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PartnerRe 10-Q 2011
Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2011

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to              .

Commission file number 1-14536

 

 

PartnerRe Ltd.

(Exact name of registrant as specified in its charter)

 

 

 

Bermuda   Not Applicable
(State of incorporation)  

(I.R.S. Employer

Identification No.)

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 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.

 

Large accelerated filer   x    Accelerated filer   ¨
Non-accelerated filer   ¨    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

The number of the registrant’s common shares (par value $1.00 per share) outstanding, net of treasury shares, as of April 29, 2011 was 67,522,909.

 

 

 


Table of Contents

PartnerRe Ltd.

INDEX TO FORM 10-Q

 

     Page  
PART I—FINANCIAL INFORMATION   

ITEM 1.

   Financial Statements   
   Report of Independent Registered Public Accounting Firm      3   
   Unaudited Condensed Consolidated Balance Sheets—March 31, 2011 and December 31, 2010      4   
   Unaudited Condensed Consolidated Statements of Operations and Comprehensive (Loss) Income—Three Months Ended March 31, 2011 and 2010      5   
   Unaudited Condensed Consolidated Statements of Shareholders’ Equity—Three Months Ended March 31, 2011 and 2010      6   
   Unaudited Condensed Consolidated Statements of Cash Flows—Three Months Ended March 31, 2011 and 2010      7   
   Notes to Unaudited Condensed Consolidated Financial Statements      8   

ITEM 2.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations      22   

ITEM 3.

   Quantitative and Qualitative Disclosures about Market Risk      54   

ITEM 4.

   Controls and Procedures      57   
PART II—OTHER INFORMATION   

ITEM 1.

   Legal Proceedings      57   

ITEM 1A.

   Risk Factors      57   

ITEM 2.

   Unregistered Sales of Equity Securities and Use of Proceeds      58   

ITEM 3.

   Defaults upon Senior Securities      58   

ITEM 4.

   Reserved      58   

ITEM 5.

   Other Information      58   

ITEM 6.

   Exhibits      58   
   Signatures      59   
   Exhibit Index      60   


Table of Contents

PART I—FINANCIAL INFORMATION

 

Item 1. Financial Statements

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 March 31, 2011, and the related condensed consolidated statements of operations and comprehensive (loss) income for the three-month periods ended March 31, 2011 and 2010, and of shareholders’ equity, and of cash flows for the three-month periods ended March 31, 2011 and 2010. 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, 2010 and the related consolidated statements of operations and comprehensive (loss) income, shareholders’ equity, and of cash flows for the year then ended (not presented herein); and in our report dated February 28, 2011, 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, 2010 is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

 

/s/ Deloitte & Touche
Deloitte & Touche

Hamilton, Bermuda

May 4, 2011

 

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Table of Contents

PartnerRe Ltd.

Unaudited Condensed Consolidated Balance Sheets

(Expressed in thousands of U.S. dollars, except parenthetical share and per share data)

 

     March 31,
2011
    December 31,
2010
 

Assets

    

Investments:

    

Fixed maturities, trading securities, at fair value (amortized cost: 2011, $12,968,674; 2010, $12,394,797)

   $ 13,258,543     $ 12,824,389  

Short-term investments, trading securities, at fair value (amortized cost: 2011, $81,094; 2010, $49,132)

     80,707       49,397  

Equities, trading securities, at fair value (cost: 2011, $908,144; 2010, $942,745)

     1,053,083       1,071,676  

Other invested assets

     292,220       352,405  
                

Total investments

     14,684,553       14,297,867  

Funds held – directly managed (cost: 2011, $1,506,386; 2010, $1,751,276)

     1,514,453       1,772,118  

Cash and cash equivalents, at fair value, which approximates amortized cost

     2,009,737       2,111,084  

Accrued investment income

     187,718       201,928  

Reinsurance balances receivable

     2,515,845       2,076,884  

Reinsurance recoverable on paid and unpaid losses

     456,352       382,878  

Funds held by reinsured companies

     848,182       937,032  

Deferred acquisition costs

     671,417       595,557  

Deposit assets

     231,922       256,702  

Net tax assets

     14,270       14,960  

Goodwill

     455,533       455,533  

Intangible assets

     166,187       178,715  

Other assets

     146,606       83,113  
                

Total assets

   $ 23,902,775     $ 23,364,371  
                

Liabilities

    

Unpaid losses and loss expenses

   $ 11,887,316     $ 10,666,604  

Policy benefits for life and annuity contracts

     1,670,768       1,750,410  

Unearned premiums

     2,102,053       1,599,139  

Other reinsurance balances payable

     505,198       491,194  

Deposit liabilities

     241,948       268,239  

Net tax liabilities

     257,062       316,325  

Accounts payable, accrued expenses and other

     242,608       244,552  

Debt related to senior notes

     750,000       750,000  

Debt related to capital efficient notes

     70,989       70,989  
                

Total liabilities

     17,727,942       16,157,452  
                

Shareholders’ Equity

    

Common shares (par value $1.00, issued: 2011, 84,271,175 shares; 2010, 84,033,089 shares)

     84,271       84,033  

Series C cumulative preferred shares (par value $1.00, issued and outstanding: 2011 and 2010, 11,600,000 shares; aggregate liquidation value: 2011 and 2010, $290,000)

     11,600       11,600  

Series D cumulative preferred shares (par value $1.00, issued and outstanding: 2011 and 2010, 9,200,000 shares; aggregate liquidation value: 2011 and 2010, $230,000)

     9,200       9,200  

Additional paid-in capital

     3,429,429       3,419,864  

Accumulated other comprehensive income:

    

Currency translation adjustment

     53,882       16,101  

Other accumulated comprehensive loss (net of tax of: 2011, $5,395; 2010, $4,872)

     (12,280     (12,045

Retained earnings

     3,908,446       4,761,178  

Common shares held in treasury, at cost (2011, 16,831,534 shares; 2010, 14,046,895 shares)

     (1,309,715     (1,083,012
                

Total shareholders’ equity

     6,174,833       7,206,919  
                

Total liabilities and shareholders’ equity

   $ 23,902,775     $ 23,364,371  
                

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

 

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PartnerRe Ltd.

Unaudited Condensed Consolidated Statements of Operations and Comprehensive (Loss) Income

(Expressed in thousands of U.S. dollars, except share and per share data)

 

     For the three
months ended
March 31,
2011
    For the three
months ended
March 31,
2010
 

Revenues

    

Gross premiums written

   $ 1,557,561     $ 1,909,326  
                

Net premiums written

   $ 1,470,419     $ 1,784,165  

Increase in unearned premiums

     (405,830     (630,386
                

Net premiums earned

     1,064,589       1,153,779  

Net investment income

     151,633       173,122  

Net realized and unrealized investment (losses) gains

     (112,199     145,474  

Other income

     1,813       1,274  
                

Total revenues

     1,105,836       1,473,649  

Expenses

    

Losses and loss expenses and life policy benefits

     1,607,217       1,012,337  

Acquisition costs

     207,849       220,107  

Other operating expenses

     104,297       128,134  

Interest expense

     12,300       7,132  

Amortization of intangible assets

     8,827       4,803  

Net foreign exchange gains

     (695     (3,627
                

Total expenses

     1,939,795       1,368,886  

(Loss) income before taxes and interest in earnings of equity investments

     (833,959     104,763  

Income tax (benefit) expense

     (26,258     27,554  

Interest in earnings of equity investments

     745       2,445  
                

Net (loss) income

     (806,956     79,654  

Preferred dividends

     8,631       8,631  
                

Net (loss) income available to common shareholders

   $ (815,587   $ 71,023  
                

Comprehensive (loss) income

    

Net (loss) income

   $ (806,956   $ 79,654  

Change in currency translation adjustment

     37,781       (68,743

Change in other accumulated comprehensive loss, net of tax

     (235     (3,933
                

Comprehensive (loss) income

   $ (769,410   $ 6,978  
                

Per share data

    

Net (loss) income per common share:

    

Basic net (loss) income

   $ (11.99   $ 0.87  

Diluted net (loss) income

   $ (11.99   $ 0.85  

Weighted average number of common shares outstanding

     67,997,426       81,696,881  

Weighted average number of common shares and common share equivalents outstanding

     67,997,426       83,328,824  

Dividends declared per common share

   $ 0.55     $ 0.50  

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

 

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PartnerRe Ltd.

Unaudited Condensed Consolidated Statements of Shareholders’ Equity

(Expressed in thousands of U.S. dollars)

 

     For the three
months ended
March 31,
2011
    For the three
months ended
March 31,
2010
 

Common shares

    

Balance at beginning of period

   $ 84,033     $ 82,586  

Issuance of common shares

     238       441  
                

Balance at end of period

     84,271       83,027  

Preferred shares

    

Balance at beginning and end of period

     20,800       20,800  

Additional paid-in capital

    

Balance at beginning of period

     3,419,864       3,357,004  

Issuance of common shares

     9,565       16,041  
                

Balance at end of period

     3,429,429       3,373,045  

Accumulated other comprehensive income

    

Balance at beginning of period

     4,056       84,927  

Change in currency translation adjustment

     37,781       (68,743

Change in other accumulated comprehensive loss, net of tax

     (235     (3,933
                

Balance at end of period

     41,602       12,251  

Retained earnings

    

Balance at beginning of period

     4,761,178       4,100,782  

Net (loss) income

     (806,956     79,654  

Dividends on common shares

     (37,145     (40,701

Dividends on preferred shares

     (8,631     (8,631
                

Balance at end of period

     3,908,446       4,131,104  

Common shares held in treasury

    

Balance at beginning of period

     (1,083,012     (372

Repurchase of common shares

     (226,703     (231,344
                

Balance at end of period

     (1,309,715     (231,716
                

Total shareholders’ equity

   $ 6,174,833     $ 7,388,511  
                

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

 

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PartnerRe Ltd.

Unaudited Condensed Consolidated Statements of Cash Flows

(Expressed in thousands of U.S. dollars)

 

     For the three
months ended
March 31,
2011
    For the three
months ended
March 31,
2010
 

Cash flows from operating activities

    

Net (loss) income

   $ (806,956   $ 79,654  

Adjustments to reconcile net (loss) income to net cash provided by operating activities:

    

Amortization of net premium on investments

     17,759       17,957  

Amortization of intangible assets

     8,827       4,803  

Net realized and unrealized investment losses (gains)

     112,199       (145,474

Changes in:

    

Reinsurance balances, net

     (404,556     (643,079

Reinsurance recoverable on paid and unpaid losses, net of ceded premiums payable

     19,179       25,580  

Funds held by reinsured companies and funds held – directly managed

     393,061       111,504  

Deferred acquisition costs

     (51,434     (98,950

Net tax assets and liabilities

     (68,732     1,882  

Unpaid losses and loss expenses including life policy benefits

     821,108       409,258  

Unearned premiums

     405,830       630,386  

Other net changes in operating assets and liabilities

     40,029       20,183  
                

Net cash provided by operating activities

     486,314       413,704  

Cash flows from investing activities

    

Sales of fixed maturities

     839,611       2,424,795  

Redemptions of fixed maturities

     429,158       271,520  

Purchases of fixed maturities

     (1,553,630     (2,748,913

Sales and redemptions of short-term investments

     26,787       78,443  

Purchases of short-term investments

     (55,797     (15,573

Sales of equities

     154,861       79,651  

Purchases of equities

     (181,573     (126,805

Other, net

     20,753       5,870  
                

Net cash used in investing activities

     (319,830     (31,012

Cash flows from financing activities

    

Cash dividends paid to shareholders

     (45,776     (49,332

Proceeds from issuance of senior notes

     —          500,000  

Repurchase of common shares

     (244,222     (231,344

Issuance of common shares

     3,616       6,810  

Contract fees on forward sale agreement

     —          (1,310
                

Net cash (used in) provided by financing activities

     (286,382     224,824  

Effect of foreign exchange rate changes on cash

     18,551       (26,550

(Decrease) increase in cash and cash equivalents

     (101,347     580,966  

Cash and cash equivalents—beginning of period

     2,111,084       738,309  
                

Cash and cash equivalents—end of period

   $ 2,009,737     $ 1,319,275  
                

Supplemental cash flow information:

    

Taxes paid

   $ 42,177     $ 23,919  

Interest paid

   $ —        $ 608  

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

 

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PartnerRe Ltd.

Notes 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 and Partner Reinsurance Company of the U.S. 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, mortality, longevity 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. To facilitate comparison of information across periods, certain reclassifications have been made to prior year amounts to conform to the current year’s presentation.

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:

 

   

Unpaid losses and loss expenses;

 

   

Policy benefits for life and annuity contracts;

 

   

Gross and net premiums written and net premiums earned;

 

   

Recoverability of deferred acquisition costs;

 

   

Recoverability of deferred tax assets;

 

   

Valuation of goodwill and intangible assets; and

 

   

Valuation of certain assets and derivative financial instruments that are measured using significant unobservable inputs.

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, 2010.

3. 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 observability of inputs as follows:

 

   

Level 1 inputs—Unadjusted, quoted prices in active markets for identical assets or liabilities that the Company has the ability to access.

 

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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.

 

   

Level 2 inputs—Quoted prices in active markets for similar assets or liabilities, quoted prices for identical or similar assets or liabilities in inactive markets and directly or indirectly observable inputs, other than quoted prices, used in industry accepted models.

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 bonds; Organization for Economic Co-operation and Development Sovereign Treasury bonds; investment grade and high yield corporate bonds; catastrophe bonds; mortality bonds; mortgage-backed securities; asset-backed securities; certain fixed income mutual funds; foreign exchange forward contracts and over-the-counter derivatives such as foreign currency option contracts, equity put and call options, credit default swaps, non-exchange traded futures and interest rate swaps.

 

   

Level 3 inputs—Unobservable inputs.

The Company’s financial instruments that it measures at fair value using Level 3 inputs generally include: unlisted equities; inactively traded fixed maturities; real estate mutual fund investments; inactively traded weather derivatives; notes receivable and total return swaps.

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 March 31, 2011 and December 31, 2010, 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):

 

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March 31, 2011

   Quoted prices in
active markets for
identical assets
(Level 1)
    Significant other
observable inputs
(Level 2)
    Significant
unobservable
inputs

(Level 3)
    Total  

Fixed maturities

        

U.S. government and agencies

   $ —        $ 972,735     $ 55,929     $ 1,028,664  

Non-U.S. sovereign government, supranational and government related

     —          3,068,059       —          3,068,059  

Corporate

     —          6,084,092       115,107       6,199,199  

Asset-backed securities

     —          377,155       262,408       639,563  

Residential mortgage-backed securities

     —          2,271,396       4,301       2,275,697  

Other mortgage-backed securities

     —          46,785       576       47,361  
                                

Fixed maturities

   $ —        $ 12,820,222     $ 438,321     $ 13,258,543  

Short-term investments

   $ —        $ 79,503     $ 1,204     $ 80,707  

Equities

        

Consumer noncyclical

   $ 154,288     $ 122     $ —        $ 154,410  

Energy

     108,729       405       —          109,134  

Finance

     95,126       99       161       95,386  

Technology

     92,596       —          —          92,596  

Communications

     90,519       29       —          90,548  

Industrials

     83,824       —          —          83,824  

Consumer cyclical

     62,618       —          —          62,618  

Insurance

     44,262       —          —          44,262  

Other

     77,929       —          —          77,929  

Mutual funds and exchange traded funds

     70,831       130,094       41,451       242,376  
                                

Equities

   $ 880,722     $ 130,749     $ 41,612     $ 1,053,083  

Other invested assets

        

Foreign exchange forward contracts

   $ —        $ 5,191     $ —        $ 5,191  

Foreign currency option contracts

     —          (209     —          (209

Futures contracts

     (7,422     212       —          (7,210

Credit default swaps (protection purchased)

     —          (2,225     —          (2,225

Credit default swaps (assumed risks)

     —          603       —          603  

Insurance-linked securities

     (778     —          (10,191     (10,969

Total return swaps

     —          241       (6,851     (6,610

Interest rate swaps

     —          (4,968     —          (4,968

Other

     —          586       84,662       85,248  
                                

Other invested assets

   $ (8,200   $ (569   $ 67,620     $ 58,851  

Funds held – directly managed

        

U.S. government and agencies

   $ —        $ 231,305     $ 366     $ 231,671  

Non-U.S. sovereign government, supranational and government related

     —          359,867       —          359,867  

Corporate

     —          570,617       —          570,617  

Short-term investments

     —          44,010       —          44,010  

Other invested assets

     —          —          22,456       22,456  
                                

Funds held – directly managed

   $ —        $ 1,205,799     $ 22,822     $ 1,228,621  
                                

Total

   $ 872,522     $ 14,235,704     $ 571,579     $ 15,679,805  

During the three months ended March 31, 2011, there were no significant transfers between Levels 1 and 2.

 

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December 31, 2010

   Quoted prices in
active markets for
identical assets
(Level 1)
     Significant other
observable inputs
(Level 2)
    Significant
unobservable
inputs
(Level 3)
    Total  

Fixed maturities

         

U.S. government and agencies

   $ —         $ 917,600     $ 55,124     $ 972,724  

Non-U.S. sovereign government, supranational and government related

     —           2,819,193       —          2,819,193  

Corporate

     —           6,066,865       76,982       6,143,847  

Asset-backed securities

     —           343,518       213,139       556,657  

Residential mortgage-backed securities

     —           2,305,525       —          2,305,525  

Other mortgage-backed securities

     —           26,153       290       26,443  
                                 

Fixed maturities

   $ —         $ 12,478,854     $ 345,535     $ 12,824,389  

Short-term investments

   $ —         $ 49,397     $ —        $ 49,397  

Equities

         

Consumer noncyclical

   $ 186,016      $ —        $ —        $ 186,016  

Technology

     119,214        —          —          119,214  

Energy

     118,372        —          —          118,372  

Finance

     112,309        —          2,486       114,795  

Communications

     110,982        —          —          110,982  

Industrials

     100,572        —          —          100,572  

Consumer cyclical

     81,595        —          —          81,595  

Insurance

     48,611        —          —          48,611  

Other

     90,220        —          —          90,220  

Mutual funds and exchange traded funds

     60,372        —          40,927       101,299  
                                 

Equities

   $ 1,028,263      $ —        $ 43,413     $ 1,071,676  

Other invested assets

         

Foreign exchange forward contracts

   $ —         $ 14,233     $ —        $ 14,233  

Foreign currency option contracts

     —           3,516       —          3,516  

Futures contracts

     22,637        —          —          22,637  

Credit default swaps (protection purchased)

     —           (2,314     —          (2,314

Credit default swaps (assumed risks)

     —           132       —          132  

Insurance-linked securities

     625        —          (698     (73

Total return swaps

     —           449       (7,256     (6,807

Interest rate swaps

     —           (5,787     —          (5,787

Other

     —           (441     86,278       85,837  
                                 

Other invested assets

   $ 23,262      $ 9,788     $ 78,324     $ 111,374  

Funds held – directly managed

         

U.S. government and agencies

   $ —         $ 288,164     $ 368     $ 288,532  

Non-U.S. sovereign government, supranational and government related

     —           384,553       —          384,553  

Corporate

     —           798,587       —          798,587  

Mortgage/asset-backed securities

     —           —          12,118       12,118  

Short-term investments

     —           38,613       —          38,613  

Other invested assets

     —           —          20,528       20,528  
                                 

Funds held – directly managed

   $ —         $ 1,509,917     $ 33,014     $ 1,542,931  
                                 

Total

   $ 1,051,525      $ 14,047,956     $ 500,286     $ 15,599,767  

At March 31, 2011 and December 31, 2010, the aggregate carrying amounts of items included in Other invested assets that the Company did not measure at fair value were $233.4 million and $241.0 million, respectively, which related to the Company’s investments that are accounted for using the cost method of accounting, equity method of accounting or investment company accounting.

In addition to the investments underlying the funds held – directly managed account held at fair value of $1,228.6 million and $1,542.9 million at March 31, 2011 and December 31, 2010, respectively, the funds held – directly managed account also included cash and cash equivalents, carried at fair value, of $111.5 million and $129.2 million, respectively, and accrued investment income of $17.8 million and $19.9 million, respectively. At March 31, 2011 and December 31, 2010, the aggregate carrying amounts of items included in the funds held – directly managed account that the Company did not measure at fair value were $156.6 million and $80.1

 

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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 5 to the Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010).

At March 31, 2011 and December 31, 2010, substantially all of the accrued investment income in the Unaudited Condensed Consolidated Balance Sheets related to the Company’s investments and the investments underlying the funds held – directly managed account for which the fair value option was elected.

Disclosures about the fair value of financial instruments that the Company does not measure at fair value exclude insurance contracts and certain other financial instruments. At March 31, 2011 and December 31, 2010, the fair values of financial instrument assets recorded in the Unaudited Condensed Consolidated Balance Sheets not described above, approximate their carrying values.

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 March 31, 2011 and 2010 (in thousands of U.S. dollars):

 

For the three months ended

March 31, 2011

   Balance at
beginning
of period
    Realized and
unrealized
investment
gains (losses)
included in
net loss
    Purchases      Sales     Net
transfers
into
Level 3 (a)
    Balance at
end
of period
    Change in
unrealized
investment
gains (losses)
relating to
assets  held at
end of period
 

Fixed maturities

               

U.S. government and agencies

   $ 55,124     $ 805     $ —         $ —        $ —        $ 55,929     $ 805  

Corporate

     76,982       (39,115     40,794        (3,734     40,180         115,107       (33,873

Asset-backed securities

     213,139       2,971       54,514        (8,216     —          262,408       (1,837

Residential mortgage-backed securities

     —          539       4,212        (450     —          4,301       541  

Other mortgage-backed securities

     290       (33     408        (89     —          576       (33
                                                         

Fixed maturities

   $ 345,535     $ (34,833   $ 99,928      $ (12,489   $ 40,180       $ 438,321     $ (34,397

Short-term investments

   $ —        $ (339   $ 1,543      $ —        $ —        $ 1,204     $ (339

Equities

               

Finance

   $ 2,486     $ 237     $ —         $ (2,562   $ —        $ 161     $ 10  

Mutual funds and exchange traded funds

     40,927       648       —           (124     —          41,451       692  
                                                         

Equities

   $ 43,413     $ 885     $ —         $ (2,686   $ —        $ 41,612     $ 702  

Other invested assets

               

Derivatives, net

   $ (7,954   $ (9,125   $ 37      $ —        $ —        $ (17,042   $ (9,125

Other

     86,278       (1,904     2,980        (2,692     —          84,662       (1,480
                                                         

Other invested assets

   $ 78,324     $ (11,029   $ 3,017      $ (2,692   $ —        $ 67,620     $ (10,605

Funds held – directly managed

               

U.S. government and agencies

   $ 368     $ (2   $ —         $ —        $ —        $ 366     $ (2

Mortgage/asset-backed securities

     12,118       (150     —           (11,968     —          —          —     

Other invested assets

     20,528       1,928       —           —          —          22,456       1,928  
                                                         

Funds held – directly managed

   $ 33,014     $ 1,776     $ —         $ (11,968   $ —        $ 22,822     $ 1,926  
                                                         

Total

   $ 500,286     $ (43,540   $ 104,488      $ (29,835   $ 40,180       $ 571,579     $ (42,713

 

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For the three months ended

March 31, 2010

   Balance at
beginning
of period
    Realized and
unrealized
investment
gains (losses)
included in
net  income
    Net
purchases,
sales and
settlements
    Net
transfers
(out of)/into
Level 3 (a)
    Balance
at end of
period
    Change in
unrealized
investment gains
(losses) relating
to assets  held
at end of period
 

Fixed maturities

            

U.S. government and agencies

   $ 4,286     $ —        $ 9,720     $ (4,286   $ 9,720     $ —     

Corporate

     15,041       123       5,820       (10,927     10,057       123  

Asset-backed securities

     99,952       (2,758     (9,310     (2,900 )       84,984       (2,782

Residential mortgage-backed securities

     77,440       191       17,398       —          95,029       191  

Other mortgage-backed securities

     874       30       (93     —          811       30  
                                                

Fixed maturities

   $ 197,593     $ (2,414   $ 23,535     $ (18,113   $ 200,601     $ (2,438

Equities

            

Finance

   $ 2,488     $ (29   $ —        $ —        $ 2,459     $ (29

Industrials

     805       (84     (721     —          —          —     

Mutual funds and exchange traded funds

     34,810       860       —          —          35,670       860  
                                                

Equities

   $ 38,103     $ 747     $ (721   $ —        $ 38,129     $ 831  

Other invested assets

            

Derivatives, net

   $ (9,361   $ 2,543     $ (9,346   $ 8,166       $ (7,998   $ 720  

Other

     25,815       84       19       —          25,918       84  
                                                

Other invested assets

   $ 16,454     $ 2,627     $ (9,327   $ 8,166       $ 17,920     $ 804  

Funds held – directly managed

            

U.S. government and agencies

   $ 375     $ (171   $ —        $ —        $ 204     $ (171

Non-U.S. sovereign government, supranational and government related

     3,417       (13     (3,404     —          —          —     

Mortgage/asset-backed securities

     142       (3,748     —          16,866         13,260       (3,748

Other invested assets

     35,685       (5,337     —          —          30,348       (5,337
                                                

Funds held – directly managed

   $ 39,619     $ (9,269   $ (3,404   $ 16,866       $ 43,812     $ (9,256
                                                

Total

   $ 291,769     $ (8,309   $ 10,083     $ 6,919       $ 300,462     $ (10,059

 

(a) The Company’s policy is to recognize the transfers between the hierarchy levels at the beginning of the period.

During the three months ended March 31, 2011, a catastrophe bond (included within corporate fixed maturities) with a fair value of $40.2 million was transferred from Level 2 into Level 3. The transfer into Level 3 was due to the lack of observable market inputs at March 31, 2011, leading the Company to apply inputs that were not directly observable.

During the three months ended March 31, 2010, certain fixed maturities with a fair value of $18.1 million were transferred from Level 3 into Level 2. The reclassifications to Level 2 consisted of municipals (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 March 31, 2010, resulting from the continued recovery of the financial markets. In addition, during the three months ended March 31, 2010, certain derivatives with a fair value in a net liability position of $8.2 million were transferred out of Level 3 into Level 2 due to the availability of observable inputs.

During the three months ended March 31, 2010, certain fixed maturities within the investments underlying the funds held – directly managed account with a fair value of $16.9 million were transferred from Level 2 into Level 3. At March 31, 2010, 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 at March 31, 2010, leading the Company to apply inputs that were not directly observable.

 

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Changes in the fair value of the Company’s financial instruments subject to the fair value option during the three months ended March 31, 2011 and 2010, respectively, were as follows (in thousands of U.S. dollars):

 

     For the three
months ended
March 31, 2011
    For the three
months ended
March 31, 2010
 

Fixed maturities

   $ (140,228   $ 99,097  

Short-term investments

     (641     (2,425

Equities

     16,118       25,412  

Other invested assets

     356       84  

Funds held – directly managed

     (12,250     11,179  
                

Total

   $ (136,645   $ 133,347  

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 (losses) 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

 

   

U.S. government and agencies — U.S. government and agencies securities consist primarily of bonds issued by the U.S. Treasury, corporate debt securities issued by the Federal National Mortgage Association, the Federal Home Loan Bank and other U.S. agencies as well as bonds issued by U.S. domiciled state and municipal entities. These securities are generally priced by independent pricing services. The independent pricing services may use actual transaction prices for securities that have been actively traded. For securities that have not been actively traded, each pricing source has its own proprietary method to determine the fair value, which may incorporate option adjusted spreads (OAS), interest rate data and market news. The Company generally classifies these securities in Level 2. Certain of the U.S. domiciled states and municipal investments issued by municipal housing authorities are not actively traded and are priced based on internal models using unobservable inputs. Accordingly, the Company classifies these securities in Level 3.

 

   

Non-U.S. sovereign government, supranational and government related — Non-U.S. sovereign government, supranational and government related securities consist primarily of bonds issued by non-U.S. national governments and their agencies, non-U.S. regional governments and supranational organizations. These securities are generally priced by independent pricing services using the techniques described for U.S. government and agencies above. The Company generally classifies these securities in Level 2.

 

   

Corporate — Corporate securities consist primarily of U.S. and foreign corporations covering a variety of industries. These securities are generally priced by independent pricing services and brokers. The pricing provider incorporates information including credit spreads, interest rate data and market news into the valuation of each security. The Company generally classifies these securities in Level 2. When a corporate security is inactively traded or the valuation model uses unobservable inputs, the Company classifies the security in Level 3.

 

   

Asset-backed securities — Asset-backed securities primarily consist of student loans, automobile loans, credit card receivables, equipment leases, and special purpose financing. With the exception of special purpose financing, these asset-backed securities are generally priced by independent pricing services and brokers. The pricing provider applies dealer quotes and other available trade information, prepayment speeds, yield curves and credit spreads to the valuation. The Company generally classifies these securities in Level 2. Special purpose financing securities are generally inactively traded and are priced based on valuation models using unobservable inputs, including cash flow assumptions and credit spreads. The Company generally classifies these securities in Level 3.

 

   

Residential mortgage-backed securities — Residential mortgage-backed securities primarily consist of bonds issued by the Government National Mortgage Association, the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation, as well as private, non-agency issuers. With the exception of private, non-agency issuers, these residential mortgage-backed securities are generally priced by independent pricing services and brokers. When current market trades are not available, the pricing provider will employ proprietary models with observable inputs including other trade information, prepayment speeds, yield curves and credit spreads. The Company generally classifies these securities in Level 2. Bonds issued by private, non-agency issuers are generally inactively traded and are priced based on valuation models using unobservable inputs, including cash flow assumptions and credit spreads. The Company generally classifies these securities in Level 3.

 

   

Other mortgage-backed securities — Other mortgage-backed securities primarily consist of commercial mortgage-backed securities. These securities are generally priced by independent pricing services and brokers. The pricing provider applies

 

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dealer quotes and other available trade information, prepayment speeds, yield curves and credit spreads to the valuation. The Company generally classifies these securities in Level 2. When a commercial mortgage-backed security is inactively traded or the valuation model uses unobservable inputs, the Company classifies the security in Level 3.

In general, the methods employed by the independent pricing services to determine the fair value of the securities that have not actively traded 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 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.

Short term investments

Short term investments are valued in a manner similar to the Company’s fixed maturity investments and are generally classified in Level 2.

Equities

Equity securities include U.S. and foreign common and preferred stocks, exchange traded funds and mutual funds. Equities and exchange traded funds are generally classified in Level 1 as the Company uses prices received from independent pricing sources based on quoted prices in active markets. Equities categorized as Level 2 are generally mutual funds invested in fixed income securities, where the net asset value of the fund is provided on a daily basis and common stocks traded in inactive markets. 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.

Other invested assets

The Company’s exchange traded derivatives, such as futures and certain weather derivatives, are generally categorized as Level 1 as their fair values are quoted prices in active markets. The Company’s foreign exchange forward contracts, foreign currency option contracts, equity put and call options, interest rate swaps, non-exchange traded futures and credit default swaps are generally categorized as Level 2 within the fair value hierarchy and are priced by independent pricing services.

Included in the Company’s Level 3 categorization, in general, are unlisted equities, credit linked notes, certain inactively traded weather derivatives, notes and loans receivable and total return swaps. For Level 3 instruments, 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.

 

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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

Disclosures about the fair value of financial instrument liabilities exclude insurance contracts and certain other financial instruments. At March 31, 2011 and December 31, 2010, the fair values of financial instrument liabilities recorded in the Unaudited Condensed Consolidated Balance Sheets approximate their carrying values, with the exception of the debt related to senior notes (Senior Notes) and the debt related to capital efficient notes (CENts). The methods and assumptions used by the Company in estimating the fair value of the Senior Notes and CENts did not change from December 31, 2010.

The carrying values and fair values of the Senior Notes and CENts as of March 31, 2011 and December 31, 2010 were as follows (in thousands of U.S. dollars):

 

      March 31, 2011      December 31, 2010  
     Carrying Value      Fair Value      Carrying Value      Fair Value  

Debt related to senior notes (1)

     750,000        780,862        750,000        781,950  

Debt related to capital efficient notes (2)

     63,384        59,815        63,384        59,261  

 

(1) PartnerRe Finance A LLC and PartnerRe Finance B LLC, the issuers of the Senior Notes, do not meet consolidation requirements under U.S. GAAP. Accordingly, the Company shows the related intercompany debt of $750 million in its Unaudited Condensed Consolidated Balance Sheets at March 31, 2011 and December 31, 2010, respectively.
(2) PartnerRe Finance II Inc., the issuer of the CENts, does not meet consolidation requirements under U.S. GAAP. Accordingly, the Company shows the related intercompany debt of $71 million in its Unaudited Condensed Consolidated Balance Sheets at March 31, 2011 and December 31, 2010.

4. 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. The Company also uses commodities futures to replicate the investment return on certain benchmarked commodities.

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 March 31, 2011. The counterparties on the Company’s assumed credit default swaps are all highly rated financial institutions.

 

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Insurance-Linked Securities

The Company has entered into various weather derivatives, weather futures and longevity total return swaps for which the underlying risks reference parametric weather risks for the weather derivatives and weather futures, and longevity risk for the longevity total return swaps.

Total Return and Interest Rate Swaps and Interest Rate Derivatives

The Company has entered into total return swaps referencing various project, investments and principal finance obligations. The Company has also entered into interest rate swaps to mitigate the interest rate risk on certain of the total return swaps. The Company may also use other 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 March 31, 2011 and December 31, 2010 were as follows (in thousands of U.S. dollars):

 

      March 31, 2011      December 31, 2010  
      Fair
Value
    Notional
Value
     Fair
Value
    Notional
Value
 

Derivatives designated as hedges

         

Foreign exchange forward contracts (net investment hedge)

   $ —        $ —         $ (1,160   $ 198,448  
                     

Total derivatives designated as hedges

   $ —           $ (1,160  

Derivatives not designated as hedges

         

Foreign exchange forward contracts

   $ 5,191     $ 2,117,988      $ 15,393     $ 1,770,448  

Foreign currency option contracts

     (209     150,789        3,516       104,386  

Futures contracts

     (7,210     2,010,504        22,637       1,756,811  

Credit default swaps (protection purchased)

     (2,225     109,598        (2,314     113,752  

Credit default swaps (assumed risks)

     603       27,500        132       27,500  

Insurance-linked securities

     (10,969     106,274        (73     88,765  

Total return swaps

     (6,610     168,455        (6,807     161,408  

Interest rate swaps(1)

     (4,968     —           (5,787     —     
                     

Total derivatives not designated as hedges

   $ (26,397      $ 26,697    
                     

Total derivatives

   $ (26,397      $ 25,537    

 

(1) The Company enters into interest rate swaps to mitigate notional exposures on certain total return swaps. Accordingly, the notional value of interest rate swaps is not presented separately in the table.

The fair value of all derivatives at March 31, 2011 and December 31, 2010 is recorded in Other invested assets in the Company’s Unaudited Condensed Consolidated Balance Sheets.

The gains and losses in the Unaudited Condensed Consolidated Statements of Operations for derivatives not designated as hedges for the three months ended March 31, 2011 and 2010 were as follows (in thousands of U.S. dollars):

 

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     Amount of (loss) gain on
derivatives recognized
in income for  the
three months ended
March 31, 2011
    Amount of (loss) gain on
derivatives recognized
in income for  the
three months ended
March 31, 2010
 

Foreign exchange forward contracts

   $ (17,016   $ (4,015

Foreign currency option contracts

     (77     2,200  
                

Total included in net foreign exchange gains and losses

   $ (17,093   $ (1,815

Futures contracts

   $ (20,283   $ (20,945

Credit default swaps (protection purchased)

     (244     (652

Credit default swaps (assumed risks)

     836       21  

Insurance-linked securities

     (7,073     1,138  

Total return swaps

     799       2,621  

Interest rate swaps

     823       497  

Interest rate derivatives

     —          (3,848

Other

     —          (121
                

Total included in net realized and unrealized investment gains and losses

   $ (25,142   $ (21,289

Total derivatives not designated as hedges

   $ (42,235   $ (23,104

5. Net (Loss) Income per Share

The reconciliation of basic and diluted net (loss) income per share for the three months ended March 31, 2011 and 2010 is as follows (in thousands of U.S. dollars or shares, except per share amounts):

 

      For the three
months ended
March 31, 2011
    For the three
months ended
March 31, 2010
 

Numerator:

    

Net (loss) income

   $ (806,956   $ 79,654  

Less: preferred dividends

     (8,631     (8,631
                

Net (loss) income available to common shareholders

   $ (815,587   $ 71,023  
    

Denominator:

    

Weighted number of common shares outstanding - basic

     67,997.4       81,696.9  

Share options and other (1)

     —          1,631.9  
                

Weighted average number of common shares and common share equivalents outstanding - diluted

     67,997.4       83,328.8  
    

Basic net (loss) income per share

   $ (11.99   $ 0.87  

Diluted net (loss) income per share(1)

   $ (11.99   $ 0.85  

 

(1) Dilutive securities, in the form of share options and other, that could potentially dilute basic net loss per share were not included in the computation of diluted net loss per share because to do so would have been anti-dilutive for the three months ended March 31, 2011. The weighted average number of common and common share equivalents outstanding would have amounted to 69,100.1 thousand shares if these securities had been included for the three months ended March 31, 2011. In addition, at March 31, 2011 and 2010, share based awards to purchase 703.3 and 616.7 thousand common shares, respectively, were excluded from the calculation of diluted weighted average number of common shares and common share equivalents outstanding because their exercise prices were greater than the average market price of the common shares.

6. Commitments and Contingencies

(a) Concentration of Credit Risk

Financing receivables

Included in the Company’s Other invested assets are certain notes receivable which meet the definition of financing receivables and are accounted for using the cost method of accounting. Performance of these notes receivable to date has been within expectations. As of March 31, 2011 and December 31, 2010, none of the Company’s notes receivable are past due or in default and, accordingly, the Company believes that an allowance for credit losses related to these notes receivable is not required at March 31, 2011 and December 31, 2010.

 

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The Company monitors the performance of the notes receivable based on the type of underlying collateral and by assigning a “performing” or a “non-performing” indicator of credit quality to each individual receivable. At March 31, 2011, the Company’s notes receivable of $46.6 million were all performing and were collateralized by residential property and commercial property of $24.8 million and $21.8 million, respectively.

There were no purchases of financing receivables during the three months ended March 31, 2011 and the reduction in the outstanding balance is due to the settlement of the underlying debt.

(b) Legal Proceedings

There has been no significant change in legal proceedings at March 31, 2011 compared to December 31, 2010. See Note 18(e) to the Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010.

7. 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, 2010. The Non-life segment is further divided into four sub-segments: North America, Global (Non-U.S.) Property and Casualty (Global (Non-U.S.) P&C), Global (Non-U.S.) Specialty and Catastrophe. Following the completion of the Company’s integration of PARIS RE Holdings Limited into its other Non-life sub-segments, and to reflect other changes in management responsibilities for certain lines of business and treaties, the Company redefined its financial reporting segments. The comparative data that was previously presented in the Company’s Form 10-Q for the three months ended March 31, 2010 has been recast to conform to the current period presentation.

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, 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 (all 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.

The following tables provide a summary of the segment revenues and results for the three months ended March 31, 2011 and 2010 (in millions of U.S. dollars, except ratios):

 

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Segment Information

For the three months ended March 31, 2011

 

      North
America
    Global
(Non-U.S.)
P&C
    Global
(Non-U.S.)
Specialty
    Catastrophe     Total
Non-life
Segment
    Life
Segment
    Corporate
and Other
    Total  

Gross premiums written

   $ 338     $ 318     $ 375     $ 317     $ 1,348     $ 208     $ 2     $ 1,558  

Net premiums written

   $ 338     $ 317     $ 315     $ 292     $ 1,262     $ 206     $ 2     $ 1,470  

(Increase) decrease in unearned premiums

     (79     (136     2       (168     (381     (22     (2     (405
                                                                

Net premiums earned

   $ 259     $ 181     $ 317     $ 124     $ 881     $ 184     $ —        $ 1,065  

Losses and loss expenses and life policy benefits

     (174     (150     (221     (918     (1,463     (145     —          (1,608

Acquisition costs

     (66     (40     (80     8       (178     (30     —          (208
                                                                

Technical result

   $ 19     $ (9   $ 16     $ (786   $ (760   $ 9     $ —        $ (751

Other income

             1       —          1       2  

Other operating expenses

             (66     (12     (26     (104
                                        

Underwriting result

           $ (825   $ (3     n/a      $ (853

Net investment income

               15       137       152  
                                  

Allocated underwriting result (1)

             $ 12       n/a        n/a   

Net realized and unrealized investment losses

                 (112     (112

Interest expense

                 (12     (12

Amortization of intangible assets

                 (9     (9

Net foreign exchange gains

                 —          —     

Income tax benefit

                 26       26  

Interest in earnings of equity investments

                 1       1  
                            

Net loss

                 n/a      $ (807
                            

Loss ratio (2)

     67.0      82.8      69.7      743.0 %     166.0       

Acquisition ratio (3)

     25.6       22.1       25.3       (6.7     20.3        
                                              

Technical ratio (4)

     92.6 %     104.9      95.0      736.3      186.3       

Other operating expense ratio (5)

             7.4        
                      

Combined ratio (6)

             193.7       
                      

 

(1) Allocated underwriting result is defined as net premiums earned, other income or loss and allocated net investment income less life policy benefits, acquisition costs and other operating expenses.
(2) Loss ratio is obtained by dividing losses and loss expenses by net premiums earned.
(3) Acquisition ratio is obtained by dividing acquisition costs by net premiums earned.
(4) Technical ratio is defined as the sum of the loss ratio and the acquisition ratio.
(5) Other operating expense ratio is obtained by dividing other operating expenses by net premiums earned.
(6) Combined ratio is defined as the sum of the technical ratio and the other operating expense ratio.

 

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Segment Information

For the three months ended March 31, 2010

 

      North
America
    Global
(Non-U.S.)
P&C
    Global
(Non-U.S.)
Specialty
    Catastrophe     Total
Non-life
Segment
    Life
Segment
    Corporate
and Other
    Total  

Gross premiums written

   $ 358     $ 444     $ 509     $ 409     $ 1,720     $ 187     $ 2     $ 1,909  

Net premiums written

   $ 357     $ 436     $ 456     $ 358     $ 1,607     $ 183     $ (6   $ 1,784  

(Increase) decrease in unearned premiums

     (89     (206     (119     (204     (618     (18     6       (630
                                                                

Net premiums earned

   $ 268     $ 230     $ 337     $ 154     $ 989     $ 165     $ —        $ 1,154  

Losses and loss expenses and life policy benefits

     (179     (246     (303     (153     (881     (132     —          (1,013

Acquisition costs

     (69     (52     (64     (12     (197     (23     —          (220
                                                                

Technical result

   $ 20     $ (68   $ (30   $ (11   $ (89   $ 10     $ —        $ (79

Other income

             1       —          —          1  

Other operating expenses

             (78     (14     (36     (128
                                        

Underwriting result

           $ (166   $ (4     n/a      $ (206

Net investment income

               16       157       173  
                                  

Allocated underwriting result

             $ 12       n/a        n/a   

Net realized and unrealized investment gains

                 146       146  

Interest expense

                 (7     (7

Amortization of intangible assets

                 (5     (5

Net foreign exchange gains

                 4       4  

Income tax expense

                 (27     (27

Interest in earnings of equity investments

                 2       2  
                            

Net income

                 n/a      $ 80  
                            

Loss ratio

     66.9 %     107.0 %     90.0 %     99.0 %     89.1 %      

Acquisition ratio

     25.7       22.8       18.9       7.9       19.9        
                                              

Technical ratio

     92.6 %     129.8 %     108.9 %     106.9 %     109.0 %      

Other operating expense ratio

             7.9        
                      

Combined ratio

             116.9 %      
                      

 

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Table of Contents
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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 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% and an average Operating ROE of 13% over a reinsurance cycle. Both of these metrics are defined below in Key Financial Measures. See also 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, 2010.

Key Financial Measures

In addition to the Unaudited Condensed Consolidated Balance Sheets and Unaudited Condensed Consolidated Statement of Operations and Comprehensive (Loss) Income, Management uses certain key measures to evaluate its financial performance and the overall growth in value generated for the Company’s common shareholders. The four key measures that Management uses, together with definitions of their calculations, are as follows:

 

     For the three
months ended
March 31, 2011
    For the three
months ended
March 31, 2010
 

Diluted book value per common share and common share equivalents outstanding(1)

   $ 82.50     $ 84.12  

Operating loss available to common shareholders (in millions of U.S. dollars)(2)

   $ (736   $ (50

Annualized operating return on beginning diluted book value per common share and common share equivalents outstanding(3)

     (46.1 )%      (2.9 )% 

Combined ratio(4)

     193.7  %      116.9  % 

 

(1) Diluted book value per common share and common share equivalents outstanding is calculated using common shareholders’ equity (shareholders’ equity less the aggregate liquidation value of preferred shares) divided by the number of fully diluted common shares and common share equivalents outstanding (assuming exercise of all stock-based awards and other dilutive securities).
(2) Operating earnings or loss available to common shareholders (Operating Earnings or Loss) is calculated as net income or loss available to common shareholders excluding net realized and unrealized gains or losses on investments, net of tax, net foreign exchange gains or losses, net of tax, and interest in earnings or losses of equity investments, net of tax, where the Company does not control the investee companies’ activities, and is calculated after preferred dividends. The presentation of Operating Earnings or Loss is a non-GAAP financial measure within the meaning of Regulation G (see Comment on Non-GAAP Measures below) and is reconciled to the nearest GAAP financial measure below. Effective January 1, 2011, Management redefined its Operating Earnings or Loss calculation, as discussed below.
(3) Annualized operating return on beginning diluted book value per common share and common share equivalents outstanding (Operating ROE) is calculated using Operating Earnings or Loss, as defined above, per common share and common share equivalents outstanding, divided by beginning diluted book value per common share and common share equivalents outstanding, as defined above. The presentation of Operating ROE is a non-GAAP financial measure within the meaning of Regulation G (see Comment on Non-GAAP Measures below) and is reconciled to the nearest GAAP financial measure below. Effective January 1, 2011, Management redefined its Operating ROE calculation, as discussed below.
(4) The combined ratio of the Non-life segment is calculated as the sum of the technical ratio (losses and loss expenses and acquisition costs divided by net premiums earned) and the other operating expense ratio (other operating expenses divided by net premiums earned).

Effective January 1, 2011, Management redefined its Operating earnings or loss available to common shareholders (Operating Earnings or Loss) calculation to additionally exclude net foreign exchange gains or losses. Management believes that net foreign exchange gains or losses are not indicative of the performance of, and distort trends in, the Company’s business as they predominantly result from general economic and foreign exchange market conditions. In addition, Management also redefined its Annualized operating return on beginning diluted book value per common share and common share equivalents outstanding (Operating ROE, previously referred to as operating return on beginning common shareholders’ equity) calculation to measure Operating ROE on a diluted per share basis. Management believes that the redefined Operating ROE incorporates capital management activities while remaining based on the concept of deploying available capital on an annual basis.

 

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Operating Earnings or Loss and Operating ROE for the three months ended March 31, 2010 have been recast to reflect the Company’s redefined non-GAAP measures.

Diluted book value per common share and common share equivalents outstanding (Diluted Book Value per Share): Management uses growth in Diluted Book Value per Share as a prime measure of the value the Company is generating for its common shareholders, as Management believes that growth in the Company’s Diluted Book Value per Share ultimately translates into growth in the Company’s stock price. Diluted Book Value per Share is impacted by the Company’s net income, capital resources management and external factors such as foreign exchange, interest rates and equity markets, which can drive changes in unrealized gains or losses on its investment portfolio.

The Company’s Diluted Book Value per Share decreased by 12% to $82.50 at March 31, 2011 from $93.77 at December 31, 2010, primarily due to the comprehensive loss, partially offset by the accretive impact of the share repurchases, in the three months ended March 31, 2011. The comprehensive loss in the three months ended March 31, 2011 was driven by significant catastrophic losses, which are described in Overview and Review of Net (Loss) Income. Also see Shareholders’ Equity and Capital Resources Management below.

Operating earnings or loss available to common shareholders (Operating Earnings or Loss): Management uses Operating Earnings or Loss to measure its financial performance as this measure focuses on the underlying fundamentals of the Company’s operations by excluding net realized and unrealized gains or losses on investments, interest in earnings or losses of equity investments and net foreign exchange gains or losses. Net realized and unrealized gains or losses on investments in any particular period are not indicative of the performance of, and distort trends in, the Company’s business as they predominantly result from general economic and financial market conditions, and the timing of realized gains or losses on investments is largely opportunistic. Interest in earnings or losses of equity investments are also not indicative of the performance of, or trends in, the Company’s business as the Company does not control the investee companies’ activities. Net foreign exchange gains or losses are not indicative of the performance of, and distort trends in, the Company’s business as they predominantly result from general economic and foreign exchange market conditions. Management believes that the use of Operating Earnings or Loss enables investors and other users of the Company’s financial information to analyze its performance in a manner similar to how Management analyzes performance. Management also believes that this measure follows industry practice and, therefore, allows the users of financial information to compare the Company’s performance with its industry peer group, and that the equity analysts and certain rating agencies which follow the Company, and the insurance industry as a whole, generally exclude these items from their analyses for the same reasons.

Operating Loss increased by $686 million from a loss of $50 million in the three months ended March 31, 2010 to a loss of $736 million in the same period of 2011 primarily due to a decrease in the Non-life underwriting result of $659 million, which was driven by significant catastrophic losses in the three months ended March 31, 2011. The factors contributing to the increases or decreases in Operating Earnings or Loss in the three months ended March 31, 2011 compared to the same period in 2010 are further described in Overview and Review of Net (Loss) Income below.

The presentation of Operating Earnings or Loss available to common shareholders is a non-GAAP financial measure within the meaning of Regulation G and should be considered in addition to, and not as a substitute for, measures of financial performance prepared in accordance with GAAP (see Comment on Non-GAAP Measures). The table below provides a reconciliation of Operating Loss to the most comparable GAAP financial measure (in millions of U.S. dollars):

 

     For the three
months ended
March 31, 2011
    For the three
months ended
March 31, 2010
 

Net (loss) income

   $ (807   $ 80  

Less:

    

Net realized and unrealized investment (losses) gains, net of tax

     (88     110  

Net foreign exchange gains, net of tax

     7       9  

Interest in earnings of equity investments, net of tax

     1       2  

Dividends to preferred shareholders

     9       9  
                

Operating loss available to common shareholders

   $ (736   $ (50

Operating ROE: Management uses Operating ROE as a measure of profitability that focuses on the return to common shareholders. Management has set an average 13% Operating ROE target over the reinsurance cycle, which Management believes provides an attractive return to shareholders for the risk assumed. Each business unit and support department throughout the Company is focused on seeking to ensure that the Company meets the 13% return objective. This means that most economic decisions, including capital attribution and underwriting pricing decisions, incorporate an Operating ROE impact analysis. For the purpose of that analysis, an appropriate amount of capital (equity) is attributed to each transaction for determining the transaction’s priced return on attributed capital. Subject to an adequate return for the risk level as well as other factors, such as the contribution of each risk to the overall risk

 

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level and risk diversification, capital is attributed to the transactions generating the highest priced return on deployed capital. Management’s challenge consists of (i) attributing an appropriate amount of capital to each transaction based on the risk created by the transaction, (ii) properly estimating the Company’s overall risk level and the impact of each transaction on the overall risk level, (iii) assessing the diversification benefit, if any, of each transaction, and (iv) deploying available capital. The risk for the Company lies in mis-estimating any one of these factors, which are critical in calculating a meaningful priced return on deployed capital, and entering into transactions that do not contribute to the Company’s 13% Operating ROE objective.

Operating ROE decreased from a loss of 2.9% in the three months ended March 31, 2010 to a loss of 46.1% in the same period of 2011. The decrease was primarily due to the increase in Operating Loss, which was driven by significant catastrophe losses and is described further in Overview and Review of Net (Loss) Income.

The presentation of Operating ROE is a non-GAAP financial measure within the meaning of Regulation G and should be considered in addition to, and not as a substitute for, measures of financial performance prepared in accordance with GAAP (see Comment on Non-GAAP Measures). The table below provides a reconciliation of Operating ROE to the most comparable GAAP financial measure:

 

     For the three
months ended
March 31, 2011
    For the three
months ended
March 31, 2010
 

Annualized return on beginning diluted book value per common share calculated with net (loss) income per share available to common shareholders

     (51.2 )%      4.0

Less:

    

Annualized net realized and unrealized investment (losses) gains, net of tax on beginning diluted book value per common share

     (5.6     6.3  

Annualized net foreign exchange gains, net of tax, on beginning diluted book value per common share

     0.4       0.5  

Annualized net interest in earnings of equity investments, net of tax, on beginning diluted book value per common share

     0.1       0.1  
                

Annualized operating return on beginning diluted book value per common share

     (46.1 )%      (2.9 )% 

Combined Ratio: The combined ratio is used industry-wide as a measure of underwriting profitability for Non-life business. A combined ratio under 100% indicates underwriting profitability, as the total losses and loss expenses, acquisition costs and other operating expenses are less than the premiums earned on that business. While an important metric of underwriting profitability, the combined ratio does not reflect all components of profitability, as it does not recognize the impact of interest income earned on premiums between the time premiums are received and the time loss payments are ultimately made to clients. The key challenges in managing the combined ratio metric consist of (i) focusing on underwriting profitable business even in the weaker part of the reinsurance cycle, as opposed to growing the book of business at the cost of profitability, (ii) diversifying the portfolio to achieve a good balance of business, with the expectation that underwriting losses in certain lines or markets may potentially be offset by underwriting profits in other lines or markets, and (iii) maintaining control over expenses.

The Non-life combined ratio increased from 116.9% in the three months ended March 31, 2010 to 193.7% in the same period of 2011. The three months ended March 31, 2011 and 2010 were both impacted by large catastrophic losses, with the combined ratio including 30.0 points in the 2010 period related to the Chile Earthquake and 115.8 points in the 2011 period related to the impact of the Japan Earthquake and resulting tsunami (Japan Earthquake), the New Zealand Earthquake, the floods in Queensland, Australia (Australian Floods) and an aggregate contract covering losses in Australia and New Zealand.

Comment on Non-GAAP Measures

Throughout this filing, the Company’s results of operations have been presented in the way that Management believes will be the most meaningful and useful to investors, analysts, rating agencies and others who use financial information in evaluating the performance of the Company. This presentation includes the use of Operating Earnings or Loss and Operating ROE that are not calculated under standards or rules that comprise U.S. GAAP. These measures are referred to as non-GAAP financial measures within the meaning of Regulation G. Management believes that these non-GAAP financial measures are important to investors, analysts, rating agencies and others who use the Company’s financial information and will help provide a consistent basis for comparison between years and for comparison with the Company’s peer group, although non-GAAP measures may be defined or calculated differently by other companies. Investors should consider these non-GAAP measures in addition to, and not as a substitute for, measures of financial performance prepared in accordance with GAAP. A reconciliation of these measures to the most comparable U.S. GAAP financial measures, net income and return on beginning common shareholders’ equity calculated with net income available to common shareholders, is presented above.

 

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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, 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 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, 2010 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 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 the 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 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, 2010 for a discussion of the Company’s exposure to catastrophe risk, casualty reserving risk, equity investment risk and longevity risk.

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. However, Management believes that by themselves, interest rate risk and credit spread risk are unlikely to represent a material 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 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 four major risks are as follows:

 

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     Limit at
March 31, 2011
     Deployed at
March 31, 2011
     Deployed at
December 31, 2010
 

Catastrophe risk – largest zonal limit

   $ 2.8 billion       $ 2.2 billion       $ 2.5 billion   

Casualty reserving risk – total earned premiums for casualty and other long-tail lines for the four most recent underwriting periods

     6.3 billion         2.9 billion         3.0 billion   

Equity investment risk – value of equity and equity-like securities

     3.3 billion         1.5 billion         1.5 billion   

Longevity risk – net present value loss from extreme mortality improvement scenario

     2.0 billion         1.0 billion         1.0 billion   

The following table summarizes risk appetite and modeled economic loss for the Company’s major risks discussed above:

 

     Risk Appetite at
March 31, 2011(1)
     Modeled
Economic Loss at
March 31, 2011(1)
     Modeled
Economic Loss at
December 31, 2010(1)
 

Catastrophe risk – 1 in 75 year annual aggregate loss

   $
 
1.4 billion
 
  
  
   $
 
1.3 billion
 
  
  
   $
 
1.3 billion
 
  
  

Casualty reserving risk – casualty and other long-tail lines 1 in 15 year prior years reserve development

     0.7 billion         0.4 billion         0.4 billion   

Equity investment risk – 1 in 75 year decline in value

     1.1 billion         0.5 billion         0.5 billion   

 

(1) The Company has not defined a risk appetite for longevity risk as it believes that establishing a limit is currently the most appropriate risk management metric. In addition, the Company has not relied upon a modeled economic loss for longevity risk.

Critical Accounting Policies and Estimates

Critical Accounting Policies and Estimates of the Company at March 31, 2011 have not changed materially compared to December 31, 2010. 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, 2010. 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, 2010 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.

 

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The Company’s best estimate of total loss reserves is typically in excess of the midpoint of the actuarial ultimate liability estimate. 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 liability estimates. The selected best estimates of reserves are always within the reasonable range of estimates indicated by the Company’s actuaries.

During the three months ended March 31, 2011 and 2010, the Company reviewed its estimate for prior year losses for each sub-segment of the Non-life segment (defined below in Results by Segment) and, in light of developing data, adjusted 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 ended March 31, 2011 and 2010 (in millions of U.S. dollars):

 

     For the three
months ended
March 31, 2011
    For the three
months ended
March 31, 2010
 

Net prior year favorable reserve development:

    

Non-life segment

    

North America

   $ 40     $ 23  

Global (Non-U.S.) P&C

     32       34  

Global (Non-U.S.) Specialty

     35       16  

Catastrophe

     35       20  
                

Total net Non-life prior year favorable reserve development

   $ 142     $ 93  

The net favorable reserve development on prior accident years for the three months ended March 31, 2011 and 2010 was driven by the following factors (in millions of U.S. dollars):

 

     For the three
months ended
March 31, 2011
    For the three
months ended
March 31, 2010
 

Net prior year (adverse) favorable reserve development:

    

Non-life segment

    

Net prior year reserve development due to changes in premiums

   $ (28   $ (6

Net prior year reserve development due to all other factors (1)

     170       99  
                

Total net Non-life prior year favorable reserve development

   $ 142     $ 93  

 

(1) Net prior year reserve development due to all other factors includes, but is not limited to, loss experience, changes in assumptions and changes in methodology.

For a discussion of net prior year favorable reserve development by Non-life sub-segment, see Results by Segment below. 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, 2010 for additional information by reserving lines.

The following table shows the gross reserves reported by cedants (case reserves), those estimated by the Company (ACRs and IBNR reserves) and the total gross, ceded and net loss reserves recorded as of March 31, 2011 for each Non-life sub-segment (in millions of U.S. dollars):

 

     Case
reserves
     ACRs      IBNR
reserves
     Total gross
loss reserves
recorded
     Ceded loss
reserves
    Total net
loss reserves
recorded
 

North America

   $ 980      $ 144      $ 2,164      $ 3,288      $ (25   $ 3,263  

Global (Non-U.S.) P&C

     1,597        5        1,368        2,970        (35     2,935  

Global (Non-U.S.) Specialty

     2,059        51        1,797        3,907        (218     3,689  

Catastrophe

     335        277        1,110        1,722        (105     1,617  
                                                    

Total Non-life

   $ 4,971      $ 477      $ 6,439      $ 11,887      $ (383   $ 11,504  

The net loss reserves represent the Company’s best estimate of future losses and loss expense amounts based on the information available as of March 31, 2011. Loss reserves rely upon estimates involving actuarial and statistical projections at a given time that reflect the Company’s expectations of the costs of the ultimate settlement and administration of claims. These estimates are continually reviewed and the ultimate liability may be in excess of, or less than, the amounts provided, for which any adjustments will be reflected in the period in which the need for an adjustment is determined.

The Company’s best estimates are point estimates within a reasonable range of actuarial liability estimates. These ranges are developed using stochastic simulations and techniques and provide an indication as to the degree of variability of the loss reserves.

 

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The Company interprets the ranges produced by these techniques as confidence intervals around the point estimates for each Non-life sub-segment. However, due to the inherent volatility in the business written by the Company, there can be no guarantee that the final settlement of the loss reserves will fall within these ranges.

The recorded point estimates related to net loss reserves recorded by the Company, and the range of actuarial estimates at March 31, 2011, were as follows for each Non-life sub-segment (in millions of U.S. dollars):

 

     Recorded Point
Estimate
     High      Low  

Net Non-life sub-segment loss reserves:

        

North America

   $ 3,263      $ 3,486      $ 2,579  

Global (Non-U.S.) P&C

     2,935        3,135        2,588  

Global (Non-U.S.) Specialty

     3,689        3,869        3,218  

Catastrophe

     1,617        1,715        1,518  

It is not appropriate to add together the ranges of each sub-segment in an effort to determine a high and low range around the Company’s total Non-life carried loss reserves.

Of the $11,504 million of net loss reserves as of March 31, 2011, $1,267 million of net loss reserves for accident years 2005 and prior are guaranteed by Colisée Re, pursuant to the Reserve Agreement, and are not subject to loss reserve variability. See Summary of certain agreements between AXA SA, Colisée Re and Paris Re in Item 1 of Part I of the Company’s Annual Report on Form 10-K for the year ended December 31, 2010.

Life Policy Benefits

Policy benefits for life and annuity contracts relate to the business in the Company’s Life segment, which predominantly includes reinsurance of longevity, subdivided into standard and non-standard annuities, and mortality business, which includes traditional death and disability covers (with various riders), term assurance and critical illness (TCI) written in the UK and Ireland, and guaranteed minimum death benefit (GMDB) written in Continental Europe.

The Company categorizes life reserves into three types of reserves: reported outstanding loss reserves (case reserves), incurred but not reported (IBNR) reserves and reserves for future policy benefits. Such liabilities are established based on methods and underlying assumptions in accordance with U.S. GAAP and applicable actuarial standards. Principal assumptions used in the establishment of reserves for future policy benefits have been determined based upon information reported by ceding companies, supplemented by the Company’s actuarial estimates of mortality, critical illness, persistency and future investment income, with appropriate provision to reflect uncertainty.

For the traditional life portfolio, case reserves, IBNR reserves and reserves for future policy benefits are mainly calculated at the treaty level. The Company updates its estimates for each of the aforementioned categories on a quarterly basis using information received from its cedants.

For long duration products, a reserve adequacy test is periodically performed based on the latest best estimate assumptions by line of business, including an experience analysis and a review of likely future experience. If such review produces reserves in excess of those currently held, then the locked-in assumptions will be revised and a loss recognized.

See Critical Accounting Policies and Estimates—Losses and Loss Expenses and Life Policy Benefits—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, 2010 for additional information on the reserving methodologies employed by the Company for its longevity and mortality lines.

The Life segment reported net favorable development on prior accident years of $4 million and $11 million during the three months ended March 31, 2011 and 2010, respectively. The net favorable prior year loss development for the three months ended March 31, 2011 was primarily due to the GMDB business, where the payout is linked to the performance of underlying capital market assets, and was partially offset by adverse development on certain short-term treaties and a credit life treaty. The net favorable prior year loss development of $11 million in the three months ended March 31, 2010 was driven by the GMDB business. See Results by Segment below.

Valuation of Investments and Funds Held – Directly Managed, including certain Derivative Financial Instruments

The Company defines fair value as the price received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The Company measures the fair value of its financial instruments according to a fair value hierarchy that prioritizes the information used to measure fair value into three broad levels.

Under the fair value hierarchy, Management uses certain assumptions and judgments to derive the fair value of its investments, particularly for those assets with significant unobservable inputs, commonly referred to as Level 3 assets. The Company’s Level 3

 

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assets totaled $572 million and $500 million at March 31, 2011 and December 31, 2010, respectively. At March 31, 2011, the Level 3 assets of $572 million included fixed maturities and short-term investments of $439 million, equities of $42 million, other invested assets of $68 million and investments underlying the funds held – directly managed account of $23 million. For additional information related to the transfers into, and out of, the Company’s Level 3 classification during the three months ended March 31, 2011, see Note 3 to Unaudited Condensed Consolidated Financial Statements included in Item 1 of Part I of this report.

For additional information on the valuation techniques, methods and assumptions that were used by the Company to estimate the fair value of its fixed maturities, short-term investments, equities, other invested assets and investments underlying the funds held – directly managed account, see Note 3 to Unaudited Condensed Consolidated Financial Statements included in Item 1 of Part I of this report. For additional information on the Company’s use of derivative financial instruments, see Note 4 to Unaudited Condensed Consolidated Financial Statements included in Item 1 of Part I of this report.

Results of Operations—for the Three Months Ended March 31, 2011 and 2010

The following discussion of Results of Operations contains forward-looking statements based upon assumptions and expectations concerning the potential effect of future events that are subject to uncertainties. See Item 1A of Part I of the Company’s Annual Report on Form 10-K for the year ended December 31, 2010 and Item 1A of Part II of this report for a review of important risk factors. Any of these risk factors could cause actual results to differ materially from those reflected in such forward-looking statements.

The Company’s reporting currency is the U.S. dollar. The Company’s significant subsidiaries and branches have one of the following functional currencies: U.S. dollar, euro or Canadian dollar. As a significant portion of the Company’s operations is transacted in foreign currencies, fluctuations in foreign exchange rates may affect year over year comparisons. To the extent that fluctuations in foreign exchange rates affect comparisons, their impact has been quantified, when possible, and discussed in each of the relevant sections. See Note 2(m) to Consolidated Financial Statements in Item 8 of Part II of the Company’s Annual Report on Form 10-K for the year ended December 31, 2010 for a discussion of translation of foreign currencies.

The foreign exchange fluctuations for the principal currencies in which the Company transacts business were as follows:

 

   

the U.S. dollar average exchange rate was stronger against the euro and British pound and weaker against most other currencies in the three months ended March 31, 2011 compared to the same period in 2010; and

 

   

the U.S. dollar exchange rate weakened against most currencies, except the Japanese Yen, at March 31, 2011 compared to December 31, 2010.

Overview

The Company measures its performance in several ways. Among the performance measures accepted under U.S. GAAP is diluted net income per share, a measure that focuses on the return provided to the Company’s common shareholders. Diluted net income per share is obtained by dividing net income available to common shareholders by the weighted average number of common shares and common share equivalents outstanding. Net income available to common shareholders is defined as net income less preferred dividends. See the discussion of the non-GAAP performance measures that the Company uses (Operating Earnings or Loss and Operating ROE) and the reconciliation of those non-GAAP measures to the most comparable GAAP measures in Key Financial Measures above.

The year over year comparison of the Company’s results is primarily affected by the losses related to large catastrophic events in both the three months ended March 31, 2011 and 2010, the decrease in gross and net premiums written in the Non-life segment due to cancellations and the repositioning of the Company’s portfolio following the integration of PARIS RE Holdings Limited’s (Paris Re) business, and continued volatility in the capital and credit markets. To the extent that these events have affected the year over year comparison of the Company’s results, their impact has been quantified and discussed in each of the relevant sections. An overview of each of these events is provided below.

As the Company’s reinsurance operations are exposed to low-frequency high-severity risk events, some of which are seasonal, results for certain periods may include unusually low loss experience, while results for other periods may include significant catastrophic losses. Consequently, the Company’s results for interim periods are not necessarily indicative of results for the full year.

During the three months ended March 31, 2011, the Company incurred net losses of $1,071 million related to the combined impact of the Japan Earthquake, New Zealand Earthquake, Australian Floods and an aggregate contract covering losses in Australia and New Zealand. Of the Company’s incurred net losses of $1,071 million during the three months ended March 31, 2011, $722 million related to the Japan Earthquake, $252 million related to the New Zealand Earthquake and $97 million related to the Australian Floods and the aggregate contract covering losses in New Zealand and Australia.

Loss estimates arising from earthquakes are inherently more uncertain than those from other catastrophic events. The Company’s actual losses from the New Zealand Earthquake may materially exceed the estimated losses as a result of, among other

 

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things, an increase in industry insured loss estimates, the expected lengthy claims development period, in particular for earthquake related losses, and the receipt of additional information from cedants, brokers and loss adjusters.

The Company’s loss estimate related to the Japan Earthquake is inherently more uncertain given it is based on very limited and preliminary information that has been received from cedants to date, as well as modeled losses for the Company’s portfolio. While the Company believes its techniques for modeling the impact of losses related to this event provides a reasonable basis for the estimation of its loss exposure, the Company cautions that estimates based on modeling are subject to a high degree of uncertainty. Additionally, due to the characteristics of the Company’s reinsurance portfolio in the region, changes in loss assumptions for specific cedants may have a material impact on the Company’s loss estimate related to this event given a significant portion of the losses are concentrated with a few large cedants. The Company believes there remains a high degree of uncertainty related to its preliminary estimate of Japan Earthquake losses and the ultimate losses arising from this event may be materially in excess of, or less than, the amounts provided for in the Unaudited Condensed Consolidated Balance Sheet at March 31, 2011. Any adjustments to the Company’s preliminary estimate of its ultimate losses will be reflected in the periods in which they are determined, which may affect the Company’s operating results in future periods.

The following table reflects the combined impact of the above losses and the impact on the Company’s technical result, net realized and unrealized investment losses and pre-tax income by segment and sub-segment during the three months ended March 31, 2011 (in millions of U.S. dollars):

 

     North
America
    Global
(Non-U.S.)
P&C
    Global
(Non-U.S.)
Specialty
    Catastrophe     Total
Non-life
Segment
    Life
Segment
    Corporate
and Other
    Total  

Net losses and loss expenses and life policy benefits

   $ (13   $ (46   $ (32   $ (944   $ (1,035   $ (4   $ —        $ (1,039

Reinstatement premiums earned

     —          —          —          5       5       —          —          5  

Acquisition costs

     —          —          —          12       12       —          —          12  
                                                                

Impact on technical result

   $ (13   $ (46   $ (32   $ (927   $ (1,018   $ (4   $ —        $ (1,022

Net realized and unrealized investment losses

             —          —          (49     (49
                                        

Impact on pre-tax income

           $ (1,018   $ (4   $ (49   $ (1,071

During the three months ended March 31, 2011, the gross and net premiums written in the Company’s Non-life segment decreased by 22% and 21%, respectively, compared to the same period of 2010. The decrease in gross and net premiums written impacted all four of the Company’s Non-life sub-segments, but was most pronounced in the Global (Non-U.S.) P&C, Global (Non-U.S.) Specialty and Catastrophe sub-segments. The decreases are primarily driven by the Company’s decision to reduce or cancel business, as a result of lower pricing in certain competitive markets and to reposition its portfolios following the integration of Paris Re’s business.

During the three months ended March 31, 2011, economic growth continued with increases in risk free rates, narrowing of credit spreads and improvements in equity markets, while the U.S. dollar weakened against most major currencies compared to December 31, 2010. As a result of these movements, the value of the Company’s investment portfolio and cash and cash equivalents increased at March 31, 2011 compared to December 31, 2010, primarily due to the impact of foreign exchange, improved equity markets and narrower credit spreads, and was partially offset by the impact of increased risk free rates.

These factors affecting the year over year comparison of the Company’s results are discussed below in Review of Net (Loss) Income, Results by Segment and Financial Condition, Liquidity and Capital Resources, and may continue to affect our results of operations and financial condition in the future.

Net (loss) income, preferred dividends, net (loss) income available to common shareholders and diluted net (loss) income per share for the three months ended March 31, 2011 and 2010 were as follows (in millions of U.S. dollars, except per share data):

 

     For the three
months ended
March 31, 2011
    % Change
2011 over
2010
    For the three
months ended
March 31, 2010
 

Net (loss) income

   $ (807     NM   $ 80  

Less: preferred dividends

     9       —          9  
                  

Net (loss) income available to common shareholders

   $ (816     NM      $ 71  

Diluted net (loss) income per share

   $ (11.99     NM      $ 0.85  

 

NM: not meaningful

 

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The decrease in net (loss) income, net (loss) income available to common shareholders and diluted net (loss) income per share for the three months ended March 31, 2011 compared to the same period of 2010 resulted primarily from:

 

   

a decrease in the Non-life underwriting result of $659 million, largely driven by large catastrophic losses related to the Japan Earthquake, New Zealand Earthquake, Australian Floods and an aggregate contract covering losses in Australia and New Zealand in 2011 compared to large catastrophic losses related to the Chile Earthquake in 2010;

 

   

an increase in pre-tax net realized and unrealized investment losses of $258 million; and

 

   

a decrease in net investment income of $21 million; partially offset by

 

   

a decrease in income tax expense of $53 million, largely resulting from the increase in pre-tax net realized and unrealized investment losses.

Review of Net (Loss) Income

Management analyzes the Company’s net income in three parts: underwriting result, investment result and other components of net (loss) income. Underwriting result consists of net premiums earned and other income or loss less losses and loss expenses and life policy benefits, acquisition costs and other operating expenses. Investment result consists of net investment income, net realized and unrealized investment gains or losses and interest in earnings or losses of equity investments. Net investment income includes interest and dividends, net of investment expenses, generated by the Company’s investment activities, as well as interest income generated on funds held assets. Net realized and unrealized investment gains or losses include sales of the Company’s fixed income, equity and other invested assets and investments underlying the funds held – directly managed account and changes in net unrealized gains or losses. Interest in earnings or losses of equity investments includes the Company’s strategic investments. Other components of net (loss) income include technical result and other income or loss, other operating expenses, interest expense, amortization of intangible assets, net foreign exchange gains or losses and income tax expense or benefit.

The components of net (loss) income for the three months ended March 31, 2011 and 2010 were as follows (in millions of U.S. dollars):

 

     For the three
months ended
March 31, 2011
    % Change
2011 over
2010
    For the three
months ended
March 31, 2010
 

Underwriting result:

      

Non-life

   $ (825     395    $ (166

Life

     (3     (11     (4

Investment result:

      

Net investment income

     152       (12     173  

Net realized and unrealized investment (losses) gains

     (112     (177     146  

Interest in earnings of equity investments(1)

     1       (70     2  

Corporate and Other:

      

Technical result(2)

     —          (96     —     

Other income(2)

     1       NM        —     

Other operating expenses

     (26     (27     (36

Interest expense

     (12     72       (7

Amortization of intangible assets(3)

     (9     84       (5

Net foreign exchange gains

     —          (81     4  

Income tax benefit (expense)

     26       NM        (27
                  

Net (loss) income

   $ (807     NM      $ 80  

 

NM: not meaningful

(1) Interest in earnings of equity investments represents the Company’s aggregate share of earnings or losses related to several private placement investments and limited partnerships within the Corporate and Other segment. See the discussion in Corporate and Other – Interest in Earnings of Equity Investments below for more details.
(2) Technical result and other income primarily relate to income on insurance-linked securities and principal finance transactions within the Corporate and Other segment. See the discussion in Corporate and Other – Technical Result and Other Income below for more details.
(3) Amortization of intangible assets relates to intangible assets acquired in the acquisition of Paris Re in 2009.

Underwriting result is a measurement that the Company uses to manage and evaluate its Non-life and Life segments, as it is a primary measure of underlying profitability for the Company’s core reinsurance operations, separate from the investment results. The Company believes that in order to enhance the understanding of its profitability, it is useful for investors to evaluate the components of net income separately and in the aggregate. Underwriting result should not be considered a substitute for net income and does not reflect the overall profitability of the business, which is also impacted by investment results and other items.

 

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The underwriting result for the Non-life segment decreased by $659 million, from a loss of $166 million in the three months ended March 31, 2010 to a loss of $825 million in the same period of 2011. The decrease was primarily attributable to:

 

   

an increase in large catastrophic losses of approximately $722 million, net of reinstatement premiums and related profit commissions, related to the Japan Earthquake, New Zealand Earthquake, Australian Floods and an aggregate contract covering losses in Australia and New Zealand in 2011 compared to the Chile Earthquake in 2010; partially offset by

 

   

an increase in net favorable loss development on prior accident years of $49 million, from $93 million in the three months ended March 31, 2010 to $142 million in the same period of 2011. The components of the net favorable loss development are described in more detail in the discussion of individual sub-segments in Results by Segment below;

 

   

a decrease in other operating expenses of $12 million, primarily driven by lower personnel costs; and

 

   

an increase of approximately $2 million resulting from a lower level of loss estimates in the credit/surety line of business, partially offset by normal fluctuations in profitability and premiums earned between periods and a higher level of mid-sized loss activity.

Underwriting result for the Life segment in the three months ended March 31, 2011 was comparable to the same period of 2010. The underwriting result included a decrease in net favorable prior year loss development which was offset by a change in the mix of business towards the longevi