|
|
 | | | |
- close
- close
- close
- close
| |||||||||
Transatlantic Holdings 10-K 2008 UNITED STATES
FORM 10-K (Mark One)
TRANSATLANTIC HOLDINGS, INC.
(212) 770-2000 Securities registered pursuant to Section 12(b) of the Act:
Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes R No £ Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes £ No R 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 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 R No £ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (Section 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. £ 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. (check one): Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes £ No R The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant computed by reference to the price at which the common equity was last sold, as of June 30, 2007 (the last business day of the registrant’s most recently completed second fiscal quarter) was approximately $1,912,278,267. As of January 31, 2008, there were outstanding 66,234,360 shares of Common Stock, $1.00 par value, of the registrant. Documents Incorporated by Reference Portions of the registrant’s definitive proxy statement filed or to be filed with the Securities and Exchange Commission pursuant to Regulation 14A involving the election of directors at the annual meeting of the stockholders of the registrant scheduled to be held on May 22, 2008 are incorporated by reference in Part III of this Form 10-K.
TRANSATLANTIC HOLDINGS, INC. AND SUBSIDIARIES
Page Business
1 Risk Factors
19 Unresolved Staff Comments
26 Properties
26 Legal Proceedings
26 Submission of Matters to a Vote of Security Holders
26 Market for the Registrant’s Common Equity, Related Stockholder Matters and
Issuer Purchases of Equity Securities
27 Selected Financial Data
29 Management’s Discussion and Analysis of Financial Condition and Results of
Operations
31 Quantitative and Qualitative Disclosures About Market Risk
62 Financial Statements and Supplementary Data
63 Changes in and Disagreements With Accountants on Accounting and Financial
Disclosure
101 Controls and Procedures
101 Other Information
101 Directors, Executive Officers and Corporate Governance
101 Executive Compensation
103 Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters
103 Certain Relationships and Related Transactions, and Director Independence
103 Principal Accounting Fees and Services
103 Exhibits and Financial Statement Schedules
104
Introduction Transatlantic Holdings, Inc. (the “Company”, and collectively with its subsidiaries, “TRH”) is a holding company incorporated in the state of Delaware. Originally formed in 1986 under the name
PREINCO Holdings, Inc. as a holding company for Putnam Reinsurance Company (“Putnam”), the Company’s name was changed to Transatlantic Holdings, Inc. on April 18, 1990 following the acquisition
on April 17, 1990 of all of the common stock of Transatlantic Reinsurance Company® (“TRC”) in exchange for shares of Common Stock of the Company (the “Share Exchange”). Prior to the Share Exchange,
American International Group, Inc. (“AIG”, and collectively, with its subsidiaries, the “AIG Group”) held a direct and indirect interest of approximately 25% in the Company and an indirect interest of
49.99% in TRC. As a result of the Share Exchange, AIG became the beneficial owner of approximately 41% of the Company’s outstanding Common Stock and TRC became a wholly-owned subsidiary of the
Company. In June 1990, certain stockholders of the Company (other than AIG) sold shares of the Company’s Common Stock (“TRH shares”) in a public offering. As of December 31, 2007, 2006 and 2005,
AIG beneficially owned approximately 59% of the Company’s outstanding shares. The Company, through its wholly-owned subsidiaries, TRC, Trans Re Zurich (“TRZ”), acquired by TRC in 1996, and Putnam (contributed by the Company to TRC in 1995), offers reinsurance capacity
for a full range of property and casualty products on both a treaty and facultative basis. These products are offered directly and through brokers, to insurance and reinsurance companies, in both the domestic
and international markets. One or both of TRC and Putnam is licensed, accredited, authorized or can serve as a reinsurer in 50 states and the District of Columbia in the United States and in Puerto Rico and
Guam. TRC is licensed in Canada, Japan, the United Kingdom, the Dominican Republic, the Hong Kong Special Administrative Region, People’s Republic of China and Australia. In addition, TRC is
registered or authorized as a foreign reinsurer in Argentina (where it maintains a representative office in Buenos Aires, Transatlantic Re (Argentina) S.A.), Brazil (where it maintains a representative office in
Rio de Janeiro, Transatlantic Re (Brasil) Ltda.), the Republic of Panama (where it maintains a representative office, TRC (PANAMÁ) S.A.), Bolivia, Chile, Colombia, Ecuador, El Salvador, France,
Guatemala, Honduras, Mexico, Nicaragua, Paraguay, Peru, Uruguay, Venezuela and is authorized to maintain a representative office in Shanghai, People’s Republic of China. TRZ is licensed as a reinsurer in
Switzerland and registered in Paraguay, Ecuador, Argentina, Honduras, El Salvador, Dominican Republic, Brazil and Colombia. Transatlantic Polska Sp. z o.o., a subsidiary of TRC, maintains a registered
representative office in Warsaw, Poland. TRH’s principal lines of reinsurance include other liability (including directors’ and officers’ liability (“D&O”), errors and omissions liability (“E&O”) and general casualty), medical malpractice, ocean
marine and aviation, auto liability (including non-standard risks), accident and health (“A&H”) and surety and credit in the casualty lines, and fire, allied lines, auto physical damage and homeowners multiple
peril lines in the property lines. Reinsurance is provided for most major lines of insurance on both excess-of-loss and pro rata bases. TRH’s website, which can be found on the Internet at http://www.transre.com, contains frequently updated information about the Company and its operations. Copies of TRH’s recent Forms 10-K, Forms
10-Q and Forms 8-K, and all amendments to those reports, can be accessed free of charge as soon as reasonably practicable after the reports and amendments are electronically filed with or furnished to the
Securities and Exchange Commission by selecting “SEC Filings” on the drop-down menu under “Investor Information.” TRH also makes available on its corporate website copies of its charters for its Audit,
Nominating and Corporate Governance and Compensation Committees, as well as its Corporate Governance Guidelines, Director Independence Standards, Director, Executive Officer and Senior Financial
Officer Code of Business Conduct & Ethics, Employee Code of Conduct and Related-Party Transaction Approval Policy. 1
In addition, copies of any of TRH’s reports on Form 10-K, Form 10-Q and Form 8-K, and all amendments to those reports, as well as any Quarterly Earnings Press Release may be obtained by contacting
TRH’s Investor Relations Department at:
Transatlantic Holdings, Inc. Throughout this Annual Report on Form 10-K, TRH presents its operations in the way it believes will be most meaningful. TRH’s unpaid losses and loss adjustment expenses, net of related reinsurance
recoverable, and TRH’s combined ratio and its components are presented in accordance with principles prescribed or permitted by insurance regulatory authorities as these are standard measures in the
insurance and reinsurance industries. The Reinsurance Business Reinsurance is an arrangement whereby one or more companies, the reinsurer(s), agrees to indemnify another (re)insurance company, the ceding company, for all or part of the insurance risks
underwritten by the ceding company. Reinsurance can provide certain basic benefits to the ceding company. It reduces net liability on individual risks, thereby enabling the ceding company to underwrite
more business than its own resources can support and it provides catastrophe protection to lessen the impact of large or multiple losses. There are two major classes of reinsurance: treaty reinsurance and facultative reinsurance. Treaty reinsurance is a contractual arrangement that provides for the automatic reinsuring of a type or
category of risk underwritten by the ceding company. Facultative reinsurance is the reinsurance of individual risks. Rather than agreeing to reinsure all or a portion of a class of risk, the reinsurer separately
rates and underwrites each risk. Facultative reinsurance is normally purchased for risks not covered by treaty reinsurance or for individual risks covered by reinsurance treaties that are in need of capacity
beyond that provided by such treaties. A ceding company’s reinsurance program may involve pro rata and excess-of-loss reinsurance on both a treaty and facultative basis. Under pro rata reinsurance (also referred to as proportional), the
ceding company and the reinsurer share the premiums as well as the losses and expenses in an agreed proportion. As pro rata business is a proportional sharing of premiums and losses between ceding
company and reinsurer, generally, the underwriting results of such business more closely reflect the underwriting results of the business ceded than do the results of excess-of-loss business. In pro rata
reinsurance, the reinsurer generally pays the ceding company a ceding commission. Generally, the ceding commission is based on the ceding company’s cost of obtaining the business being reinsured (i.e.,
brokers’ and agents’ commissions, local taxes and administrative expenses). Under excess-of-loss reinsurance, the reinsurer agrees to reimburse the ceding company for all losses in excess of a predetermined amount up to a predetermined limit. Premiums paid by the ceding
company to the reinsurer for excess-of-loss coverage are generally not proportional to the premiums that the ceding company receives because the reinsurer does not assume a proportionate risk. Often
there is no ceding commission on excess-of-loss reinsurance and therefore the pricing mechanism used by reinsurers in those instances is a rate applicable to premiums of the individual policy or policies
subject to the reinsurance agreement. In general, casualty insurance protects the insured against financial loss arising out of its obligation to others for loss or damage to their person or property. Property insurance protects the insured
against financial loss arising out of the loss of property or its use caused by an insured peril. Property and casualty reinsurance protects the ceding company against loss to the extent of the reinsurance
coverage provided. Casualty insurance can be written on a claims-made or an occurrence basis. Claims-made policies generally provide coverage for claims made during the policy period regardless of when the act causing 2
the claim occurred. Occurrence policies generally provide coverage in perpetuity for acts committed during the policy period regardless of when the claim is made. Depending on the nature of the business
and statute of limitations, the final claims costs for occurrence business can take many years to be definitively known given that new claims can come in at any time and existing claims may continue to
develop. Claims-made business, while also taking a significant time to finalize claims costs, due to the development of open claims, generally has a shorter period for completion as the number of claims is
known shortly after the policy expires. Casualty business as a whole is volatile in that the ultimate claims costs for a policy or portfolio are not known for a significant amount of time. Reasons for this are the complexity of liability theory,
the occurrence nature of some coverages, the potential for litigation, adverse court rulings, unpredictable claims and social inflation trends and reporting lag time between cedents and reinsurers. Property reinsurance is written on an occurrence basis, but, because the loss is generally immediate and manifest, claims are adjusted and closed in a much shorter period. However, due to the
unpredictable nature of fires, hurricanes, earthquakes and other natural or man-made catastrophic events as well as the imperfect models that exist in measuring the probability and potential magnitude of
costs from these events, there is a great deal of volatility in property reinsurance as well. General TRH’s activities in the United States are conducted through its worldwide headquarters in New York, N.Y., its branch in Miami, FL and offices in Chicago, IL, Overland Park, KS, San Francisco, CA,
Columbus, OH and Stamford, CT. All domestic treaty and facultative business is underwritten by, or under the supervision of, senior officers of TRH located in New York. TRH’s headquarters in New
York and offices in Miami, Toronto, London, Paris, Zurich, Hong Kong, Tokyo and Sydney offer treaty as well as facultative reinsurance. In addition, TRH operates representative offices in Buenos Aires,
Rio de Janeiro, Panama, Warsaw and Shanghai, maintains exclusive representative arrangements with MS Upson Associates c.c. in Johannesburg, South Africa and with NOBARE in Stockholm, Sweden
and maintains an arrangement with Momentum Underwriting Management, Ltd. (“Momentum Underwriting”) in London, England. Momentum Underwriting has the underwriting authority to bind TRH,
pursuant to strict underwriting guidelines. TRH also operates Professional Risk Management Services, Inc. (“PRMS”), its wholly-owned subsidiary. Based in Arlington, VA, PRMS is an insurance program
manager specializing in professional liability insurance services, including underwriting, claims, and risk management, for individual healthcare providers, group practices, facilities and organizations. TRH reinsures risks from a broad spectrum of industries throughout the United States and foreign countries. Business underwritten by all branches located outside the United States and by the Miami
branch (which underwrites business in Latin America and the Caribbean) accounted for approximately 51%, 52% and 55% of worldwide net premiums written in 2007, 2006 and 2005, respectively. The
London branch had net premiums written totaling $813.2 million, $744.5 million and $759.3 million in 2007, 2006 and 2005, respectively, representing 21%, 20% and 22%, respectively, of worldwide net
premiums written in each of those years. TRZ had net premiums written totaling $366.7 million, $342.6 million and $369.2 million in 2007, 2006 and 2005, respectively, representing 9%, 9% and 11%,
respectively, of worldwide net premiums written in each of those years. (See Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) for a discussion of premium
fluctuations between years, Regulation for a discussion of certain conditions associated with international business and Note 16 of Notes to Consolidated Financial Statements for financial data by business
segment.) A portion of the reinsurance written by TRH is assumed from other subsidiaries of AIG and therefore generally reflects their underwriting philosophy and diversified insurance products, except for
insurance business written by other subsidiaries of AIG that is almost entirely reinsured by TRH by prearrangement. Approximately $555 million (13%), $593 million (15%) and $575 million (15%) of gross
premiums written by TRH in the years 2007, 2006 and 2005, respectively, were attributable to reinsurance purchased by other subsidiaries of AIG. (See Relationship with the AIG Group.) In addition, TRH holds a 40% interest in Kuwait Reinsurance Company (K.S.C.) (“Kuwait Re”), acquired in 2000, which has a balance sheet carrying value of $52.8 million at December 31, 2007. 3
Kuwait Re provides property, casualty and life reinsurance products to clients in Middle Eastern and North African markets. TRC and Putnam have a quota share reinsurance agreement where TRC cedes 5% of its assumed reinsurance, net of other retrocessions, to Putnam. Presently all of Putnam’s business is assumed from
TRC pursuant to this quota share reinsurance agreement. This agreement was entered into for operational reasons and had no impact on TRH’s financial position or results of operations. In general, the overall operating results (including investment performance) and other changes to stockholders’ equity of property and casualty insurance and reinsurance companies, and TRH, in
particular, are subject to significant fluctuations due to competition, natural and man-made catastrophic events, economic and social conditions, foreign currency exchange rate fluctuations, interest rates,
operating performance and prospects of investee companies and other factors, such as changes in tax laws, tort laws and the regulatory environment. Operating results in 2007, 2006 and 2005 included pre-tax net catastrophe costs of $55 million, $29 million and $544 million, respectively. (See MD&A.) TRH seeks to focus on more complex risks within the casualty and property lines, and to adjust its mix of business to take advantage of market opportunities. Casualty reinsurance constitutes the larger
portion of TRH’s business, accounting for 71% of net premiums written in 2007, 73% in 2006 and 70% in 2005. The following table presents certain underwriting information concerning TRH’s casualty and
property business for the periods indicated (see MD&A):
Years Ended December 31,
Net Premiums Written
Net Premiums Earned
Net Losses and Loss
Loss and Loss
2007
2006
2005
2007
2006
2005
2007
2006
2005
2007
2006
2005
(dollars in millions) Casualty: Other liability(1)(2)(3)(4)
$
1,040.4
$
1,003.4
$
865.3
$
1,043.9
$
899.6
$
830.2
$
941.7
$
784.8
$
896.8
90.2
%
87.2
%
108.0
% Medical malpractice(2)(3)(4)
388.8
318.0
308.0
379.8
304.9
306.5
304.2
233.2
258.5
80.1
76.5
84.3 Ocean marine and aviation(4)
335.7
349.4
304.7
350.9
325.6
301.4
251.5
234.6
237.1
71.7
72.0
78.7 Auto liability
289.6
288.3
308.7
268.0
302.4
359.7
213.6
229.4
258.0
79.7
75.9
71.7 Accident and health
248.3
230.4
173.2
238.5
232.7
166.4
185.6
181.4
134.3
77.8
77.9
80.7 Surety and credit(3)
177.6
174.0
152.6
173.8
165.4
146.6
84.7
118.3
96.9
48.7
71.6
66.1 Other(2)
324.7
298.2
320.4
313.5
318.2
282.0
208.1
221.5
144.2
66.4
69.6
51.1 Total casualty
2,805.1
2,661.7
2,432.9
2,768.4
2,548.8
2,392.8
2,189.4
2,003.2
2,025.8
79.1
78.6
84.7 Property: Fire(2)(3)(4)
568.6
474.0
473.9
534.2
487.7
485.0
235.6
156.8
349.2
44.1
32.2
72.0 Allied lines(2)(4)
284.4
230.5
135.5
289.4
220.3
125.8
73.4
99.4
246.3
25.4
45.1
195.7 Auto physical damage
111.4
108.3
139.6
101.4
136.7
126.6
78.1
107.6
83.5
77.1
78.7
66.0 Homeowners multiple peril(2)(3)(4)
64.5
45.9
169.2
83.4
97.6
143.6
(6.6)
29.8
147.8
(7.9)
30.5
102.9 Other(2)(3)(4)
118.9
113.0
115.3
125.9
113.0
111.2
68.1
65.9
24.4
54.1
58.3
22.0 Total property
1,147.8
971.7
1,033.5
1,134.3
1,055.3
992.2
448.6
459.5
851.2
39.6
43.5
85.8 Total
$
3,952.9
$
3,633.4
$
3,466.4
$
3,902.7
$
3,604.1
$
3,385.0
$
2,638.0
$
2,462.7
$
2,877.0
67.6
68.3
85.0
(1)
A large majority of the amounts within the other liability line relates to complex risks such as E&O and D&O, to general casualty risks and, to a much lesser extent, environmental impairment liability. (2) In 2007, development on reserves held at December 31, 2006 relating to losses that occurred in 2006 and prior years significantly increased net losses and loss adjustment expenses incurred in the other liability, medical malpractice and other property
lines and significantly decreased net losses and loss adjustment expenses incurred in the homeowners multiple peril, fire, allied lines and other casualty lines. In addition, pre-tax net catastrophe losses of $65 million, including $11 million which is included
in development on reserves held at December 31, 2006, significantly increased net losses and loss adjustment expenses incurred in the fire line. (3) In 2006, development on reserves held at December 31, 2005 relating to losses that occurred in 2005 and prior years significantly increased net losses and loss adjustment expenses incurred in the other liability, medical malpractice, surety and credit and
other property lines and significantly decreased net losses and loss adjustment expenses incurred in the homeowners multiple peril and fire lines. 2006 pre-tax net catastrophe costs did not have a significant impact on that year’s results. (footnotes continued on next page) 4
(footnotes continued from previous page)
(4)
In 2005, development on reserves held at December 31, 2004 relating to losses that occurred in 2004 and prior years significantly increased net losses and loss adjustment expenses incurred in the other liability and medical malpractice lines and
significantly decreased net losses and loss adjustment expenses incurred in the fire, homeowners multiple peril, ocean marine and aviation and other property lines. In addition, pre-tax net catastrophe losses of $483 million, including $14 million that is
included in development on reserves held at December 31, 2004, significantly increased net losses and loss adjustment expenses incurred in the allied lines, fire, ocean marine and aviation and homeowners multiple peril lines. Also, net ceded
reinstatement premiums of $61 million reduced net premiums written and earned primarily in the allied lines and fire lines.
Treaty reinsurance constitutes the great majority of TRH’s business, accounting for 96%, 95% and 96% of net premiums written in 2007, 2006 and 2005, respectively. Facultative reinsurance comprises
the balance of net premiums written. The following table presents certain information concerning TRH’s treaty and facultative business for the periods indicated:
Treaty
Years Ended December 31,
2007(1)
2006(2)
2005
(in millions) Gross premiums written
$
3,971.5
$
3,655.2
$
3,614.7 Net premiums written
3,805.8
3,461.6
3,310.6 Net premiums earned
3,748.4
3,434.7
3,241.5
Facultative
Years Ended December 31,
2007(1)
2006(2)
2005
(in millions) Gross premiums written
$
312.1
$
328.2
$
273.0 Net premiums written
147.1
171.8
155.8 Net premiums earned
154.3
169.4
143.5
(1)
In 2007 compared to 2006, domestic treaty net premiums written increased significantly in the property, medical malpractice and auto liability lines, offset in part by a significant decrease in the A&H line. International treaty net premiums written
increased significantly in the other liability, A&H and property lines, partially offset by a significant decrease in the auto liability line. Facultative net premiums written in 2007 decreased compared to 2006 principally in the medical malpractice and
property lines. (2) In 2006 compared to 2005, domestic treaty net premiums written increased significantly in the other liability, A&H and auto liability lines, offset in part by significant decreases in the surety line. International treaty net premiums written decreased
significantly in the auto liability and property lines, partially offset by significant increases in the ocean marine, surety and credit and A&H lines. Facultative gross premiums written increased in 2006 compared to 2005 due significantly to an increase in
premiums that, by prearrangement with TRH, were assumed from an affiliate and then ceded in an equal amount to other affiliates in the property and other liability lines. Facultative net premiums written, in 2006 compared to 2005, increased
principally in the medical malpractice and other liability lines. Treaty Reinsurance Treaty reinsurance accounted for approximately $3,971.5 million of gross premiums written and $3,805.8 million of net premiums written in 2007. Approximately 71% of treaty net premiums written
resulted from casualty lines treaties, with the remainder from property lines treaties. Approximately 67% of total treaty gross premiums written in 2007 represented treaty reinsurance written on a pro rata
basis and the balance represented treaty reinsurance written on an excess-of-loss basis. Approximately 10% of treaty gross premiums written in 2007 were attributable to other subsidiaries of AIG and were
primarily written on a pro rata basis. (See Relationship with the AIG Group.) The majority of TRH’s non-AIG Group treaty premiums were also written on a pro rata basis. Non-U.S. treaty business
accounted for approximately 48% of TRH’s total net premiums written for the year ended December 31, 2007. TRH’s treaty business consists primarily of business within the other liability (including D&O and E&O), medical malpractice, ocean marine and aviation, auto liability (including non-standard risks), A&H,
surety and credit, fire, allied lines, auto physical damage and homeowners multiple peril lines. A significant portion of TRH’s business within these lines (primarily other liability, medical malpractice and
A&H) is derived from complex risks. 5
TRH’s treaty business accepts a portfolio of risks on either a risk attaching basis or loss occurring during (“LOD”) basis. For the risk attaching treaties, if an individual risk covered by the treaty incepts
during the treaty period, TRH’s liability for that policy goes to that treaty year regardless of when the loss occurs. For LOD treaties, TRH covers losses occurring during the treaty coverage period on all in-
force policies, regardless of the date the policies were issued by the ceding company. TRH’s treaty underwriting process emphasizes a team approach among TRH’s underwriters, actuaries and claims staff, as appropriate. Treaties are reviewed for compliance with TRH’s underwriting
guidelines and objectives and most treaties are evaluated in part based upon actuarial analyses conducted by TRH. TRH’s actuarial models used in such analyses are tailored in each case to the exposures
and experience underlying the specific treaty and the loss experience for the risks covered. Property catastrophe exposed treaties are generally evaluated using industry standard models. These models are
used as a guide for risk assessment and are continually being updated. TRH also frequently conducts underwriting and claims audits at the offices of a prospective ceding company both before and after
entering into major treaties, because reinsurers, including TRH, do not separately evaluate each of the individual risks assumed under their treaties and, consequently, are largely dependent on the original
underwriting decisions made by the ceding company. Such dependence subjects TRH, and reinsurers in general, to the possibility that the ceding companies have not adequately evaluated the risks to be
reinsured and, therefore, that the premiums ceded in connection therewith may not adequately compensate the reinsurer for the risk assumed. TRH offers brokers full service with large capacity for both casualty and property risks. For non-AIG Group business, TRH often seeks to lead treaty arrangements. The lead reinsurer on a treaty
generally accepts one of the largest percentage shares of the treaty and takes the initiative in negotiating price, terms and conditions. TRH believes that this strategy has enabled it to influence more
effectively the terms and conditions of the treaties in which it has participated. Except where insurance business written by AIG subsidiaries is almost entirely reinsured by TRH by prearrangement, TRH
has generally not set terms and conditions as lead underwriter with respect to treaty reinsurance purchased by other subsidiaries of AIG, although it may do so in the future. When TRH does not lead the
treaty, it may still suggest changes to any aspect of the treaty. In either case, TRH may reject any treaty business offered to it by AIG subsidiaries or others based upon its assessment of all relevant factors.
Such factors include type and level of risk assumed, actuarial and underwriting judgment with respect to rate adequacy, various treaty terms, prior and anticipated loss experience (including exposure to
natural and man-made catastrophes) on the treaty, prior business experience with the ceding company, overall financial position, operating results, the A.M. Best Company (“Best”), Standard & Poor’s
(“S&P”) and Moody’s Investors Service (“Moody’s”) ratings of the ceding company and social, legal, regulatory, environmental and general economic conditions affecting the risks assumed or the ceding
company. TRH currently has approximately 4,400 treaties in effect for the current underwriting year. In 2007, no single treaty exceeded 2% of treaty gross premiums written. No ceding company accounted for
more than 3% of total treaty gross premiums written in 2007 except for other subsidiaries of AIG (see Relationship with the AIG Group). Members of Lloyd’s of London (“Lloyd’s”) in the aggregate
accounted for 6% of treaty gross premiums written. Facultative Reinsurance During 2007, TRH wrote approximately $312.1 million of gross premiums written and $147.1 million of net premiums written of facultative reinsurance. Approximately 64% of facultative net premiums
written represented casualty risks with the balance comprising property risks. TRH provides facultative reinsurance on predominantly an excess-of-loss basis, although some business is written on a pro rata
basis. Non-U.S. facultative business accounted for approximately 2% of TRH’s total net premiums written for the year ended December 31, 2007. TRH’s facultative contracts (also called certificates) provide prospective coverage on virtually the same basis as the original policy issued by the ceding insurer. In 2007, TRH’s facultative book of
business focused on the property, other liability, medical malpractice and A&H lines, although coverage is generally offered for most lines of business, and is written principally on a risk attaching basis for
each risk (i.e., TRH’s liability starts with the underlying policy inception and ends when the underlying policy expires). With respect to facultative contracts, TRH’s clients come to TRH on a risk by risk
basis 6
when they wish to obtain a larger policy limit than provided by their existing outward treaty reinsurance or when their existing treaty reinsurance excludes a class of business or type of coverage they
provide to policyholders. Other underwriting expenses associated with facultative business are generally higher in proportion to related premiums than those associated with treaty business, reflecting, among other things, the
more labor-intensive nature of underwriting and servicing facultative business. Approximately 56% of facultative gross premiums written in 2007 were attributable to other subsidiaries of AIG. The large
majority of such facultative gross premiums written in 2007, 2006 and 2005, were, by prearrangement with TRH, assumed from one AIG subsidiary and ceded in an equal amount to other AIG subsidiaries.
(See Note 15 of Notes to Consolidated Financial Statements (“Note 15”).) Except for AIG subsidiaries, no single ceding company accounted for more than 4% of total facultative gross premiums written in
2007. Retrocession Arrangements TRH generally enters into retrocession arrangements for many of the same reasons primary insurers seek reinsurance, including reducing the effect of individual or aggregate losses and increasing gross
premium writings and risk capacity without requiring additional capital. Retrocession arrangements do not relieve TRH from its obligations to the insurers and reinsurers from whom it assumes business. The failure of retrocessionnaires to honor their obligations could result
in losses to TRH. TRH holds substantial amounts of funds and letters of credit to collateralize reinsurance recoverables. Such funds and letters of credit can be drawn on for amounts remaining unpaid
beyond contract terms. In addition, an allowance has been established for estimated unrecoverable amounts. As of December 31, 2007, TRH had in place approximately 150 active retrocessional arrangements for current and prior underwriting years with approximately 360 retrocessionnaires, and reinsurance
recoverable on paid and unpaid losses and loss adjustment expenses (“LAE”) totaled $1.07 billion, including $443.9 million recoverable from affiliates. No unsecured recoverables from a single
retrocessionnaire, other than amounts due from affiliates, are considered material to the financial position of TRH. (See Note 15.) Marketing TRH provides property and casualty reinsurance capacity through brokers as well as directly to insurance and reinsurance companies in both the domestic and international markets. TRH believes its
worldwide network of offices and its relationship with the AIG Group help position TRH to take advantage of market opportunities. Business assumed from other subsidiaries of AIG is generally obtained directly from the ceding company. No ceding company, other than such AIG subsidiaries has accounted for 10% or more of
TRH’s consolidated revenues in any of the last five years. Non-AIG Group treaty business is produced primarily through brokers, while non-AIG Group facultative business is produced both directly and through brokers. In 2007, approximately 83% of TRH’s
non-AIG Group business was written through brokers and the balance was written directly. Also in 2007, companies controlled by Aon Corporation (“Aon”) and Marsh & McLennan Companies, Inc.
(“Marsh”), TRH’s largest brokerage sources of non-AIG Group business, accounted for 16% and 14%, respectively, of TRH’s consolidated revenues. In addition, Aon and Marsh each accounted for non-
AIG Group business representing 17% and 15% of total gross premiums written in 2007, respectively. TRH’s largest 10 brokers accounted for non-AIG Group business aggregating approximately 57% of
total gross premiums written. Brokerage fees generally are paid by reinsurers. TRH believes that its emphasis on seeking the lead position in non-AIG Group reinsurance treaties in which it participates is
beneficial in obtaining business. Brokers do not have the authority to bind TRH with respect to reinsurance agreements, nor does TRH commit in advance to accept any portion of the business that brokers
submit to it. 7
Claims Claims are managed by TRH’s professional claims staff whose responsibilities include the review of initial loss reports, creation of claim files, determination of whether further investigation is required,
establishment and adjustment of case reserves and payment of claims. In addition to claims assessment, processing and payment, the claims staff conducts comprehensive claims audits of both specific claims
and overall claims procedures at the offices of selected ceding companies, which TRH believes benefit all parties to the reinsurance arrangement. Claims audits are conducted in the ordinary course of
business. In certain instances, a claims audit may be performed prior to assuming reinsurance business. Reserves for Unpaid Losses and Loss Adjustment Expenses (“Gross Loss Reserves”) Significant periods of time may elapse between the occurrence of an insured loss, the reporting of the loss to the ceding company and the reinsurer, and the ceding company’s payment of that loss and
subsequent payments to the ceding company by the reinsurer. Insurers and reinsurers establish gross loss reserves, which represent estimates of future amounts needed to pay claims and related expenses
with respect to insured events which have occurred on or before the balance sheet date, including events which have not been reported to the ceding company. Upon receipt of a notice of claim from the ceding company, TRH establishes its own case reserve for the estimated amount of the ultimate settlement, if any. Case reserves usually are based upon the
amount of reserves recommended by the ceding company and may be supplemented by additional amounts as deemed necessary. In certain instances, TRH establishes case reserves even when the ceding
company has not reported any liability to TRH. TRH also establishes reserves to provide for the estimated expenses of settling claims, including legal and other fees, the general expenses of administering the claims adjustment process (i.e., LAE),
and for losses and LAE incurred but not reported (“IBNR”). TRH calculates LAE and IBNR reserves by using generally accepted actuarial reserving techniques to estimate the ultimate liability for losses
and LAE. Such reserves are periodically reassessed by TRH to adjust for changes in the expected loss emergence pattern over time. TRH has an in-house actuarial staff which periodically reviews its unpaid
losses and loss adjustment expenses both gross and net of related reinsurance recoverables, and does not retain any outside actuarial firm to review its loss reserves on an ongoing basis. Gross loss reserves represent the accumulation of case reserves and IBNR. Provisions for inflation and social inflation (e.g., awards by judges and juries which progressively increase in size at a rate
exceeding that of general inflation) are implicitly considered in the overall reserve setting process as an element of the numerous judgments which are made as to expected trends in average claim severity.
Legislative changes may also affect TRH’s liabilities, and evaluation of the impact of such changes is made in the reserve setting process. The methods of determining estimates for unreported losses and establishing resulting reserves and related reinsurance recoverable are continually reviewed and updated, and any resulting adjustments
are reflected in income currently. The process relies upon the basic assumption that past experience, adjusted for the effect of current developments and likely trends, is an appropriate basis for predicting
future events. However, estimation of loss reserves is a difficult process, especially in view of changes in the legal and tort environment which impact the development of loss reserves, and therefore
quantitative techniques frequently have to be supplemented by subjective considerations and managerial judgment. In addition, trends that have affected development of liabilities in the past may not
necessarily occur or affect liability development to the same degree in the future. While the reserving process is difficult and subjective for the ceding companies, the inherent uncertainties of estimating such reserves are even greater for the reinsurer, due primarily to the longer term
nature of much reinsurance business, the diversity of development patterns among different types of reinsurance treaties or facultative contracts, the necessary reliance on the ceding companies for
information regarding reported claims and differing reserving practices among ceding companies, which are subject to change without notice. TRH writes a significant amount of non-proportional assumed
casualty reinsurance as well as proportional assumed reinsurance of excess casualty business for classes such as medical malpractice and D&O, which can exhibit greater volatility over time than most other
classes due to their low frequency, high severity nature, and loss cost trends that are more difficult to predict. 8
Included in TRH’s unpaid losses and loss adjustment expenses net of related reinsurance recoverables (“net loss reserves”) are amounts related to environmental impairment and asbestos-related
illnesses. (See MD&A for more detail regarding the significant uncertainties related to these reserves.) During the loss settlement period, which can be many years in duration, additional facts regarding individual claims and trends usually become known. As these become apparent, it usually becomes
necessary to refine and adjust the reserves upward or downward. Even then, the ultimate net liability may be materially different from the revised estimates which are reflected in TRH’s consolidated
financial statements, and such differences may have, and in recent years have had, a material effect on net income. (See MD&A, including the discussion of Critical Accounting Estimates, and Note 2(i) of
Notes to Consolidated Financial Statements for further discussion.) Net losses and LAE incurred consists of the estimated ultimate cost of settling claims incurred within the reporting period (net of related reinsurance recoverable), including IBNR claims, plus changes
in estimates of prior period losses. The “Analysis of Consolidated Net Loss Reserves Development” which follows presents the development of net loss reserves for calendar years 1997 through 2007. The upper half of the table shows
the cumulative amounts paid during successive years relating to the opening reserve. For example, with respect to the net loss reserve of $2,522.7 million as of December 31, 1997, by the end of 2007 (ten
years later) $2,380.5 million had actually been paid in settlement of those net loss reserves. In addition, as reflected in the lower section of the table, the original net loss reserve of $2,522.7 million was
reestimated to be $2,691.3 million at December 31, 2007. This change from the original estimate would normally result from a combination of a number of factors, including losses being settled for different
amounts than originally estimated. The original estimates will also be increased or decreased as more information becomes known about the individual claims and overall claim frequency and severity
patterns. The net deficiency depicted in the table, for any particular calendar year, shows the aggregate change in estimates over the period of years subsequent to the calendar year reflected at the top of
the respective columns. For example, the net deficiency of $168.6 million at December 31, 2007 relating to December 31, 1997 net loss reserves of $2,522.7 million, represents the cumulative amount by
which net loss reserves as of year-end 1997 have developed adversely from 1998 through 2007. Each amount other than the original reserves in the following table includes the effects of all changes in amounts for prior periods. For example, if a loss settled in 2004 for $150,000 was first reserved in
2001 at $100,000 and remained unchanged until settlement, the $50,000 deficiency (actual loss minus original estimate) would be included in the cumulative net redundancy (deficiency) in each of the years
in the period 2001 through 2003 shown in the following table. Conditions and trends that have affected development of liability in the past may not necessarily occur in the future. Accordingly, it may not be
appropriate to extrapolate future development based on this table. The “Analysis of Net Unpaid Losses and Loss Adjustment Expenses and Net Reestimated Liability” presents additional information regarding the development of gross loss reserves. 9
ANALYSIS OF CONSOLIDATED NET LOSS RESERVES DEVELOPMENT(1)(2)
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
(in thousands) Net loss reserves, as of
December 31:(3)
$
2,522,728
$
2,656,103
$
2,762,162
$
2,614,917
$
2,908,887
$
3,257,906
$
3,956,420
$
4,980,609
$
5,690,443
$
6,207,220
$
6,899,716 Cumulative paid as of: One year later
543,539
702,603
953,708
892,752
1,033,574
1,057,314
1,090,058
1,492,464
1,447,284
1,464,916 Two years later
1,003,059
1,224,593
1,570,329
1,573,227
1,759,047
1,806,388
2,035,299
2,416,036
2,526,261 Three years later
1,339,141
1,620,068
2,050,795
2,071,480
2,332,901
2,535,149
2,792,484
3,263,061 Four years later
1,604,714
1,982,347
2,408,700
2,499,596
2,932,043
3,198,831
3,485,611 Five years later
1,835,665
2,213,639
2,722,971
2,940,058
3,479,594
3,792,955 Six years later
1,972,791
2,417,530
3,039,306
3,333,401
3,953,515 Seven years later
2,079,993
2,620,053
3,306,557
3,649,883 Eight years later
2,187,524
2,794,230
3,525,322 Nine years later
2,284,911
2,937,132 Ten years later
2,380,457 Net reestimated liability
as of:(3) End of year
2,522,728
2,656,103
2,762,162
2,614,917
2,908,887
3,257,906
3,956,420
4,980,609
5,690,443
6,207,220
6,899,716 One year later
2,463,239
2,588,626
2,776,519
2,650,589
3,248,013
3,580,493
4,273,802
5,249,445
5,871,571
6,295,600 Two years later
2,369,885
2,496,422
2,802,612
3,088,303
3,561,876
4,112,290
4,781,344
5,557,243
6,133,365 Three years later
2,265,351
2,508,278
3,158,790
3,392,021
4,176,419
4,637,194
5,110,862
5,878,870 Four years later
2,235,533
2,764,144
3,379,226
3,872,054
4,641,988
4,976,922
5,485,195 Five years later
2,342,492
2,886,020
3,725,975
4,217,748
4,904,646
5,345,798 Six years later
2,396,192
3,073,754
3,944,728
4,396,225
5,184,316 Seven years later
2,483,736
3,218,944
4,064,479
4,584,446 Eight years later
2,567,505
3,313,104
4,193,632 Nine years later
2,632,555
3,407,352 Ten years later
2,691,298 Net deficiency as of
December 31, 2007
$
(168,570
)
$
(751,249
)
$
(1,431,470
)
$
(1,969,529
)
$
(2,275,429
)
$
(2,087,892
)
$
(1,528,775
)
$
(898,261
)
$
(442,922
)
$
(88,380
)
(1)
This table is on a calendar year basis and does not present accident or underwriting year data. (2) Data have been affected by transactions between TRH and the AIG Group. (See Relationship with the AIG Group and Notes 13 and 15 of Notes to Consolidated Financial Statements.) (3) Represents unpaid losses and loss adjustment expenses, net of related reinsurance recoverables. 10
ANALYSIS OF NET UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
(in thousands) End of year: Gross liability
$
2,918,782
$
3,116,038
$
3,304,931
$
3,077,162
$
3,747,583
$
4,032,584
$
4,805,498
$
5,941,464
$
7,113,294
$
7,467,949
$
7,926,261 Related reinsurance recoverable
396,054
459,935
542,769
462,245
838,696
774,678
849,078
960,855
1,422,851
1,260,729
1,026,545 Net liability
$
2,522,728
$
2,656,103
$
2,762,162
$
2,614,917
$
2,908,887
$
3,257,906
$
3,956,420
$
4,980,609
$
5,690,443
$
6,207,220
$
6,899,716 One year later: Gross reestimated liability
$
2,864,610
$
3,083,643
$
3,369,520
$
3,126,518
$
4,136,126
$
4,465,908
$
5,117,490
$
6,344,019
$
7,306,595
$
7,633,138 Reestimated related reinsurance recoverable
401,371
495,017
593,001
475,929
888,113
885,415
843,688
1,094,574
1,435,024
1,337,538 Net reestimated liability
$
2,463,239
$
2,588,626
$
2,776,519
$
2,650,589
$
3,248,013
$
3,580,493
$
4,273,802
$
5,249,445
$
5,871,571
$
6,295,600 Two years later: Gross reestimated liability
$
2,776,598
$
3,033,092
$
3,426,471
$
3,565,853
$
4,556,676
$
5,003,598
$
5,761,231
$
6,633,579
$
7,618,979 Reestimated related reinsurance recoverable
406,713
536,670
623,859
477,550
994,800
891,308
979,887
1,076,336
1,485,614 Net reestimated liability
$
2,369,885
$
2,496,422
$
2,802,612
$
3,088,303
$
3,561,876
$
4,112,290
$
4,781,344
$
5,557,243
$
6,133,365 Three years later: Gross reestimated liability
$
2,701,351
$
3,039,473
$
3,788,866
$
3,970,012
$
5,188,506
$
5,678,239
$
6,096,568
$
7,017,192 Reestimated related reinsurance recoverable
436,000
531,195
630,076
577,991
1,012,087
1,041,045
985,706
1,138,322 Net reestimated liability
$
2,265,351
$
2,508,278
$
3,158,790
$
3,392,021
$
4,176,419
$
4,637,194
$
5,110,862
$
5,878,870 Four years later: Gross reestimated liability
$
2,649,925
$
3,298,599
$
4,098,524
$
4,492,711
$
5,814,220
$
6,034,785
$
6,536,334 Reestimated related reinsurance recoverable
414,392
534,455
719,298
620,657
1,172,232
1,057,863
1,051,139 Net reestimated liability
$
2,235,533
$
2,764,144
$
3,379,226
$
3,872,054
$
4,641,988
$
4,976,922
$
5,485,195 Five years later: Gross reestimated liability
$
2,762,480
$
3,502,673
$
4,479,946
$
4,868,258
$
6,099,084
$
6,467,893 Reestimated related reinsurance recoverable
419,988
616,653
753,971
650,510
1,194,438
1,122,095 Net reestimated liability
$
2,342,492
$
2,886,020
$
3,725,975
$
4,217,748
$
4,904,646
$
5,345,798 Six years later: Gross reestimated liability
$
2,887,038
$
3,713,151
$
4,728,479
$
5,058,733
$
6,441,624 Reestimated related reinsurance recoverable
490,846
639,397
783,751
662,508
1,257,308 Net reestimated liability
$
2,396,192
$
3,073,754
$
3,944,728
$
4,396,225
$
5,184,316 Seven years later: Gross reestimated liability
$
2,997,036
$
3,893,259
$
4,860,380
$
5,262,921 Reestimated related reinsurance recoverable
513,300
674,315
795,901
678,475 Net reestimated liability
$
2,483,736
$
3,218,944
$
4,064,479
$
4,584,446 Eight years later: Gross reestimated liability
$
3,112,127
$
3,995,364
$
5,007,580 Reestimated related reinsurance recoverable
544,622
682,260
813,948 Net reestimated liability
$
2,567,505
$
3,313,104
$
4,193,632 Nine years later: Gross reestimated liability
$
3,181,550
$
4,105,512 Reestimated related reinsurance recoverable
548,995
698,160 Net reestimated liability
$
2,632,555
$
3,407,352 Ten years later: Gross reestimated liability
$
3,260,196 Reestimated related reinsurance recoverable
568,898 Net reestimated liability
$
2,691,298 Gross deficiency as of December 31, 2007
$
(341,414
)
$
(989,474
)
$
(1,702,649
)
$
(2,185,759
)
$
(2,694,041
)
$
(2,435,309
)
$
(1,730,836
)
$
(1,075,728
)
$
(505,685
)
$
(165,189
)
(1)
This table is on a calendar year basis and does not represent accident or underwriting year data. (2) Data has been affected by transactions between TRH and the AIG Group. (See Relationship with the AIG Group and Notes 13 and 15 of Notes to Consolidated Financial Statements.) 11
The trend depicted in the latest development year in the net reestimated liability portion of the “Analysis of Consolidated Net Loss Reserves Development” table and in the “Analysis of Net Unpaid
Losses and Loss Adjustment Expenses and Net Reestimated Liability” table reflects net adverse development. Net adverse development of $88.4 million was recorded in 2007 on losses occurring in all prior
years. This net adverse development was comprised of $368.9 million relating to losses occurring in 2002 and prior, largely offset by net favorable development of $280.5 million, principally relating to losses
occurring in 2006 and, to lesser extents, 2005 and 2004. (See MD&A.) In general, the deficiencies shown in the tables for years 1998 through 2006 developed principally in 2002 through 2007 and resulted largely from losses occurring between 1998 and 2002 in certain
casualty lines. Such adverse development involved an unexpected increase in the frequency and severity of large claims reported in late 2002 through 2007, as was common in the industry, relating to non-
proportional assumed casualty reinsurance as well as proportional assumed reinsurance of excess casualty business for such volatile classes as medical malpractice, D&O, E&O and other general casualty. (See
MD&A.) See Note 5 of Notes to Consolidated Financial Statements for a reconciliation of beginning and ending gross and net loss reserves. For TRH’s domestic subsidiaries (TRC and Putnam), there is no
difference in reserves for losses and LAE, net of related reinsurance recoverable, whether determined in accordance with accounting principles generally accepted in the United States of America or
statutory accounting principles. Investment Operations TRH’s investments must comply with the insurance laws of the state of New York, the state of domicile of TRC and Putnam, and of the other states and jurisdictions in which the Company and its
subsidiaries are regulated. These laws prescribe the kind, quality and concentration of investments which may be made by insurance companies. In general, these laws permit investments, within specified
limits and subject to certain qualifications, in federal, state and municipal obligations, corporate fixed maturities, preferred and common stocks, real estate mortgages and real estate. The Finance Committee
of the Company’s Board of Directors and senior management oversee investments, establish TRH’s investment strategy and implement investment decisions with the assistance of certain subsidiaries of
AIG, which act as financial advisors and managers of TRH’s investment portfolio and, in connection therewith, make the selection of particular investments. Other than as set forth above, there are no
guidelines or policies with respect to the specific composition of TRH’s overall investment portfolio or the composition of its fixed maturity portfolio by rating or maturity. A significant portion of TRH’s
domestic investments are in tax-exempt fixed maturities. TRH’s current investment strategy seeks to maximize after-tax income through a high quality diversified taxable fixed maturity and tax-exempt municipal fixed maturity portfolio, while maintaining an
adequate level of liquidity. TRH adjusts its mix of taxable and tax-exempt investments, as appropriate, generally as a result of strategic investment and tax planning considerations. Tax-exempt fixed
maturities carry lower pre-tax yields than taxable fixed maturities that are comparable in risk and term to maturity due to their tax-advantaged status. (See MD&A.) The majority of the equity portfolio is
structured to achieve capital appreciation primarily through investment in quality growth companies. Other invested assets principally includes investments in limited partnerships and TRH’s 40% interest in
Kuwait Re. TRH engages in a securities lending program managed by a subsidiary of AIG, whereby certain securities (principally fixed maturities and common stocks available for sale) from its portfolio are
loaned to third parties. (See Note 2(c) of Notes to Consolidated Financial Statements.) In these transactions, initial collateral, principally cash, is received by TRH in an amount exceeding the fair value of
the loaned security. The collateral is invested in portfolios containing floating rate bonds (i.e., fixed maturities), including asset-backed and collateralized securities, and interest-bearing cash equivalents
which are maintained in segregated accounts for TRH by the program manager. A liability is recorded in an amount equal to the collateral received to recognize TRH’s obligation to return such funds when
the related loaned securities are returned. The fair value of the loaned securities, which is reflected parenthetically as pledged on the balance sheet, is monitored on a daily 12
basis with additional collateral obtained or refunded as the value fluctuates. Income earned on invested collateral, net of interest payable to the collateral provider, is included in net investment income. The following table reflects investment results for TRH for each of the five years in the period ended December 31, 2007. INVESTMENT RESULTS
Years Ended December 31,
Average
Pre-Tax Net
Pre-Tax
(dollars in thousands) 2007
$
12,024,944
$
469,772
3.9
% 2006
10,270,004
434,540
4.2 2005
8,748,640
343,247
3.9 2004
7,566,066
306,786
4.1 2003
6,211,294
270,972
4.4
(1)
Average of the beginning and ending carrying values of investments and cash for the year, excluding non-interest-bearing cash. See Results of Operations in MD&A. (2) Pre-tax net investment income divided by average investments. The carrying values of available for sale and trading securities are subject to significant volatility from changes in their fair values. (See MD&A.) As of December 31, 2007, the fair value of the total investment portfolio was $12,786.0 million. In addition, TRH’s investments are exposed to market and other significant risks which could result in the loss of fair value. Market risk results from the potential for adverse fluctuations in interest
rates, equity prices and foreign currency exchange rates. TRH has performed Value at Risk (“VaR”) analyses to estimate the maximum potential loss of fair value that could occur as a result of market risk
over a period of one month at a confidence level of 95%. As market risk is assessed based upon VaR historical simulation methodology, it does not provide weight in its analysis to risks relating to current
market issues such as liquidity and the credit-worthiness of investments. (See MD&A.) Competition The reinsurance business is a mature, highly competitive industry in virtually all lines of business. See MD&A for a discussion of market conditions and trends in competition intensity in recent years. Competition in the types of reinsurance in which TRH engages is based on many factors, including the perceived overall financial strength of the reinsurer, Best, S&P and Moody’s ratings, the states or
other jurisdictions where the reinsurer is licensed, accredited, authorized or can serve as a reinsurer, capacity and coverages offered, premiums charged, specific terms and conditions of the reinsurance
offered, value-added services offered, speed of claims payment and reputation and experience in the lines of business underwritten. These factors also operate in the aggregate across the reinsurance
industry, generally in combination with prevailing economic conditions. Reinsurance purchases are also sensitive to cyclical movements in reinsurance rates, terms and conditions and ultimately the
reinsurance industry’s overall financial results. TRH competes in the United States and international reinsurance markets with numerous major international reinsurance companies and numerous domestic reinsurance companies, some of which
have greater financial and other resources than TRH. TRH’s competitors include independent reinsurance companies, subsidiaries or affiliates of established worldwide insurance companies, reinsurance
departments of certain primary insurance companies, domestic and European underwriting syndicates and in some instances with government owned or subsidized facilities. Although most reinsurance
companies operate in the broker market, TRH’s largest competitors also work directly with ceding companies, competing with brokers. Traditional reinsurers as well as capital market participants from time to time produce alternative products (such as reinsurance securitizations, catastrophe bonds and various derivatives such as swaps)
that may compete with certain types of reinsurance, such as property catastrophe. Over time, these 13
numerous initiatives could significantly affect supply, pricing and competition in the reinsurance industry. Employees At December 31, 2007, TRH had approximately 570 employees. Approximately 240 employees were located in the New York headquarters; 110 employees were located in other locations in the United
States and 220 employees were located in offices outside of the United States. Regulation TRH’s operations around the world are subject to regulation by insurance regulators in the U.S. and abroad. The regulatory environment can have a significant effect on TRH and its businesses. TRC,
TRZ and Putnam, in common with other reinsurers, are subject to regulation and supervision by the states and by other jurisdictions in which they do business. Within the United States, the method of such
regulation varies but generally has its source in statutes that delegate regulatory and supervisory powers to a state insurance official. The regulation and supervision relate primarily to the standards of
solvency that must be met and maintained, including risk-based capital measurements, the licensing of reinsurance, the nature of and limitations on investments, restrictions on the size of risks which may be
insured under a single contract, deposits of securities for the benefit of ceding companies, methods of accounting, periodic audits of the affairs and financial reports of insurance companies, the form and
content of reports of financial condition required to be filed, and reserves for unearned premiums, losses and other purposes. As required by the state of New York, TRC and Putnam use the Codification of
Statutory Accounting Principles as primary guidance on statutory accounting. In general, such regulation is for the protection of the ceding companies and, ultimately, their policyholders rather than security
holders. The rates and contract terms of reinsurance agreements are generally not subject to regulation by any governmental authority. This contrasts with primary insurance agreements, the rates and policy
terms of which are generally closely regulated by governmental authorities. As a practical matter, however, the rates charged by primary insurers and the policy terms of primary insurance agreements may
affect the rates charged and the policy terms associated with reinsurance agreements. The Company, TRC, TRZ and Putnam are subject to the insurance statutes, including insurance holding company statutes, of various states and jurisdictions. The insurance holding company laws and
regulations vary from jurisdiction to jurisdiction, but generally require domestic insurance holding companies and insurers and reinsurers that are subsidiaries of insurance holding companies to register with
the applicable state regulatory authority and to file with that authority certain reports which provide information concerning their capital structure, ownership, financial condition, affiliated company
transactions and general business operations. Such holding company laws generally also require prior regulatory agency approval of changes in direct or indirect control of an insurer or reinsurer and of certain material intercorporate transfers of
assets within the holding company structure. The New York Insurance Law provides that no corporation or other person, except an authorized insurer, may acquire direct control of TRC or Putnam, or
acquire control of the Company and thus indirect control of TRC and Putnam, unless such corporation or person has obtained the prior approval of the New York State Insurance Department (the “NYS
ID”) for such acquisition. For the purposes of the New York Insurance Law, any investor acquiring ten percent or more of TRH shares would be presumed to be acquiring “control” of the Company and its
subsidiaries, unless the NYS ID determines upon application that such investor would not control the Company. An investor who would be deemed to be acquiring control of the Company would be
required to obtain the approval of the NYS ID prior to such acquisition. In addition, such investor would become subject to various ongoing reporting requirements in New York and in certain other states.
(See Control of the Company for additional discussion.) Risk Based Capital (“RBC”) is designed to measure the adequacy of an insurer’s statutory surplus in relation to the risks inherent in its business. Thus, inadequately capitalized insurance companies
may be identified. The RBC formula develops a risk adjusted target level of statutory surplus by applying 14
certain factors to various asset, premium and reserve items. Higher factors are applied to items deemed to have more risk by the National Association of Insurance Commissioners (“NAIC”) and lower
factors are applied to items that are deemed to have less risk. Thus, the target level of statutory surplus varies not only as a result of the insurer’s size, but also on the risk profile of the insurer’s operations. The RBC Model Law provides for four incremental levels of regulatory attention for insurers whose surplus is below the calculated RBC target. These levels of attention range in severity from
requiring the insurer to submit a plan for corrective action to placing the insurer under regulatory control. At December 31, 2007, the statutory surpluses of TRC and Putnam each exceeded the level of surplus required under RBC requirements for regulatory attention. Through the “credit for reinsurance” mechanism, TRC and Putnam are indirectly subject to the effects of regulatory requirements imposed by the states in which TRC’s and Putnam’s ceding companies
are licensed. In general, an insurer which obtains reinsurance from a reinsurer that is licensed, accredited or authorized by the state in which the insurer files statutory financial statements is permitted to
take a credit on its statutory financial statements in an aggregate amount equal to the reinsurance recoverable on paid losses and the liabilities for unearned premiums and loss and LAE reserves ceded to
the reinsurer, subject to certain limitations where amounts of reinsurance recoverable on paid losses are more than 90 days overdue. Certain states impose additional requirements that make it difficult to
become so authorized, and certain states do not allow credit for reinsurance ceded to reinsurers that are not licensed or accredited in that state without additional provision for security. Throughout 2007, the NAIC continued to debate modifications of the collateral requirements under current credit for reinsurance guidelines. Additionally, several states including New York and
Florida have drafted separate collateral requirement proposals. While it is unclear what proposal will ultimately be adopted by the states, any revision of the collateral requirements will likely recognize that
reinsurers domiciled in certain countries outside of the U.S. are subject to financial scrutiny comparable to their U.S. domiciled counterparts. Consequently, collateral requirements under credit for
reinsurance rules will be based in part on domicile and in part on each reinsurer’s financial strength rating as assigned by the NAIC or its designated rating organization(s). TRH does not presently expect
this proposal to have a material effect on its operations. However, such proposal is expected to reduce the amount of collateral that many non-U.S. domiciled companies will need to post to secure their
obligations to U.S. domiciled insurers and reinsurers. TRH’s international operations are regulated in various jurisdictions with respect to licensing requirements, currency, amount and type of security deposits, amount and type of reserves and amount and
type of local investment. International operations and assets held abroad may be adversely affected by political and other developments in foreign countries, including possible tax changes, nationalization
and changes in regulatory policy, as well as by consequences of hostilities and unrest. The risks of such occurrences and their overall effect upon TRH vary from country to country and cannot easily be
predicted. Regulations governing constitution of technical reserves and remittance balances in some countries may hinder remittance of profits and repatriation of assets. The Terrorism Risk Insurance Act of 2002 (“TRIA”) was signed into law in November 2002 and extended for two years in December 2005. TRIA provided coverage to the insurance industry for acts
of terrorism, as defined by TRIA. The Terrorism Risk Insurance Extension Act of 2005 (“TRIEA”) greatly increased the portion of the loss the insurance industry would pay in the event of a terrorist
attack and reduced the number of lines covered. This coverage does not apply to reinsurers. Terrorism Risk Insurance Program Reauthorization Act of 2007 (“TRIPRA”) extended the TRIEA program
through 2014. TRIPRA removes the distinction between foreign and domestic acts of terrorism and hardens the cap on insurers’ aggregate liability at $100 billion. Additionally, TRIPRA mandates that
Federal fund outlays be recouped by mandatory policyholder surcharges. In general, TRH does not provide terrorism cover under international property treaties nor does it provide cover for certified acts
of terrorism, as defined by TRIEA, under domestic property treaties. TRH offers terrorism-specific treaty coverages to ceding companies on a limited basis. With respect to other lines of business, TRH
assumes terrorism risk in marine, aviation and other casualty treaties after careful underwriting consideration and, in many cases, with limitations. 15
Within the European Union (the “EU”), the EU Reinsurance Directive of November 2005 (the “Directive”) was to be phased in commencing October 2007 and fully implemented no later than
October 2008. This directive will lift barriers to trade within the EU for companies that are domiciled in an EU country. TRH operates within the EU through a series of foreign branches and continues to
evaluate the potential impact of the implementation of the Directive, which could vary from country to country. TRH has contacted insurance regulators throughout the EU to ascertain their regulatory
intent and to discuss each country’s rule applicable to TRH. Currently, TRH continues to conduct business within the EU through its foreign branches with no significant impact on its operations. As each
country within the EU adopts rules implementing the Directive, TRH could be materially affected by the adopted rules. TRH may be required to post additional collateral in EU countries or may need to
consider restructuring its business in order to comply with the rules adopted in EU countries implementing the Directive. In addition to the Directive, the EU is phasing in a new regulatory regime for regulation of financial services known as “Solvency II.” Solvency II is a principles based regulatory regime that seeks to
enhance transparency, promote uniformity, and encourage a proactive approach to company solvency. It is built on a risk-based approach to setting capital requirement of insurers and reinsurer. Solvency II
is scheduled to be introduced for insurers and reinsurers in 2010 and implemented by 2012. TRH could be materially impacted by the implementation of Solvency II depending on the costs associated with
implementation by each EU country, any increased capitalization requirements and any costs associated with adjustment to its corporate operating structure. Relationship with the AIG Group AIG AIG is a holding company which, through its subsidiaries, is engaged in a broad range of insurance and insurance-related activities in the United States and abroad. AIG’s primary activities include
both general insurance and life insurance & retirement services operations. Other significant activities include financial services and asset management. AIG subsidiaries other than TRH, collectively, are
among the largest purchasers of reinsurance in the insurance industry based on premiums ceded. Control of the Company As of December 31, 2007, 2006 and 2005, AIG beneficially owned approximately 59% of the Company’s outstanding shares. As of December 31, 2007, three of the Company’s ten current directors were
active executive officers of AIG, or in the case of Thomas R. Tizzio retired, and held a number of executive positions with AIG, including the following: Steven J. Bensinger is an Executive Vice President
and Chief Financial Officer; Martin J. Sullivan is a Director, President and Chief Executive Officer; and Thomas R. Tizzio is a Retired Senior Vice Chairman and Honorary Director. As of December 31, 2006, three of the Company’s nine directors were active executive officers of AIG, or in the case of Thomas R. Tizzio retired, and held a number of executive positions with AIG,
including the following: Steven J. Bensinger was an Executive Vice President and Chief Financial Officer; Martin J. Sullivan was a Director, President and Chief Executive Officer; and Thomas R. Tizzio
was a Retired Senior Vice Chairman and Honorary Director. As of December 31, 2005, three of the Company’s eight directors were active executive officers of AIG and held a number of executive positions with AIG, including the following: Mr. Bensinger was
an Executive Vice President and Chief Financial Officer; Mr. Sullivan was a Director, President and Chief Executive Officer; and Mr. Tizzio was an Honorary Director and Senior Vice Chairman—General
Insurance. Messrs. Bensinger and Sullivan were elected to TRH’s Board on May 19, 2005. Between April 4, 2005 and May 19, 2005, only one, Mr. Tizzio, of the Company’s six directors was an active executive officer of AIG. Between January 1, 2005 and April 3, 2005, four of the Company’s nine directors were active executive officers of AIG, or in the case of Edward E. Matthews retired, and held a number of executive
positions with AIG, including the following: Maurice R. Greenberg was a Director, Chairman 16
and Chief Executive Officer; Mr. Mathews was an Honorary Director and Senior Advisor; Howard I. Smith was a Director, Vice Chairman and Chief Financial Officer; and Mr. Tizzio served as an
Honorary Director and Senior Vice Chairman—General Insurance. On April 4, 2005, Messrs. Greenberg, Matthews and Smith resigned from TRH’s Board. AIG Group Reinsurance AIG offers TRH the opportunity to participate in a significant amount of property and casualty reinsurance purchased by other subsidiaries of AIG. TRH either accepts or rejects such reinsurance
offered based upon TRH’s assessment of risk selection, pricing, terms and conditions. Except where insurance business written by AIG subsidiaries is almost entirely reinsured by TRH by prearrangement,
TRH has generally not set terms and conditions as lead underwriter with respect to the treaty reinsurance purchased by other subsidiaries of AIG; however, TRH may in the future set terms and conditions
with respect to such business as lead underwriter and intends that the terms and conditions of any such reinsurance will be negotiated on an arm’s length basis. The operating management of TRH is not
employed by the AIG Group, and the Underwriting Committee of the Board of Directors of the Company, which includes directors of the Company who are not employees of the AIG Group, monitor
TRH’s underwriting policies. Approximately $555 million (13%), $593 million (15%) and $575 million (15%) of gross premiums written by TRH in the years 2007, 2006 and 2005, respectively, were attributable to reinsurance
purchased by other subsidiaries of AIG, for the production of which TRH recorded ceding commissions totaling approximately $114 million, $140 million and $122 million, respectively, in such years. (The
amounts discussed in the preceding sentence include transactions with C.V. Starr & Co., Inc. (“Starr”) as described in Transactions with Starr.) In 2007, 2006 and 2005, the great majority of such gross
premiums written were recorded in the property, other liability, medical malpractice and ocean marine and aviation lines. Of the premiums assumed from other subsidiaries of AIG, $248 million, $227
million and $209 million in 2007, 2006 and 2005, respectively, represent premiums resulting from certain insurance business written by other AIG subsidiaries that is almost entirely reinsured by TRH by
prearrangement, for the production of which TRH recorded ceding commissions to such AIG subsidiaries totaling approximately $41 million, $40 million and $37 million, respectively, in such years. TRH
has no goal with respect to the proportion of AIG Group subsidiary versus non-AIG Group subsidiary business it accepts. TRH’s objective in determining its business mix is to evaluate each underwriting
opportunity individually with a view to maximizing overall underwriting results. (See Note 13 of Notes to Consolidated Financial Statements.) TRH retroceded premiums written to other subsidiaries of AIG in the years 2007, 2006 and 2005 of approximately $143 million, $135 million and $95 million, respectively, and received ceding
commissions of approximately $13 million, $14 million and $9 million, respectively, for the production of such business in such years. Virtually the entire amount of such retrocessions to AIG subsidiaries in
2007, 2006 and 2005 consist of amounts which, by prearrangement with TRH, were assumed from a subsidiary of AIG and then ceded in an equal amount to other subsidiaries of AIG. (See Note 15.) Senior Notes Purchased by AIG Subsidiaries In December 2005, certain subsidiaries of AIG purchased, and at December 31, 2007 still hold, $450 million aggregate principal amount of the Company’s 5.75% senior notes due in 2015. Such amount
comprised 60% of the total amount of such notes offered. (See Note 6 of Notes to Consolidated Financial Statements.) Transactions with Starr and Compensation of Certain TRH Employees from Starr International Company (“SICO”) According to the Schedule 13D filed on March 20, 2007 by Starr, SICO, Edward E. Matthews, Maurice R. Greenberg, the Maurice R. and Corinne P. Greenberg Family Foundation, Inc., the Universal
Foundation, Inc., the Maurice R. and Corinne P. Greenberg Joint Tenancy Company, LLC and the C.V. Starr & Co., Inc. Trust, these reporting persons could be deemed to beneficially own 355.0 million
shares of AIG’s common stock at that date. Based on the shares of AIG’s common stock 17
outstanding as of October 31, 2007, this
ownership would represent approximately 14% of the voting stock of AIG. Although these reporting
persons have made filings under Section 16 of the Securities
Exchange Act of 1934, reporting sales of shares of common stock, no amendment to the Schedule 13D has been filed to report a change in ownership subsequent to March 20, 2007. Throughout 2005 certain
directors of TRH were also stockholders, executive officers or directors of Starr. On January 9, 2006, Starr released a press release indicating that all AIG executives and officers had tendered their shares in
Starr pursuant to Starr’s tender offer. In 2007 and 2006, no TRH directors were stockholders, executive officers or directors of Starr. In 2005, through April 3, Messrs. Greenberg, Matthews and Smith were directors of TRH and also stockholders, executive officers or directors of Starr. On April 4, 2005, Messrs. Greenberg, Matthews
and Smith resigned from the Board of Directors of TRH. For 2005, Messrs. Orlich and Tizzio were also stockholders, executive officers or directors of Starr. From May 19, 2005, when Messrs. Bensinger and
Sullivan were elected to the Board of TRH, through approximately December 31, 2005, Messrs. Bensinger and Sullivan were also stockholders, executive officers or directors of Starr. Transactions with Starr Throughout 2007, 2006 and 2005, certain of Starr’s subsidiaries operated as insurance agencies or brokers for insurance subsidiaries of AIG and, in such capacity, had produced reinsurance business
for TRH. Net commissions relating to Starr subsidiaries were insignificant in 2007 and 2006. Net commissions relating to Starr subsidiaries totaled $11 million in 2005 for reinsurance purchased by
subsidiaries of AIG totaling $59 million. Compensation of Certain TRH Employees from SICO SICO is a private holding company which has no direct ownership interest in TRH but which has a significant ownership interest in AIG. SICO had provided a series of two-year Deferred
Compensation Profit Participation Plans (the “SICO Plans”) to certain TRH employees through December 31, 2004. The SICO Plans came into being in 1975 when the voting shareholders and Board
of Directors of SICO, a private holding company whose principal asset is AIG common stock, decided that a portion of the capital value of SICO should be used to provide an incentive plan for the
current and succeeding managements of all American International companies, including TRH. None of the costs of the various benefits provided under the SICO Plans has been paid by TRH. Following AIG’s determination in 2005 to record a charge for the deferred compensation amounts
paid to TRH employees by SICO, TRH determined that, as a subsidiary of AIG, it was appropriate to record the compensation expense relating to its employees’ participation in such plans, with an
offsetting amount credited to additional paid-in capital reflecting amounts deemed contributed by AIG to TRH. The SICO Plans provide that shares currently owned by SICO are set aside by SICO for the benefit of the participant and distributed upon retirement. The SICO Board of Directors currently may
permit an early payout of units under certain circumstances. Prior to payout, the participant is not entitled to vote, dispose of or receive dividends with respect to such shares, and shares are subject to
forfeiture under certain conditions, including but not limited to the participant’s voluntary termination of employment prior to normal retirement age. Under the SICO Plans, SICO’s Board of Directors
may elect to pay a participant cash in lieu of shares of AIG common stock. Following notification in December 2005 from SICO to participants in the SICO Plans that it will settle specific future awards
under the SICO Plans with shares rather than cash, the accounting for the SICO Plans changed from variable to fixed measurement accounting. The impact of such change is insignificant to the amount
of expense recorded in 2005. In 2007, 2006 and 2005, TRH recorded compensation expense (included in the Consolidated Statements of Operations in “Other, net”) relating to the SICO Plans of $1.4 million, $1.1 million and
$3.3 million, respectively, with a corresponding increase to additional paid-in capital. TRH will continue to record compensation expense and increases to additional paid-in capital relating to the SICO
Plans in future periods. 18
As total SICO compensation expense for each year prior to 2005 would not have been material to any such prior year, TRH recorded in 2005 the total amount of compensation expense relating to
the SICO Plans that would have been recorded in all prior periods through December 31, 2004 as a reduction of retained earnings of $8.3 million, which was net of income tax savings that TRH
expected to realize of $3.0 million. The entire amount of such prior year compensation cost, before tax effect, of $11.3 million, was considered a contribution to capital, and was recorded as an increase
to additional paid-in capital. In making this determination, TRH evaluated the impact that expense recognition would have had on all prior years to which SICO Plans compensation would have applied. In addition, these
amounts were calculated as variable stock awards, which considered the fair value of AIG common stock at each measurement date, and included any distributions made under the SICO Plans. In addition, during 2005, AIG initiated the 2005–2006 Deferred Compensation Profit Participation Plan (the “AIG DCPPP”) that has been modeled after the SICO Plans and includes certain TRH
employees as participants. TRH will bear the costs relating to TRH employees’ participation in the AIG DCPPP. Compensation expense relating to the AIG DCPPP was not material in 2007 and 2006. The risks described below could materially affect TRH’s business, results of operations, cash flows or financial condition. The occurrence of severe catastrophic events could have a material adverse effect on TRH’s financial condition, results of operations and operating cash flows. Because TRH underwrites property and casualty reinsurance and has large aggregate exposures to natural and man-made disasters, TRH expects that its loss experience will from time to time include
infrequent events of great severity. The frequency and severity of catastrophe losses are inherently unpredictable. Consequently, the occurrence of losses from a severe catastrophe or series of catastrophes
could have a material adverse effect on TRH’s financial condition, results of operations and cash flows. Increases in the values and geographic concentrations of insured property and the effects of inflation
have historically resulted in increased severity of industry losses in recent years, and TRH expects that those factors will increase the severity of catastrophe losses in the future. If TRH is required to increase its liabilities for loss reserves, TRH’s financial condition and results of operations may be materially adversely affected. Significant periods of time may elapse between the occurrence of an insured loss, the reporting of the loss to the ceding company and the reinsurer, and the ceding company’s payment of that loss and
subsequent payments to the ceding company by the reinsurer. TRH is required by applicable insurance laws and regulations and U.S. generally accepted accounting principles (“GAAP”) to establish
liabilities on its consolidated balance sheet for payment of losses and LAE that will arise in the future from its reinsurance products for losses that have occurred as of the balance sheet date. Under GAAP,
TRH is not permitted to establish liabilities until an event occurs that may give rise to a loss. Once such an event occurs, liabilities are established in TRH’s financial statements for TRH’s losses, based
upon estimates of losses incurred by the ceding companies. As a result, only liabilities applicable to losses incurred up to the reporting date may be established, with no allowance for the provision of a
contingency reserve to account for expected or unexpected future losses. Losses arising from future events will be estimated and recognized at the time the losses occur. Although TRH annually reviews the
adequacy of its established reserves for losses and LAE, there can be no assurance that TRH’s loss reserves will not develop adversely and have a material effect on TRH’s results of operations. To the
extent these liabilities may be insufficient to cover actual losses or LAE, TRH will have to add to these liabilities and incur a charge to its earnings, which could have a material adverse effect on TRH’s
financial condition and results of operations. (See MD&A for further discussion of the risks and uncertainties relating to loss reserves.) 19
A downgrade in the ratings assigned to TRH’s operating subsidiaries could adversely affect TRH’s ability to write new business and may adversely impact TRH’s existing agreements. Best, S&P and Moody’s are generally considered to be significant rating agencies with respect to the evaluation of insurance and reinsurance companies. Ratings are used by ceding companies and
reinsurance intermediaries as an important means of assessing the financial strength and quality of reinsurers. These ratings are subject to periodic review at the discretion of each respective rating agency
and may be revised downward or revoked at their sole discretion. Rating agencies also may increase their scrutiny of rated companies, revise their rating standards or take other action. In addition, a ceding
company’s own rating may be adversely affected by a downgrade in the rating of its reinsurer or an affiliated company. Therefore, a downgrade of TRH’s rating may dissuade a ceding company from
reinsuring with TRH in the future and may influence a ceding company to reinsure with a competitor of TRH that has a higher financial strength rating. Best maintains a financial strength rating of A+ (Superior) and issuer credit ratings of aa– on the Company’s major operating subsidiaries, TRC, Putnam and TRZ. In addition, Best maintains an issuer
credit rating of a– for the Company. These financial strength ratings represent the second highest rating level. The issuer credit ratings of the Company’s major operating subsidiaries represent the fourth
highest rating level and the issuer credit rating of the Company represents the seventh highest rating level. On February 14, 2008, following the issuance by AIG of a Form 8-K on February 11, 2008, Best placed the issuer credit rating of AIG and the financial strength and issuer credit ratings of certain of
AIG’s domestic property/casualty subsidiaries, including the Company, TRC, TRZ and Putnam, under review with negative implications. According to Best, the placement of the financial strength and
issuer credit ratings of the Company, TRC, TRZ and Putnam under review with negative implications reflects the fact that these ratings incorporate implicit support from AIG. Following a detailed review of AIG’s year-end 2007 results and further discussion with AIG management, Best has indicated that it will re-evaluate AIG’s and its subsidiaries’ under review status. S&P maintains counterparty credit and insurer financial strength ratings on each of TRC, Putnam and TRZ of AA– (Very Strong). This rating is the fourth highest rating level. The outlook for the AA–
rating is presently negative, due to S&P’s view that Transatlantic’s operating performance has produced lower returns in recent years than would be expected at the AA rating level. While describing the
conditions that would contribute to a revision back to a stable outlook, S&P also commented that if operating results are below S&P’s expectations, or should Transatlantic be unsuccessful in integrating the
economic capital model into the strategic planning process or fail to maintain its disciplined underwriting standards, S&P would review the rating for a possible downgrade. Moody’s maintains an insurance financial strength rating of Aa3 (Excellent) on TRC. The outlook for the rating is stable. This rating is the fourth highest rating level. The Company’s 5.75% senior notes due in 2015 are presently rated A2 by Moody’s, A– by S&P and a– by Best. The outlook for the Moody’s rating is stable. The outlook for the S&P rating is currently
negative and the Best rating is under review with negative implications, each for the same reasons as discussed above relative to the other ratings from such rating agencies. If these debt ratings were
lowered, future borrowing costs, if any, may increase. A significant portion of TRC’s and TRZ’s in-force treaty contracts as of December 31, 2007 permit the ceding company to cancel the contract if TRC’s or TRZ’s financial strength rating is downgraded
below a certain rating level, generally A–. TRC’s and TRZ’s financial strength ratings are at least three levels above the most common trigger point. In addition, contracts may also permit the ceding
company to cancel the contract if there is a significant decline in the statutory surplus of TRC, generally of at least 20%. Contracts may contain one or both of the aforementioned contractual provisions, certain other cancellation triggers or other stipulations, such as a requirement to post collateral for all or a portion of
TRH’s obligations under the contract if a triggering event occurs. Whether a ceding company would exercise any of these cancellation rights would depend on, among other factors, the reason and extent 20
of such downgrade or surplus reduction, the prevailing market conditions and the pricing and availability of replacement reinsurance coverage, among other factors. When a contract is cancelled on a “cut-off” basis, as opposed to a “run-off” basis, the liability of the reinsurer under policies which became effective under the treaty prior to the cancellation date of
such treaty ceases with respect to losses resulting from events taking place on and after said cancellation date. Accordingly, unearned premiums on that business as of the cut-off date are returned to the
ceding company, net of a proportionate share of the original ceding commission. In the accounting period of the cancellation effective date, the amount of unearned premiums returned would be recorded as
a reduction of gross premiums written with a like reduction in gross unearned premiums with no effect on gross premiums earned. Thus, the canceling of a contract generally has future implications to
TRH’s business but rarely affects premiums already earned. TRH cannot predict in advance the extent to which these cancellation rights would be exercised, if at all, or what effect such cancellations would have on TRH’s financial condition or future operations,
but such effect potentially could be material. TRH may secure its obligations under its various reinsurance contracts using trusts and letters of credit. TRH may enter into agreements with ceding companies that require TRH to provide collateral
for its obligations under certain reinsurance contracts with these ceding companies under various circumstances, including where TRH’s obligations to these ceding companies exceed negotiated thresholds.
These thresholds may vary depending on TRH’s ratings and a downgrade of TRH’s ratings or a failure to achieve a certain rating may increase the amount of collateral TRH is required to provide. TRH
may provide the collateral by delivering letters of credit to the ceding company, depositing assets into trust for the benefit of the ceding company or permitting the ceding company to withhold funds that
would otherwise be delivered to TRH under the reinsurance contract. The amount of collateral TRH is required to provide typically represents all or a portion of the obligations TRH may owe the ceding
company, often including estimates made by the ceding company of IBNR claims. Since TRH may be required to provide collateral based on the ceding company’s estimate, TRH may be obligated to
provide collateral that exceeds its estimates of the ultimate liability to the ceding company. An increase in the amount of collateral TRH is obligated to secure its obligations may have an impact on TRH’s
ability to write additional reinsurance. These ratings are current opinions of the rating agencies. As such, they may be changed, suspended or withdrawn at any time by the rating agencies as a result of changes in, or unavailability of,
information or based on other circumstances, including TRH’s relationship with AIG. Ratings may also be withdrawn at the request of TRH’s management. Ratings are not a recommendation to buy, sell or
hold securities and each rating should be evaluated independently of any other rating. If TRH’s risk management methods and pricing models are not effective, TRH’s financial condition, results of operations and cash flows could be materially adversely affected. TRH’s property and casualty reinsurance contracts cover unpredictable events such as hurricanes, windstorms, hailstorms, earthquakes, volcanic eruptions, fires, industrial explosions, freezes, riots,
floods and other natural or man-made disasters, including those that may result from terrorist activity. TRH is also exposed to multiple insured losses arising out of a single occurrence that have the
potential to accumulate to material amounts and affect multiple risks/programs and classes of business. TRH uses modeling techniques to manage certain of such risks to acceptable limits, although current
techniques used to estimate the exposure may not accurately predict the probability of such an event nor the extent of resulting losses. In addition, TRH may purchase retrocession protection designed to
limit the amount of losses that TRH may incur. Retrocession arrangements do not relieve TRH from its obligations to the insurers and reinsurers from whom it assumes business, and the failure of
retrocessionnaires to honor their obligations could result in losses to TRH. Moreover, from time to time, market conditions may limit and in some cases prevent reinsurers from obtaining the types and
amounts of reinsurance that they consider adequate for their risk management. It is likely that TRH will face more difficulty obtaining certain retrocession protection in the future, and will also be required
to pay higher prices for such protections than in the recent past. If TRH is unable to obtain retrocessional coverage in the 21
amounts it desires or on acceptable terms, TRH’s capacity and appetite for risk could change, and TRH’s financial condition and results of operations may be materially adversely affected. Various provisions of TRH’s contracts, such as limitations to or exclusions from coverage or choice of forum, may not be enforceable in the manner TRH intends, due to, among other things, disputes
relating to coverage and choice of legal forum. Underwriting is a matter of judgment, involving important assumptions about matters that are inherently difficult to predict and beyond TRH’s control, and
for which historical experience and probability analysis may not provide sufficient guidance. One or more catastrophic or other events could result in claims that substantially exceed TRH’s expectations,
which could have a material adverse effect on TRH’s financial condition, results of operations and cash flows. The property and casualty reinsurance business is historically cyclical, and TRH expects to experience periods with excess underwriting capacity and unfavorable pricing. Historically, property and casualty reinsurers have experienced significant fluctuations in operating results. Demand for reinsurance is influenced significantly by underwriting results of primary insurers
and prevailing general economic and market conditions, all of which affect ceding companies’ decisions as to the amount or portion of risk that they retain for their own accounts and consequently how
much they decide to cede to reinsurance companies. The supply of reinsurance is related to prevailing prices, the levels of insured losses, and levels of industry surplus, among other factors, that, in turn,
may fluctuate in response to changes in rates of return on investments being earned in the reinsurance industry. In addition, the supply of reinsurance is affected by a reinsurer’s confidence in its ability to
accurately assess the probability of expected underwriting outcomes, particularly as respects catastrophe losses. As a result, the property and casualty reinsurance business historically has been a cyclical
industry, characterized by periods of intense price competition due to excessive underwriting capacity as well as periods when shortages of capacity permitted favorable pricing. The cyclical trends in the industry and the industry’s profitability can also be affected significantly by volatile and unpredictable developments, including what TRH believes to be a trend of courts to
grant increasingly larger awards for certain damages, changes in the political, social or economic environment, natural disasters (such as catastrophic hurricanes, windstorms, tornadoes, earthquakes and
floods), man-made disasters (such as those arising from terrorist activities), fluctuations in interest rates, changes in the investment environment that affect market prices of and returns on investments and
inflationary pressures that may tend to affect the size of losses experienced by primary insurers. TRH cannot predict whether market conditions will improve, remain constant or deteriorate. Unfavorable
market conditions may affect TRH’s ability to write reinsurance at rates that it considers appropriate relative to the risk assumed. If TRH cannot write property and casualty reinsurance at appropriate
rates, its ability to transact reinsurance business would be significantly and adversely affected. Increased competition could adversely affect TRH’s profitability. The property and casualty reinsurance industry is highly competitive in virtually all lines. TRH faces competition from new market entrants and from existing market participants that devote increasing
amounts of capital to the types of business written by TRH. Over the past few years, increased market capacity, domestic and international merger and acquisition activity, the strengthening of Lloyd’s of
London’s capital base, and limited catastrophe activity in 2006 and 2007, have added to competitive pressures. As a result of certain 2005 catastrophe events, namely, Hurricane Katrina, the insurance
industry’s largest natural catastrophe loss ever, and two subsequent substantial hurricanes, existing insurers and reinsurers raised new capital and significant investments have been made in new insurance
and reinsurance companies in Bermuda. The ultimate impact on the market of these events is uncertain. Competition in the types of reinsurance in which TRH is engaged is based on many factors, including the perceived overall financial strength of the reinsurer, the ratings of Best, S&P and Moody’s, the
states or other jurisdictions where the reinsurer is licensed, accredited, authorized or can serve as a reinsurer, capacity and coverages offered, premiums charged, specific terms and conditions of the
reinsurance offered, services offered, speed of claims payment and reputation and experience in the lines of business underwritten. 22
TRH competes in the United States and international reinsurance markets with numerous major international reinsurance companies and numerous domestic reinsurance companies, some of which
have greater financial and other resources than TRH. TRH’s competitors include independent reinsurance companies, subsidiaries or affiliates of established worldwide insurance companies, reinsurance
departments of certain primary insurance companies, domestic and European underwriting syndicates and in some instances with government owned or subsidized facilities. Certain of these competitors
have been operating substantially longer than TRH has and have established long-term and continuing business relationships throughout the industry, which can be a significant competitive advantage. Traditional reinsurers as well as capital market participants from time to time produce alternative products or reinsurance vehicles (such as reinsurance securitizations, catastrophe bonds, various
derivatives such as swaps and sidecars) that may compete with certain types of reinsurance, such as property catastrophe. Capital markets, including hedge funds, have become more active in assuming more
reinsurance risk other than from investing in various companies. Numerous hedge funds have provided both pro rata and excess-of-loss reinsurance and retrocessional protections through captive companies
or other alternative transactions on a fully collateralized basis for property and energy catastrophe business. Over time, these numerous initiatives could significantly affect supply, pricing and competition in
the reinsurance industry. In December 2006, the Florida legislature adopted legislation, since signed into law, which directed the Florida Hurricane Catastrophe Fund to more than double its catastrophe reinsurance fund limit.
The rate for this coverage is mandated to be significantly below the prevailing market rate. The same law froze current property insurance rates and imposed a moratorium on policy non-renewals. Several
other Southeast states have publicly indicated that they are considering similar proposals. While it is too early to make a prediction of the full impact of this law, given TRH’s historical participation in this
market, TRH does not presently expect the impact of this legislation to materially reduce its premiums assumed as a result of the loss of some catastrophe excess-of-loss premiums covering Florida risks.
However, this measure will likely reduce the demand for catastrophe reinsurance within the Florida market and may compel current market participants to seek greater participation and thus increase
competition in other regions such as Latin America, the Caribbean, and the Coastal Mid-Atlantic and New England states. Liquidity risk represents the potential inability of TRH to meet all payment obligations when they become due. TRH’s liquidity could be impaired by unforeseen significant outflows of cash. This situation may arise due to circumstances specific to TRH or that TRH may be unable to control, such as a general
market disruption or an operational problem that affects third parties or TRH. The Company depends on dividends, distributions and other payments from its subsidiaries to fund dividend payments and to
fund payments on its obligations, including debt obligations. Regulatory and other legal restrictions may limit TRH’s ability to transfer funds freely, either to or from its subsidiaries. In particular, certain of
TRH’s branches or subsidiaries are subject to laws and regulations, including those in foreign jurisdictions, that authorize regulatory bodies to block or reduce transfers of funds to the home office in the
U.S. or its affiliates. These laws and regulations may hinder TRH’s ability to access funds that TRH may need to make payments on its obligations. Certain of TRH’s investments may become illiquid. TRH’s investments include fixed maturities (including asset-backed and collateralized securities), equity investments and limited partnerships
(including hedge funds and private equities). The current disruption in the credit markets may materially affect the liquidity of TRH’s
investments, including U.S. residential mortgage-backed securities which represent
2% of total investments and cash. If TRH requires significant amounts of cash
on short notice in excess of normal cash requirements (which could include
the requirement to return significant amounts of collateral in connection with
its securities lending activities on short notice) in a period of market illiquidity,
then TRH may have difficulty selling investments in a timely manner or may
be forced to dispose of them for less than what TRH might otherwise have been
able to under other conditions. 23
Concentration of TRH’s investment portfolios in any particular segment of the economy may have adverse effects. Concentration of TRH’s investment portfolios in any particular industry, group of related industries, asset classes, such as residential mortgage-backed securities, or geographic sector could have an
adverse effect on the investment portfolios and consequently on TRH’s consolidated results of operations or financial condition. While TRH seeks to mitigate this risk by having a broadly diversified
portfolio, events or developments that have a negative effect on any particular industry, asset class, group of related industries or geographic region may have a greater adverse effect on investment
portfolios to the extent that the portfolios are concentrated rather than diversified. Further, TRH’s ability to sell assets relating to such particular groups of related assets may be limited if other market
participants are seeking to sell at the same time. TRH may be adversely affected by the current disruption in the global credit markets. During the second half of 2007, disruption in the global credit markets created increasingly difficult conditions in the financial markets. These conditions have resulted in greater volatility, less liquidity
and a widening of credit spreads in certain markets. These conditions adversely affected the fair value of certain investment securities held by TRH, particularly those backed by U.S. residential mortgage
loans, and could potentially increase claim activity under mortgage guaranty, D&O, E&O and credit reinsurance business TRH has underwritten. It is difficult to predict how long these conditions will exist and
how TRH’s markets, business and investments will continue to be adversely affected. Accordingly, these conditions could have a material adverse effect on TRH’s consolidated financial condition or results
of operations in future periods. TRH may be adversely affected by the impact of market volatility and interest rate and foreign currency exchange rate fluctuation on its invested assets. TRH’s principal invested assets are fixed maturity investments and other interest rate sensitive securities, which are subject to the market risk of potential losses from adverse changes in interest rates
and may also be adversely affected by foreign currency exchange rate fluctuations. Depending on TRH’s classification of its investments as available for sale, trading or other, changes in the fair value of
TRH’s securities are reflected in the Consolidated Balance Sheet and/or Statement of Operations. TRH’s investment portfolio is also subject to credit risk resulting from adverse changes in the issuers’
ability to repay the debt or the ability of bond issurers to meet their obligations to provide insurance if an issuer is unable to repay its debt. These risks could materially adversely affect TRH’s results of
operations and/or financial condition. A principal exposure to foreign currency risk is TRH’s obligation to settle claims in foreign currencies. The possibility exists that TRH may incur foreign currency exchange gains or losses as TRH
ultimately settles claims required to be paid in foreign currencies. To mitigate this risk, TRH also maintains investments denominated in certain foreign currencies in which the claims payments will be
made. To the extent TRH does not seek to hedge its foreign currency risk or hedges prove ineffective, the resulting impact of a movement in foreign currency exchange rate could materially adversely affect
TRH’s results of operations or financial condition. TRH’s businesses are heavily regulated, and changes in regulation may reduce TRH’s profitability and limit its growth. The Company’s reinsurance subsidiaries are subject to extensive regulation and supervision in the jurisdictions in which they conduct business. This regulation is generally designed to protect the
interests of policyholders, as opposed to reinsurers and their stockholders and other investors, and relates to authorization to transact certain lines of business, capital and surplus requirements, investment
limitations, underwriting limitations, transactions with affiliates, dividend limitations, changes in control and a variety of other financial and non-financial components of an insurance company’s business. In recent years, the state insurance regulatory framework in the U.S. has come under increased federal scrutiny, and some state legislatures have considered or enacted laws that may alter or increase
state authority to regulate insurance and reinsurance companies and insurance holding companies. Further, the NAIC and state insurance regulators are re-examining existing laws and regulations, 24
specifically focusing on modifications to holding company regulations, interpretations of existing laws and the development of new laws. Any proposed or future legislation or NAIC initiatives may be more
restrictive than current regulatory requirements or may result in higher costs. Within the EU, the Directive was to be phased in commencing October 2007 and fully implemented no later than October 2008. The Directive will lift barriers to trade within the EU for companies
that are domiciled in an EU country. TRH operates within the EU through a series of foreign branches and continues to evaluate the potential impact of the implementation of the Directive which could
vary from country to country. TRH has contacted insurance regulators throughout the EU to ascertain their regulatory intent and to discuss each country’s rule applicable to TRH. Currently, TRH
continues to conduct business within the EU through its foreign branches with no significant impact on its operations. As each country within the EU adopts rules implementing the Directive, TRH could be
materially affected by the adopted rules. TRH may be required to post additional collateral in EU countries or may need to consider restructuring its business in order to comply with the rules adopted in
EU countries implementing the Directive. In addition to the Directive, the EU is phasing in a new regulatory regime for regulation of financial services known as “Solvency II.” Solvency II is a principles based regulatory regime that seeks to
enhance transparency, promote uniformity, and encourage a proactive approach to company solvency. It is built on a risk-based approach to setting capital requirement of insurers and reinsurer. Solvency II
is scheduled to be introduced for insurers and reinsurers in 2010 and implemented by 2012. TRH could be materially impacted by the implementation of Solvency II depending on the costs associated with
implementation by each EU country, any increased capitalization requirements and any costs associated with adjustment to its corporate operating structure. TRH’s offices that operate in jurisdictions outside the United States are subject to certain limitations and risks that are unique to foreign operations. TRH’s international operations are also regulated in various jurisdictions with respect to licensing requirements, currency, amount and type of security deposits, amount and type of reserves, amount
and type of local investment and other matters. International operations and assets held abroad may be adversely affected by political and other developments in foreign countries, including possibilities of
tax changes, nationalization and changes in regulatory policy, as well as by consequences of hostilities and unrest. The risks of such occurrences and their overall effect upon TRH vary from country to
country and cannot easily be predicted. In addition, TRH’s results of operations and net unrealized currency translation gain or loss (a component of accumulated other comprehensive income) are subject
to volatility as the value of the foreign currencies fluctuate relative to the U.S. dollar. Regulations governing constitution of technical reserves and remittance balances in some countries may hinder
remittance of profits and repatriation of assets. The current investigations into certain non-traditional, or loss mitigation, insurance products and other legal matters could have a material adverse effect on TRH’s financial condition or results of
operations. Various regulators including the United States Department of Justice (the “DOJ”), the Securities and Exchange Commission (the “SEC”), the Office of the New York State Attorney General (the
“NYAG”) and the NYS ID have been conducting investigations relating to certain insurance and reinsurance business practices, non-traditional insurance products and assumed reinsurance transactions
within the industry and at AIG. In connection with these investigations, AIG requested that TRH, as a subsidiary of AIG, review its documents and practices, and TRH has cooperated with AIG in all such
requests. On February 9, 2006, AIG announced that it reached a resolution of claims and matters under investigation by the DOJ, SEC, NYAG and NYS ID. AIG stated that the settlements resolved
investigations conducted by the SEC, NYAG and NYS ID against AIG and conclude negotiations with these authorities and the DOJ in connection with the accounting, financial reporting and insurance
brokerage practices of AIG and its subsidiaries, as well as claims relating to the underpayment of certain workers compensation premium taxes and other assessments. As part of these settlements, AIG has agreed to retain, for a period of three years, an independent consultant who will conduct a review that will include, among other things, the adequacy of AIG’s 25
internal controls over financial reporting, the policies, procedures and effectiveness of AIG’s regulatory, compliance and legal functions and the remediation plan that AIG has implemented as a result of its
own internal review. TRH, as a subsidiary of AIG, is cooperating with the terms of the settlements that are applicable to TRH. In addition, from time to time, other regulators have commenced, and may in the future commence, investigations into insurance brokerage practices relating to contingent commissions and other
industry-wide practices as well as other broker-related conduct, such as alleged bid-rigging, finite insurance and reinsurance transactions and other reinsurance practices. TRH has cooperated, and will
continue to cooperate, in producing documents and other information in response to subpoenas and other requests. While TRH does not believe that any of these inquiries will have a material impact on
TRH’s business or financial results, it is not possible to predict with any certainty at this time what impact, if any, these inquiries may have on TRH’s business or financial results. Item 1B. Unresolved Staff Comments None. As of December 31, 2007, the office space of TRH’s New York headquarters and its Chicago and Toronto offices are rented from the AIG Group, which leases it from others. The lease for the office
space occupied by TRH’s New York headquarters expires in 2021. The Arlington, Columbus, Overland Park, San Francisco, Stamford, Miami, Buenos Aires, Rio de Janeiro, Panama, London, Paris, Zurich,
Warsaw, Hong Kong, Shanghai, Tokyo and Sydney offices are rented from third parties. TRH, in common with the reinsurance industry in general, is subject to litigation in the normal course of its business. TRH does not believe that any pending litigation will have a material adverse
effect on its consolidated results of operations, financial position or cash flows. Various regulators including the DOJ, the SEC, the NYAG and the NYS ID have been conducting investigations relating to certain insurance and reinsurance business practices, non-traditional
insurance products and assumed reinsurance transactions within the industry and at AIG. In connection with these investigations, AIG requested that TRH, as a subsidiary of AIG, review its documents and
practices, and TRH has cooperated with AIG in all such requests. On February 9, 2006, AIG announced that it reached a resolution of claims and matters under investigation by the DOJ, SEC, NYAG and NYS ID. AIG stated that the settlements resolved
investigations conducted by the SEC, NYAG and NYS ID against AIG and conclude negotiations with these authorities and the DOJ in connection with the accounting, financial reporting and insurance
brokerage practices of AIG and its subsidiaries, as well as claims relating to the underpayment of certain workers compensation premium taxes and other assessments. As part of these settlements, AIG has agreed to retain, for a period of three years, an independent consultant who will conduct a review that will include, among other things, the adequacy of AIG’s
internal controls over financial reporting, the policies, procedures and effectiveness of AIG’s regulatory, compliance and legal functions and the remediation plan that AIG has implemented as a result of its
own internal review. TRH, as a subsidiary of AIG, is cooperating with the terms of the settlements that are applicable to TRH. In addition, from time to time, other regulators have commenced, and may in the future commence, investigations into insurance brokerage practices relating to contingent commissions and other
industry-wide practices as well as other broker-related conduct, such as alleged bid-rigging, finite insurance and reinsurance transactions and other reinsurance practices. TRH has cooperated, and will
continue to cooperate, in producing documents and other information in response to subpoenas and other requests. While TRH does not believe that any of these inquiries will have a material impact on
TRH’s business or financial results, it is not possible to predict with any certainty at this time what impact, if any, these inquiries may have on TRH’s business or financial results. There were no matters submitted to a vote of security holders during the fourth quarter of 2007. 26
The following table sets forth the high and low closing sales prices and the dividends declared per share of Transatlantic Holdings, Inc. (the “Company”) Common Stock (“TRH shares”) on the New
York Stock Exchange Composite Tape for each of the four quarters of 2007 and 2006:
2007
2006
High
Low
Dividends
High
Low
Dividends First Quarter
$
66.50
$
60.49
$
0.135
$
68.00
$
57.65
$
0.120 Second Quarter
72.52
65.31
0.160
57.83
55.25
0.135 Third Quarter
75.78
58.84
0.160
63.18
53.28
0.135 Fourth Quarter
75.05
68.69
0.160
63.51
59.87
0.135 The Company paid each dividend in the quarter following the quarter of declaration. The declaration and payment of future dividends, if any, by the Company will be at the discretion of the Board of Directors and will depend upon many factors, including the Company’s consolidated
earnings, financial condition and business needs, capital and surplus requirements of the Company’s operating subsidiaries, regulatory considerations and other factors. As of January 31, 2008, the approximate number of holders of TRH shares, including those whose TRH shares are held in nominee name, was 39,000. In November 2000, the Board of Directors authorized the purchase of up to 200,000 shares (375,000 shares after adjustment for subsequent stock splits) of TRH shares in the open market or through
negotiated transactions. The purchase program has no set expiration or termination date. As of December 31, 2007, 170,050 shares may still be purchased pursuant to this authorization. No shares were
purchased in the fourth quarter of 2007. The preceding does not include 32,555 shares relating to options exercised in the three months ended December 31, 2007 that were attested to in satisfaction of the
exercise price by holders of the Company’s employee or director stock options and 2,224 shares relating to restricted stock units (“RSU”) vesting in the three months ended December 31, 2007 that were
attested to in satisfaction of withholding taxes relating to the issuance of TRH shares for vested RSUs by holders of the Company’s employee RSUs. Performance Graph The following Performance Graph compares the cumulative total return to stockholders on TRH shares for a five-year period (December 31, 2002 to December 31, 2007) with the cumulative total
return of the S&P 500 stock index (the “S&P 500 Index”) and a peer group of companies (the “Peer Group”) consisting of fifteen reinsurance companies to which TRH compares its business and operations:
Arch Capital Group Ltd., Axis Capital Holdings Ltd. (included from July 1, 2003), Endurance Specialty Holdings Ltd. (included from February 28, 2003), Everest Re Group Ltd., IPC Holdings Ltd., Max
Capital Group Ltd., Montpelier Re Holdings Ltd. (included from October 10, 2002), Odyssey Re Holdings Corp., Partner Re Ltd., Platinum Underwriters Holdings, Ltd. (included from October 29, 2002),
PXRE Group Ltd. (through August 6, 2007 when it was acquired by Argo Group International Holdings, Ltd.), RenaissanceRe Holdings Ltd., SCOR, SCOR Holding (Switzerland) (formerly known as
Converium Holding AG) and Swiss Reinsurance Co. The performance of certain companies is included for a shorter period since they were not public companies for the entire five-year performance period.
Dividend reinvestment has been assumed and returns have been weighted to reflect relative stock market capitalization. 27
Cumulative Total Return to Stockholders
Company / Index
Dec. 2002
Dec. 2003
Dec. 2004
Dec. 2005
Dec. 2006
Dec. 2007 Transatlantic Holdings, Inc.
$
100.00
$
121.86
$
117.28
$
128.38
$
119.65
$
141.19 S&P 500 Index
100.00
128.68
142.69
149.70
173.34
182.86 Peer Group
100.00
115.85
119.32
122.96
141.66
139.06 28
Item 6. Selected Financial Data TRANSATLANTIC HOLDINGS, INC. AND SUBSIDIARIES The Selected Financial Data should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations and the consolidated financial statements and
accompanying notes included elsewhere herein.
Years Ended December 31,
2007
2006
2005
2004
2003
(in thousands, except per share data) Statement of Operations Data: Net premiums written
$
3,952,899
$
3,633,440
$
3,466,353
$
3,749,274
$
3,341,077 Net premiums earned
3,902,669
3,604,094
3,384,994
3,661,090
3,171,226 Net investment income
469,772
434,540
343,247
306,786
270,972 Realized net capital gains
9,389
10,862
39,884
22,181
9,942 Revenues
4,381,830
4,049,496
3,768,125
3,990,057
3,452,140 Income (loss) before income taxes(1)
595,752
539,908
(46,098
)
276,212
386,674 Net income
487,141
428,152
37,910
254,584
303,644 Per Common Share:(2) Net income: Basic
$
7.37
$
6.49
$
0.58
$
3.87
$
4.64 Diluted
7.31
6.46
0.57
3.85
4.60 Cash dividends declared
0.62
0.53
0.46
0.39
0.34 Share Data:(2) Weighted average common shares outstanding: Basic
66,124
65,955
65,836
65,731
65,508 Diluted
66,654
66,266
66,169
66,189
65,953 Balance Sheet Data (at year end): Investments and cash
$
12,755,972
$
11,336,096
$
9,241,837
$
8,287,003
$
6,867,165 Assets
15,484,327
14,268,464
12,364,676
10,605,292
8,707,758 Unpaid losses and loss adjustment expenses
7,926,261
7,467,949
7,113,294
5,941,464
4,805,498 Unearned premiums
1,226,647
1,144,022
1,082,282
1,057,265
917,355 5.75% senior notes due December 14, 2015(3)
746,930
746,633
746,353
—
— Stockholders’ equity
3,349,042
2,958,270
2,543,951
2,587,129
2,376,587
(1)
Includes pre-tax net catastrophe costs of $55 million in 2007, $29 million in 2006, $544 million in 2005 and $215 million in 2004. There were no significant catastrophe losses occurring in 2003. (2) Share and per share data have been retroactively adjusted, as appropriate, to reflect common stock splits. (3) Includes amounts payable to affiliates and others as follows: 2007—Affiliates $448,158; Others $298,772; 2006—Affiliates $447,980; Others $298,653; 2005—Affiliates $447,812; Others $298,541. 29
Cautionary Statement Regarding Forward-Looking Information This Annual Report on Form 10-K and other publicly available documents may include, and Transatlantic Holdings, Inc. and its subsidiaries (collectively, “TRH”) officers and representatives may from
time to time make, statements which may constitute “forward-looking statements” within the meaning of the U.S. federal securities laws. These forward-looking statements are identified, including without
limitation, by their use of such terms and phrases as:
• “intend”
• “plans” These statements are not historical facts but instead represent only TRH’s belief regarding future events and financial performance, many of which, by their nature, are inherently uncertain and outside
of TRH’s control. These statements may address, among other things, TRH’s strategy and expectations for growth, product development, government and industry regulatory actions, legal matters, market
conditions, financial results and reserves, as well as the expected impact on TRH of natural and man-made (e.g., terrorist attacks) catastrophic events and political, economic, legal and social conditions. It is possible that TRH’s actual results, financial condition and expected outcomes may differ, possibly materially, from those anticipated in these forward-looking statements. Important factors that
could cause TRH’s actual results to differ, possibly materially, from those discussed in the specific forward-looking statements may include, but are not limited to, uncertainties relating to economic
conditions and cyclical industry conditions, credit quality, government, regulatory and accounting policies, volatile and unpredictable developments (including natural and man-made catastrophes), the legal
environment, legal and regulatory proceedings, the reserving process, the competitive environment in which TRH operates, interest rate and foreign currency exchange rate fluctuations, and the
uncertainties inherent in international operations. These factors are further discussed throughout Management’s Discussion and Analysis of Financial Condition and Results of Operations and in Item 1A. Risk Factors of this Form 10-K. TRH is not
under any obligation to (and expressly disclaims any such obligations to) update or alter any forward-looking statement, whether written or oral, that may be made from time to time, whether as a result of
new information, future events or otherwise. 30
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations Throughout this Annual Report on Form 10-K, Transatlantic Holdings, Inc. and its subsidiaries (collectively, “TRH”) presents its operations in the way it believes will be most meaningful. TRH’s
unpaid losses and loss adjustment expenses net of related reinsurance recoverable (“net loss reserves”) and TRH’s combined ratio and its components are included herein and presented in accordance with
principles prescribed or permitted by insurance regulatory authorities, as these are standard measures in the insurance and reinsurance industries. Financial Statements The following discussion refers to the consolidated financial statements of TRH as of December 31, 2007 and 2006 and for each of the three years in the period ended December 31, 2007, which are
presented elsewhere herein. Financial data discussed below have been affected by certain transactions between TRH and related parties. (See Notes 6, 11, 12, 13 and 15 of Notes to Consolidated Financial
Statements.) Executive Overview The operations of Transatlantic Holdings, Inc. (the “Company”) are conducted principally by its three major operating subsidiaries—Transatlantic Reinsurance Company® (“TRC”), Trans Re Zurich
(“TRZ”) and Putnam Reinsurance Company (“Putnam”)—and managed based on its geographic segments. Through its operations on six continents, TRH offers reinsurance capacity on both a treaty and
facultative basis—structuring programs for a full range of property and casualty products, with an emphasis on specialty lines, which may exhibit greater volatility of results over time than most other lines.
Such capacity is offered through reinsurance brokers and, to a lesser extent, directly to domestic and foreign insurance and reinsurance entities. TRH conducts its business and assesses performance through segments organized along geographic lines. The Domestic segment principally includes financial data from branches in the United States
except Miami, as well as revenues and expenses of the Company (including interest expense on the Company’s senior notes) and stock-based compensation expense. Data from the London and Paris
branches and from TRZ are reported in the aggregate as International—Europe and considered as one segment due to operational and regional similarities. Data from the Miami (which serves Latin America
and the Caribbean), Toronto, Hong Kong and Tokyo branches are grouped as International—Other and represent the aggregation of non-material segments. TRH’s operating strategy emphasizes product and geographic diversification as key elements in managing its level of risk concentration. TRH also adjusts its mix of business to take advantage of
market opportunities. Over time, TRH has most often capitalized on market opportunities when they arise by strategically expanding operations in an existing location or opening a branch or representative
office in new locations. TRH’s operations that serve international markets leverage TRH’s product knowledge, worldwide resources and financial strength, typically utilizing indigenous management and
staff with a thorough knowledge of local markets and product characteristics. In 2007, casualty lines comprised 71% of TRH’s net premiums written, while property lines totaled 29%. In addition, treaty reinsurance totaled 96% of net premiums written, with the balance
representing facultative accounts. Moreover, business written by international operations represented 51% of net premiums written in 2007. American International Group, Inc. (“AIG”), which through its subsidiaries is one of the largest providers of insurance and investment products and services to businesses and individuals around the
world, beneficially owned approximately 59% of the Common Stock of the Company (“TRH shares”) as of December 31, 2007, 2006 and 2005. On September 28, 2007, AIG filed an amendment to its
Schedule 13D relating to the Company stating, among other things, that it “intends to continuously evaluate their investment in the Company and may acquire or dispose of shares of Common Stock, other
securities of the Company, or loans or other interests in the Company.” TRH’s major sources of revenues are net premiums earned for reinsurance risks undertaken and net investment income earned on investments made. The great majority of TRH’s investments are in
fixed maturity securities held to maturity and available for sale with an average duration of 5.8 years as of December 31, 2007. In general, premiums are received significantly in advance of related claims
payments. 31
Consolidated Results The following table summarizes TRH’s revenues, income (loss) before income taxes and net income for the periods indicated:
Years Ended December 31,
2007
2006
2005
Amount
Change
Amount
Change
Amount
Change
(dollars in millions) Revenues
$
4,381.8
8.2
%
$
4,049.5
7.5
%
$
3,768.1
(5.6
)% Income (loss) before income taxes
595.8
10.3
539.9
—
(46.1
)
— Net
income
487.1
13.8
428.2
1,029.4
37.9
(85.1
) Revenues increased in 2007 compared to 2006 due primarily to increases in Domestic net premiums earned and, to lesser extents, International—Europe net premiums earned, Domestic realized net
capital gains and consolidated net investment income, offset in part by decreases in International—Other net premiums earned and international realized net capital gains (losses). The increase in
International—Europe net premiums earned occurred principally in the London and Paris branches. The decrease in International—Other net premiums earned occurred in the Miami and Hong Kong branches.
The most significant increases in consolidated net premiums earned occurred in the other liability, property and medical malpractice lines, partially offset by a significant decrease in the auto liability line.
Net investment income increased in 2007 due largely to an increase in investment income from fixed maturities. The increase in investment income from such securities was due in part to the investment of
significant positive net operating cash flows generated in recent periods. Revenues in 2006 increased compared to 2005 due primarily to increases in Domestic and, to a lesser extent, International—Other net premiums earned and consolidated net investment income, offset in
part by decreases in International—Europe net premiums earned and decreases in Domestic and International—Europe realized net capital gains (losses). The increase in International—Other net premiums
earned occurred principally in the Miami branch and, to a lesser extent, in the Toronto branch. The London and Paris branches reported the great majority of the decrease in International—Europe net
premiums earned in 2006. The most significant increases in consolidated net premiums earned occurred in the other liability, accident & health (“A&H”) and property lines, partially offset by a significant
decrease in the auto liability line. The changes in net premiums earned generally reflected prevailing market conditions over recent periods, as discussed below. Net investment income increased in 2006 due
largely to an increase in fixed maturity investment income and, to a lesser extent, to an increase in investment income from limited partnerships. The increase in fixed maturity investment income was due in
part to investment returns from continued positive operating cash flows and the investment of the net proceeds from the issuance of $750 million principal amount senior notes in December 2005. Results for 2007 include pre-tax net catastrophe costs of $55 million principally arising from European Windstorm Kyrill and floods in the U.K. Catastrophe costs include losses and related
reinstatement premiums, the details of which can be found in Note 9 of Notes to Consolidated Financial Statements (“Note 9”). Reinstatement premiums may arise on both assumed and ceded business as a
result of contractual provisions found in certain catastrophe excess-of-loss reinsurance contracts that require additional premiums to be paid in the event of a loss to reinstate coverage for the remaining
portion of the contract period. Net assumed (ceded) reinstatement premiums serve to increase (reduce) net premiums written and earned. While there were no significant catastrophe losses occurring in 2006, the year 2006 includes pre-tax net catastrophe costs of $29 million relating to events which occurred in prior years. The year 2005 was the worst year ever in recorded history for insured catastrophe losses. In addition, Hurricane Katrina was the largest insured catastrophe loss in reported history. An industry source
projected insurance and reinsurance industry costs relating to Hurricane Katrina of approximately $40 billion. 32
Results
for 2005 include pre-tax net catastrophe costs of $544 million, or $354 million
after tax, principally arising from Hurricanes Katrina ($304 million on a
pre-tax basis), Rita ($44 million on a pre-tax basis) and Wilma ($111 million
on a pre-tax basis) and, to a lesser extent, from Central European floods
and European Windstorm Erwin. Such catastrophe costs consist of pre-tax net
catastrophe losses of $483 million (gross $870 million; ceded $387 million)
and net ceded reinstatement premiums of $61 million (gross $72 million; ceded
$133 million). Income
before income taxes and net income increased in 2007 as compared to 2006
principally due to increased underwriting profit and net investment income.
Net income also benefited from a lower effective tax rate in 2007. The increased
underwriting profit in 2007 reflects increased premiums earned and a lower
combined ratio. The lower combined ratio reflected decreased net adverse
loss reserve development, offset in part by a higher level of catastrophe
costs in 2007. Lower net adverse loss reserve development and higher catastrophe
costs in 2007 had the impact of improving underwriting profit (loss) in 2007
by $47.7 million compared to 2006. (See Note 16 of Notes to Consolidated
Financial Statements for underwriting profit (loss) by segment.) Income
(loss) before income taxes and net income increased in 2006 as compared to
2005 principally due to increased underwriting profit (loss) and net investment
income, offset in part by interest expense on TRH’s senior notes and
decreased realized net capital gains. The increased underwriting profit (loss)
in 2006 reflects an improved combined ratio resulting largely from reduced
significant net catastrophe costs and, to a lesser extent, lower net adverse
loss reserve development. Decreases in net catastrophe costs and lower net
adverse loss reserve development in the aggregate increased underwriting
profit (loss) by $618.4 million in 2006 compared to 2005. The reasons for
the increase in net investment income are as discussed earlier. The significant
tax expense in 2006 compared to the tax benefit recognized in 2005 tempered
the impact of the above changes on net income. Underwriting profit (loss) is defined as net premiums earned less net losses and loss adjustment expenses (“LAE”) incurred, net commissions and other underwriting expenses, plus (minus) the increase
(decrease) in deferred acquisition costs. (See Operational Review for further discussion.) Market Conditions and Outlook The market conditions in which TRH operates have historically been cyclical. For the period under discussion, the reinsurance market has been characterized by significant competition worldwide in
most lines of business. Generally
softening property market conditions were prevalent in the first half of
2005 on both primary and reinsurance business. In addition, market conditions
in many casualty lines also softened for a significant portion of 2005. However,
pricing, terms and conditions on short tail lines of business, such as property,
marine and energy, improved significantly in the U.S. and, to some degree,
outside the U.S. after Hurricanes Katrina, Rita and Wilma. These improvements,
which had little effect on 2005 results, were driven by several factors,
including the amount of industry capital consumed by the catastrophe losses
in that year (an industry record), market-wide adjustments for the failure
of traditional property catastrophe models to accurately capture the severity
of a Hurricane Katrina type loss and the modification of capital adequacy
models by certain rating agencies to increase capital charges relating to
catastrophe exposures. Searching for a proper return and looking to minimize
the uncertainty of property catastrophe modeling, the market arrived at meaningfully
higher pricing parameters, higher attachment points, tighter terms and conditions
for such programs and a more conservative management of aggregate exposure.
These improvements were most significant in the U.S. nationwide property
and energy catastrophe programs as well as in energy pro rata contracts.
To lesser extents, U.S. regional property catastrophe, international property
catastrophe, marine excess-of-loss, property per risk excess-of-loss and
property pro rata programs saw improvements. Other lines of business, including
casualty lines, while not experiencing much deterioration in terms, did not
see the same magnitude of improvement in market conditions. A large amount of capital flowed into the market after the major catastrophe events of 2005 with much of the capital raised going to existing reinsurers. Some of the capital also went to new reinsurance
companies that were started in Bermuda in the fourth quarter of 2005. The capital raised by existing reinsurers was not just to replace some of the capital lost in the catastrophe events of 2005, but also to 33
meet the higher capital thresholds required by the rating agencies to support catastrophe exposure. Also, due to the severe impact on capital that the hurricanes had on property monoline carriers, the rating
agencies imposed higher hurdles for ratings for this type of (re)insurer. Nevertheless, most of the start up companies achieved a rating of at least A– from Best by year-end. While these new companies did
write a fair amount of property catastrophe and energy excess-of-loss business in 2006, they did not slow the momentum of rate increases in these lines and, in fact, these companies began to diversify their
writings in order to fully apply their capital. In addition to new company formations, capital markets, including hedge funds, have become more active in assuming reinsurance risk other than from investing in various companies. Numerous hedge
funds have provided both pro rata and excess-of-loss reinsurance and retrocessional protections through captive companies or other alternative transactions on a fully collateralized basis for property and
energy catastrophe business. One type of an alternative transaction is a vehicle known as a “sidecar”. Sidecars are essentially reinsurance companies set up as a special purpose reinsurer to reinsure a
discrete group of risks. The sidecar may have an equity investment from its sponsor as well as additional capital provided by hedge funds and other institutional investors and may also have a debt portion
that is provided by a bank or other financial institution. Hedge funds and other investment vehicles also formed or sponsored reinsurers or used other reinsurance companies as conduits to offer traditional reinsurance as well as industry loss warranties
(“ILWs”) and other forms of index-based protections. While rates for property catastrophe and other lines of business exposed to natural peril losses in U.S. peak zones (areas with concentrations of coastal exposures to hurricanes or general exposure to
earthquakes) improved meaningfully at January 1, 2006, rates in these areas experienced more significant increases starting April 1, 2006 and this trend continued throughout the remainder of the year.
These improvements were a confluence of capital depletion from the 2005 storms, model changes by the generally accepted catastrophe loss models and stricter rating agency requirements. With the exception of some parts of the Caribbean, catastrophe exposed lines of business in other parts of the world did not enjoy the same magnitude of rate increases in 2006 but did stabilize
following a decreasing trend prior to the 2005 events. International property business continued to see increased competition from established European reinsurers and from newer Bermudian companies
that sought to diversify their books. Casualty business experienced downward pressure worldwide, with international rates coming under more pressure than U.S. rates. Other terms and conditions on this
business generally held up well worldwide. Given the amount of capital attracted by year-end 2006, catastrophe exposed accounts renewing on January 1, 2007 saw a slowing of upward rate movements on programs. During the second half of
2007, property catastrophe rates began to decline as did the pricing for primary property risks in general. Nevertheless, TRH believes rates for U.S. catastrophe exposed business remained at an attractive
level through 2007 and anticipates that will be the case in 2008. Internationally, catastrophe rates in the U.K. and Europe did improve on programs impacted by the storms and floods of 2007, while in other
regions, rates exhibited modest downward trends. Through 2007, casualty lines have experienced steady rate reductions in the insurance markets on a global basis for approximately two years, but reinsurance rates did not experience the same amount
of downward pressure. However, the January 2008 renewals did see rates coming under additional strain, but other terms and conditions for casualty business have remained stable. Although casualty rates
have generally declined in recent periods, TRH anticipates there will be a large amount of casualty business that will remain attractive throughout 2008. One major factor keeping overall casualty rates from sliding too much is the actuarial, claims and underwriting barriers to entry for certain specialty casualty lines of business (such as directors’ and
officers’ liability (“D&O”), errors and omissions liability (“E&O”) and medical malpractice classes). TRH has been underwriting casualty business for over 20 years and has developed a favorable reputation for
knowledge and commitment to the casualty marketplace. This expertise is difficult to duplicate and has kept some newer competitors from entering these lines. Furthermore, many buyers of casualty
reinsurance have been far more cautious about the ability and willingness of reinsurers to pay claims that may not come due for many years. TRH’s capital base, financial strength ratings from major 34
rating agencies and favorable claims paying record has generally proven to be a competitive advantage. With fewer reinsurers qualified, in the market’s view, to write casualty reinsurance, capacity in these
lines may be more restricted and may mitigate somewhat the downward pressure on rates. Due to the favorable trading conditions for most insurance companies in recent years and strong industry results in 2006 and 2007, many insurance companies’ capitalization is now higher than ever.
This factor has had a generally negative effect on pricing and has also caused certain ceding companies to choose to rely less on reinsurance as a form of capital and retain more business—thereby ceding less
business to reinsurers. In formulating a reinsurance purchasing strategy, the ceding company will also consider the perceived volatility of the business to be ceded. The existence of favorable market conditions in certain regions and lines of business do not necessarily translate into ultimate pricing adequacy for business written under such conditions. In addition,
there is no guarantee that these conditions will remain in effect as TRH cannot predict, with any reasonable certainty, future market conditions. Additionally, as a practical matter, the rates charged by primary insurers and the policy terms of primary insurance agreements may affect the rates charged and the policy terms associated with
reinsurance agreements, particularly for pro rata reinsurance business. Further information relating to items discussed in this Executive Overview may be found throughout Management’s Discussion and Analysis of Financial Condition and Results of Operations
(“MD&A”). Critical Accounting Estimates This discussion and analysis of financial condition and results of operations is based upon TRH’s consolidated financial statements which have been prepared in accordance with U.S. generally accepted
accounting principles (“GAAP”). The preparation of these financial statements requires the use of estimates and judgments that affect the reported amounts and related disclosures. TRH relies on historical
experience and on various other assumptions that it believes to be reasonable under the circumstances, to make judgments about the carrying values of assets and liabilities that are not readily apparent
from other sources. Actual results may differ materially from these estimates. TRH
believes its most critical accounting estimates are those with respect to
loss reserves, fair value measurements of financial instruments, other-than-temporary
impairments, premium revenues and deferred acquisition costs, as they require
management’s most significant exercise of judgment on both a quantitative
and qualitative basis used in the preparation of TRH’s consolidated
financial statements and footnotes. The accounting estimates that result
require the use of assumptions about certain matters that are highly uncertain
at the time of estimation. To the extent actual experience differs from the
assumptions used, TRH’s results of operations and financial condition
would be affected. A discussion of these most critical accounting estimates
follows: Loss Reserves Estimates of loss reserves take into account TRH’s assumptions with respect to many factors that will affect ultimate loss costs but are not yet known. The ultimate process by which actual carried
reserves are determined considers not only actuarial estimates but a myriad of other factors. Such factors, both internal and external, which contribute to the variability and unpredictability of loss costs,
include trends relating to jury awards, social inflation, medical inflation, worldwide economic conditions, tort reforms, court interpretations of coverages, the regulatory environment, underlying policy
pricing, terms and conditions and claims handling, among others. In addition, information gathered through underwriting and claims audits are also considered. To the extent that these assumptions
underlying the loss reserve estimates are significantly incorrect, ultimate losses may be materially different from the estimates included in the financial statements and may have a material adverse effect on
results of operations and financial condition. The impact of those differences is reflected in the period they become known. The reserving process is inherently difficult and subjective, especially in view of changes in the legal and tort environment which impact the development of loss reserves, and therefore quantitative 35
techniques frequently have to be supplemented by subjective considerations and managerial judgment. In addition, trends that have affected development of liabilities in the past may not necessarily occur
or affect development to the same degree in the future. While this process is difficult and subjective for ceding companies, the inherent uncertainties of estimating loss reserves are even greater for reinsurers, due primarily to the longer term nature of much
reinsurance business, the diversity of development patterns among different types of reinsurance treaties or facultative contracts, the necessary reliance on the ceding companies for information regarding
reported claims and differing reserving practices among ceding companies, which are subject to change without notice. Nevertheless, data received from cedants is subjected to audits periodically by TRH
claims and underwriting personnel, to help ensure that reported data is supported by proper documentation and conforms to contract terms, and analyzed, as appropriate, by TRH underwriting and actuarial
personnel. Such analysis often includes a detailed review of reported data to assess the underwriting results of reinsurance assumed and to explain any significant departures from expected performance.
Over time, reported loss information is ultimately corroborated when such information eventually attains paid status. Standard actuarial methodologies employed to estimate ultimate losses incorporate the inherent “lag” from the time claims are reported to the cedant to when the cedant reports the claims to the
reinsurer. Certain actuarial methodologies may be more appropriate than others in instances where this “lag” may not be consistent from period to period. Consequently, additional actuarial judgment is
employed in the selection of methodologies to best incorporate the potential impact of this situation. Generally, for each line of business, significant actuarial judgments are made with respect to the following factors used in the loss reserve setting process:
•
Loss trend factors are used to establish expected loss ratios (“ELRs”) for subsequent accident years based on the projected loss ratios for prior accident years. Provisions for inflation and social
inflation (e.g., awards by judges and juries which progressively increase in size at a rate exceeding that of general inflation) and trends in court interpretations of coverage are among the factors which
must be considered. • ELRs for the latest accident years generally reflect the ELRs from prior accident years adjusted for the loss trend (see loss trend factors discussion immediately above), as well as the impact of rate
level changes and other quantifiable factors. For certain longer tail lines of business that are typically lower frequency, higher severity classes, such as excess medical malpractice and D&O, ELRs are
often utilized for the last several accident years. • Loss development factors are used to arrive at the ultimate amount of losses incurred for each accident year based on reported loss information. These factors, which are initially calculated based on
historical loss development patterns (i.e., the emergence of reported losses over time relative to the ultimate losses to be paid), are then adjusted for current trends. During the loss settlement period, which can be many years in duration, additional facts regarding individual claims and trends usually become known. As these facts and trends emerge, it usually
becomes necessary to refine and adjust the loss reserves upward or downward and even then the ultimate net liability may be materially different from the revised estimates. The methodologies that TRH employed in 2007 and 2006 to assess the reasonableness of loss reserve estimates included paid loss development, incurred loss development, paid Bornhuetter-Ferguson
(“B-F”) and incurred B-F methods. The actuarial methods that TRH employs to determine the appropriate loss reserves for shorter tail lines of business are the same as those employed for longer tail lines.
However, the judgments that are made with regard to factors such as loss trends, ELRs and loss development factors for shorter lines generally have much less of an effect on the determination of the loss
reserve amount than when those same judgments are made regarding longer tailed lines of business. In contrast to the longer tailed lines of business, reported losses for the shorter tailed classes, such as the
property lines of business (e.g., fire and homeowners) and certain marine and energy classes, generally reach the ultimate level of incurred losses in a relatively short period of time. Rather than having to
rely on assumptions regarding ELRs and loss development factors for many accident years for a given line, these assumptions are generally only relevant for the most recent accident year or two. 36
Therefore, these assumptions tend to be less critical and the reserves calculated pursuant to these assumptions are subject to less variability for the shorter tailed lines of business. The characteristics of each line of business are considered in the reserving process. TRH’s major lines of business and reserve methodologies are discussed below:
•
Excess Casualty: The vast majority of this class, which is a key component of the other liability line of business, consists of domestic treaties, including pro rata and excess-of-loss contracts of general
liability business. Excess casualty is dominated by umbrella business, some of which has very high attachment points. This business is generally very long tailed and characterized by relatively low
frequency and high severity type losses. Therefore, expected loss ratio methods, such as the incurred B-F method, are heavily relied upon for most years due to the lack of mature reported experience
available. The ELRs utilized for the most recent years are based on the projected ultimate loss ratios of prior years adjusted for rate level changes, estimated loss cost trends and other quantifiable
changes, as well as actuarial pricing indications. • D&O and E&O: These classes, which are significant components of the other liability line of business, are dominated by high layer excess-of-loss D&O business as well as E&O classes such as lawyers and
accountants. Much of this business is domestic, although significant amounts are written out of the London branch. This business is reviewed separately by operating branch and for pro rata versus
excess-of-loss contracts, treaty versus facultative and D&O separately from certain classes of E&O. Additionally, homogeneous groupings of accountants, lawyers, and architects and engineers risks may
be reviewed separately. These classes are long tailed in nature, often characterized by very high attachment points. Therefore, B-F methods are generally relied upon for the most recent years due to
the lack of mature reported experience. The selections for older years will often be based on the weighted average of the loss development methods and B-F methods. The selection of ELRs for these
classes is generally analogous to that of the Excess Casualty class described above but with added emphasis on actuarial pricing indications, as these accounts are often very large and are virtually all
actuarially reviewed before the business is underwritten. • Healthcare Professional: This business, which is the most significant component of TRH’s medical malpractice line of business, is reviewed separately for treaty and facultative contracts. Pro rata
contracts are reviewed separately from excess-of-loss contracts. There is significant volume in all categories. This class is also quite long tailed due to the excess-of-loss nature of most of the contracts.
Due to the lack of mature reported experience, B-F methods are generally utilized for the most recent five underwriting years with some weight given to the loss development methods for earlier
years. Because almost all of these accounts are actuarially priced, the indications from these reviews are critical to the selection of the ELRs. • Shorter tailed lines: These would include the property lines of business, such as fire and homeowners, A&H and certain marine and energy classes. These lines are written out of several of TRH’s
worldwide offices and the reserves are reviewed separately for each operating branch. Where sufficiently credible experience exists, these lines are generally reviewed after segregating pro rata
contracts from excess-of-loss contracts. As a reinsurer, these lines do not develop to ultimate loss as quickly as when written on a primary basis; however, they are significantly shorter tailed than the
casualty classes discussed earlier. For these classes, a combination of loss development methods and B-F methods are used. Generally, selections for all but the most recent few years are based on loss
development methods with the most recent years based on weightings of loss development and expected loss ratio indications. A comprehensive annual loss reserve review is conducted in the fourth quarter of each year. These reviews are conducted in full detail for each class or line of business for each underwriting office and
consists of more than one hundred individual analyses. In completing these detailed actuarial reserve analyses significant actuarial judgment is often employed. TRH is required to make numerous
assumptions, including the selection of loss development factors and ELRs. Additionally, TRH needs to select the most appropriate actuarial method(s) to employ for each class of business. Triangles of written premium, paid losses and incurred losses are organized by underwriting year evaluated at six month intervals. The data triangles are split by branch, contract type (i.e., treaty versus 37
facultative), line of business
and often between excess-of-loss and pro rata business. The line of business
groupings vary by branch and are reviewed annually to ensure a proper balance
between homogeneity and credibility of data. In the loss development methods,
paid and incurred losses by underwriting year are projected to an ultimate
basis by applying appropriate age to ultimate development factors to the
inception to date paid and incurred losses. The development factors are selected
based on curves fitted to the historical average which best represent the
data. In the B-F methods, estimates of unpaid and unreported losses are arrived
at by multiplying underwriting year earned premium by an ELR and an estimated
percentage of unpaid or unreported losses. These percentages of unpaid or
unreported losses are derived from the loss development factors described above.
These methods yield an indication of the ultimate losses for each underwriting
year. The indicated incurred but not reported (“IBNR”) reserve
need is then determined (by year, by line of business) by subtracting the
reported losses (which are equal to the sum of inception to date paid losses
and the case reserves as of the balance sheet date) from the indicated ultimate
losses. In the course of these detailed loss reserve reviews, which are performed by year and by line of business, a point estimate of the loss reserve need is determined. Differences between the indications
arising from the various methods are analyzed to understand the drivers of these differences, so that TRH can make a selection based on the methods that are believed to be most appropriate for that line of
business. Frequently, the selection is based on an average of the various indications, giving the most weight to the indications deemed most appropriate. Generally speaking, TRH is often able to give more
weight to loss development indications for more mature years where credible reported losses exist, as opposed to the more current years, where the B-F method is often highly relied upon due to the lack of
credible and mature reported experience. When the actuarial point estimate is compared to the carried reserve, it is recognized that there is an implicit range around the indicated point estimate whereby a
carried reserve within that range may be considered reasonable. TRH reviews the appropriateness of the held reserves relative to the indicated point estimate considering many factors. These factors may
include, but are not limited to, the amount and direction of any difference between the point estimate and the held reserve, any operational issues which may be difficult to actuarially quantify, various
actuarial assumptions on which management may want additional input or any observations regarding optimism or conservatism which management may believe need to be considered. Thus, the carried
reserves, as determined by management, may be more or less than the actuarially determined point estimate. As of December 31, 2007, TRH’s carried loss and LAE reserves, net of related reinsurance
recoverable, were $6.90 billion and were equal to the actuarial point estimate. As of December 31, 2006, the indicated point estimate was within 0.5% of the carried reserve. There is potential for significant variation in the development of loss reserves when actual costs differ from those costs implied by the assumptions used to test the loss reserves. This is particularly true
for assumed reinsurance of long-tail casualty classes. Among the most critical assumptions are those made for ELRs and loss development factors. TRH’s annual loss reserve review for 2007 did not include the calculation of a range of loss reserve estimates. Because management does not believe it can currently assign credible probabilistic values
to a range, a better understanding of the volatility of loss reserve estimates can be gained via an analysis of the sensitivity of these estimates to changes in the critical assumptions used in the loss reserve
review process as opposed to creating a range. An analysis of the sensitivity of the loss reserve indications to these key assumptions can be performed by measuring the effect of various changes to the assumptions utilized in the reviews. The
assumptions made regarding factors considered in the sensitivity analysis, such as loss trends, ELRs and loss development factors, are generally consistent with TRH’s historical experience. Loss
development factors, for example, which are used to project reported paid and incurred losses to an ultimate incurred loss, are selected based on the curves fitted to the historical averages which best
represent the data. ELRs are based on the ultimate loss ratios for the more mature years adjusted for changes in the rate levels and other quantifiable factors to enable the ELRs to remain consistent with
historical experience. In general, it is believed that the vast majority of potential volatility in the loss reserves results from the longer tailed lines of business. For the purpose of these sensitivity analyses,
only loss reserves from these longer tailed lines, which represent approximately 65% of total loss reserves, were included in the calculations. Additionally, only those underwriting years where it is believed
reasonable for deviations 38
from the original assumptions to occur were utilized. Generally, the last 12 years were included in the analysis. This sensitivity analysis was performed on unpaid losses and loss adjustment expenses (“gross
loss reserves”) and net loss reserves. The results derived from these analyses were roughly equivalent. While noting that there exists the potential for greater variations, TRH believes utilizing 5% to 10% changes to the assumptions made for both loss development factors and ELRs provide reasonable
benchmarks for a sensitivity analysis of the loss reserve estimates. For example, changing the ELRs by 5 percentage points has an impact of about $155 million (either positively or negatively) on the loss
reserve estimate. While less likely for most classes of business, we note that changing the ELRs by 10 percentage points has an effect of about $310 million. As previously described, another key assumption
is the selection of loss development patterns. The effect of a 5% deviation from the loss development factors utilized in the loss reserve review would be about $285 million. Similarly, a 10% deviation would
impact the reserve estimate by about $565 million. Because a downward deviation of 5% or 10% results in negative future development of reported losses for certain years, this scenario is not believed to be
as likely as that of an upward deviation of this amount. Due to the assumptions and methodologies utilized by TRH in its reviews of longer tailed classes of business, changes to the ELRs generally have a much greater impact on the assessment of loss
reserves for the most recent few underwriting years while deviations from the loss development factors utilized in the reviews generally are more critical to the loss reserve indications for older underwriting
years (i.e., 2002 and prior). Management believes that it is reasonable to simultaneously vary both of the assumptions previously discussed by 5%. The effect of varying these assumptions together by 5% is
about $450 million. Increasing these assumptions by 10% simultaneously adds approximately $900 million to the reserve estimates, although management considers this scenario to be significantly less likely
than the 5% scenario previously discussed. We also note that the classes of business for which these assumptions are most critical are medical malpractice and D&O, particularly for excess-of-loss business,
and excess casualty. Net
loss reserves include amounts for risks relating to environmental impairment
and asbestos-related illnesses. The majority of TRH’s environmental
and asbestos-related net loss reserves arose from contracts entered into
after 1985 that were underwritten specifically as environmental or asbestos-related
coverages rather than as standard general liability coverages, where the
environmental or asbestos-related liabilities were neither clearly defined
nor specifically excluded. The reserves carried for these claims, including
loss and loss adjustment expenses incurred but not reported,
are based upon known facts and current law. However, significant uncertainty
exists in determining the amount of ultimate liability for environmental
impairment and asbestos-related losses, particularly for those occurring
in 1985 and prior. This uncertainty is due to inconsistent court resolutions
and judicial interpretations with respect to underlying policy intent and
coverage and uncertainties as to the allocation of responsibility for resultant
damages, among other things. See discussion of net adverse development on losses occurring in prior years (which includes a discussion of the causative factors of such net adverse development) under Results of Operations and
further discussion and detail information about gross loss reserves under Financial Condition and Liquidity. Fair Value Measurements of Financial Instruments TRH measures financial instruments in its trading and available for sale securities portfolios at fair value and discloses the fair value of its fixed maturities held to maturity. Fair value is the amount that
would be received to sell an asset in an orderly transaction between market participants at the measurement date. The
degree of judgment used in measuring the fair value of financial instruments
generally correlates with the level of pricing observability. Financial instruments
with quoted prices in active markets generally have more pricing observability
and less judgment is used in measuring fair value. Conversely, financial
instruments traded in other than active markets or financial instruments
that do not have quoted prices, have less observability and are measured
at fair value using valuation models or other pricing techniques that require
more judgment. Pricing observability is affected by a number of 39
factors, including the type of financial instrument, whether the financial instrument is new to the market and not yet established, the characteristics specific to the transaction and general market conditions. TRH maximizes the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value. The large majority of TRH’s securities are valued using observable inputs. TRH
obtains market price data to value financial instruments whenever such information is available. Market price data generally is obtained from market exchanges or dealer quotations. The types of
instruments valued based on market price data include government and agency securities, equities listed in active markets and investments in publicly traded mutual funds with quoted market prices. TRH estimates the fair value of fixed maturities not traded in active markets by referring to traded securities with similar attributes and using a matrix pricing methodology. This methodology considers
such factors as the issuer’s industry, the security’s rating and tenor, its coupon rate, its position in the capital structure of the issuer and other relevant factors. The types of fixed maturities not traded in
active markets include municipal bonds, most corporate bonds and most asset-backed and collateralized (including mortgage-backed) securities. For fixed maturity and equity instruments that are not traded in active markets, valuations are adjusted to reflect illiquidity, and such adjustments generally are based on available market evidence. In
the absence of such evidence, management’s best estimate is used. TRH obtains the fair value of its investments in limited partnerships from information provided by the general partner or manager of each of these investments, the accounts of which generally are
audited on an annual basis. Subsidiaries of AIG manage the
investments and perform investment recordkeeping services for TRH. In a recently
filed Form 8-K, AIG reported that their independent auditors had concluded and
advised AIG that as of December 31, 2007, AIG had a material weakness in its
internal control over financial reporting and oversight relating to the fair
value valuation of the super senior credit default swap portfolio of AIG
Financial Products and AIG Trading Group Inc., including their respective
subsidiaries (collectively, “AIGFP”). TRH’s portfolio does not
contain any of these instruments, and TRH has determined that the control
weakness identified by AIG’s independent auditors did not affect any class
of TRH’s investments. Other-Than-Temporary Impairments TRH evaluates its investments for other-than-temporary impairments. The determination that a security has incurred an other-than-temporary impairment in value and the amount of any loss
recognition requires the judgment of TRH’s management and a continual review of its investments. TRH evaluates its investments for other-than-temporary impairment such that a security is considered a candidate for other-than-temporary impairment if it meets any of the following criteria:
•
Trading at a significant (25% or more) discount to par, amortized cost (if lower) or cost for an extended period of time (nine consecutive months or longer); • The occurrence of a discrete credit event resulting in (i) the issuer defaulting on a material outstanding obligation; (ii) the issuer seeking protection from creditors under the bankruptcy laws or any
similar laws intended for court supervised reorganization of insolvent enterprises; (iii) the issuer proposing a voluntary reorganization pursuant to which creditors are asked to exchange their claims
for cash or securities having a fair value substantially lower than the par value of their claims; or • TRH
may not realize a full recovery on its investment, regardless of the
occurrence of one or more of the foregoing events. The
above criteria also consider circumstances of a rapid and severe market
valuation decline, such as that experienced in current credit markets, in
which TRH could not reasonably assert that the recovery period would be temporary. At each balance sheet date, TRH evaluates its securities holdings with unrealized losses. When TRH does not intend to hold such securities until they have fully recovered their cost basis, based on the
circumstances at the date of evaluation, TRH records a realized capital loss. If a loss is recognized 40
from a sale subsequent to a balance sheet date pursuant to changes in circumstances, the loss is recognized in the period in which the intent to hold the securities to recovery no longer exists. TRH has the ability to hold any fixed maturity security to its stated maturity, including fixed maturities classified as available for sale. Therefore, the decision to sell any fixed maturity security classified
as available for sale reflects the judgment of management that the security sold is unlikely to provide, on a relative value basis, as attractive a return in the future as alternative securities entailing
comparable risks. With respect to distressed securities, the sale decision reflects management’s judgment that the risk-discounted anticipated ultimate recovery is less than the value achievable on sale. Premium Revenues Management must make certain judgments in the determination of premiums written and earned by TRH. For pro rata treaty contracts, premiums written and earned are based on reports received
from ceding companies. Generally for excess-of-loss treaty contracts, premiums are recorded as written based on contract terms and are earned ratably over the terms of the related coverages provided. In
recent years, treaty contracts have generated approximately 96% of TRH’s premium revenues. Unearned premiums and prepaid reinsurance premiums represent the portion of gross premiums written and
ceded premiums written, respectively, relating to the unexpired terms of such coverages. The relationship between net premiums written and net premiums earned will, therefore, vary depending generally
on the volume and inception dates of the business assumed and ceded and the mix of such business between pro rata and excess-of-loss reinsurance. Premiums written and earned, along with related costs, for which data has not been reported by the ceding companies, are estimated based on historical patterns and other relevant information. Such
estimates of premiums earned are considered when establishing the reserve for loss and LAE IBNR. The differences between these estimates and the actual data subsequently reported, which may be
material as a result of the diversity of cedants and reporting practices and the inherent difficulty in estimating premium inflows, among other factors, are recorded in the period when the actual data
becomes available and may materially affect results of operations. In the Consolidated Statements of Operations, premiums written and earned and the change in unearned premiums are presented net of
reinsurance ceded. TRH’s financial statements reflected estimates of gross premiums written, commissions and premium balances receivable, for which data had as yet to be reported by cedants as of December 31, 2007
and 2006, as follows: 2007
Gross
Commissions
Premiums Major Class
(in thousands) Casualty: Other liability
$
118,914
$
32,837
$
86,077 Medical malpractice
44,788
11,396
33,392 Ocean marine and aviation
40,553
2,052
38,501 Auto liability
19,925
4,824
15,101 Accident and health
13,507
3,958
9,549 Surety and credit
7,250
2,336
4,914 Other
27,594
8,681
18,913 Total casualty
272,531
66,084
206,447 Property: Fire
80,110
23,828
56,282 Allied lines
32,480
5,541
26,939 Auto physical damage
10,318
2,254
8,064 Homeowners multiple peril
3,021
943
2,078 Other
5,432
1,691
3,741 Total property
131,361
34,257
97,104 Total
$
403,892
$
100,341
$
303,551 41
2006
Gross
Commissions
Premiums Major Class
(in thousands) Casualty: Other liability
$
153,959
$
38,213
$
115,746 Medical malpractice
27,220
5,869
21,351 Ocean marine and aviation
70,293
9,443
60,850 Auto liability
20,091
5,057
15,034 Accident and health
32,835
8,870
23,965 Surety and credit
22,666
8,110
14,556 Other
42,870
10,411
32,459 Total casualty
369,934
85,973
283,961 Property: Fire
49,481
11,221
38,260 Allied lines
50,178
7,483
42,695 Auto physical damage
5,102
1,356
3,746 Homeowners multiple peril
2,811
746
2,065 Other
12,346
2,945
9,401 Total property
119,918
23,751
96,167 Total
$
489,852
$
109,724
$
380,128 TRH has provided no allowance for bad debts relating to the premium estimates based on its historical experience, general profile of its cedants and the ability TRH has in most cases to significantly
offset these premium receivables with losses and LAE or other amounts payable to the same parties. Deferred Acquisition Costs Acquisition costs, consisting primarily of net commissions incurred on business conducted through reinsurance contracts or certificates, are deferred and then amortized over the period in which the
related premiums are earned, generally one year. The evaluation of recoverability of acquisition costs to be deferred considers the expected profitability of the underlying treaties and facultative certificates,
which may vary materially from actual results. If the actual profitability varies from the expected profitability, the impact of such differences is recorded, as appropriate, when actual results become known
and may have a material effect on results of operations. Operational Review Results of Operations TRH derives its revenue from two principal sources: premiums from reinsurance assumed net of reinsurance ceded (i.e., net premiums earned) and income from investments. The following table shows
net premiums written, net premiums earned and net investment income of TRH for the periods indicated:
Years Ended December 31,
2007
2006
2005
Amount
Change
Amount
Change
Amount
Change
(dollars in millions) Net premiums written
$
3,952.9
8.8
%
$
3,633.4
4.8
%
$
3,466.4
(7.5
)% Net premiums earned
3,902.7
8.3
3,604.1
6.5
3,385.0
(7.5
) Net investment income
469.8
8.1
434.5
26.6
343.2
11.9 Net premiums written increased in 2007 compared to 2006. The sources of the most significant growth were premiums generated by domestic regional offices which were opened during 2006 but
generated minimal premium volume in that year, increased international other liability business and A&H premiums generated by TRZ. In addition, the impact of changes in foreign currency exchange 42
rates contributed significantly to premium growth as shown in the table below. Excluding the impact of the change in foreign currency exchange rates, net premiums written would have increased by
approximately 6.4% in 2007 compared to 2006. In general, premium fluctuations reflect prevailing market conditions in recent periods as discussed earlier in MD&A. Premium growth continues to be
mitigated by increased ceding company retentions in certain lines. The increase in net premiums written in 2006 compared to 2005 generally reflected prevailing market conditions in recent periods. Excluding the impact of the reduction in net ceded reinstatement
premiums and the impact of changes in foreign currency exchange rates, net premiums written would have increased approximately 2.5% in 2006 compared to 2005. In 2007 and 2006, as compared to the
respective immediately prior year, premium increases were primarily from treaty business. On a worldwide basis, casualty lines business represented 71.0% of net premiums written in 2007 versus 73.3% and
70.2% in 2006 and 2005, respectively. The balance represented property lines. Treaty business represented 96.3% of net premiums written in 2007 versus 95.3% and 95.5% in 2006 and 2005, respectively.
The balance represented facultative accounts. The following table summarizes the net effect of changes in foreign currency exchange rates compared to the U.S. dollar on the percentage change in net premiums written in 2007 and 2006 compared
to its respective immediately prior year.
2007
2006 Increase in original currency
6.4
%
4.4
% Foreign exchange effect
2.4
0.4 Increase as reported in U.S. dollars
8.8
4.8 Domestic net premiums written increased in 2007 by $196.8 million, or 11.2%, from the prior year to $1,948.0 million, with the large majority of that increase emanating from domestic regional offices
which were opened during 2006. Significant increases in domestic net premiums written were recorded in the property ($142.8 million), medical malpractice ($58.8 million) and auto liability ($48.2 million)
lines. These increases were partially offset by a significant decrease in the A&H ($23.0 million) line. International net premiums written increased in 2007 by $122.6 million, or 6.5%, from the prior year to $2,004.9 million due largely to the impact of changes in foreign currency exchange rates
compared to the U.S. dollar. Significant increases in the London ($68.7 million), Paris ($30.1 million) and Toronto ($14.1 million) branches and in TRZ ($24.1 million) were partially offset by a significant
decrease in the Miami branch ($11.5 million). Of the $122.6 million increase in international net premiums written, $88.5 million is attributable to changes in foreign currency exchange rates between the
U.S. dollar and the currencies in which TRH does business. Significant increases in international net premiums written were recorded in the other liability (principally D&O, E&O and the general casualty
class) ($43.9 million), A&H ($40.8 million), property ($33.3 million) and boiler and machinery ($22.8 million) lines. These increases were partially offset by a significant decrease in the auto liability ($46.8
million) line. International business represented 50.7% of 2007 net premiums written compared to 51.8% in 2006. Domestic net premiums written increased in 2006 by $182.9 million, or 11.7%, from the prior year to $1,751.2 million due to generally favorable market conditions in certain lines and reduced net ceded
reinstatement premiums. Significant increases in domestic net premiums written were recorded in the other liability ($153.1 million), A&H ($33.3 million) and auto liability ($33.0 million) lines. These
increases were partially offset by a significant decrease in the surety ($21.5 million) line. International net premiums written in 2006 totaled $1,882.2 million, a decrease of $15.8 million from 2005 due in part to some weakness in market conditions in Europe and increased ceding company
retentions. Significant decreases in TRZ ($26.6 million) and the Paris ($16.5 million) and London ($14.8 million) branches were mostly offset by significant increases in the Miami ($37.1 million) and
Toronto ($14.6 million) branches. The increased premium volume in the Miami branch benefited from favorable market conditions in Latin America following significant catastrophe losses affecting the
region in 2005. International net premiums written decreased significantly in the auto liability ($53.4 million) and property ($48.9 million) lines. These decreases were partially offset by significant increases
in the ocean marine ($41.9 million), credit ($25.1 million) and A&H ($24.0 million) lines. The overall change in international net premiums written includes the impact of changes in foreign currency exchange
rates 43
between the U.S. dollar and the currencies in which TRH does business as discussed earlier. International business represented 51.8% of 2006 net premiums written compared to 54.8% in 2005. Reinstatement premiums were not significant in 2007 and 2006. Net premiums written and earned in 2005 include net ceded reinstatement premiums (relating to catastrophe losses) of $61.1 million
(gross $72.3 million; ceded $133.4 million), principally relating to domestic operations, of which $19.1 million relates to gross adverse development on catastrophe events occurring in 2004. (See Note 9.) Generally, reasons for changes in gross premiums written between years are similar to those for net premiums written, except as discussed earlier as regards reinstatement premiums and changes in
premiums assumed from an affiliate that, by prearrangement, were ceded in an equal amount to other affiliates (see Note 15 of Notes to Consolidated Financial Statements (“Note 15”)). The decrease in
ceded premiums written and earned in 2006 compared to 2005 is due to a reduction in ceded reinstatement premiums relating to 2005 and 2004 catastrophes, partially offset by increases in premiums
assumed from an affiliate that, by prearrangement, were ceded in an equal amount to other affiliates. As further discussed in Notes 13 and 15 of Notes to Consolidated Financial Statements, TRH transacts a significant amount of business assumed and ceded with other subsidiaries of AIG. TRH either
accepts or rejects the proposed transactions with such companies based on its assessment of risk selection, pricing, terms and conditions. As premiums written are primarily earned ratably over the terms of the related coverages, the reasons for changes in net premiums earned are generally similar to the reasons for changes in net
premiums written over time. Net investment income increased in 2007 compared to 2006 principally due to an increase in fixed maturity income, resulting mostly from investment returns from continued positive operating cash
flows. The strengthening of foreign currencies against the U.S. dollar increased net investment income by approximately $9 million in 2007 compared to 2006. Net investment income increased in 2006
compared to 2005 due generally to investment returns from continued positive operating cash flows, the investment of the net proceeds from issuance of $750 million principal amount senior notes in
December 2005 and increases in investment income from limited partnerships. (See Note 3(b) of Notes to Consolidated Financial Statements for a breakdown of the components of net investment income
and the cash flow discussion under Financial Condition and Liquidity.) For 2007, 2006 and 2005, the pre-tax effective yields on investments were 3.9%, 4.2% and 3.9%, respectively. The pre-tax effective yield on investments represents net investment income divided by the
average balance sheet carrying value of investments and interest-bearing cash. The reduction in investment yield in 2007 compared to 2006 resulted in part from the growth in securities lending collateral,
which generates minimal net investment income because investment income earned from invested collateral is reduced by interest payable to the collateral provider. The reduction in pre-tax effective yields
also resulted in part from a decline in investment return from the equities trading portfolio and a slight reduction of investment income from limited partnerships. Generally, market interest rates on fixed
maturities increased during the first half of 2006, losing much of that increase in the second half of the year. The increase in the pre-tax effective yield on investments in 2006 compared to 2005 was due in
part to increased investment income from limited partnerships offset in part by a significant increase in 2006 in securities lending collateral, which produces minimal net investment income. In addition, a
portion of the increase in investment yield in 2006 compared to 2005 relates to the investment in December 2005 of significant net proceeds from the issuance of senior notes. Such investments generated
limited investment income in 2005, due to the minimal amount of time that they were owned. (See Note 2(c) of Notes to Consolidated Financial Statements (“Note 2(c)”).) Realized net
capital gains totaled $9.4 million in 2007, $10.9 million in 2006 and $39.9
million in 2005. Realized net capital gains result in part from investment
dispositions, which reflect TRH’s investment and tax planning strategies to
maximize after-tax income, and write-downs of securities that, in the opinion of
management, had experienced a decline in fair value that was other-than-temporary.
Such write-downs in 2007 totaled $2.5 million relating to fixed
maturities available for sale and $24.7 million relating to equities available
for sale, principally common stocks. Given the unrest in the equity markets and
uncertainty in the economy as a whole at year-end 2007 which caused declines in
the fair 44
values of certain equities, TRH could not assert that certain of these equities would be held to recovery. Therefore, TRH determined that such equities were other than temporarily impaired and recorded
write-downs to fair value. Write-downs in 2006 totaled $1.3 million relating to fixed maturities available for sale and $0.1 million relating to equities available for sale. Such write-downs in 2005 totaled $1.7
million relating to equities available for sale. Upon the ultimate disposition of securities for which write-downs have been recorded, a portion of the write-downs may be recovered depending on market
conditions at the time of disposition. (See Note 2(c) for criteria used in determination of such write-downs.) In addition, realized net capital gains in 2007 and 2006 were reduced by net foreign currency
transaction losses, principally relating to non-functional currencies, of $24.6 million and $11.2 million, respectively. The property and casualty insurance and reinsurance industries use the combined ratio as a measure of underwriting profitability. The combined ratio reflects only underwriting results, and does not
include income from investments. Generally, a combined ratio under 100% indicates an underwriting profit and a combined ratio exceeding 100% indicates an underwriting loss. Underwriting profitability is
subject to significant fluctuations due to competition, natural and man-made catastrophic events, economic and social conditions, foreign currency exchange rate fluctuations, interest rates and other factors.
The loss ratio represents net losses and LAE incurred expressed as a percentage of net premiums earned. The underwriting expense ratio represents the sum of net commissions and other underwriting
expenses expressed as a percentage of net premiums written. The combined ratio represents the sum of the loss ratio and the underwriting expense ratio. The following table presents loss ratios, underwriting expense ratios and combined ratios for consolidated TRH, and separately for its domestic and international components, for the years indicated:
Years Ended
2007
2006
2005 Consolidated: Loss ratio
67.6
%
68.3
%
85.0
% Underwriting expense ratio
27.7
27.7
27.0 Combined ratio
95.3
96.0
112.0 Domestic: Loss ratio
74.2
%
77.5
%
103.6
% Underwriting expense ratio
25.9
25.6
25.6 Combined ratio
100.1
103.1
129.2 International: Loss ratio
61.1
%
60.1
%
70.7
% Underwriting expense ratio
29.5
29.6
28.2 Combined ratio
90.6
89.7
98.9 The improvement in the loss ratio for consolidated TRH in 2007 compared to 2006 reflects improvement from domestic operations partially offset by deterioration from international operations. The
loss ratio for consolidated TRH in 2007 benefited from lower net adverse loss reserve development, partially offset by increased net catastrophe costs. The improvement in the loss ratio for consolidated
TRH in 2006 as compared to 2005 reflects improvements from both domestic and international operations. Two factors in the improvement in the loss ratio for consolidated TRH in 2006 compared to 2005
are lower net catastrophe costs and, to a much lesser extent, lower net adverse loss reserve development, primarily from domestic operations. In the aggregate, catastrophe costs and estimated net adverse
loss reserve development added 3.4%, 5.0% and 23.4% to the consolidated TRH combined ratio in 2007, 2006 and 2005, respectively. 2007 includes net catastrophe costs of $55.2 million principally relating to European Windstorm Kyrill and floods in the U.K. Net catastrophe costs in the aggregate added 1.4%, 0.4% and 2.4% to the
2007 combined ratios for consolidated, domestic and international, respectively. (See Note 9 for the amounts of net catastrophe costs by segment and the amounts of consolidated gross and ceded
catastrophe losses incurred and reinstatement premiums. See discussion in Catastrophe Exposure of the magnitude of TRH’s catastrophe exposures.) 45
In addition, in 2007,
TRH determined that its estimates of the ultimate amounts of net losses
occurring in 2006 and prior years needed to be increased as a result of greater
than expected loss activity in 2007. As a result of that determination, TRH
increased net losses and LAE incurred by $88.4 million, representing significant
net adverse development in 2007 of losses occurring in all prior years. This net
adverse development was comprised of $368.9 million relating to losses occurring
in 2002 and prior, partially offset by net favorable development of $280.5
million, principally relating to losses occurring in 2006 and, to a lesser extent,
2005 and 2004. The detail of the $88.4 million net adverse development by line
of business relating to all prior years is presented in the table
below: Lines of Business
Net Loss Reserve at
Year-end 2006 Net
Amount of
(in thousands) Other liability
$
2,558,979
$
2,780,364
$
(221,385
) Medical Malpractice
926,906
964,977
(38,071
) Fire
461,105
377,473
83,632 Allied lines
113,335
69,990
43,345 Homeowners multiple peril
50,838
16,662
34,176 Other, net
2,096,057
2,086,134
9,923 Total
$
6,207,220
$
6,295,600
$
(88,380
)
(1)
Amount of reestimation represents the amount of net losses and LAE incurred in 2007 relating to losses occurring in 2006 and prior years.
As presented in the table above, the line of business with the most significant net adverse development recorded in 2007 was the other liability line, arising principally from losses occurring between
1998 and 2002. The other liability line includes certain specialty casualty classes, such as D&O and E&O, and general casualty classes. In addition, significant net adverse development was recorded in 2007 in
the medical malpractice line, arising principally from losses occurring between 1998 and 2002. These increases to incurred losses were offset in part by net favorable development occurring most significantly
in the fire line, arising principally from losses occurring in 2006, and in the allied lines and homeowners multiple peril lines, each arising principally from losses occurring between 2004 and 2006. (See Note 9
for amounts included in net adverse development that relate to catastrophe losses.) The net adverse development arising from losses occurring in years 1998 through 2002, which represent the great majority of the 2002 and prior development, generally relates to the fact that for many
classes within these years, ceding companies continue to experience increased loss costs relative to expectations coupled with an unexpected lengthening of the loss emergence patterns. Generally, loss
activity was greater than expected from losses occurring in the D&O and E&O classes, which continued to be impacted by claims relating to corporate bankruptcies and IPO allocation/laddering claims. Also,
classes such as Excess Umbrella and Architects & Engineers were impacted by construction defect and other late reported high layer excess claims to a greater extent than expected. Contributing to this
increase is the fact that many policies during this period covered underlying contracts that extended over multiple years, which contributed to recent reported loss activity exceeding previous expectations.
This has led to an increase in both the frequency and severity of claims entering the reinsured excess-of-loss coverage layers at later points in time than had previously been experienced. The favorable
development in accident years 2004 through 2006 results from favorable loss trends. TRH writes a significant amount of non-proportional assumed casualty reinsurance as well as proportional assumed reinsurance of excess liability business for such volatile classes as medical
malpractice, D&O, E&O and general casualty. At the primary level, there are significant risk factors which contribute to the variability and unpredictability of the loss trend factors for this business such as jury
awards, social inflation, medical inflation, tort reforms and court interpretations of coverage. In addition, as a reinsurer, TRH is also highly dependent upon the claims reserving and reporting practices of its
cedants, which vary greatly by size, specialization and country of origin and whose practices are subject to change without notice. Based on information presently available, TRH believes its current loss reserves are adequate, but there can be no assurance that TRH’s loss reserves will not develop adversely due to, for example, the 46
inherent volatility in loss
trend factors and variability of reporting practices for those classes, among
other factors, and materially exceed the carried loss reserves as of December
31, 2007 and thus, have a material adverse effect on future net income,
financial condition and cash flows. For 2007
compared to 2006, the changes in gross and ceded losses and LAE incurred each
include the effect of a $151 million decrease in losses and LAE incurred
relating to business assumed from an affiliate which, by prearrangement with
TRH, was then ceded in an equal amount to other affiliates (see Note 15). In
addition, the change in gross and ceded losses and LAE incurred includes the
changes in gross and ceded catastrophe losses as discussed in Note 9. There were no significant net catastrophe costs for events occurring in 2006. Net catastrophe costs (relating to events principally occurring in 2005) in the aggregate added 0.8%, 1.1% and 0.6% to the
2006 combined ratios for consolidated, domestic and international, respectively. However, in 2006, TRH determined that its estimates of the ultimate amounts of net losses occurring in 2005 and prior years needed to be increased as a result of greater than expected loss activity in
2006. As a result of that determination, TRH increased net losses and LAE incurred by $181.1 million, representing significant net adverse development in 2006 of losses occurring in all prior years. This net
adverse development was comprised of $339.7 million relating to losses occurring in 2002 and prior, partially offset by favorable development of $158.6 million relating primarily to 2005. The detail of the
$181.1 million net adverse development by line of business relating to all prior years is presented in the table below: Lines of Business
Net Loss Reserve at
Year-end 2005 Net
Amount of
(in thousands) Other liability
$
2,272,605
$
2,464,599
$
(191,994
) Fire
503,396
374,606
128,790 Homeowners multiple peril
128,839
92,526
36,313 Medical malpractice
826,558
861,489
(34,931
) Fidelity
147,921
176,037
(28,116
) Ocean marine and aviation
499,305
521,074
(21,769
) Other, net
1,311,819
1,381,240
(69,421
) Total
$
5,690,443
$
5,871,571
$
(181,128
)
(1)
Amount of reestimation represents the amount of net losses and LAE incurred in 2006 relating to losses occurring in 2005 and prior years.
As presented in the table above, the line of business with the most significant net adverse development recorded in 2006 was the other liability line, arising principally from losses occurring in 2000 to
2002 for reasons similar to those discussed earlier for the other liability line development in 2007. The other liability line includes certain specialty casualty classes, such as D&O and E&O, and general casualty
classes. In addition, significant net adverse development was recorded in 2006 in the medical malpractice line, arising principally from losses occurring between 1998 and 2002, the fidelity line, arising
principally from losses occurring between 1999 and 2005, and the ocean marine and aviation line, arising principally from losses occurring in 2005. The large majority of such net adverse development related
to domestic operations. These increases to incurred losses were offset in part by net favorable development occurring most significantly in the fire line, arising principally from losses occurring in 2005, and
the homeowners multiple peril line, arising principally from losses occurring between 2004 and 2005. (See Note 9 for amounts included in net adverse development that relate to catastrophe losses.) The main reason for the decrease in gross and ceded losses and LAE incurred in 2006 compared to 2005 is the decrease in gross and ceded catastrophe losses (see Note 9) in 2006 partially offset by a
$199 million increase in gross and ceded losses and LAE incurred relating to business assumed from an affiliate which, by prearrangement with TRH, was then ceded in an equal amount to other affiliates. TRH’s 2005 results include net catastrophe costs of $543.9 million (domestic $385.8 million; international $158.1 million) principally relating to Hurricanes Katrina, Rita and Wilma and, to a lesser 47
extent, to Central European floods and European Windstorm Erwin. Such net catastrophe costs include net ceded reinstatement premiums of $61.1 million (domestic $56.2 million; international $4.9
million). Approximately $123.9 million of net catastrophe costs included in international operations relate to hurricanes occurring in the Americas. Net catastrophe costs in the aggregate added 16.0%,
26.3% and 8.2% to the combined ratios for consolidated TRH, domestic and international, respectively. In addition, in 2005, TRH determined that its estimates of the ultimate amounts of net losses occurring in 2004 and prior years needed to be increased as a result of greater than expected loss activity in
2005. As a result of that determination, TRH increased net losses and LAE incurred by $268.8 million, representing significant net adverse development in 2005 of losses occurring in all prior years. This net
adverse development was comprised of $524.9 million relating to losses occurring in 2002 and prior, partially offset by favorable development of $256.1 million relating primarily to 2004 and, to a lesser
extent, to 2003. The detail of the $268.8 million net adverse development by line of business relating to all prior years is presented in the table below: Lines of Business
Net Loss Reserve at
Year-end 2004 Net
Amount of
(in thousands) Other liability
$
1,800,415
$
2,166,198
$
(365,783
) Fire
439,680
340,281
99,399 Medical malpractice
715,739
780,119
(64,380
) Ocean marine and aviation
462,167
420,075
42,092 Homeowners multiple peril
87,444
63,962
23,482 Other, net
1,475,164
1,478,810
(3,646
) Total
$
4,980,609
$
5,249,445
$
(268,836
)
(1)
Amount of reestimation represents the amount of net losses and LAE incurred in 2005 relating to losses occurring in 2004 and prior years.
As presented in the table above, the lines of business with the most significant net adverse development recorded in 2005 were the other liability line, arising principally from losses occurring in 1996 to
2002 for reasons similar to those discussed earlier for the other liability line development in 2007, and the medical malpractice line, arising principally from losses occurring between 1997 and 2001. The large
majority of such net adverse development related to domestic operations. These increases to incurred losses were offset in part by net favorable development occurring most significantly in the fire line,
which arose principally from losses occurring in 2004, and in the ocean marine and aviation line, which arose principally from losses occurring in 2001 through 2004. (See Note 9 for amounts included in net
adverse development that relate to catastrophe losses.) While TRH believes that it has taken appropriate steps to manage its exposure to possible future catastrophe losses, the occurrence of one or more natural or man-made catastrophic events of
unanticipated frequency or severity, such as a terrorist attack, earthquake or hurricane, that causes insured losses could have a material adverse effect on TRH’s results of operations, liquidity or financial
condition. Current techniques and models may not accurately predict the probability of catastrophic events in the future and the extent of the resulting losses (as was the case with Hurricane Katrina).
Moreover, one or more catastrophe losses could weaken TRH’s retrocessionnaires and result in an inability of TRH to collect reinsurance recoverables. The
underwriting expense ratio for consolidated TRH remained level in 2007 compared
to 2006 due to a decrease of 0.1% in the commission expense component, offset
by an increase of 0.1% in the other underwriting expense component. The underwriting expense ratio for consolidated TRH increased in 2006 compared to 2005 due to an increase of 0.5% in the other underwriting expense component of the ratio and 0.2% in the net
commission component of the ratio. The increase in the other underwriting expense component is due largely to increased employee compensation and benefits expenses. 48
Deferred acquisition costs vary as the components of net unearned premiums change and the deferral rate changes. Acquisition costs, consisting primarily of net commissions incurred, are charged to
earnings over the period in which the related premiums are earned. In December 2005, the Company completed a public offering of $750 million principal amount of its 5.75% senior notes due in 2015 (the “Senior Notes”). The Senior Notes remained outstanding at
December 31, 2007 and 2006. Interest expense incurred in connection with the Senior Notes totaled $43.4 million, $43.4 million and $2.1 million in 2007, 2006 and 2005, respectively. Interest paid on the
Senior Notes totaled $43.1million, $43.1 million and nil in 2007, 2006 and 2005, respectively. General corporate expenses, certain stock-based compensation costs and expenses relating to Professional Risk Management Services, Inc. (“PRMS”), which was acquired in 2007, are the primary
components of “other, net” expenses on the Consolidated Statement of Operations. PRMS is an insurance program manager specializing in professional liability insurance services, including underwriting,
claims, and risk management, for individual healthcare providers, group practices, facilities and organizations. The increase in “other, net” in 2007 compared to 2006 is due to PRMS expenses and an
increase in general corporate expenses. Income (loss) before income taxes was $595.8 million in 2007, $539.9 million in 2006 and $(46.1) million in 2005. The increase in income before income taxes in 2007 compared to 2006 resulted primarily
from increased underwriting profit (loss) and net investment income. The increased underwriting profit (loss) in 2007 reflected increased net premiums earned together with a lower combined ratio
benefiting largely from decreased net adverse loss reserve development offset in part from higher catastrophe costs in 2007 compared to 2006 which together had the impact of increasing income before
income taxes in 2007 by $47.7 million. The increase in income (loss) before income taxes in 2006 compared to 2005 resulted primarily from increased underwriting profit (loss) and net investment income
offset in part by increased interest expense and decreased realized net capital gains, each in 2006 as compared to 2005. The increased underwriting profit (loss) in 2006 resulted primarily from lower pre-tax
net catastrophe costs and lower net adverse loss reserve development. The lower pre-tax net catastrophe costs and lower net adverse loss reserve development in the aggregate increased income (loss)
before income taxes by approximately $618.4 million in 2006 compared to 2005. Federal and foreign income tax expense (benefit) of $108.6 million, $111.8 million and $(84.0) million were recorded in 2007, 2006 and 2005, respectively. The 2005 tax benefit, which exceeds the
amount of pre-tax loss in 2005, resulted from TRH carrying its current year tax net operating loss back to prior years ($61.2 million current tax benefit on the Consolidated Statement of Operations and a
current tax recoverable in the same amount included in other assets on the Consolidated Balance Sheet) and recording a deferred tax benefit on the Consolidated Statement of Operations (also included on
the Consolidated Balance Sheet as a deferred tax asset) of $20.9 million for a minimum tax credit carryforward. In 2007 and 2006, TRH generated an additional $32.9 million and $6.6 million, respectively,
of deferred tax benefits from minimum tax credit carryforwards. The Company and its domestic subsidiaries (which includes foreign operations) file consolidated federal income tax returns. The tax burden among the companies is allocated in accordance with a tax
sharing agreement. TRC also includes as part of its taxable income or loss those items of income of the non-U.S. subsidiary, TRZ, which are subject to U.S. income tax currently, pursuant to Subpart F
income rules of the Internal Revenue Code, and included, as appropriate, in the consolidated federal income tax return. The effective tax rates, which represent the sum of current and deferred income taxes (benefits) divided by income (loss) before income taxes, were 18.2% in 2007, 20.7% in 2006 and 182.2% in 2005.
The decrease in the effective tax rate in 2007 compared to 2006 was primarily attributable to the recognition of a previously uncertain tax benefit of $5.3 million, dividends received deduction and additional
tax credits approximating $4.6 million and interest income anticipated of $4.3 million on net tax refunds. (See Note 4 of Notes to Consolidated Financial Statements.) With respect to the unusual effective tax rate in 2005, it is important to note that while the actual tax benefit derived from tax-exempt interest income and the dividends received deduction in 2005 is
not significantly different from 2006, the percentage impact in the effective tax rate calculation from such items is significantly greater. The greater impact is caused by the fact that income (loss) before
income 49
taxes (i.e., denominator in the effective tax rate calculation) is a lower absolute value in 2005 compared to 2007 and 2006, due largely to the greater amount of catastrophe costs in 2005. The effective tax
rates for 2007 and 2006 reflect the fact that there were no significant net catastrophe costs during those years. Net income and net income per common share on a diluted basis, respectively, were as follows: 2007—$487.1 million, $7.31; 2006—$428.2 million, $6.46; 2005—$37.9 million, $0.57. Reasons for the changes
between years are as discussed earlier. (See Note 8 of Notes to Consolidated Financial Statements.) Segment Results (a) Domestic: 2007
compared to 2006—Domestic revenues increased from the prior year
due principally to increases in net premiums written, for reasons discussed
earlier in MD&A, net of the difference in the change in
unearned premiums between years and, to lesser extents, increased realized
net capital gains, despite significant impairment write-downs in the equities
portfolio, and net investment income. The increase in net premiums earned
in 2007 occurred primarily in the property, other liability, medical malpractice
and auto liability lines offset in part by a significant decrease in the
fidelity and A&H lines. The increase in
net investment income is due in part to continued positive operating cash flows,
offset in part by a reduced investment return from the equities trading
portfolio. Income before income taxes for 2007 increased due primarily
to a decrease in underwriting loss and, to lesser extents, increases in
realized net capital gains and net investment income, partially offset
by increases in general corporate expenses and expenses relating to PRMS,
acquired in 2007. The decrease in underwriting loss is due in part to improved
loss experience in calendar year 2007. 2007 includes net catastrophe costs of $8.0 million relating to catastrophe events occurring in 2005. 2006 includes net catastrophe costs of $18.2 million relating to catastrophe events occurring in prior
years. Assets increased $208 million in 2007 due largely to a $490 million increase in investments and cash, partially offset by a $334 million decrease in reinsurance recoverable on paid and unpaid losses and
LAE. The increase in investments and cash was due largely to $550.5 million of net operating cash inflows. 2006 compared to 2005—Domestic revenues increased from the prior year due primarily to increases in net premiums earned, for reasons similar to those discussed earlier in MD&A for the increase in net
premiums written, and, to a lesser extent, increased net investment income offset in part by a decrease in realized net capital gains. The increase in net premiums earned in 2006 occurred primarily in the
other liability, property, A&H and auto liability lines offset in part by a significant decrease in the surety line. The increase in net investment income in 2006 is due in part to investment returns from the
investment of the $745 million net proceeds from the issuance of the Senior Notes, continued positive operating cash flows and increases in investment income from limited partnerships. Income (loss)
before income taxes for 2006 increased due primarily to an increase in underwriting profit (loss) and, to a lesser extent, by increased net investment income. The increase in underwriting profit (loss) is
caused principally by decreased net catastrophe costs, which totaled $18.2 million in 2006 compared to $385.8 million in 2005. Both years included significant adverse development of losses occurring in prior
years, though such development was lower in 2006 then 2005, in certain more volatile casualty classes, as discussed earlier under Results of Operations. Assets increased $247 million in 2006 as increases in investments and cash were partially offset by reductions in reinsurance recoverable on paid and unpaid losses and LAE. The increase in investments
and cash was due largely to $445.4 million of net operating cash flows. (b) International—Europe (London and Paris branches and TRZ): 2007 compared to 2006—Revenues increased due to increases in net premiums earned and net investment income, partially offset by an increase in realized net capital losses, related in part to increased
foreign exchange transaction losses. Revenues increased principally in the London and Paris branches. Net premiums earned increased principally in the other liability, A&H and medical 50
malpractice lines offset in part by a significant decrease in the auto liability line. Income before income taxes for 2007 increased due primarily to increases in underwriting profit, despite a significant
increase in catastrophe loss activity (as further discussed below) and increased net investment income offset in part by an increase in realized net capital losses. The increase in underwriting profit reflects a
lower combined ratio from the London branch, reflecting improved loss experience, partially offset by a higher combined ratio from the Paris branch due to increased loss activity relating to catastrophe
losses occuring in 2007. 2007 includes net catastrophe costs of $47.4 million principally relating to Windstorm Kyrill in Europe and floods in the U.K. 2006 includes net catastrophe costs of $16.9 million relating to catastrophe
events occurring in prior years. Assets increased $799 million in 2007 due largely to a $742 million increase in investments and cash. The increase in investments and cash was due in part to significant net operating cash inflows in
recent periods. 2006 compared to 2005—Revenues decreased due principally to a decrease in net premiums earned in the London and Paris branches and, to a lesser extent, a decrease in realized net capital gains
(losses), partially offset by increased net investment income. Net premiums earned decreased principally in the auto liability, other liability and property lines offset in part by increases in the ocean marine,
A&H and credit lines. The decrease in net premiums earned is due in part to some weakness in market conditions and increased ceding company retentions. Income before income taxes for 2006 increased
due primarily to an increase in underwriting profit (loss) in the London branch and TRZ and, to a lesser extent, to increased net investment income in each location. The increase in underwriting profit
(loss) is caused principally by decreased net catastrophe costs, which totaled $16.9 million in 2006 compared to $119.6 million in 2005. Assets increased $1.37 billion in 2006 due largely to an increase of $1.1 billion in securities lending collateral, due to increased demand to borrow securities denominated in certain European currencies,
and an increase of $400 million in fixed maturities available for sale reflecting significant positive operating cash flows in recent periods. (c) International—Other (Miami (serving Latin America and the Caribbean), Toronto, Hong Kong and Tokyo branches): 2007 compared to 2006—Revenues decreased in 2007 due to decreases in net premiums earned and realized net capital gains (losses), partially offset by an increase in net investment income. The decrease
in net premiums earned generally occurred in the property, auto liability and A&H lines offset in part by an increase in the other liability line. Significant decreases in net premiums earned occurred in the
Miami and Hong Kong branches, partially offset by a significant increase in net premiums earned from the Toronto branch. Income before income taxes decreased in 2007 due to a decrease in underwriting
profit from the Miami branch, reflecting a significant increase in loss activity, and a decrease in realized net capital gains (losses), partially offset by increased net investment income. 2007 includes net catastrophe costs of ($0.2) million relating to events occurring in 2005. 2006 includes net catastrophe costs of ($6.4) million relating to catastrophe events occurring in prior years. Assets increased $208 million in 2007 due largely to a $189 million increase in investments and cash. The increase in investments and cash was due in part to significant positive net operating cash flows
in recent periods. 2006 compared to 2005—Revenues increased in 2006 due primarily to increases in net premiums earned in all branches, with the largest increases in the Miami and Toronto branches. These increases
generally occurred in the property line along with relatively minor increases spread among several other lines. The increased net premiums earned in the Miami branch benefited from favorable market
conditions in Latin America following significant catastrophe losses affecting the region in 2005. Income before income taxes increased in 2006 due to increases in underwriting profit (loss) and net
investment income. The increase in underwriting profit (loss) is caused in part by decreased net catastrophe costs, which totaled ($6.4) million in 2006 compared to $38.5 million in 2005, and generally
improved loss experience in 2006. 51
Assets increased by $284 million in 2006 due principally to increases in reinsurance recoverable from affiliates on paid and unpaid losses and LAE and increases in investments and cash. Financial Condition and Liquidity As a holding company, the Company’s assets consist primarily of the stock of TRC. The Company’s liabilities consist primarily of the Senior Notes and related interest payable. The Company’s future
cash flows depend on the availability of dividends or other statutorily permissible payments from TRC and its wholly-owned operating subsidiaries, TRZ and Putnam. (See Note 14 of Notes to Consolidated
Financial Statements for a discussion of restrictions on dividend payment.) In 2007 and 2006, the Company received cash dividends from TRC of $81.0 million and $88.0 million, respectively. As of
December 31, 2007, TRC could pay dividends to the Company of $336.9 million without regulatory approval. In 2005, TRC, the primary operating subsidiary, received a capital contribution of $745 million
from the Company. These funds were obtained by the Company in connection with its public offering of the Senior Notes. (See Note 6 of Notes to Consolidated Financial Statements.) The Company uses
cash primarily to pay interest to the holders of the Senior Notes, dividends to its common stockholders and, to a lesser extent, operating expenses. Sources of funds for the operating subsidiaries consist primarily of premiums, reinsurance recoverables, investment income, proceeds from sales, redemptions and the maturing of investments and the
receipt of securities lending collateral. Funds are applied by the operating subsidiaries primarily to payments of claims, commissions, ceded reinsurance premiums, insurance operating expenses, income
taxes and securities lending payables and the purchase of investments. Premiums are generally received substantially in advance of related claims payments. Cash and cash equivalents, which are principally
interest-bearing, are maintained for the payment of claims and expenses as they become due. TRH does not anticipate any material capital expenditures in the foreseeable future. While the expected payout pattern of liabilities (see contractual obligations table later in this section) is considered in the investment management process, it is not the only factor considered as TRH
has historically funded its claims payments from current operating cash flows. As a result of such funding history, TRH has not historically maintained a credit facility. TRH’s primary investment goal is to
maximize after-tax income through a high quality diversified taxable fixed maturity and tax-exempt municipal fixed maturity portfolio, while maintaining an adequate level of liquidity. See discussion later in
this section of the potential liquidity strain that could arise as a result of a significant acceleration of paid losses beyond TRH’s ability to fund such payments. At December 31, 2007, total investments and cash were $12.76 billion compared to $11.34 billion at December 31, 2006. The increase was caused, in large part, by $1,026.8 million of cash provided by
operating activities and $306.0 million from the net receipt of collateral from securities lending activities, offset by changes in net unrealized appreciation (depreciation) of investments which decreased
investments and cash by $155.6 million (see discussion of the change in unrealized appreciation of investments, net of tax, below). In addition, the impact of foreign currency exchange rate changes between
the U.S. dollar and certain currencies in which investments and cash are denominated increased total investments and cash by approximately $255 million. 52
The following table summarizes the investments and cash of TRH (on the basis of carrying value) as of December 31, 2007 and 2006:
December 31, 2007
December 31, 2006
Amount
Percent
Amount
Percent
(dollars in thousands) Fixed maturities: Held to maturity (at amortized cost): States, municipalities and political subdivisions
$
1,249,935
9.8
%
$
1,254,017
11.1
% Available for sale (at fair value): Corporate
2,060,757
16.2
1,727,715
15.2 U.S. Government and government agencies
330,838
2.6
348,672
3.1 Foreign government
330,012
2.6
304,824
2.7 States, municipalities and political subdivisions
5,335,119
41.8
4,650,278
41.0 Asset-backed and collateralized securities
42,526
0.3
29,601
0.3
8,099,252
63.5
7,061,090
62.3 Total fixed maturities
9,349,187
73.3
8,315,107
73.4 Equities: Available for sale: Common stocks
587,373
4.6
571,422
5.1 Nonredeemable preferred stocks
197,870
1.5
236,846
2.1
785,243
6.1
808,268
7.2 Trading, principally common stocks
35,357
0.3
38,232
0.3 Total equities
820,600
6.4
846,500
7.5 Other invested assets
250,921
2.0
231,502
2.0 Securities lending collateral
2,012,031
15.8
1,694,841
14.9 Short-term investments
67,801
0.5
42,882
0.4 Cash and cash equivalents
255,432
2.0
205,264
1.8 Total investments and cash
$
12,755,972
100.0
%
$
11,336,096
100.0
% Based on the composition of its investments and cash, TRH considers its liquidity to be adequate through the end of 2008 and thereafter for a period the length of which is difficult to predict, but which
TRH believes will be at least one year. TRH’s fixed maturities classified as held to maturity and available for sale are predominantly investment grade, liquid securities, approximately 42.0% of which will mature in less than 10 years. The
average duration of these fixed maturities was 5.8 years as of December 31, 2007. Activity within the fixed maturities available for sale portfolio for the years under discussion generally represented strategic
portfolio realignments to maximize after-tax income. TRH adjusts its mix of taxable and tax-exempt investments, as appropriate, generally as a result of strategic investment and tax planning considerations.
With respect to the fixed maturities which are classified as held to maturity and carried at amortized cost, TRH has the positive intent and ability to hold each of these securities to maturity. The
following table summarizes the ratings of fixed maturities held to maturity
and available for sale as of December 31, 2007:
Aaa
Aa
A
Baa
Not Rated
Total
(dollars in millions) Held to maturity: Non-asset-backed and collateralized
$
1,002.7
$
202.5
$
44.7
$
—
$
—
$
1,249.9 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
