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Transatlantic Holdings 10-K 2009 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. 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, 2008 (the last business day of the registrant’s most recently completed second fiscal quarter) was approximately $1,524,810,394. As of January 31, 2009, there were outstanding 66,364,358 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 21, 2009 are incorporated by reference in Part III of this Form 10-K.
TRANSATLANTIC HOLDINGS, INC. AND SUBSIDIARIES
Page Business
1 Risk Factors
21 Unresolved Staff Comments
33 Properties
33 Legal Proceedings
33 Submission of Matters to a Vote of Security Holders
34 Market for the Registrant’s Common Equity, Related Stockholder Matters and
Issuer Purchases of Equity Securities
35 Selected Financial Data
37 Management’s Discussion and Analysis of Financial Condition and Results of
Operations
39 Quantitative and Qualitative Disclosures About Market Risk
73 Financial Statements and Supplementary Data
74 Changes in and Disagreements With Accountants on Accounting and Financial
Disclosure
117 Controls and Procedures
117 Other Information
117 Directors, Executive Officers and Corporate Governance
118 Executive Compensation
119 Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters
119 Certain Relationships and Related Transactions, and Director Independence
120 Principal Accounting Fees and Services
120 Exhibits and Financial Statement Schedules
120
PART I Throughout this Annual Report on Form 10-K, Transatlantic Holdings, Inc. (the “Company”, and collectively with its subsidiaries, “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. Item 1. Business The Company and Its History The Company 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, 2008, 2007 and 2006, AIG beneficially owned approximately 59% of the Company’s outstanding shares. (See Relationship
with the AIG Group for a description of recent events relating to AIG.) 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. TRC is an Admitted Reinsurer in Brazil, where it maintains an office in Rio de Janeiro. In addition, TRC is registered and authorized as
a foreign reinsurer in Argentina (where it maintains a representative office in Buenos Aires, Transatlantic Re (Argentina) S.A.), 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. In October 2008, TRC formed a company in Munich, Germany, TransRe Germany GmbH, and was granted permission by the German regulator Bundesanstalt fur Finanzdienstleistungsaufsicht
(“Bafin”) to conduct reinsurance business from its registered office in Munich, Germany. The Reinsurance Business Reinsurance is an arrangement whereby one or more companies, the reinsurer(s), agrees to indemnify another insurance or reinsurance 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. 1
TRH offers two types of reinsurance based on the underlying insurance coverage:
•
Casualty. Casualty insurance protects the insured against financial loss arising out of its obligation to others for loss or damage to their person or property. Casualty reinsurance protects the ceding company against loss to the extent of the reinsurance coverage provided. TRH’s principal lines of casualty
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. 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 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 cedants and reinsurers. • 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 reinsurance protects the ceding company against loss to the extent of the reinsurance coverage provided. TRH’s principal lines of property reinsurance
include fire, allied lines, auto physical damage and homeowners multiple peril. 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 than casualty business. 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. TRH writes reinsurance either through treaty or facultative reinsurance arrangements:
•
Treaty. 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. 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. TRH provides reinsurance for most major lines of insurance on both pro rata and excess-of-loss bases. A ceding company’s reinsurance program may involve pro rata and excess-of-loss reinsurance on both a treaty and facultative basis:
•
Pro rata. 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 2
business being reinsured (i.e., brokers’ and agents’ commissions, local taxes and administrative expenses). • Excess-of-Loss. 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. Operations TRH’s activities in the United States are conducted through its worldwide headquarters in New York, NY, 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, Rio de Janeiro, 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,
Panama, Warsaw, Munich and Shanghai, and maintains exclusive representative arrangements with MS Upson Associates c.c. in Johannesburg, South Africa and with NOBARE in Stockholm, Sweden. TRH’s arrangement with Momentum Underwriting Management, Ltd. (“Momentum Underwriting”) in London,
England, in which Momentum Underwriting had the underwriting authority to bind TRH, pursuant to strict underwriting guidelines, lapsed and was not renewed by TRH on January 2, 2009. Momentum Underwriting no longer has underwriting authority on behalf of TRH. The termination of this arrangement did not
affect business previously bound by Momentum Underwriting on behalf of TRH before the termination of this arrangement. TRH also operates Professional Risk Management Services, Inc. (“PRMS”), a wholly-owned subsidiary of the Company. 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 50%,
51% and 52% of worldwide net premiums written in 2008, 2007 and 2006, respectively. The London branch had net premiums written totaling $829.1 million, $813.2 million and $744.5 million in 2008, 2007 and 2006, respectively, representing 20%, 21% and 20%, respectively, of worldwide net premiums written
in 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 17 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. Approximately $550 million (12%), $555 million (13%) and $593 million (15%) of gross premiums written by TRH in the years 2008, 2007 and 2006, 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 $51.4 million at December 31, 2008. 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. 3
Property and Casualty Lines of Business Casualty reinsurance constitutes the larger portion of TRH’s business, accounting for 70% of net premiums written in 2008, 71% in 2007 and 73% in 2006. 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
2008
2007
2006
2008
2007
2006
2008
2007
2006
2008
2007
2006
(dollars in millions) Casualty: Other liability(1)(2)(3)(4)
$
1,037.2
$
1,040.4
$
1,003.4
$
1,061.3
$
1,043.9
$
899.6
$
842.3
$
941.7
$
784.8
79.4
%
90.2
%
87.2
% Medical malpractice(2)(3)(4)
372.4
388.8
318.0
372.5
379.8
304.9
295.8
304.2
233.2
79.4
80.1
76.5 Ocean marine and aviation(2)
323.6
335.7
349.4
329.2
350.9
325.6
251.7
251.5
234.6
76.5
71.7
72.0 Auto liability(2)
317.6
289.6
288.3
297.0
268.0
302.4
210.2
213.6
229.4
70.8
79.7
75.9 Accident and health
314.0
248.3
230.4
302.8
238.5
232.7
232.0
185.6
181.4
76.6
77.8
77.9 Surety and credit(4)
224.6
177.6
174.0
214.7
173.8
165.4
140.3
84.7
118.3
65.3
48.7
71.6 Other(3)
278.6
324.7
298.2
300.7
313.5
318.2
273.5
208.1
221.5
91.0
66.4
69.6 Total casualty
2,868.0
2,805.1
2,661.7
2,878.2
2,768.4
2,548.8
2,245.8
2,189.4
2,003.2
78.0
79.1
78.6 Property: Fire(2)(3)(4)
582.7
568.6
474.0
573.7
534.2
487.7
393.5
235.6
156.8
68.6
44.1
32.2 Allied lines(2)(3)
314.6
284.4
230.5
304.8
289.4
220.3
128.6
73.4
99.4
42.2
25.4
45.1 Auto physical damage
170.5
111.4
108.3
136.9
101.4
136.7
93.7
78.1
107.6
68.4
77.1
78.7 Homeowners multiple peril(2)(3)(4)
72.8
64.5
45.9
72.4
83.4
97.6
13.5
(6.6)
29.8
18.7
(7.9)
30.5 Other(3)(4)
99.5
118.9
113.0
101.4
125.9
113.0
32.1
68.1
65.9
31.7
54.1
58.3 Total property
1,240.1
1,147.8
971.7
1,189.2
1,134.3
1,055.3
661.4
448.6
459.5
55.6
39.6
43.5 Total
$
4,108.1
$
3,952.9
$
3,633.4
$
4,067.4
$
3,902.7
$
3,604.1
$
2,907.2
$
2,638.0
$
2,462.7
71.5
67.6
68.3
(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 2008, development on reserves held at December 31, 2007 relating to losses that occurred in 2007 and prior years significantly decreased net losses and loss adjustment expenses incurred in the allied lines, homeowners multiple peril, auto liability and fire lines and significantly increased net losses and loss adjustment expenses incurred in the other liability and medical malpractice
lines. In addition, pre-tax net catastrophe losses of $180 million significantly increased net losses and loss adjustment expenses incurred in the allied lines, ocean marine and fire lines. (3) 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 significantly increased net losses and loss adjustment expenses incurred in the fire line. (4) 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. Operating results in 2008, 2007 and 2006 included pre-tax net catastrophe costs of $170 million, $55 million and $29 million, respectively. (See MD&A.) 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,
general economic and social conditions, financial, credit and industry market 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. 4
Treaty and Facultative Reinsurance Treaty reinsurance constitutes the great majority of TRH’s business, accounting for 97%, 96% and 95% of net premiums written in 2008, 2007 and 2006, 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,
2008(1)
2007(2)
2006
(in millions) Gross premiums written
$
4,088.7
$
3,971.5
$
3,655.2 Net premiums written
3,976.6
3,805.8
3,461.6 Net premiums earned
3,938.0
3,748.4
3,434.7
Facultative
Years Ended December 31,
2008(1)
2007(2)
2006
(in millions) Gross premiums written
$
334.5
$
312.1
$
328.2 Net premiums written
131.5
147.1
171.8 Net premiums earned
129.4
154.3
169.4
(1)
In 2008 compared to 2007, domestic treaty net premiums written increased significantly in the property, A&H, auto liability and other liability lines, offset in part by a significant decrease in the fidelity line. International treaty net premiums written increased significantly in the property, credit and A&H lines, partially offset by a significant decrease in the other liability and ocean marine lines.
Facultative gross premiums written increased in 2008 compared to 2007 due largely 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 fire line. Facultative net premiums written in 2008 decreased compared to 2007 principally in the property and A&H lines. (2) 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. Treaty Reinsurance Treaty reinsurance accounted for approximately $4.09 billion of gross premiums written and $3.98 billion of net premiums written in 2008. Approximately 70% of treaty net premiums written resulted from casualty lines treaties, with the remainder from property lines treaties. Approximately 69% of total treaty
gross premiums written in 2008 represented treaty reinsurance written on a pro rata basis and the balance represented treaty reinsurance written on an excess-of-loss basis. Approximately 8% of treaty gross premiums written in 2008 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, 2008. 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. TRH’s treaty business accepts a portfolio of risks on either a risk attaching basis or loss occurring during (“LOD”) basis. For 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. 5
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 4,100 treaties in effect for the current underwriting year. In 2008, no single treaty exceeded 3% of treaty gross premiums written. No ceding company accounted for more than 5% of total treaty gross premiums written in 2008 except for other subsidiaries of AIG (see
Relationship with the AIG Group). Facultative Reinsurance During 2008, TRH wrote approximately $334.5 million of gross premiums written and $131.5 million of net premiums written of facultative reinsurance. Approximately 65% 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, 2008. 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 2008, 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 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. 6
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 62% of
facultative gross premiums written in 2008 were attributable to other subsidiaries of AIG. The large majority of such facultative gross premiums written in 2008, 2007 and 2006, were, by prearrangement with TRH, assumed from one AIG subsidiary and ceded in an equal amount to other AIG subsidiaries. (See
Note 16 of Notes to Consolidated Financial Statements (“Note 16”).) Except for AIG subsidiaries, no single ceding company accounted for more than 4% of total facultative gross premiums written in 2008. 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, trust agreements and letters of credit to
collateralize reinsurance recoverables. Such funds, trust agreements 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, 2008, TRH had in place approximately 160 active retrocessional arrangements for current and prior underwriting years with approximately 340 retrocessionnaires, and reinsurance recoverable on paid and unpaid losses and loss adjustment expenses totaled $790.5 million, including
$250.5 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 16.) Risk Management TRH employs an Enterprise Risk Management (“ERM”) framework to identify, assess, quantify, mitigate and manage TRH’s risks in order to maximize its long-term value and achieve its corporate objectives. This framework is integrated into the day-to-day activities of TRH as well as its strategic planning
processes. As part of this framework, TRH determines its underwriting risk appetite by giving underwriters written underwriting
authorities which are linked to competence and delegated according to class, risk limits, program limits and premium limits. The monitoring of underwriting and claims performance takes various
forms including the qualitative review of underwriting files and rationales by peers and internal audit reviews of underwriting authorities and data input into TRH’s real-time management
information system. Class results are reviewed quarterly at meetings between the regional Chief Underwriting Officers, the risk
management department, the heads of underwriting areas, line underwriters, actuaries and the claims department. In addition, the actuarial department monitors rate adequacy, conducts
profitability studies and assesses reserve adequacy. Aggregating exposures are managed centrally through the establishment of risk tolerances which are set annually and monitored through quarterly and half-yearly roll ups of actual exposures. TRH has also developed a scenario-based assessment of potential loss events that focuses on cross-class
aggregations and correlations. For natural catastrophe exposures, roll-ups are conducted using proprietary rating models supplemented by internally generated assessments for un-modeled exposures.
(See Catastrophe Exposure in MD&A for further information.) The risk management team is led by the Chief Risk Officer (“CRO”) who reports directly to the Chief Executive Officer who chairs the Risk Management Committee composed of executive officers including the CRO, Chief Financial Officer, Chief Information Officer, General Counsel, Chief Actuary, Senior
Claims Executive in New York as well as the Chief Underwriting Officers for the Domestic Operations, International Operations and the Caribbean and Latin American Operations among other 7
officers. In addition, the Underwriting and Risk Management Committee of the Company’s Board of Directors provides Board oversight of the risk management of TRH. In
all major branches, local risk committees meet quarterly to review the major
risks of TRH including regulatory, operational, credit and other financial
risks. These committees include senior representatives from the finance and
accounting, claims, actuarial, systems, legal and underwriting departments
and report to the risk management department in New York. TRH uses various
tools including an employee code of conduct, mandatory ethics training, internal
audit reviews and business continuity planning to mitigate its operational
risks. TRH utilizes investment strategies to manage asset type, sector, industry, issuer and issue concentrations within the investment portfolio and uses an approved reinsurers list to communicate throughout TRH the acceptability of potential retrocessionaires. TRH is engaged in the continuous enhancement of its ERM framework, which includes the development of an economic capital model to assess the probability and potential severity of risk events and to determine the optimum risk adjusted appetite for TRH. 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 helps 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 2008, approximately 82% of TRH’s non-AIG Group business was written through brokers and the balance was written directly. Also in 2008,
companies controlled by Aon Corporation (“Aon”) and Marsh & McLennan Companies, Inc. (“Marsh”), TRH’s largest brokerage sources of non-AIG Group business, accounted for 27% and 15%, respectively, of TRH’s consolidated revenues. In addition, Aon and Marsh each accounted for non-AIG Group business
representing 25% and 14% of total gross premiums written in 2008, respectively. Premiums brokered by Aon in 2008 increased over previous years due in large part to Aon’s acquisition of Benfield Group Limited in the fourth quarter of 2008 and Arthur J. Gallagher & Co.’s U.S. and U.K. reinsurance brokerage
business in the first quarter of 2008. The business attributable to Aon above includes all TRH gross premiums brokered by Aon and its affiliates in the full year 2008 regardless of the date that any such affiliate was acquired. TRH’s largest 10 brokers accounted for non-AIG Group business aggregating
approximately 58% 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. 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. 8
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., loss adjustment expenses (“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 TRH’s 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 reserves. 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. 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 9
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 certain recent years have had, a material effect on net
income. (See MD&A, including the discussion of Critical Accounting Estimates, and Note 2(j) 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 liabilities for prior period losses. The “Analysis of Consolidated Net Loss Reserves Development” which follows presents the development of net loss reserves for calendar years 1998 through 2008. 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 $2.66 billion as of December 31, 1998, by the end of 2008 (ten years later) $3.08 billion 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 $2.66 billion was reestimated to be
$3.49 billion at December 31, 2008. 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) redundancy 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 $833.5 million at December 31, 2008 relating to December 31, 1998 net loss reserves of $2.66 billion, represents the cumulative amount by which net loss reserves as of year-end 1998 have developed adversely from 1999 through 2008. 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 2005 for $150,000 was first reserved in 2002 at $100,000 and remained unchanged until settlement, the $50,000 deficiency (actual loss minus
original estimate) would be included in the cumulative net (deficiency) redundancy in each of the years in the period 2002 through 2004 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. 10
ANALYSIS OF CONSOLIDATED NET LOSS RESERVES DEVELOPMENT(1)(2)
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
(in thousands) Net loss reserves, as of
December 31:(3)
$
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
$
7,349,078 Cumulative paid as of: One year later
702,603
953,708
892,752
1,033,574
1,057,314
1,090,058
1,492,464
1,447,284
1,464,916
1,841,768 Two years later
1,224,593
1,570,329
1,573,227
1,759,047
1,806,388
2,035,299
2,416,036
2,526,261
2,761,250 Three years later
1,620,068
2,050,795
2,071,480
2,332,901
2,535,149
2,792,484
3,263,061
3,549,463 Four years later
1,982,347
2,408,700
2,499,596
2,932,043
3,198,831
3,485,611
4,028,731 Five years later
2,213,639
2,722,971
2,940,058
3,479,594
3,792,955
4,112,690 Six years later
2,417,530
3,039,306
3,333,401
3,953,515
4,297,909 Seven years later
2,620,053
3,306,557
3,649,883
4,365,880 Eight years later
2,794,230
3,525,322
3,952,850 Nine years later
2,937,132
3,765,082 Ten years later
3,076,176 Net reestimated liability as
of:(3) End of year
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
7,349,078 One year later
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
6,899,232 Two years later
2,496,422
2,802,612
3,088,303
3,561,876
4,112,290
4,781,344
5,557,243
6,133,365
6,385,124 Three years later
2,508,278
3,158,790
3,392,021
4,176,419
4,637,194
5,110,862
5,878,870
6,282,334 Four years later
2,764,144
3,379,226
3,872,054
4,641,988
4,976,922
5,485,195
6,066,219 Five years later
2,886,020
3,725,975
4,217,748
4,904,646
5,345,798
5,701,065 Six years later
3,073,754
3,944,728
4,396,225
5,184,316
5,555,013 Seven years later
3,218,944
4,064,479
4,584,446
5,390,160 Eight years later
3,313,104
4,193,632
4,747,977 Nine years later
3,407,352
4,321,030 Ten years later
3,489,633 Net (deficiency)
redundancy as of
December 31, 2008
$
(833,530
)
$
(1,558,868
)
$
(2,133,060
)
$
(2,481,273
)
$
(2,297,107
)
$
(1,744,645
)
$
(1,085,610
)
$
(591,891
)
$
(177,904
)
$
484
(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 14 and 16 of Notes to Consolidated Financial Statements.) (3) Represents unpaid losses and loss adjustment expenses, net of related reinsurance recoverables. 11
ANALYSIS OF NET UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
(in thousands) End of year: Gross liability
$
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
$
8,124,482 Related reinsurance recoverable
459,935
542,769
462,245
838,696
774,678
849,078
960,855
1,422,851
1,260,729
1,026,545
775,404 Net liability
$
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
$
7,349,078 One year later: Gross reestimated liability
$
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
$
7,918,300 Reestimated related reinsurance recoverable
495,017
593,001
475,929
888,113
885,415
843,688
1,094,574
1,435,024
1,337,538
1,019,068 Net reestimated liability
$
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
$
6,899,232 Two years later: Gross reestimated liability
$
3,033,092
$
3,426,471
$
3,565,853
$
4,556,676
$
5,003,598
$
5,761,231
$
6,633,579
$
7,618,979
$
7,722,795 Reestimated related reinsurance recoverable
536,670
623,859
477,550
994,800
891,308
979,887
1,076,336
1,485,614
1,337,671 Net reestimated liability
$
2,496,422
$
2,802,612
$
3,088,303
$
3,561,876
$
4,112,290
$
4,781,344
$
5,557,243
$
6,133,365
$
6,385,124 Three years later: Gross reestimated liability
$
3,039,473
$
3,788,866
$
3,970,012
$
5,188,506
$
5,678,239
$
6,096,568
$
7,017,192
$
7,769,983 Reestimated related reinsurance recoverable
531,195
630,076
577,991
1,012,087
1,041,045
985,706
1,138,322
1,487,649 Net reestimated liability
$
2,508,278
$
3,158,790
$
3,392,021
$
4,176,419
$
4,637,194
$
5,110,862
$
5,878,870
$
6,282,334 Four years later: Gross reestimated liability
$
3,298,599
$
4,098,524
$
4,492,711
$
5,814,220
$
6,034,785
$
6,536,334
$
7,219,505 Reestimated related reinsurance recoverable
534,455
719,298
620,657
1,172,232
1,057,863
1,051,139
1,153,286 Net reestimated liability
$
2,764,144
$
3,379,226
$
3,872,054
$
4,641,988
$
4,976,922
$
5,485,195
$
6,066,219 Five years later: Gross reestimated liability
$
3,502,673
$
4,479,946
$
4,868,258
$
6,099,084
$
6,467,893
$
6,766,081 Reestimated related reinsurance recoverable
616,653
753,971
650,510
1,194,438
1,122,095
1,065,016 Net reestimated liability
$
2,886,020
$
3,725,975
$
4,217,748
$
4,904,646
$
5,345,798
$
5,701,065 Six years later: Gross reestimated liability
$
3,713,151
$
4,728,479
$
5,058,733
$
6,441,624
$
6,692,327 Reestimated related reinsurance recoverable
639,397
783,751
662,508
1,257,308
1,137,314 Net reestimated liability
$
3,073,754
$
3,944,728
$
4,396,225
$
5,184,316
$
5,555,013 Seven years later: Gross reestimated liability
$
3,893,259
$
4,860,380
$
5,262,921
$
6,660,562 Reestimated related reinsurance recoverable
674,315
795,901
678,475
1,270,402 Net reestimated liability
$
3,218,944
$
4,064,479
$
4,584,446
$
5,390,160 Eight years later: Gross reestimated liability
$
3,995,364
$
5,007,580
$
5,439,253 Reestimated related reinsurance recoverable
682,260
813,948
691,276 Net reestimated liability
$
3,313,104
$
4,193,632
$
4,747,977 Nine years later: Gross reestimated liability
$
4,105,512
$
5,145,660 Reestimated related reinsurance recoverable
698,160
824,630 Net reestimated liability
$
3,407,352
$
4,321,030 Ten years later: Gross reestimated liability
$
4,200,914 Reestimated related reinsurance recoverable
711,281 Net reestimated liability
$
3,489,633 Gross (deficiency) redundancy as of December 31, 2008
$
(1,084,876
)
$
(1,840,729
)
$
(2,362,091
)
$
(2,912,979
)
$
(2,659,743
)
$
(1,960,583
)
$
(1,278,041
)
$
(656,689
)
$
(254,846
)
$
7,961
(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 14 and 16 of Notes to Consolidated Financial Statements.) 12
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 minimal net favorable
development. Net favorable development of $0.5 million was recorded in 2008 on losses occurring in all prior years. (See MD&A.) This net favorable development was comprised of net favorable development of $209.7 million for losses occurring in 2003 to 2007, offset by net adverse development of $209.2 million
for losses occurring in 2002 and prior. 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 2001 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 6 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 U.S. generally accepted accounting principles 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 and Investment 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. 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 hedge funds and TRH’s 40% interest in Kuwait Re. Through 2008, TRH participated in a securities lending program (the “Securities Lending Program”) managed by a subsidiary of AIG, whereby certain securities from its portfolio were loaned to third parties. (See Note 2(c) of Notes to Consolidated Financial Statements.) Under such program, TRH loaned
securities to counterparties and received collateral, generally cash, which was invested to earn a spread. Prior to the fourth quarter of 2008, the transfers of securities in exchange for collateral under the Securities Lending Program were accounted for as secured borrowings, with a liability recorded in an amount equal to the collateral received, reflecting TRH’s obligation to return the collateral when the loaned
securities were returned. Securities lending invested collateral was shown on the balance sheet at fair value. As a result of conditions affecting the financial and credit markets, in the fourth quarter of 2008, counterparties were successful in negotiating significantly reduced collateral levels (i.e., collateral received
as a percentage of the fair value of the security loaned). Due to the lower collateral levels, during the fourth quarter of 2008, many of such loaned securities were accounted for as sales at 13
the time of transfer and as purchases when the securities were subsequently returned. In the fourth quarter of 2008, TRH terminated its participation in the Securities Lending Program. During
2008, the financial impact on the Statement of Operations of the Securities
Lending Program was as follows: With respect to securities lending invested
collateral: Net investment income from the Securities Lending Program (i.e., income
earned on invested collateral, net of interest payable to the collateral
provider) totaled $2.6 million; Net realized losses on sales of securities
lending invested collateral totaled $8.0 million; Other-than-temporary impairment
write-downs (included in net realized capital losses) totaled $97.7 million.
With respect to the securities loaned, realized losses in the fourth quarter
of 2008 on “deemed” sales of securities loaned totaled $16 million. In 2008, TRH repaid certain securities lending payables using cash from sources other than the sale of securities lending invested collateral. In that regard, certain fixed maturities, including commercial mortgage-backed securities, residential mortgage-backed securities and other asset-backed securities,
were transferred from securities lending invested collateral to fixed maturities available for sale. Other than the potential for future losses related to the securities that were transferred from securities lending invested collateral, TRH expects no further costs from the Securities Lending Program. The following table reflects investment results for TRH for each of the five years in the period ended December 31, 2008. INVESTMENT RESULTS(1)
Years Ended
Consolidated
Excluding Securities Lending Program (2)
Average
Pre-Tax Net
Pre-Tax
Average
Pre-Tax Net
Pre-Tax 2008
$
11,595,522
$
440,451
3.8
%
$
10,589,507
$
437,883
4.1
% 2007
12,024,944
469,772
3.9
10,171,508
467,293
4.6 2006
10,270,004
434,540
4.2
9,119,143
432,343
4.7 2005
8,748,640
343,247
3.9
8,007,658
341,631
4.3 2004
7,566,066
306,786
4.1
6,885,591
305,567
4.4 (1) See
discussion of the impact of the Securities Lending Program on investment
yields in 2008, 2007 and 2006 in Results of Operations in MD&A.
(2)
Represents the consolidated information excluding the Securities Lending Program which better reflects the return on the ongoing investment portfolio as the Securities Lending Program has been terminated in the fourth quarter of 2008. (3) Average of beginning and ending carrying values of investments and interest-bearing cash and cash equivalents for the year. (4) Pre-tax net investment income divided by average investments and interest-bearing cash and cash equivalents. (5) Average of beginning and ending carrying values of investments and interest-bearing cash and cash equivalents excluding securities lending invested collateral for the year. (6) Pre-tax net investment income excluding net investment income from securities lending invested collateral. (7) Pre-tax net investment income excluding net investment income from securities lending invested collateral divided by average investments and interest-bearing cash and cash equivalents excluding securities lending invested collateral. 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, 2008, the fair value of the total investment portfolio was $10.22 billion. 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.) 14
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 resources than TRH or operate in different regulatory jurisdictions and tax environments. 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
numerous initiatives could significantly affect supply, pricing and competition in the reinsurance industry. Employees At December 31, 2008, TRH had approximately 600 employees. Approximately 260 employees were located in the New York headquarters; 110 employees were located in other locations in the United States and 230 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 with non-affiliates 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 15
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
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, 2008, 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. At the December 2008 Winter National
Meeting, the NAIC formally adopted the new NAIC Reinsurance Regulatory
Modernization Framework proposal (the “Framework”). The Framework
contemplates the creation of the NAIC Reinsurance Supervision Review Department
(the “RSRD”). The purpose of the RSRD will be to review and evaluate
systems of reinsurance regulation in U.S. jurisdictions and non-U.S.
jurisdictions to determine whether those regulatory systems are equivalent in
terms of effectiveness to the systems of reinsurance regulation in typical U.S.
jurisdictions. International reinsurers domiciled in an RSRD approved
jurisdiction would be eligible to participate 16
in the Framework. The same would
be true for U.S. reinsurers domiciled in a U.S. state that has been approved by
the RSRD. Under the Framework, the issue of whether credit for reinsurance in financial statements would be allowed will be determined primarily by the single state that is the primary U.S. regulator of the reinsurer, rather than by the domestic regulators of all of the ceding insurers as is done currently. Participating reinsurers would be assigned one of five security ratings by their U.S. regulator—ranging from 1 (secure) to 5 (vulnerable). The ratings would be based upon a number of factors, including but not limited to the reinsurer’s ratings from rating agencies. The level of collateral required for reinsurance
placed with reinsurers would vary from zero for reinsurers with the highest security rating to 100% of gross assumed liabilities for reinsurers with the lowest security ratings. It should be noted that the NAIC’s approval of the Framework is not, in and of itself, sufficient to implement the Framework. The Framework
requires enabling legislation from the U.S. Congress. The Framework needs to be adopted separately by each state legislature and the NAIC Reinsurance Task Force must develop an operating plan for the RSRD. Finally, the Framework would be applied only on a prospective basis. In addition to the NAIC actions, several federal proposals were introduced in Congress which would allow industry participants to voluntarily choose a federal charter over the current state system. With the current debate in Congress over financial services regulatory reform, TRH believes that any insurance
industry reform will most likely be addressed within the broader financial services industry proposals. Several states including New York and Florida have also 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 may 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 of 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. The 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. 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 17
October
2008. As of December 31, 2008, not all EU members have adopted the Directive. 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 reinsurers. 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. Traditionally, regulatory and legislative changes affecting the insurance and reinsurance industry, as well as the financial services industry as a whole, are conducted in an organized and structured manner usually encompassing the issuance of draft legislation or regulations and a significant period for review,
evaluation and comment by the industry and markets. As a result of the displacement in the financial markets and its impact on the insurance and reinsurance industry, legislators and/or regulators may feel compelled to pass new rules in an expedited manner without the normal review periods. The passage of
new regulatory rules on an expedited basis may have a materially adverse impact on TRH if those rules increase the cost of doing business or restrict TRH’s ability to underwrite certain lines of business and/or make certain investments without providing TRH with the normal amount of time to review the new
rules, assess their impact on TRH and allow TRH to alter its business strategies or restructure in the most efficient manner. Relationship with the AIG Group Control of the Company AIG, a Delaware corporation, 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 and 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. As of December 31, 2008, 2007 and 2006, AIG beneficially owned approximately 59% of the Company’s outstanding shares. As of December 31, 2008, one of the Company’s eight current directors, Thomas R. Tizzio, was a retired executive officer of AIG. Mr. Tizzio is a Retired Senior Vice Chairman and
Honorary Director of AIG. Between July 1, 2008 and October 24, 2008, two of the Company’s nine directors, Steven J. Bensinger and Mr. Tizzio, were active, former or retired executive officers of AIG. Mr. Bensinger resigned as Vice Chairman—Financial Services and Chief Financial Officer of AIG on October 9, 2008. Between January 1, 2008 and June 30, 2008, three of the Company’s ten directors, Mr. Bensinger, Martin J. Sullivan and Mr. Tizzio, were active, former or retired executive officers of AIG. Mr. Sullivan was a Director, President and Chief Executive Officer of AIG until June 15, 2008. As of December 31, 2007, three of the Company’s ten
current directors were active executive officers of AIG, or in the case of Mr. Tizzio retired, and held a number of executive positions with AIG, including the
following: Mr. Bensinger was an Executive Vice President and Chief Financial Officer; Mr. 18
Sullivan
was a Director, President and Chief Executive Officer; and Mr. Tizzio was 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 Mr. Tizzio retired, 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 a Retired Senior Vice Chairman and Honorary Director. Recent Actions by AIG which Impact TRH In September 2008, AIG experienced a severe strain on its liquidity that resulted in AIG entering into an $85 billion credit agreement, subsequently reduced to $60 billion (“AIG’s Fed Credit Agreement”), with the Federal Reserve Bank of New York (the “NY Fed”), and, pursuant to that agreement, agreed to
issue 100,000 shares of AIG Series C Perpetual, Convertible, Participating Preferred Stock (“AIG’s Series C Preferred Stock”) to a trust for the benefit of the U.S. Treasury (the “Trust”). AIG’s Fed Credit Agreement is secured by, among other things, 17.1 million shares of the Company’s common stock held
directly by AIG; however, TRH did not guarantee AIG’s obligation under AIG’s Fed Credit Agreement and none of TRH’s assets were pledged to secure AIG’s obligations under AIG’s Fed Credit Agreement. On September 29, 2008, AIG filed an amendment to its Schedule 13D relating to the Company, stating, among other things, that “AIG is exploring all strategic alternatives in connection with a potential disposition or other monetization of its...interest in the Company.” In October 2008, AIG announced a
restructuring of its operations, and its intent to retain its U.S. property and casualty and foreign general insurance businesses, and to retain a continuing ownership interest in certain of its foreign life insurance operations, while exploring divestiture opportunities for its remaining businesses. Proceeds from these
sales are contractually required to be applied toward the repayment of AIG’s Fed Credit Agreement. A special committee of the Company’s independent directors (the “Special Committee”) was subsequently formed to evaluate proposals received from AIG relating to the possible disposition of, or other transactions involving, AIG’s 59% beneficial ownership of the Company as well as any related business
combination transactions involving TRH’s outstanding shares. The Special Committee is continuing its process; however, there can be no assurance as to whether or when AIG will dispose of all or any portion of its interest in the Company or whether or when the Company will engage in any transaction. In October 2008, TRH adopted an employee retention plan covering a significant number of its employees, including its senior-most management. Salary expense associated with this plan totaled approximately $8 million in 2008 and is expected to total approximately $20 million in 2009. (See Note 19 of
Notes to Consolidated Financial Statements.) Pursuant to AIG’s Fed Credit Agreement, AIG will be required to issue AIG’s Series C Preferred Stock. It is expected that AIG’s Series C Preferred Stock will not be redeemable and will, to the extent permitted by law, vote with AIG common stock as a single class and represent 77.9% of the voting power of
AIG’s common stock. In February 2009, AIG received a waiver from the NY Fed stating that neither the Company nor its wholly-owned subsidiary PRMS are deemed to be “restricted subsidiaries” as that term is defined under AIG’s Fed Credit Agreement. If such entities had been deemed to be “restricted subsidiaries,” then they
may have been subject to various restrictive covenants and compliance obligations under AIG’s Fed Credit Agreement. TRH’s other subsidiaries are not deemed to be “restricted subsidiaries” under AIG’s Fed Credit Agreement as they are regulated insurance subsidiaries. TRH is not a party to AIG’s Fed Credit
Agreement and has not received the benefit of any funding thereunder. TRH is subject to various regulatory
requirements and is a party to numerous contracts, agreements, licenses, permits, authorizations and other arrangements (“Arrangements”)
that contain provisions giving regulators and counterparties certain rights (including, in some cases, termination rights) in the event
of a change in control of the Company or its subsidiaries, as applicable. Whether 19
the issuance of AIG’s Series C Preferred Stock will
constitute a change in control of the Company or any of its
subsidiaries under any of such Arrangements is dependent upon the specific provisions thereof. Based upon the facts and circumstances known to TRH as of the date hereof, TRH does not believe that the exercise of rights, if any, accruing to regulators and counterparties as a result of the issuance of AIG’s Series C Preferred Stock will have a material impact on TRH. Additionally, a sale of AIG’s interest in the Company could result in a change of control of TRH under a significant portion of TRH’s reinsurance agreements. If a change in control occurs, cedants may be permitted to cancel contracts on a cut-off or run-off basis, and TRH may be required to provide collateral
to secure premium and reserve balances or be required to cancel and commute contracts, subject to an agreement between the parties that may be settled in arbitration. If the contract is cancelled on a cut-off basis, TRH may be required to return unearned premiums, net of commissions. Whether a ceding company would have cancellation rights in the event of a sale of AIG’s interest depends upon the language of its agreement with TRH. Whether a ceding company would exercise any cancellation rights it did have would depend on, among other factors, such ceding company’s views with
respect to the financial strength and business reputation of the new controlling party or other significant owners of the Company’s shares, the extent to which such ceding company currently has reinsurance coverage with such person or its affiliates, the prevailing market conditions, the pricing and availability of
replacement reinsurance coverage and TRH’s ratings following the change in control. See Item 1A. Risk Factors for a description of the possible impact of AIG’s recent actions on TRH. 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 and Risk Management Committee of the Board of Directors
of the Company, which includes three independent directors of the Company who
are not current or former executive officers of the AIG Group, monitor TRH’s underwriting policies. Approximately $550 million (12%), $555 million (13%) and $593 million (15%) of gross premiums written by TRH in the years 2008, 2007 and 2006, respectively, were attributable to reinsurance purchased by other subsidiaries of AIG, for the production of which TRH recorded ceding commissions totaling
approximately $99 million, $114 million and $140 million, respectively, in such years. In 2008, 2007 and 2006, 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, $241 million, $248 million and $227 million in 2008, 2007 and 2006, 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 $30 million, $41 million and $40 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 14 of Notes to Consolidated Financial Statements.) TRH retroceded premiums written to other subsidiaries of AIG in the years 2008, 2007 and 2006 of approximately $188 million, $143 million and $135 million, respectively, and received ceding commissions of approximately $17 million, $13 million and $14 million, respectively, for the production of such
business in such years. Virtually the entire amount of such retrocessions to AIG subsidiaries in 2008, 2007 and 2006 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 16.) 20
Senior Notes Purchased by AIG Subsidiaries In December 2005, certain subsidiaries of AIG purchased, and at December 31, 2008 still hold, $450 million aggregate principal amount of the Company’s 5.75% senior notes due in 2015. Such amount comprises 62% of the total outstanding amount of such notes as of December 31, 2008. (See Note 7 of
Notes to Consolidated Financial Statements.) Available Information 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. 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. 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 events of great severity. The frequency and severity of catastrophe losses are inherently unpredictable,
particularly in light of the acceleration of climate change. 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 21
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.) 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. Financial strength and credit ratings by these rating agencies are important factors in establishing competitive position for insurance and reinsurance
companies. Financial strength ratings measure a company’s ability to meet its obligations to contract holders. Credit ratings measure a company’s ability to repay its obligations and directly affect the cost and availability of unsecured financing. 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 a rating of the Company or its operating subsidiaries may dissuade a ceding company from reinsuring with the Company’s operating subsidiaries in the future and may influence a ceding company to reinsure with a competitor of TRH that has a
higher financial strength rating. In general, if TRC’s, Putnam’s or TRZ’s insurer financial strength ratings and/or financial strength ratings from these rating agencies fall below “A-”, certain rating agency triggers in TRH’s contracts would allow customers to elect to take a number of actions such as 1) terminating
the contracts on a run-off or cut-off basis; 2) requiring TRH to post collateral for all or a portion of the obligations; or 3) require commutation under the contract as described below. A downgrade of the debt ratings of the Company may also increase future borrowing costs, if any. On September 15, 2008, due to the deterioration of the financial strength and flexibility of AIG, Best downgraded the ratings of AIG and most of its subsidiaries. Best downgraded the financial strength ratings of the Company’s major operating subsidiaries, TRC, Putnam and TRZ, to “A (Excellent)” from “A+
(Superior)” and the issuer credit ratings to “a” from “aa-”. Best also downgraded the issuer credit rating of the Company to “bbb” from “a-” and downgraded the rating assigned to the Company’s 5.75% senior notes due December 14, 2015 (the “Senior Notes”) to “bbb” from “a-”. All of these ratings have negative
outlooks. The financial strength rating “A (Excellent)” represents the third highest rating level. The issuer credit rating “a” represents the sixth highest rating level and the issuer credit rating “bbb” represents the ninth highest rating level. On January 20, 2009, S&P lowered the ratings of the Company and its major operating subsidiaries stating that this action reflected “TRH’s inability to meet operating performance expectations over time and, to a lesser extent, concerns that the uncertainty surrounding the majority ownership stake of AIG
could put constraints on the company’s financial flexibility in the coming months”. S&P lowered the counterparty credit ratings and insurer financial strength ratings on each of TRC, Putnam and TRZ to “A+” (Strong) from “AA-” (Very Strong). The Company’s counterparty credit rating
was lowered to “BBB+” from “A-”. The outlook for these ratings is stable. The Company’s senior unsecured debt rating and its Senior Notes’ rating were also lowered to “BBB+” from “A-”. The counterparty credit rating and insurer financial strength rating “A+” represents the fifth highest level. The counterparty credit rating “BBB+”
represents the eighth highest level. Moody’s maintains an insurance financial strength rating of “Aa3” (Excellent) on TRC. This rating is the fourth highest rating level. On September 15, 2008, while affirming TRC’s financial strength rating of “Aa3”, Moody’s lowered the senior unsecured debt rating of the Company to “A3” from “A2”, 22
noting that the debt rating previously incorporated one notch of rating uplift from AIG’s ownership stake and that Moody’s increasingly assesses TRH on a stand-alone basis. The Company’s senior unsecured debt rating (“A3”) is the seventh highest level. On October 3, 2008, following AIG’s announcement of a
restructuring plan related to the facility created under AIG’s Fed Credit Agreement, Moody’s placed these ratings on review with direction uncertain, signaling potential sales to buyers whose credit profiles could be stronger, weaker or similar to that of AIG. All of these ratings are current opinions of Best, S&P and Moody’s, respectively. As such, they may be changed, suspended or withdrawn at any time by the respective 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. A significant portion of TRH’s in-force treaty contracts as of December 31, 2008 permit the ceding company to cancel the contract on a cut-off or run-off basis if TRH’s operating subsidiaries’ financial strength rating is downgraded below a certain rating level, generally “A-”. TRC’s and TRZ’s financial strength
ratings are at least two 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 or require commutation 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 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 liquidity and 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 provide to secure its obligations may have an adverse impact on TRH’s ability to write additional reinsurance. 23
Uncertainty about the continued ownership by AIG of a majority of the Company’s outstanding shares may have an adverse effect on TRH. In September 2008, AIG experienced a severe strain on its liquidity that resulted in AIG entering into AIG’s Fed Credit Agreement with the NY Fed, and, pursuant to that agreement, agreed to issue 100,000 shares of AIG’s Series C Preferred Stock to the Trust. AIG’s Fed Credit Agreement is secured by,
among other things, 17.1 million shares of the Company’s common stock held directly by AIG; however, TRH did not guarantee AIG’s obligation under AIG’s Fed Credit Agreement and none of TRH’s assets were pledged to secure AIG’s obligations under AIG’s Fed Credit Agreement. On September 29, 2008, AIG filed an amendment to its Schedule 13D relating to the Company, stating, among other things, that “AIG is exploring all strategic alternatives in connection with a potential disposition or other monetization of its...interest in the Company.” In October 2008, AIG announced a
restructuring of its operations, and its intent to retain its U.S. property and casualty and foreign general insurance businesses, and to retain a continuing ownership interest in certain of its foreign life insurance operations, while exploring divestiture opportunities for its remaining businesses. Proceeds from these
sales are contractually required to be applied toward the repayment of AIG’s Fed Credit Agreement. A special committee of the Company’s independent directors (the “Special Committee”) was subsequently formed to evaluate proposals received from AIG relating to the possible disposition of, or other transactions involving, AIG’s 59% beneficial ownership of the Company as well as any related business
combination transactions involving TRH’s outstanding shares. The Special Committee is continuing its process; however, there can be no assurance as to whether or when AIG will dispose of all or any portion of its interest in the Company or whether or when the Company will engage in any transaction. In October 2008, TRH adopted an employee retention plan covering a significant number of its employees, including its senior-most management. Salary expense associated with this plan totaled approximately $8 million in 2008 and is expected to total approximately $20 million in 2009. (See Note 19 of
Notes to Consolidated Financial Statements.) Pursuant to AIG’s Fed Credit Agreement, AIG will be required to issue AIG’s Series C Preferred Stock. It is expected that AIG’s Series C Preferred Stock will not be redeemable and will, to the extent permitted by law, vote with AIG common stock as a single class and represent 77.9% of the voting power of
AIG’s common stock. In February 2009, AIG received a waiver from the NY Fed stating that neither the Company nor its wholly-owned subsidiary PRMS are deemed to be “restricted subsidiaries” as that term is defined under AIG’s Fed Credit Agreement. If such entities had been deemed to be “restricted subsidiaries,” then they
may have been subject to various restrictive covenants and compliance obligations under AIG’s Fed Credit Agreement. TRH’s other subsidiaries are not deemed to be “restricted subsidiaries” under AIG’s Fed Credit Agreement as they are regulated insurance subsidiaries. TRH is not a party to AIG’s Fed Credit
Agreement and has not received the benefit of any funding thereunder. Continuing uncertainty surrounding AIG’s ownership interest in the Company may continue to impact TRH’s ability to obtain new and renewal business, result in employee retention issues and further negatively impact TRH’s financial strength and credit ratings, all of which could adversely impact TRH’s
financial results in future periods. In addition, as AIG provides certain services to TRH (see Note 14 of Notes to Consolidated Financial Statements), a sale of AIG’s interest in TRH may result in additional operating expenses in the future. TRH is also subject to various regulatory requirements and is a party to numerous contracts, agreements, licenses, permits, authorizations and other arrangements (“Arrangements”) that contain provisions giving regulators and counterparties certain rights (including, in some cases, termination rights) in the
event of a change in control of TRH or its subsidiaries, as applicable. Additionally, a sale of AIG’s interest in the Company could result in a change of control of TRH under a significant portion of TRH’s reinsurance agreements. If a change in control occurs, the cedant may be permitted to cancel the contract on a cut-off or run-off basis, and TRH may be required to provide
collateral to secure premium and reserve balances or be required to cancel and commute the 24
contract, subject to an agreement between the parties that may be settled in arbitration. If the contract is cancelled on a cut-off basis, TRH may be required to return unearned premiums, net of commissions. Whether a ceding company would have cancellation rights in the event of a sale of AIG’s interest depends upon the language of its agreement with TRH. Whether a ceding company would exercise any cancellation rights it did have would depend on, among other factors, such ceding company’s views with
respect to the financial strength and business reputation of the new controlling party or other significant owners of the Company’s shares, the extent to which such ceding company currently has reinsurance coverage with such person or its affiliates, the prevailing market conditions, the pricing and availability of
replacement reinsurance coverage and TRH’s ratings following the change in control. In certain instances, contracts contain dual triggers, such as a change in control and a ratings downgrade, both of which must be satisfied for the contractual right to be exercisable. For purposes of discussing the impact on TRH, where a change in control option appears in a contract, the amounts below
assume that the ratings downgrade stipulation has been met, thereby providing the exposure under the change in control clause. In addition, contracts may provide a ceding company with multiple options, such as collateralization or commutation that would be triggered by the same event. The amount of (i) premiums to be returned, net of commission; (ii) unearned premium reserves or loss reserves to be collateralized; or (iii) unearned
premium reserves or loss reserves to be included in a commutation are listed for each consequence, even though it may emanate from the same contract and therefore the options would be mutually exclusive. Nevertheless, for purposes of this discussion, the amounts below reflect each of those amounts
separately and therefore cannot be aggregated together. Subject to the limitations expressed above, TRH estimates that with respect to a change in control of TRH, approximately $650 million of unearned premiums, which is net of estimated commissions, could be subject to return to the ceding company should every cedant exercise their contractual termination
right, including the right of commutation. With respect to gross loss reserves, approximately $980 million of gross loss reserves are subject to commutation. Should cedants invoke the right to commute, an amount would be payable by TRH to the respective ceding companies representing both a return of
unearned premiums and a settlement of loss reserves. Such amount would typically consider a discount to the financial statement loss reserve value, reflecting the time value of money resident in the ultimate settlement of such loss reserves. In the event of a change of control of TRH, approximately $120 million of unearned premiums and approximately $970 million of gross loss reserves could be subject to collateralization requirements. Collateral requirements may take the form of trust agreements, funded by securities held, or letters of credit.
It is important to note that there is significant duplication in the amounts that are subject to either collateralization or commutation as many contracts have multiple options. Of such amounts that are subject to collateralization or commutation, contracts with AIG subsidiaries account for approximately $100 million of unearned premiums and approximately $700 million gross loss reserves. If a sale of AIG’s interest in the Company is announced, TRH may engage in discussions and activities with regulators and counterparties to take necessary actions to remedy, amend, or comply with the provisions of the Arrangements. However, TRH cannot presently predict the effects, if any, a change of
control will have on such Arrangements, including the extent to which cancellation rights would be exercised, if at all, or on TRH’s financial condition, results of operations, or cash flows, but such effect could be material. In addition to a sale of AIG’s direct interest in TRH, upon the issuance of AIG’s Series C Preferred Stock to the Trust, the Trust will obtain control of AIG. The issuance of AIG’s Series C Preferred Stock may be deemed a change of control of AIG. Whether the issuance of AIG’s Series C Preferred Stock will
constitute a change in control of the Company or any of its subsidiaries under any of such Arrangements is dependent upon the specific provisions thereof. Based upon the facts and circumstances known
to TRH as of the date hereof, TRH does not believe that the exercise of 25
rights, if any, accruing to regulators and counterparties as a result of the issuance of AIG’s Series C Preferred Stock will have a material impact on TRH. TRH’s business may continue to be adversely affected by AIG’s recent liquidity problems. TRH’s business depends upon the financial stability (both actual and perceived) of the Company and its subsidiaries. AIG’s recent liquidity problems may continue to negatively affect perceptions of TRH’s ability to meet its financial obligations. Perceptions that TRH or its subsidiaries may not be able to meet
their obligations could negatively impact TRH’s business in many ways including, among others:
•
rating downgrades by major rating agencies (see above for the potential implications to TRH of rating agency downgrades); • customers and other parties being more cautious about doing business with TRH; and • requests by customers and other parties to terminate or renegotiate existing contractual relationships. As part of AIG’s recent liquidity problems AIG entered into AIG’s Fed Credit Agreement with the NY Fed (see Relationship with the AIG Group–Recent Actions by AIG which Impact TRH). AIG pledged 17.1 million shares of the Company’s common stock held directly by AIG to secure its obligations under
AIG’s Fed Credit Agreement. In the event that the NY Fed were to perfect its interest and take control of the shares of the Company pledged to secure AIG’s obligations, TRH may be further negatively impacted as some companies may be restricted from doing business with or may become more cautious about
doing business with TRH or its subsidiaries. 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. 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 given current market conditions, 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
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. 26
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 and investment 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 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 could face increased competition from new market entrants, existing market participants devoting additional capital to the types of business written by TRH, alternatives to reinsurance available to cedants, such as
capital market alternatives, and government sponsored reinsurance entities. 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. 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 resources than TRH or operate in different regulatory jurisdictions and tax environments. 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. Hedge funds may provide reinsurance and retrocessional protections through captive companies or other alternative transactions on a fully collateralized basis for property and 27
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 TRH cannot predict 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. 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 in other regions and thus increase
competition in other regions such as Latin America, the Caribbean, and the Coastal Mid-Atlantic and New England states. A limited number of brokers account for a large portion of TRH’s revenues; the loss of all or a substantial portion of the business provided by them may have an adverse effect on TRH. The great majority of TRH’s business from non-affiliates is written through brokers. In 2008, companies controlled by Aon and Marsh accounted for 27% and 15% of TRH’s consolidated revenues, respectively, and, accounted for 25% and 14%, respectively, of total gross premiums written. In addition, TRH’s
largest 10 brokers accounted for 58% of total gross premiums written in 2008. These brokers also have, or may in the future acquire, ownership interests in insurance and reinsurance companies that may compete with TRH. The loss of all or a substantial portion of the business provided by TRH’s brokers could
have a material adverse effect on TRH. 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 securities), equity investments and limited partnerships (including hedge funds and private equities). The current disruption in the credit and financial markets may materially affect the
liquidity of TRH’s investments, including residential mortgage-backed securities which represent 3% of total investments. If TRH requires significant amounts of cash on short notice in excess of normal cash requirements 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. Furthermore, TRH does not currently have a credit facility to help it respond to any liquidity problems it may encounter, and expects that it will be difficult to obtain a credit facility in the short-term. In addition, the current disruptions in the credit and financial markets, combined with the recent decline in the
Company’s stock price, will make it more difficult for TRH to raise cash in the capital markets. 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 28
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. The valuation of TRH’s investments includes methodologies, estimations and assumptions which are subject to differing interpretations; these differing interpretations could result in changes to investment valuations that may adversely affect TRH’s results of operations or financial
condition. The vast majority of TRH’s investments are fixed maturity investments which are subject to the classification provisions of Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measurements” (“SFAS 157”). SFAS 157 requires assets recorded at fair value in the consolidated balance
sheet to be measured and classified in a hierarchy for disclosure purposes consisting of three “levels” based on the observability of inputs available in the marketplace used to measure the fair values. Level 1 assets use fair value measurements that are quoted prices (unadjusted) in active markets that TRH has the ability to access for identical assets. Level 2 assets use fair value measurements based on inputs other than quoted prices included in Level 1 that are observable for the asset, either directly
or indirectly. Level 2 inputs include quoted prices for similar assets in active markets and inputs other than quoted prices that are observable for the asset, such as interest rates and yield curves that are observable at commonly quoted intervals. Level 3 assets use fair value measurements based on valuation techniques that use significant inputs that are unobservable. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level in the fair value hierarchy within which the fair
value measurement in its entirety falls is determined based on the lowest level input that is significant to the fair value measurement in its entirety. Securities that are less liquid are more difficult to value and trade. During periods of market disruption, including periods of significantly rising or high interest rates, rapidly widening credit spreads or illiquidity, it may be difficult to value certain of the securities in TRH’s investment portfolio, if trading becomes
less frequent and/or market data becomes less observable. There may be certain asset classes that were in active markets with significant observable data that become illiquid due to the current financial environment. In such cases, more securities may fall to Level 3 and thus require more subjectivity and
management judgment. In addition, prices provided by independent pricing services and independent broker quotes can vary widely even for the same security. As such, valuations may include inputs and assumptions that are less observable or require greater estimation as well as valuation methods which are more sophisticated, thereby resulting in values which may be greater or less than the value at which the investments may be ultimately sold. Further, rapidly
changing and unprecedented credit and equity market conditions could materially impact the valuation of securities as reported within TRH’s consolidated financial statements and the period-to-period changes in value could vary significantly. Decreases in value may have a material adverse effect on TRH’s
results of operations or financial condition. The determination of the amount of impairments taken on TRH’s investments is subjective and could materially impact TRH’s results of operations or financial position. The determination that a security has incurred an other-than-temporary decline in value requires the judgment of TRH’s management and consideration of the fundamental condition of the issuer, its near-term prospects and all relevant facts and circumstances. 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 recovered their cost basis, TRH records the unrealized
loss in income as a realized capital loss. If a loss is recognized from a sale subsequent to a balance sheet date pursuant to changes in circumstances, the loss is recognized in the period in 29
which the intent to hold the securities to recovery no longer exists. There can, however, be no assurance that TRH has accurately assessed the level of impairments reflected in its financial statements.
Furthermore, additional impairments may need to be taken in the future. Historical trends may not be indicative of future impairments. An investment is impaired if its fair value falls below its cost or amortized cost. The determination of whether an impairment is other-than-temporary is subjective and involves the considerable judgment and the consideration of various factors and circumstances. The significant factors include:
•
the severity of the decline in fair value • the length of time the fair value is below cost • issuer financial condition, including profitability and cash flows • credit status of the issuer • the issuer’s specific and general competitive environment • published reports • general economic environment • regulatory and legislative environment • other factors as may become available from time to time The impact of governmental actions made in response to the economic crisis on TRH is difficult to determine at this time. In
response to the financial crises affecting the credit and financial markets
and concern about financial institutions’ ongoing viability, numerous regulatory and governmental actions have been taken or proposed. Within the U.S., the Federal Reserve has taken action through reduced federal funds rates
and the expansion of acceptable collateral for its loans to provide additional liquidity. Numerous financial institutions have received and may continue to receive capital both in the form of emergency loans and direct Treasury equity investments. In addition, in February 2009, the U.S. Congress passed a $787
billion “economic stimulus” plan. Within the United Kingdom and Europe, similar actions including interest rate cuts and capital injections into financial institutions have been undertaken. It is possible that some of our competitors may participate in some of these programs. An additional regulatory concern involving residential mortgage-backed securities is “cram-down legislation” currently under consideration in the U.S. Congress. If passed, this legislation would reallocate losses from defaults on the underlying residential mortgages across all tranches of the security, effectively
negating the contractual terms of the security. TRH has investments in residential mortgage-backed securities. Should this legislation become law, certain securities held by TRH at December 31, 2008 could be put at greater risk for loss and could be downgraded to below investment grade by one or more rating
agencies. There can be no assurance as to the effect that any such governmental actions will have on the financial markets generally or on TRH’s financial condition, results of operations and cash flows in particular. Difficult and volatile conditions in the global capital and credit markets and in the overall economy could materially and adversely affect TRH’s operating results, investment portfolio and financial condition. Ongoing disruption and volatility in the global capital and credit markets and in the overall economy affects TRH’s business in a number of ways, including the following:
•
Disruption in the capital and credit markets may increase claims activity in TRH’s reinsurance lines such as D&O, E&O, credit and, to a limited extent, mortgage guaranty business; • Significant fluctuations in the fixed maturities, asset-backed securities and equities markets could reduce TRH’s investment returns and the value of its investment portfolio; and • Volatility in the capital and credit markets makes it more difficult to access those markets, if necessary, to maintain or improve TRH’s financial strength and credit ratings or to generate liquidity. 30
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 fluctuations. 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, credit spreads or trading liquidity and may also be adversely affected by foreign currency exchange rate
fluctuations. Depending on TRH’s classification of its investments as available for sale 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 insurers to meet their obligations to provide insurance if an issuer is unable to repay its debt. Moreover, many issuers are facing liquidity pressures as a result of the current economic downturn and, in turn, may be subject to downgrades by the credit rating
agencies in the future. 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 rates 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, 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. As of December 31, 2008, not all EU members have adopted the Directive. 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. 31
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 reinsurers. 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. Traditionally, regulatory and legislative changes affecting the insurance and reinsurance industries, as well as the financial services industry as a whole, are conducted in an organized and structured manner usually encompassing the issuance of draft legislation or regulations and a significant period for review,
evaluation and comment by the industry and markets. As a result of the displacement in the financial markets and its impact on the insurance and reinsurance industry, legislators and/or regulators may feel compelled to pass new rules in an expedited manner without the normal review periods. The passage of
new regulatory rules on an expedited basis may have a materially adverse impact on TRH if those rules increase the cost of doing business or restrict TRH’s ability to underwrite certain lines of business and/or make certain investments without providing TRH with the normal amount of time to review the new
rules, assess their impact on TRH and allow TRH to alter its business strategies or restructure in the most efficient manner. 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 decline in the Company’s common stock price and the uncertainty relating to AIG’s continued ownership interest in the Company may prevent TRH from retaining key personnel. TRH relies upon the knowledge and talent of its employees to successfully conduct business. The decline in the Company’s common stock price has reduced the value of equity awards previously made to key employees. In addition, the uncertainty around the continued ownership by AIG of a majority of the
outstanding shares of the Company’s common stock may result in competitors seeking to hire TRH’s key employees. TRH has implemented a retention program to seek to keep certain of its key employees, but there can be no assurance that the program is sufficient or will be effective. A loss of key personnel
could have a material effect on TRH’s results of operations, financial condition and cash flows in future periods. 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
32
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 concluded 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. Item 1B. Unresolved Staff Comments None. As of December 31, 2008, 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 City, London, Paris, Zurich, Warsaw, Munich, 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 concluded 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, 33
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 2008. 34
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 2008 and 2007:
2008
2007
High
Low
Dividends
High
Low
Dividends First Quarter
$
73.70
$
62.75
$
0.160
$
66.50
$
60.49
$
0.135 Second Quarter
69.51
56.47
0.190
72.52
65.31
0.160 Third Quarter
66.95
53.64
0.190
75.78
58.84
0.160 Fourth Quarter
56.83
31.16
0.190
75.05
68.69
0.160 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. See Note 15 of Notes to Consolidated Financial Statements for restrictions on the Company’s operating subsidiaries’ ability to pay dividends. As of January 31, 2009, the approximate number of holders of TRH shares, including those whose TRH shares are held in nominee name, was 32,000. 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, 2008, 170,050 shares may still be purchased pursuant to this authorization. No shares were purchased in the fourth quarter of 2008. The preceding does not include 44,389 shares relating to restricted stock units (“RSU”) vesting in the three months ended December 31, 2008 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, 2003 to December 31, 2008) 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., Endurance Specialty Holdings Ltd., Everest Re Group Ltd., IPC Holdings Ltd., Max Capital Group Ltd., Montpelier Re Holdings Ltd., Odyssey Re Holdings Corp.,
Partner Re Ltd., Platinum Underwriters Holdings, Ltd., 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 through June 27, 2008 when it was
delisted) and Swiss Reinsurance Co. The performance of PXRE Group Ltd. and SCOR Holding (Switzerland) are 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. 35
Cumulative Total Return to Stockholders
Company / Index
Dec. 2003
Dec. 2004
Dec. 2005
Dec. 2006
Dec. 2007
Dec. 2008 Transatlantic Holdings, Inc.
$
100.00
$
96.24
$
105.35
$
98.18
$
115.86
$
64.74 S&P 500 Index
100.00
110.88
116.33
134.70
142.10
89.53 Peer Group
100.00
103.00
106.14
122.28
120.04
100.32 36
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,
2008
2007
2006
2005
2004
(in thousands, except per share data) Statement of Operations Net premiums written
$
4,108,092
$
3,952,899
$
3,633,440
$
3,466,353
$
3,749,274 Net premiums earned
4,067,389
3,902,669
3,604,094
3,384,994
3,661,090 Net investment income
440,451
469,772
434,540
343,247
306,786 Realized net capital (losses) gains(1)
(435,541
)
9,389
10,862
39,884
22,181 Gain on early extinguishment of debt
10,250
—
—
—
— Revenues
4,082,549
4,381,830
4,049,496
3,768,125
3,990,057 Income (loss) before income taxes(2)
3,223
595,752
539,908
(46,098
)
276,212 Net income
102,254
487,141
428,152
37,910
254,584 Per Common Share:(3) Net income: Basic
$
1.54
$
7.37
$
6.49
$
0.58
$
3.87 Diluted
1.53
7.31
6.46
0.57
3.85 Cash dividends declared
0.73
0.62
0.53
0.46
0.39 Share Data:(3) Weighted average common shares outstanding: Basic
66,270
66,124
65,955
65,836
65,731 Diluted
66,722
66,654
66,266
66,169
66,189 Ratios:(4) Loss ratio
71.5
%
67.6
%
68.3
%
85.0
%
75.3
% Underwriting expense ratio
27.0
27.7
27.7
27.0
26.2 Combined ratio
98.5
95.3
96.0
112.0
101.5 Balance Sheet Data Investments and cash
$
10,518,477
$
12,755,972
$
11,336,096
$
9,241,837
$
8,287,003 Assets
13,376,938
15,484,327
14,268,464
12,364,676
10,605,292 Unpaid losses and loss adjustment expenses
8,124,482
7,926,261
7,467,949
7,113,294
5,941,464 Unearned premiums
1,220,133
1,226,647
1,144,022
1,082,282
1,057,265 5.75% senior notes due December 14, 2015(5)
722,243
746,930
746,633
746,353
— Stockholders’ equity
3,198,220
3,349,042
2,958,270
2,543,951
2,587,129 Book value per common share(6)
$
48.19
$
50.56
$
44.80
$
38.60
$
39.30
(1)
Includes other-than-temporary impairment write-downs of $318 million in 2008, $27 million in 2007, $1 million in 2006, $2 million in 2005 and $6 million in 2004. (2) Includes pre-tax net catastrophe costs of $170 million in 2008, $55 million in 2007, $29 million in 2006, $544 million in 2005 and $215 million in 2004. (3) Share and per share data have been retroactively adjusted, as appropriate, to reflect common stock splits. (4) The loss ratio represents net losses and loss adjustment expenses 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. (5) Includes amounts payable to affiliates and others as follows: 2008—Affiliates $448,346; Others $273,897; 2007—Affiliates $448,158; Others $298,772; 2006—Affiliates $447,980; Others $298,653; 2005—Affiliates $447,812; Others $298,541. (6) Book value per common share is stockholders’ equity divided by outstanding common stock. 37
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, financial, credit and industry 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, financial and credit market conditions, 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, the uncertainties inherent in international operations and the uncertainty surrounding AIG’s continued
ownership interest in TRH. These factors are further discussed throughout Management’s Discussion and Analysis of Financial Condition and Results of Operations and in Part I, 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. 38
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, 2008 and 2007 and for each of the three years in the period ended December 31, 2008, which are presented elsewhere herein. Financial data discussed below have been affected by certain transactions
between TRH and related parties. (See Notes 7, 12, 14 and 16 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 seeks to focus on more complex risks within the casualty and property lines and 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 2008, casualty lines comprised 70% of TRH’s net premiums written, while property lines totaled 30%. In addition, treaty reinsurance totaled 97% of net premiums written, with the balance representing facultative accounts. Moreover, business written by international operations represented 50% of net
premiums written in 2008. TRH’s major sources of revenues are net premiums earned for reinsurance risks undertaken and income from investments. The great majority of TRH’s investments are in fixed maturity securities held to maturity and available for sale with an average duration of 6.0 years as of December 31, 2008. In
general, premiums are received significantly in advance of related claims payments. American International Group, Inc. (“AIG”), which through its subsidiaries is a provider of insurance and investment products and services to businesses and individuals around the world, 39
beneficially owned approximately 59% of the Common Stock of the Company (“TRH shares”) as of December 31, 2008, 2007 and 2006. Recent Actions by AIG which Impact TRH In September 2008, AIG experienced a severe strain on its liquidity that resulted in AIG entering into an $85 billion credit agreement, subsequently reduced to $60 billion (“AIG’s Fed Credit Agreement”), with the Federal Reserve Bank of New York (the “NY Fed”). Pursuant to that agreement, AIG agreed to
issue 100,000 shares of AIG’s Series C Perpetual, Convertible, Participating Preferred Stock (“AIG’s Series C Preferred Stock”) to a trust for the benefit of the U.S. Treasury. AIG’s Fed Credit Agreement is secured by, among other things, 17.1 million shares of the Company’s common stock held directly by AIG;
however, TRH did not guarantee AIG’s obligation under AIG’s Fed Credit Agreement and none of TRH’s assets were pledged to secure AIG’s obligations under AIG’s Fed Credit Agreement. On September 29, 2008, AIG filed an amendment to its Schedule 13D relating to the Company, stating, among other things, that “AIG is exploring all strategic alternatives in connection with a potential disposition or other monetization of its...interest in the Company.” In October 2008, AIG announced a
restructuring of its operations, and its intent to retain its U.S. property and casualty and foreign general insurance businesses, and to retain a continuing ownership interest in certain of its foreign life insurance operations, while exploring divestiture opportunities for its remaining businesses. Proceeds from these
sales are contractually required to be applied toward the repayment of AIG’s Fed Credit Agreement. A
special committee of the Company’s independent directors (the “Special Committee”) was subsequently formed to evaluate proposals received from AIG relating to the possible disposition of, or other
transactions involving, AIG’s 59% beneficial ownership of the Company as well as any related business combination transactions involving TRH’s outstanding shares. The Special Committee is continuing its process; however, there can be no assurance as to whether or when AIG will dispose of all or any portion
of its interest in the Company or whether or when the Company will engage in any transaction. In October 2008, TRH adopted an employee retention plan covering a significant number of its employees, including its senior-most management. Salary expense associated with this plan totaled approximately $8 million in 2008 and is expected to total approximately $20 million in 2009. (See Note 19 of
Notes to Consolidated Financial Statements.) Pursuant to AIG’s Fed Credit Agreement, AIG will be required to issue AIG’s Series C Preferred Stock. It is expected that AIG’s Series C Preferred Stock will not be redeemable and will, to the extent permitted by law, vote with AIG common stock as a single class and represent 77.9% of the voting power of
AIG’s common stock. In February 2009, AIG received a waiver from the NY Fed stating that neither the Company nor its wholly-owned subsidiary PRMS are deemed to be “restricted subsidiaries” as that term is defined under AIG’s Fed Credit Agreement. If such entities had been deemed to be “restricted subsidiaries,” then they
may have been subject to various restrictive covenants and compliance obligations under AIG’s Fed Credit Agreement. TRH’s other subsidiaries, are not deemed to be “restricted subsidiaries” under AIG’s Fed Credit Agreement as they are regulated insurance subsidiaries. TRH is not a party to AIG’s Fed Credit
Agreement and has not received the benefit of any funding thereunder. TRH is subject to various regulatory requirements and is a party to numerous contracts, agreements, licenses, permits, authorizations and other arrangements (“Arrangements”) that contain provisions giving regulators and counterparties certain rights (including, in some cases, termination rights) in the event
of a change in control of the Company or its subsidiaries, as applicable. Whether the issuance of AIG’s Series C Preferred Stock will constitute a change in control of the Company or any of its subsidiaries under any of such Arrangements is dependent upon the specific provisions thereof. Based upon the facts and
circumstances known to TRH as of the date hereof, TRH does not believe that the exercise of rights, if any, accruing to regulators and counterparties as a result of the issuance of AIG’s Series C Preferred Stock will have a material impact on TRH. 40
Additionally, a sale of AIG’s interest in the Company could result in a change of control of TRH under a significant portion of TRH’s reinsurance agreements. If a change in control occurs, cedants
may be permitted to cancel contracts on a cut-off or run-off basis, and TRH may be required to provide collateral to secure premium and reserve balances or be required to cancel and commute contracts, subject to an agreement between the parties that may be settled in arbitration. If the contract is cancelled on
a cut-off basis, TRH may be required to return unearned premiums, net of commissions. Whether a ceding company would have cancellation rights in the event of a sale of AIG’s interest depends upon the language of its agreement with TRH. Whether a ceding company would exercise any cancellation rights it did have would depend on, among other factors, such ceding company’s views with
respect to the financial strength and business reputation of the new controlling party or other significant owners of the Company’s shares, the extent to which such ceding company currently has reinsurance coverage with such person or its affiliates, the prevailing market conditions, the pricing and availability of
replacement reinsurance coverage and TRH’s ratings following the change in control. See Item 1A. Risk Factors for a description of the possible impact of AIG’s recent actions on TRH. Consolidated Results The following table summarizes TRH’s revenues, income before income taxes and net income for the periods indicated:
Years Ended December 31,
2008
2007
2006
Amount
Change
Amount
Change
Amount
Change
(dollars in millions) Revenues
$
4,082.5
(6.8
)%
$
4,381.8
8.2
%
$
4,049.5
7.5
% Income before income taxes
3.2
(99.5
)
595.8
10.3
539.9
— Net income
102.3
(79.0
)
487.1
13.8
428.2
1,029.4 Revenues decreased in 2008 compared to 2007 due primarily to significant realized net capital losses and a decrease in net investment income, partially offset by an increase in net premiums earned. The significant realized net capital losses of $435.5 million, including other-than-temporary impairment write-
downs of $317.8 million, in 2008 generally resulted from declines in market values due to the downturn in the U.S. economy, turmoil in the financial markets, financial market illiquidity and issuer-specific credit events. The decrease in net investment income is due largely to a decrease in investment results from other invested assets,
principally related to hedge funds, partially offset by an increase in fixed maturity income. The increase in net premiums earned emanated primarily from Domestic operations and the Miami and London branches. The most significant increases in net premiums earned occurred in the accident and health (“A&H”),
property, credit and auto liability lines, partially offset by significant decreases in the fidelity and ocean marine lines. In general, changes in net premiums earned between periods are influenced by prevailing market conditions and strategic decisions by TRH’s management in recent periods. 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. Results
for 2008 include pre-tax net catastrophe costs of $170 million principally
arising from Hurricane Ike. Results for 2007 include pre-tax net catastrophe
costs of $55 million principally arising 41
from European Windstorm
Kyrill and floods in the U.K. 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. Catastrophe
costs include losses incurred and related reinstatement premiums, the details
of which can be found in Note 10 of Notes to Consolidated Financial
Statements (“Note 10”). 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. Income before income taxes and net income decreased in 2008 as compared to 2007 principally due to significant realized net capital losses, including significant other-than-temporary-impairment write-downs, and decreases in underwriting profit (loss) and net investment income. The decrease in net income
between periods was mitigated by significant deferred tax benefits in 2008. The decrease in underwriting profit (loss) is largely due to decreased current accident year underwriting profit (loss) excluding catastrophe costs in 2008 compared to 2007 and a significant increase in net catastrophe costs partly offset by
a decrease in net loss reserve development. Higher catastrophe costs and lower net loss reserve development in 2008 had the net impact of decreasing underwriting profit (loss) in 2008 by $47.3 million compared to 2007. (See Note 17 of Notes to Consolidated Financial Statements for underwriting profit (loss) by
segment.) 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 reflects 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. 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, experiencing cycles of price erosion followed by rate strengthening as a result of catastrophes or other significant losses that affect the overall capacity of the industry to provide coverage. For the period under discussion, the
reinsurance market has been characterized by significant competition worldwide in most lines of business. Following the terrorist attacks in the United States in 2001, the insurance and reinsurance markets experienced a considerable hardening of rates as well as terms and conditions. These improvements peaked in late 2003 / early 2004. From that point, while terms and conditions remained strong, globally
rates began moving downward with property rate decreases generally outpacing casualty rate decreases and insurance rate decreases outpacing reinsurance rate decreases. While these trends continued for the most part internationally, in the U.S., property catastrophe losses in 2004 and, more meaningfully, in 2005 produced significant rate increases and improvements in terms and conditions in both the insurance and reinsurance property markets. In addition, while U.S.
casualty insurance rates maintained a downward trend, U.S. reinsurance rates remained quite stable. The improvement in the U.S. property marketplace resulted in new companies being formed in Bermuda as well as the entrance of additional capacity from the capital markets via sidecars, catastrophe bonds
and other derivative products. The
entrance of the new capacity slowly eroded property insurance and reinsurance
rates in 2007 and the first half of 2008, although the marketplace remained
generally favorable. During the second half of 2008, however, the global
credit and financial crisis began to significantly impact the insurance and
reinsurance markets. First, many alternative reinsurance solutions (such as
sidecars) were terminated or not renewed. Second, the impairment of company
balance sheets meant historical risk 42
levels in many cases
now represented a higher than desired percentage of surplus. Third, Hurricane
Ike produced one of the highest insured losses from a natural peril event
despite being only a category 2 storm. These changes produced an increase
in demand for traditional reinsurance from insurance companies as they 1)
could not raise capital by issuing debt; 2) did not want to issue equity
at depressed stock prices; and 3) lost the ability to go to the capital markets
for alternative reinsurance solutions. In addition, reinsurers, affected
by many of the same issues, in many cases did not have the same capacity
to take on risk as they had in recent years. The increase in demand coupled with a decrease in supply led to a significant increase in property and off-shore energy reinsurance pricing at January 1, 2009, most notably in the peak U.S. catastrophe zones such as the Southeast, West and Northeast. This pricing effect was much less noticeable in areas
of the country where there is less catastrophe risk and internationally as well, where loss experience has been favorable, but improvements were evident. The casualty market did not enjoy the same type of increases except for certain areas such as financial institution directors’ and officers’ liability (“D&O”), related
errors and omissions liability (“E&O”) covers, surety and credit and fidelity. In fact, some areas of casualty business continued to see deterioration of insurance pricing levels. TRH expects that the U.S. property catastrophe reinsurance marketplace will continue to improve during 2009, especially where there is coastal storm or earthquake exposure and casualty rates will also begin to improve as loss trends emerge and the cost of capital increases. Internationally, most lines and
markets continued to be impacted by overcapacity in 2008, but increased reinsurance industry discipline and contracting capacity toward the end of 2008 may potentially lead to stabilization or improvement of market conditions in 2009. Additionally, in April 2008, the Brazilian reinsurance market was opened to the private sector. As an Admitted Reinsurer in Brazil, TRC expects to see new opportunities arise in Brazil in future periods. The existence of favorable or improving market conditions in certain regions and lines of business does not necessarily translate into ultimate pricing adequacy for business written under such conditions. In addition, there can be no assurance that these favorable or improving conditions will occur or remain in
effect in the future. 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. Starting in mid-2007 and continuing through 2009, the U.S. residential mortgage market and the global credit and financial markets have been experiencing serious disruptions. TRH’s operating results and financial condition have been adversely affected and may continue to be adversely affected by this
disruption (see Disruption in Global Credit and Financial Markets). 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 certain financial assets, other-than-temporary impairments of investments, premium revenues and deferred acquisition costs, as they require management’s most significant exercise of
judgment on both a quantitative and qualitative basis in the preparation of TRH’s
consolidated financial statements and footnotes. The accounting estimates that
result require the use 43
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, possibly materially.
A discussion of these most critical accounting estimates follows: (a) 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 is 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 materially and adversely affect 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 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. 44
• 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. There is potential for significant variation in the development of loss reserves when actual costs differ from the costs implied by the use of the assumptions employed in the reserve setting process. 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. The methodologies that TRH employed 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
short 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 tail 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 multiple peril) 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. 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:
Other Liability: The key components of the other liability line of business are excess casualty, D&O and E&O.
Excess Casualty: The vast majority of this class 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 have 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 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 by 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 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. 45
•
Medical Malpractice: Healthcare professional, 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 multiple peril), 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 reviewed after segregating pro rata contracts from excess-of-loss contracts. For 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. The review is 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 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 46
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, 2008 and 2007,
TRH’s carried loss and LAE reserves, net of related reinsurance recoverable,
were $7.35 billion and $6.90 billion, respectively, and were equal to the actuarial
point estimate. 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 2008 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 during the loss reserve review process. 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 from the
original assumptions to occur were utilized. Generally, the last 13 years were included in the analysis. The results derived from the sensitivity analyses are roughly the same whether utilizing unpaid losses and loss adjustment expenses (“gross loss reserves”) or net loss reserves. While noting that there exists the potential for greater variations, TRH believes utilizing 5% and 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 $180 million (either positively or negatively) on the loss reserve estimate. While less likely for many classes of business, we note that changing the ELRs by 10 percentage points has an effect of about $360 million. As previously described, another key assumption is the
selection of loss development patterns. The effect of increasing the tail on the selected loss development patterns by 5% is about $370 million. Similarly, a 10% deviation would impact the reserve estimate by about $730 million. Because a downward adjustment to the loss development patterns can result in
implied negative future development on 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% and 10%. The effect of varying these assumptions together by 5% is
about $560 million. Increasing these assumptions by 10% simultaneously adds approximately $1.1 billion 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, D&O, E&O and excess casualty. 47
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 development on losses occurring in prior years (which includes a discussion of the causative factors of such net development) under Results of Operations and further information about gross loss reserves under Financial Condition and Liquidity. (b) Fair Value Measurements of Certain Financial Assets TRH measures at fair value on a recurring basis financial instruments included principally in its available for sale securities portfolios, securities lending invested collateral (which includes asset-backed and non-asset-backed fixed maturities) and certain short-term investments and cash equivalents. The fair
value of a financial instrument is the amount that would be received to sell an asset in an orderly transaction between willing, able and knowledgeable 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 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. An active market is one in which transactions for the asset being valued occurs with
sufficient frequency and volume to provide pricing information on an ongoing basis. An other-than-active market is one in which there are few transactions, the prices are not current, price quotations vary substantially either over time or among market makers, or in which little information is released publicly for
the asset being valued. Pricing observability is affected by a number of 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’s management is responsible for the determination of the value of the financial assets carried at fair value and the supporting methodologies and assumptions. With respect to securities, TRH employs independent third-party valuation service providers to gather, analyze and interpret market information
and derive fair values based upon relevant methodologies and assumptions for individual instruments. When TRH’s valuation service providers are unable to obtain sufficient market observable information upon which to estimate the fair value for a particular security, fair value is determined either by requesting
brokers who are knowledgeable about these securities to provide a quote, which is generally non-binding, or by employing widely accepted internal valuation models. Valuation
service providers typically obtain data about market transactions and other
key valuation model inputs from multiple sources and, through the use of
widely accepted internal valuation models, provide a single fair value measurement
for individual securities for which a fair value has been requested under
the terms of service agreements. The inputs used by the valuation service
providers include, but are not limited to, market prices from recently completed
transactions and transactions of comparable securities, interest rate yield
curves, credit spreads, currency rates, and other market observable information,
as applicable. The valuation models take into account, among other things,
market observable information as of the measurement date as well as the specific
attributes of the security being valued including its term, interest rate,
credit rating, industry sector, and when applicable, collateral quality and
other issue or issuer specific information. When market transactions or 48
other
market observable data is limited, the extent to which judgment is applied
in determining fair value is greatly increased. TRH
employs specific control processes to determine the reasonableness of the
fair values of TRH’s financial assets. TRH’s processes are designed to ensure that the values received or internally estimated are accurately recorded and that the data inputs and the valuation techniques utilized are
appropriate, consistently applied, and that the assumptions are reasonable and consistent with the objective of determining fair value. TRH assesses the reasonableness of individual security values received from valuation service providers through various analytical techniques. In addition, TRH may validate the
reasonableness of fair values by comparing information obtained from TRH’s
valuation service providers to other third party valuation sources for selected
securities. TRH also validates prices for selected securities obtained from
brokers through reviews by those who have relevant expertise and who are independent
of those charged with executing investing transactions. As of December 31, 2008, the fair value of substantially all of TRH’s fixed maturity and equity securities is based on external sources, of which approximately $198 million is primarily based on broker quotes. Subsidiaries of AIG manage the investments and perform investment recordkeeping and the above valuation services for TRH. (i) Fixed Maturities (Including Fixed Maturities within Securities Lending Invested Collateral) and Equity Securities Available for Sale TRH maximizes the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value. Whenever available, TRH obtains quoted prices in active markets for identical assets at the balance sheet date to measure at fair value fixed maturity and marketable equity securities
in its available for sale portfolios. Market price data generally is obtained from exchange or dealer markets. TRH estimates the fair value of fixed maturity securities not traded in active markets by referring to traded securities with similar attributes, using dealer quotations and matrix pricing methodologies, discounted cash flow analyses or internal valuation models. 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, yield curves, credit curves, prepayment rates and other relevant factors. For fixed maturity securities that are not traded in active markets or that are subject to transfer restrictions, valuations
are adjusted to reflect illiquidity and/or non-transferability, and such adjustments generally are based on available market evidence. In the absence of such evidence, management’s best estimate is used. Fair values for fixed maturity securities based on observable market prices for identical or similar instruments implicitly include the incorporation of counterparty credit risk. Fair values for fixed maturity securities based on internal models incorporate counterparty credit risk by using discount rates that
take into consideration cash issuance spreads for similar instruments or other observable information. (ii) Certain Short-Term Investments and Cash Equivalents Short-term investments and cash equivalents are carried at cost or amortized cost, which approximates fair value, and principally include money market instruments and commercial paper. These instruments are typically not traded in active markets; however, their fair values are based on market
observable inputs. (iii) Fair Value Hierarchy and Level 3 Assets Under
Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair
Value Measurements” (“SFAS 157”), assets recorded at fair
value in the consolidated balance sheet are classified in a hierarchy for
disclosure purposes consisting of three “levels” based on the observability
of inputs available in the market place used to measure the fair value. (See
Note 3 of Notes to Consolidated Financial Statements for additional
information about fair value measurements.) 49
The valuation of Level 3 assets requires the greatest degree of judgment, as these measurements may be made under circumstances in which there is little, if any, market activity for the asset. At December 31, 2008, TRH classified $121.1 million of assets measured at fair value on a recurring basis as Level 3. This represented 1.4% of total assets measured at fair value on a recurring basis. Level 3 fair value measurements are based on valuation techniques that use at least one
significant input that is unobservable. TRH’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment. In making the assessment, TRH considers factors specific to the asset. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls is
determined based on the lowest level input that is significant to the fair value measurement in its entirety. TRH values its assets classified as Level 3 using judgment and valuation models or other pricing techniques that require a variety of inputs including contractual terms, market prices and rates, yield curves, credit curves, measures of volatility, prepayment rates and correlations of such inputs, some of
which may be unobservable. The following paragraphs describe the methods TRH uses to measure on a recurring basis the fair value of assets classified in Level 3.
•
Certain Residential Mortgage-Backed Securities (“RMBS”): These assets initially are valued at the transaction price. Subsequently, they may be valued by comparison to transactions in instruments with similar collateral and risk profiles, remittances received and updated cumulative loss data on
underlying obligations, discounted cash flow techniques and/or option adjusted spread analyses. • Certain Other Asset-Backed Securities—non-mortgage: These assets initially are valued at the transaction price. Subsequently, they may be valued based on external price/spread data. When position-specific external price data are not observable, the valuation is based on prices of comparable
securities. (c) Other-Than-Temporary Impairments of Investments TRH evaluates its investments for other-than-temporary impairments in valuation. 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 determination that a security has incurred an other-than-temporary impairment in value requires the judgment of management and consideration of the fundamental condition of the issuer, its near-term prospects and all relevant facts and circumstances. 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 impairment period would be temporary (severity losses). 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 recovered their cost basis, TRH records the unrealized loss in income as a realized capital loss. If a loss is recognized 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. 50
In periods subsequent to the recognition of an other-than-temporary impairment write-down of fixed maturity securities, which are not credit or foreign exchange related, TRH generally accretes into income the discount or amortizes the reduced premium resulting from the reduction in cost basis over the remaining life of the security. (d) 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. 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 97% 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, 2008 and 2007, as follows: 2008
Gross
Commissions
Premiums Major Class
(in thousands) Casualty: Other liability
$
111,165
$
30,237
$
80,928 Medical malpractice
37,748
10,271
27,477 Ocean marine and aviation
42,942
4,485
38,457 Auto liability
14,228
3,871
10,357 Accident and health
11,628
3,486
8,142 Surety and credit
25,973
9,999
15,974 Other
26,337
7,463
18,874 Total casualty
270,021
69,812
200,209 Property: Fire
56,105
13,228
42,877 Allied lines
27,624
4,248
23,376 Auto physical damage
19,749
5,256
14,493 Homeowners multiple peril
3,586
1,279
2,307 Other
1,877
445
1,432 Total property
108,941
24,456
84,485 Total
$
378,962
$
94,268
$
284,694 51
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 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. (e) 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, net investment income, realized net capital (losses) gains,
gain on early extinguishment of debt and total revenue of TRH for the periods indicated:
Years Ended December 31,
2008
2007
2006
Amount
Change
Amount
Change
Amount
Change
(dollars in millions) Net premiums written
$
4,108.1
3.9
%
$
3,952.9
8.8
%
$
3,633.4
4.8
% Net premiums earned
4,067.4
4.2
3,902.7
8.3
3,604.1
6.5 Net investment income
440.5
(6.2
)
469.8
8.1
434.5
26.6 Realized net capital (losses) gains
(435.5
)
—
9.4
(13.6
)
10.9
(72.8
) Gain on early extinguishment of debt
10.3
—
—
—
—
— Total revenues
4,082.5
(6.8
)
4,381.8
8.2
4,049.5
7.5 52
Net premiums written increased in 2008 compared to 2007 due to increases in Domestic and International operations. Overall premium growth in 2008 was mitigated by increased ceding company retentions in certain lines and price erosion in many classes and regions in 2007 and the first half of 2008. 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 rates contributed significantly to premium growth as shown in the table below. Premium growth in 2007 was mitigated by increased ceding company retentions in certain lines. In general, premium fluctuations reflect prevailing market conditions and strategic decisions by TRH’s management in recent periods as discussed earlier in MD&A. In 2008 and 2007, as compared to the respective immediately prior year, the increase in net premiums written was from treaty business. On a worldwide basis, casualty lines business represented 69.8% of net premiums written in 2008 versus 71.0% and 73.3% in 2007 and 2006, respectively. The balance
represented property lines. Treaty business represented 96.8% of net premiums written in 2008 versus 96.3% and 95.3% in 2007 and 2006, 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 2008 and 2007 compared to the respective immediately prior year.
2008
2007 Increase in original currency
3.9
%
6.4
% Foreign exchange effect
—
2.4 Increase as reported in U.S. dollars
3.9
8.8 Domestic net premiums written increased in 2008 by $87.6 million, or 4.5%, from the prior year to $2.04 billion. Significant increases in Domestic net premiums written were recorded in the property ($56.8 million), A&H ($48.5 million), auto liability ($20.8 million) and other liability ($18.9 million) lines. These
increases were partially offset by significant decreases in the fidelity ($41.9 million) and medical malpractice ($27.9 million) lines. International net premiums written increased in 2008 by $67.6 million, or 3.4%, from the prior year to $2.07 billion. The most significant increases in net premiums written occurred in the Miami ($37.2 million), London ($15.9 million) and Hong Kong ($11.9 million) branches and in TRZ ($18.7 million), partially
offset by a significant decrease in the Toronto ($27.5 million) branch. International net premiums written increased significantly in the property ($35.4 million), credit ($25.1 million) and A&H ($17.2 million) lines and were partially offset by significant decreases in the other liability ($22.0 million) and ocean marine
($12.7 million) lines. International business represented 50.4% of 2008 net premiums written compared to 50.7% in 2007. Domestic net premiums written increased in 2007 by $196.8 million, or 11.2%, from the prior year to $1.95 billion, 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 $2.00 billion 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. 53
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. Generally, reasons for changes in gross premiums written between years are similar to those for net premiums written, except for changes resulting from reinstatement premiums and changes in ceded premiums, including premiums assumed from an affiliate that, by prearrangement, were ceded in an equal
amount to other affiliates (see Note 10 and Note 16 of Notes to Consolidated Financial Statements (“Note 16”)). The increase in premiums ceded to affiliates in 2008 compared to 2007 is due principally to an increase in premiums assumed from an affiliate that, by prearrangement with TRH, were then ceded in an
equal amount to other affiliates. The decrease in premiums ceded to non-affiliates in 2008 compared to 2007 is due in part to the purchase of less retrocession coverage. As further discussed in Notes 14 and 16 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 in 2008 decreased compared to 2007 due to a decrease in investment results from other invested assets of $57 million, principally related to hedge funds, partially offset by an increase in investment income from fixed maturities. The decrease in investment results from hedge funds
was due in part to the recent turmoil in the financial markets. The increase in investment income from fixed maturities is due in part to investment returns from continued positive operating cash flows. 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. (See Note 4(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 2008, 2007 and 2006, the pre-tax effective yields on investments were 3.8%, 3.9% and 4.2%, 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. Investment returns from
securities lending invested collateral served to negatively impact the yields in each of the above years by 0.3%, 0.7% and 0.5%, respectively, as the net return from the invested collateral is very small in relation to the balance sheet carrying amount because investment income earned from invested collateral is
reduced by interest payable to the collateral provider. In 2008 compared to 2007, the decline in investment results from other invested assets reduced the yield by 0.5%. (See Investment Results in Item 1. Business.) Realized net capital (losses) gains generally result from 1) investment dispositions, which reflect TRH’s investment and tax planning strategies to maximize after-tax income; 2) write-downs of securities that, in the opinion of management, had experienced a decline in fair value for which TRH could not
reasonably assert that the recovery period would be temporary; and 3) foreign currency transaction gains (losses). Realized net capital (losses) gains totaled ($435.5) million, $9.4 million and $10.9 million in 2008, 2007 and 2006, respectively (see Note 4(c) of Notes to Consolidated Financial Statements for the components of realized net capital (losses) gains). Realized net capital losses in 2008 included $99.9 million of
net losses on sales and redemptions of securities and $317.8 million of other-than-temporary impairment write-downs. The significant realized net capital losses from sales and redemptions of securities and other-than-temporary impairment write-downs in 2008 generally resulted from declines in the market
values of securities due to the downturn in the U.S. economy, turmoil in the financial markets, financial market illiquidity and issuer-specific credit events in 2008. Upon the ultimate disposition of securities for which write-downs
have been recorded, a portion of the write-downs may be recoverable depending on market conditions at the time of disposition. (See Critical Accounting Estimates
for the criteria used in the determination of such write-downs.) 54
Other-than-temporary impairment write-downs by balance sheet category at the time of impairment and type of impairment recorded for the years indicated are presented in the table below:
Fixed
Equities
Securities
Total
(in millions) Year Ended December 31, 2008: Severity
$
115.4
$
69.2
$
79.7
$
264.3 Lack of intent to hold to recovery
2.4
3.3
3.9
9.6 Issuer-specific credit events
7.3
22.5
14.1
43.9 Total
$
125.1
$
95.0
$
97.7
$
317.8 Year Ended December 31, 2007: Severity
$
—
$
21.1
$
—
$
21.1 Lack of intent to hold to recovery
2.1
0.7
—
2.8 Issuer-specific credit events
2.5
0.7
—
3.2 Total
$
4.6
$
22.5
$
—
$
27.1 Year Ended December 31, 2006: Severity
$
—
$
—
$
—
$
— Lack of intent to hold to recovery
1.3
0.2
—
1.5 Issuer-specific credit events
—
—
—
— Total
$
1.3
$
0.2
$
—
$
1.5 Through 2008, TRH participated in a securities lending
program (the “Securities Lending Program”) managed by a subsidiary of
AIG, whereby certain securities from its portfolio were loaned to third parties.
(See Note 2(c) of Notes to Consolidated Financial Statements (“Note 2(c)”).) Under such
program, TRH loaned securities to counterparties and received collateral,
generally cash, which was invested to earn a spread. Prior to the fourth quarter of 2008, the transfers of securities in exchange for collateral under the Securities Lending Program were accounted for as secured borrowings, with a liability recorded in an amount equal to the collateral received, reflecting TRH’s obligation to return the collateral when the loaned
securities were returned. As a result of conditions affecting the financial and credit markets, in the fourth quarter of 2008, counterparties were successful in negotiating significantly reduced collateral levels (i.e., collateral received as a percentage of the fair value of the security loaned). Due to the lower collateral
levels, during the fourth quarter of 2008, many of such loaned securities were accounted for as sales at the time of transfer and as purchases when the securities were subsequently returned. In the fourth quarter of 2008, TRH terminated its participation in the Securities Lending Program. The financial impact on the Statement of Operations of the Securities Lending Program was as follows: With respect to securities lending invested collateral: Net investment income from the Securities Lending Program (i.e., income earned on invested collateral, net of interest payable to the collateral
provider) totaled $2.6 million, $2.5 million and $2.2 million in 2008, 2007 and 2006, respectively; Net realized losses on sales of securities lending invested collateral totaled $8.0 million, $1.8 million and nil in 2008, 2007 and 2006, respectively; Other-than-temporary impairment write-downs (included in net
realized capital losses) totaled $97.7 million in 2008 and nil in 2007 and 2006. With respect to the securities loaned, realized losses in the fourth quarter of 2008 on “deemed” sales of securities loaned totaled $16 million. In 2008, TRH repaid certain securities lending payables using cash from sources other than the sale of securities lending invested collateral. In that regard, certain fixed maturities, including commercial mortgage-backed securities (“CMBS”), RMBS and other asset-backed securities were transferred from
securities lending invested collateral to fixed maturities available for sale. Other than the potential for future losses related to the securities that were transferred from securities lending invested collateral, TRH expects no further costs from the Securities Lending Program. 55
In 2008, TRH repurchased $25 million principal amount of its 5.75% senior notes due in 2015 (the “Senior Notes”) from non-affiliates for $15 million, realizing a gain of $10 million. 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 December 31,
2008
2007
2006 Consolidated: Loss ratio
71.5
%
67.6
%
68.3
% Underwriting expense ratio
27.0
27.7
27.7 Combined ratio
98.5
95.3
96.0 Domestic: Loss ratio
78.7
%
74.2
%
77.5
% Underwriting expense ratio
26.3
25.9
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