over time as the business of the Company evolves. For each reserving cell, the Company’s estimates of loss reserves are reached after a review of the results of several commonly accepted actuarial projection methodologies. In selecting its best estimate, the Company considers the appropriateness of each methodology to the individual circumstances of the reserving cell and underwriting year for which the projection is made. See Critical Accounting Policies and Estimates—Losses and Loss Expenses and Life Policy Benefits in Item 7 of Part II of the Company’s Annual Report on Form 10-K for the year ended December 31, 2009 for additional information on the reserving methodologies employed by the Company, the principal reserving methods used for the reserving lines, the principal parameter assumptions underlying the methods and the main underlying factors upon which the estimates of reserving parameters are predicated. The Company’s best estimate of total loss reserves is typically in excess of the midpoint of the actuarial reserve estimates. The Company believes that there is potentially significant risk in estimating loss reserves for long-tail lines of business and for immature underwriting years that may not be adequately captured through traditional actuarial projection methodologies as these methodologies usually rely heavily on projections of prior year trends into the future. In selecting its best estimate of future liabilities, the Company considers both the results of actuarial point estimates of loss reserves as well as the potential variability of these estimates as captured by a reasonable range of actuarial reserve estimates. The selected best estimates of reserves are always within the indicated reasonable range of estimates indicated by the Company’s actuaries. During the three months and six months ended June 30, 2010 and 2009, the Company reviewed its estimate for prior year losses for each sub-segment of the Non-life segment and, in light of developing data, determined to adjust its ultimate loss ratios for prior accident years. The following table summarizes the net prior year favorable reserve development for the Company’s Non-life segment for the three months and six months ended June 30, 2010 and 2009 (in millions of U.S. dollars):
| |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||