Transatlantic Holdings 10-K 2011
COMMISSION FILE NUMBER 1-10545
TRANSATLANTIC HOLDINGS, INC.
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 ý No o
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 o No ý
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ý No o
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. ý
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 o No ý
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, 2010 (the last business day of the registrant's most recently completed second fiscal quarter) was approximately $3,047,542,231.
As of January 31, 2011, there were outstanding 62,332,961 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 26, 2011 are incorporated by reference in Part III of this Form 10-K.
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. In certain instances, TRH's unpaid losses and loss adjustment expenses are presented net of related reinsurance recoverable in accordance with principles prescribed or permitted by insurance regulatory authorities as these are standard measures in the insurance and reinsurance industries.
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 in a public offering.
Prior to June 10, 2009 and as of December 31, 2008, AIG beneficially owned approximately 59% of the Company's outstanding shares. On June 10, 2009, AIG and American Home Assurance Company ("AHAC"), a wholly owned subsidiary of AIG, consummated a secondary public offering (the "June 2009 Offering") of 29.9 million issued and outstanding shares of the Company owned by AIG and AHAC. On March 15, 2010, AHAC consummated another secondary public offering (the "March 2010 Offering", and collectively with the June 2009 Offering, the "Secondary Offerings") of 8.5 million issued and outstanding shares of the Company's common stock owned by AHAC. The Company repurchased two million shares of its common stock from AHAC in the March 2010 Offering pursuant to a stock offering agreement for an aggregate purchase price of approximately $105 million. TRH did not receive any proceeds from the Secondary Offerings. Immediately following the March 2010 Offering, the AIG Group, including AHAC, beneficially owned 0.7 million shares of the Company's common stock (excluding shares held by certain mutual funds that are advised or managed by subsidiaries of AIG), representing approximately 1.1% of the Company's then outstanding shares. As a result of its reduced ownership percentage, the AIG Group was no longer considered a related party after March 15, 2010. (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 Reinsurance Company Ltd. ("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, directly and through brokers, to insurance and reinsurance companies, in both the domestic and international markets on both a treaty and facultative basis. 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. Through its international locations, TRH has operations worldwide, including Bermuda, Canada, seven locations in Europe, three locations in Central and South America, two locations in Asia (excluding Japan), and one location in each of Japan, Australia and Africa. TRC is licensed in Bermuda, Canada, Japan, the United Kingdom, the Dominican Republic, the Hong Kong Special Administrative Region, the
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, Germany, Guatemala, Honduras, Mexico, Nicaragua, Paraguay, Peru, Uruguay and Venezuela, and is authorized to maintain a representative office in Shanghai, the People's Republic of China. TRZ is licensed as a reinsurer in Switzerland and registered in Argentina, Honduras, Guatemala, the Dominican Republic and Colombia. Transatlantic Polska Sp. z o.o., a subsidiary of TRC, maintains a registered representative office in Warsaw, Poland.
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.
TRH offers two types of reinsurance based on the underlying insurance coverage:
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 the cost of existing claims may continue to change over time. 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 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:
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:
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, Bermuda, London, Paris, Zurich, Munich, Hong Kong, Tokyo and Sydney offer treaty as well as facultative reinsurance. In addition, TRH operates representative offices in Buenos Aires, Panama, Warsaw and Shanghai, and maintains exclusive representative arrangements with MS Upson Associates c.c. in Johannesburg, South Africa and with NOBARE in Stockholm, Sweden. 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. During 2010, TRH opened an office in Bermuda to further support TRH's local business partners; upgraded TRH's Munich office to full branch status to enhance TRH's standing in the local market; established a new entity in Gibraltar, Calpe Insurance Company Limited, to expand TRH's access to business in Europe; and completed a strategic investment to participate as a corporate name in Lloyd's of London.
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%, 49% and 50% of worldwide net premiums written in 2010, 2009 and 2008, respectively. (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.)
After March 15, 2010, the AIG Group ceased to be a related party of TRH, as discussed above. Gross premiums written originated by the AIG Group and ceded to TRH from contracts that were entered into while the AIG Group was a related party totaled approximately $196 million (4.8%), $263 million (6.3%) and $310 million (7.0%) in 2010, 2009 and 2008, respectively. These amounts exclude (a) premiums assumed that initially were insured by AIG subsidiaries as a result of TRH's marketing efforts and then ceded to TRH by prearrangement; (b) amounts assumed from an AIG subsidiary and ceded in an equal amount to other AIG subsidiaries; and (c) all premiums from contracts that were effective after March 15, 2010. The amount of premiums assumed that initially were insured by AIG subsidiaries as a result of TRH's marketing efforts and then ceded to TRH by prearrangement are not material. (See Note 16 of Notes to Consolidated Financial Statements ("Note 16") for the amount of premiums assumed from an AIG subsidiary and ceded in an equal amount to other AIG subsidiaries.) (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 $49.0 million and $44.2 million at December 31, 2010 and 2009, respectively. 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 consolidated financial position or results of operations.
Property and Casualty Lines of Business
Casualty reinsurance constitutes the larger portion of TRH's business, accounting for 71% of net premiums written in 2010, 71% in 2009 and 70% in 2008. The following table presents certain underwriting information concerning TRH's casualty and property business for the periods indicated (see MD&A):
Operating results in 2010, 2009 and 2008 included pre-tax net catastrophe costs (net of reinsurance and reinstatement premiums) of $202 million, ($6) million and $170 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.
Treaty and Facultative Reinsurance
Treaty reinsurance constitutes the great majority of TRH's business, accounting for 97% of net premiums written in each of 2010, 2009 and 2008. 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 reinsurance accounted for approximately $3.84 billion of gross premiums written and $3.75 billion of net premiums written in 2010. Approximately 68% of total treaty gross premiums written in 2010 represented treaty reinsurance written on a pro rata basis and the balance represented treaty reinsurance written on an excess-of-loss basis. Approximately 71% of treaty net premiums written resulted from casualty lines treaties, with the remainder from property lines treaties. Treaty business written by TRH's international operations accounted for approximately 48% of TRH's total net premiums written for the year ended December 31, 2010.
TRH's treaty business consists primarily of business within the other liability (including D&O and E&O), A&H, medical malpractice, ocean marine and aviation, auto liability (including non-standard risks), 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.
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. 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. When TRH does not lead the treaty, it may still suggest changes to any aspect of the treaty. TRH may reject any treaty business offered to it 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 Standard & Poor's ("S&P"), A.M. Best Company ("Best") 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 4,000 treaties in effect for the current underwriting year. In 2010, no single treaty exceeded 4% of treaty gross premiums written. No single ceding company accounted for more than 6% of total treaty gross premiums written in 2010.
Approximately 5% of treaty gross premiums written in 2010 were originated by the AIG Group and ceded to TRH. These originated amounts exclude premiums assumed that initially were insured by AIG subsidiaries as a result of TRH's marketing efforts and then ceded to TRH by prearrangement. The amount of premiums assumed that initially were insured by AIG subsidiaries as a result of TRH's marketing efforts and then ceded to TRH by prearrangement are not material. (See Relationship with the AIG Group.) The majority of TRH's treaty premiums were written on a pro rata basis.
During 2010, TRH wrote approximately $288.2 million of gross premiums written and $127.1 million of net premiums written of facultative reinsurance. The vast majority of ceded premiums written represents amounts assumed from an AIG subsidiary and ceded in an equal amount to other AIG subsidiaries. Approximately 62% 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. Facultative business written by TRH's international operations accounted for approximately 1% of TRH's total net premiums written for the year ended December 31, 2010.
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 2010, TRH's facultative book of business focused on the property, other liability and medical malpractice 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.
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.
No single ceding company accounted for more than 6% of total facultative gross premiums written in 2010. Approximately 5% of facultative gross premiums written in 2010 were originated by the AIG Group. These originated amounts exclude amounts assumed from an AIG subsidiary and ceded in an equal amount to other AIG subsidiaries. (See Relationship with the AIG Group.)
To a limited extent, TRH enters into retrocession arrangements, generally in order to reduce the effect of individual or aggregate losses, to reduce volatility in specific lines, to improve risk adjusted portfolio returns and to increase 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, 2010, TRH had in place approximately 120 active retrocessional arrangements for current and prior underwriting years with approximately 310 retrocessionnaires, and reinsurance recoverable on paid and unpaid losses and loss adjustment expenses totaled $819.7 million. No unsecured recoverables from a single retrocessionnaire are considered material to the financial position of TRH. (See Note 16.)
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 profile 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 ("CEO"). The CEO chairs a Corporate Risk Management Committee composed of executive officers including the CRO, Chief Financial Officer, Chief Underwriting Officer, Domestic Operations, President International Operations, President Latin American and Caribbean Division, Chief Actuary, General Counsel, Chief Information Officer, Senior Claims Executive in New York and the Chief Compliance Officer, among others. In addition, the 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, compliance 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 review and 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 profile for TRH.
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.
Brokerage fees generally are paid by reinsurers. In 2010, approximately 76% of TRH's gross premiums written was written through brokers and the balance was written directly. In 2010, companies controlled by Aon Corporation ("Aon") and Marsh & McLennan Companies, Inc. ("Marsh"), were TRH's largest brokerage sources of business. Business brokered by Aon, Marsh and the rest of TRH's ten largest
brokerage sources of business as a percentage of TRH's consolidated revenues and total gross premiums written in 2010 are presented below:
The business attributable to a broker includes all gross premiums produced by that broker and its affiliates in the full year regardless of the date that any such affiliate was acquired.
TRH believes that its emphasis on generally seeking the lead position in 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 are managed by TRH's professional claims staff whose responsibilities include the review of initial loss reports, creation of claim files, determination of whether further investigation is required, establishment and adjustment of case reserves and payment of claims. In addition to claims assessment, processing and payment, the claims staff conducts comprehensive claims audits of both specific claims and overall claims procedures at the offices of selected ceding companies, which TRH believes benefit all parties to the reinsurance arrangement. Claims audits are conducted in the ordinary course of business. In certain instances, a claims audit may be performed prior to assuming reinsurance business.
Reserves for Unpaid Losses and Loss Adjustment Expenses ("Gross Loss Reserves")
Significant periods of time may elapse between the occurrence of an insured loss, the reporting of the loss to the ceding company and the reinsurer, and the ceding company's payment of that loss and subsequent payments to the ceding company by the reinsurer. Insurers (and reinsurers) establish gross loss reserves, which represent estimates of future amounts needed to pay claims and related expenses with respect to insured events which have occurred on or before the balance sheet date, including events which have not been reported to the 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 LAE both gross and net of related reinsurance recoverables.
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 the 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 changing legal and economic environments 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 can be 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.
During the loss settlement period, which can be many years in duration, additional facts regarding individual claims and trends usually become known. As these become apparent, it usually becomes necessary to refine and adjust the reserves upward or downward. Even then, the ultimate net liability may be materially different from the revised estimates which are reflected in TRH's consolidated financial statements, and such differences may have, and in certain years have had, a material effect on net income. (See MD&A, including the discussion of Critical Accounting Estimates, and Note 2(i) of Notes to Consolidated Financial Statements for further discussion.)
Net losses and LAE incurred consist 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 unpaid losses and LAE net of related reinsurance recoverables ("net loss reserves") for calendar years 2000 through 2010. 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 $7.35 billion as of December 31, 2008, by the end of 2010 (two years later) $2.79 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 $7.35 billion was re-estimated to be $7.41 billion at December 31, 2010. 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, 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 $56.1 million at December 31, 2010 relating to December 31, 2008 net loss reserves of $7.35 billion represents the cumulative amount by which net loss reserves as of year-end 2008 have developed adversely from that date through the end of 2010.
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 2007 for $150,000 was first reserved in 2004 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 2004 through 2006 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.
The trend depicted in the latest development year in the net reestimated liability portion of the "Analysis of Consolidated Net Loss Reserves Development" table and in the "Analysis of Net Unpaid Losses and Loss Adjustment Expenses and Net Reestimated Liability" table reflects net favorable development. Net favorable development of $57.0 million was recorded in 2010 on losses occurring in all prior years. (See MD&A for a discussion of the causes of the net favorable development.) This net favorable development was comprised of net favorable development of $216.9 million for losses occurring in 2002 to 2009, partially offset by net adverse development of $159.9 million for losses occurring in 2001 and prior.
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 generally accepted accounting principles in the U.S. ("GAAP") or statutory accounting principles. (See Note 6 of Notes to Consolidated Financial Statements for a reconciliation of beginning and ending gross and net loss reserves.)
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. Through June 30, 2009, the AIG Group acted as financial advisors and managers of TRH's investment portfolio and, in connection therewith, made the selection of particular investments. Effective July 1, 2009, TRH employs a third party not affiliated with AIG to provide these services.
TRH's current investment strategy seeks to optimize 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. Historically, 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 equity portfolio is structured to achieve capital appreciation primarily through a selection of large capitalization U.S. stocks. Other invested assets principally include alternative investments 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 (principally fixed maturities available for sale) from its portfolio were loaned to third parties. (See Note 4(h) 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. The collateral received was invested in separate portfolios containing floating rate bonds (i.e., fixed maturities), including asset-backed securities, and interest-bearing cash equivalents. These portfolios were maintained in segregated accounts for TRH by the program manager. The collateral was returned to the counterparties when the loaned securities were returned to TRH at a future date. In the fourth quarter of 2008, TRH terminated its participation in the Securities Lending Program.
The following table reflects investment results for TRH for each of the five years in the period ended December 31, 2010.
The carrying values of available for sale securities are subject to significant volatility from changes in their fair values. (See MD&A.)
As of December 31, 2010, the fair value of the total investment portfolio was $13.02 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%. TRH's market risk analyses do not provide weight to risks relating to market issues such as liquidity and the credit-worthiness of investments. (See Item 7A. Quantitative and Qualitative Disclosures About Market Risk.)
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, S&P, Best and Moody's ratings, 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 international and 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, 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.
At December 31, 2010, TRH had approximately 640 employees. Approximately 270 employees were located in the New York headquarters; 120 employees were located in other locations in the United States and 250 employees were located in offices outside of the United States.
TRH's operations are subject to regulation in the U.S. and abroad. Changes to 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 an elected or appointed state insurance official. This regulation and supervision focuses primarily on the level of solvency that must be maintained, including risk-based capital measurements, limitations on the form of investments and other forms of risk. In addition, such regulation covers the licensing of underwriters of insurance and reinsurance, restrictions on the size of risks which may be insured under a single contract, specifications for deposits of securities for the benefit of ceding companies, methods of accounting, periodic examinations 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 where the rates and policy terms are generally closely regulated by governmental authorities. As a practical matter, however, the rates charged by primary insurers and the policy terms of primary insurance agreements may affect the rates charged and the policy terms under associated reinsurance agreements.
The Company, under the relevant insurance laws, is deemed an insurance holding company and TRH and its insurance company affiliates are subject to the 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 insurance 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 the Company's common shares would be presumed to be a "controlling person" of the Company and its subsidiaries, unless the NYS ID determines upon application that such investor would not control the Company. An investor who could be deemed a "controlling person" 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.
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, in theory, inadequately capitalized insurance companies can 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, 2010, 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.
In July 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank") was enacted. Dodd-Frank included specific provisions regarding the regulation of reinsurance. Under the reinsurance provisions of Dodd-Frank, with respect to reinsurance agreements entered on or after July 21, 2011, whether credit for reinsurance in financial statements is allowed will be determined by the state that is the domestic U.S. regulator of the ceding insurer, provided such state is accredited by the NAIC or found to be substantially equivalent. This provision prevents the non-domestic regulators of the ceding insurer from reaching a separate determination with respect to availability of credit for reinsurance. Dodd-Frank also creates the Federal Insurance Office (the "FIO"). The FIO has no administrative authority but will have the authority to collect data and to assist the U.S. Secretary of the Treasury in negotiating covered agreements. A covered agreement is a bilateral or multilateral agreement regarding prudential measures with respect to the business of insurance or reinsurance that is (i) entered into between the U.S. and one or more foreign governments, authorities or regulatory entities; and (ii) relates to the recognition of prudential measures with respect to the business of insurance or reinsurance that achieves a level of protection achieved under state insurance or reinsurance regulation.
In response to Dodd-Frank, several individual states including Florida and New York have developed their own credit for reinsurance guidelines modeled on the NAIC Reinsurance Regulatory Modernization Framework proposal. These state-based initiatives permit the insurance supervisor to consider the financial condition of an assuming reinsurer in addition to its domicile when determining credit for reinsurance. The NAIC is currently in the process of drafting a sweeping Solvency Modernization Initiative. While this initiative is in its early stages, the NAIC has completed a road-map and has articulated its objectives. The final manifestation of the initiative will come in the form of draft Model laws and Acts for adoption by the individual states. These drafts are not expected to be completed in the near future.
In addition to the Dodd-Frank and the various state actions, a federal proposal was introduced in Congress which would allow industry participants to voluntarily choose a federal charter over the current state system. 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 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 adopted. The Directive requires member countries to 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 adversely 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 requirements of insurers and reinsurers. The regulatory authorities in Europe have scheduled Solvency II for implementation on January 1, 2013. 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 adjustments to TRH's 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 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 recent 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 material 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
Secondary Public Offering of the Company's Common Stock by AIG
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 general insurance, life insurance and retirement services operations. Other significant activities include financial services and asset management.
Prior to June 10, 2009 and as of December 31, 2008, AIG beneficially owned approximately 59% of the Company's outstanding shares. On June 10, 2009, AIG and AHAC, a wholly owned subsidiary of AIG, consummated the June 2009 Offering of 29.9 million issued and outstanding shares of the common stock of the Company owned by AIG and AHAC. On March 15, 2010, AHAC consummated the March 2010 Offering of 8.5 million issued and outstanding shares of the Company's common stock owned by AHAC. The Company repurchased two million shares of its common stock from AHAC in the March 2010 Offering pursuant to a stock offering agreement for an aggregate purchase price of approximately $105 million. TRH did not receive any proceeds from the Secondary Offerings. Immediately following the March 2010 Offering, the AIG Group, including AHAC, beneficially owned 0.7 million shares of the Company's common stock (excluding shares held by certain mutual funds that are advised or managed by subsidiaries of AIG), representing approximately 1.1% of the Company's then outstanding shares. As a result of its reduced ownership percentage, the AIG Group was no longer considered a related party after March 15, 2010.
Reinsurance Assumed from the AIG Group
In the normal course of business, TRH sells reinsurance to subsidiaries of the AIG Group. Based upon TRH's assessment of risk selection, pricing, terms and conditions and other relevant factors, TRH either accepts or rejects potential AIG Group business. Except where premiums assumed were insured by AIG subsidiaries as a result of TRH's marketing efforts and then ceded to TRH by prearrangement, TRH has generally not set terms and conditions as lead underwriter with respect to the treaty reinsurance purchased by the AIG Group; 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.
After March 15, 2010, the AIG Group ceased to be a related party of TRH, as discussed above. Gross premiums written originated by the AIG Group and ceded to TRH from contracts that were entered into while the AIG Group was a related party totaled approximately $196 million (4.8%), $263 million (6.3%) and $310 million (7.0%) in 2010, 2009 and 2008, respectively. These amounts exclude (a) premiums assumed that initially were insured by AIG subsidiaries as a result of TRH's marketing efforts and then ceded to TRH by prearrangement; (b) amounts assumed from an AIG subsidiary and ceded in an equal amount to other AIG subsidiaries; and (c) all premiums from contracts that were effective after March 15, 2010. The amount of premiums assumed that initially were insured by AIG subsidiaries as a result of TRH's marketing efforts and then ceded to TRH by prearrangement are not material. (See Note 16 for the amount of premiums assumed from an AIG subsidiary and ceded in an equal amount to other AIG subsidiaries.)
The Company files annual, quarterly and current reports, proxy statements and other documents with the Securities and Exchange Commission (the "SEC"). The public may read and copy any materials filed with the SEC at the SEC's Public Reference Room at 100 F Street, N.E., Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. Also, the SEC maintains an Internet Web site that contains reports, proxy and information statements, and other information regarding issuers, including the Company, that file electronically with the SEC. The public can obtain any documents that the Company files electronically with the SEC at http://www.sec.gov or through the New York Stock Exchange, 20 Broad Street, New York, New York 10005, on which the Company's common stock is listed.
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 the Company'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." References to TRH's website in this report are provided as a convenience and do not constitute, and should not be viewed as, an incorporation by reference of the information contained on, or available through, the website. Therefore, such information should not be considered part of this report.
In addition, copies of any of the Company'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 the Company's Investor Relations department at:
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, results of operations and ultimately its cash flows 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 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 its losses, based upon estimates of losses incurred by the ceding companies. As a result, only liabilities applicable to losses incurred up to the reporting date may be established, with no allowance for the provision of a contingency reserve to account for expected or unexpected future losses. Losses arising from future events will be estimated and recognized at the time the losses occur. Although TRH annually reviews the adequacy of its established reserves for losses and LAE, there can be no assurance that TRH's loss reserves will not develop adversely and have a material effect on TRH's results of operations. To the extent these liabilities may be insufficient to cover actual losses or LAE, TRH will have to add to these liabilities and incur a charge to its earnings, which could have a material adverse effect on TRH's financial condition, results of operations and ultimately its cash flows. (See MD&A for a further discussion of the risks and uncertainties relating to loss reserves.)
A downgrade in the ratings assigned to TRH could adversely affect TRH's ability to write new business and/or TRH's cost and availability of any future unsecured financing, and may adversely impact TRH's existing agreements.
S&P, Best 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 a competitive position for insurance and reinsurance companies. Financial strength ratings measure a company's ability to meet its insurance and reinsurance obligations to contract holders. Credit ratings measure a company's ability to repay its debt 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 TRH in the future and may influence a ceding company to reinsure with one of TRH's competitors that has a higher financial strength rating. In general, if the insurer financial strength ratings and/or financial strength ratings of TRC, TRZ or Putnam 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 terminating the contracts on a run-off or cut-off basis, requiring TRH to post collateral for all or a portion of the obligations or requiring commutation under the contract as described below. A downgrade of TRH's debt ratings may also increase future borrowing costs.
A significant portion of TRH's in-force treaty contracts as of December 31, 2010 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-". 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.
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 materially adverse.
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 a 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 TRH's 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, among other things, TRH's ability to write additional reinsurance.
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 or the extent of resulting losses. In addition, TRH may purchase retrocession protection designed to limit the amount of losses that it may incur. Retrocession arrangements do not relieve TRH from its obligations to the insurers and reinsurers from whom TRH 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. 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, results of operations and cash flows may be materially adversely affected.
Further, various provisions of TRH's contracts, such as limitations to or exclusions from coverage or choice of legal forum, may not be enforceable in the manner TRH intends, due to, among other things, disputes relating to coverage and choice of legal forum. Additionally, underwriting is a matter of judgment, involving important assumptions about matters that are inherently difficult to predict and are beyond TRH's control, and for which historical experience and probability analysis may not provide sufficient guidance. Also, TRH's risk management methods, models, databases and experience may not adequately address the emergence of various matters, such as the impact of climate change or TRH employees or third-party service providers exceeding their authority or otherwise breaching their obligations, that could significantly affect TRH's business in future periods. One or more catastrophic or other events and emerging risks could result in claims or have an impact that substantially exceeds TRH's expectations, which could have a material adverse effect on TRH's financial condition, results of operations and cash flows.
The property and casualty reinsurance business is historically cyclical, and TRH expects to experience periods with excess underwriting capacity and unfavorable pricing.
Historically, property and casualty reinsurers have experienced significant fluctuations in operating results. Demand for reinsurance is influenced significantly by underwriting 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 the 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 with respect to 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 TRH considers appropriate relative to the risk assumed. If TRH cannot write property and casualty reinsurance at appropriate rates, TRH's 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, ratings of S&P, Best and Moody's, 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 U.S. and international reinsurance markets with numerous international and 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, government-owned or subsidized facilities. Certain of these competitors have been operating substantially longer than TRH 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 and 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 energy catastrophe business. Over time, these numerous initiatives could significantly affect supply, pricing and competition in the reinsurance industry.
Additionally, government involvement in the reinsurance markets continues to evolve. For example, the Florida legislature has recently begun to decrease the amount of reinsurance offered by the state-run reinsurer, the Florida Hurricane Catastrophe Fund ("FHCF"). In 2009, the Florida legislature, recognizing the inadequacy of current rates, authorized Citizens Property Insurance Corporation, the state-sponsored insurer, to increase its rates and further reduce its capacity with the goals of reinstating the FHCF's role as a market of last resort and reinvigorating private reinsurer participation in the state. Further actions by the legislature are expected during 2011. Throughout 2010, the Florida insurance regulator continued to approve significant rate increases for insurers writing Florida property risks and relaxed the collateral requirements for credit for reinsurance for several non-U.S. reinsurers.
A limited number of brokers account for a large portion of TRH's premiums; 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 premiums are written through brokers. In 2010, business brokered by companies controlled by Aon and Marsh accounted for 26% and 19%, respectively, of total gross premiums written. In addition, business brokered by TRH's 10 largest brokerage sources of business accounted for 65% of total gross premiums written in 2010. 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.
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 class or geographic region could have an adverse effect on TRH's investment portfolios and consequently on TRH's consolidated results of operations or financial condition. While TRH seeks to mitigate this risk by having a broadly diversified portfolio, events or developments that have a negative effect on any particular industry, group of related industries, asset class 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; a change in 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 measured at fair value using methodologies, estimations and assumptions which are subject to differing interpretations. 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. Investments 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 marketplace used to measure the fair values. (See Note 3 of Notes to Consolidated Financial Statements for the types of assets included in each of the three levels.)
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 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 changes in the financial environment. In such cases, more securities may fall to Level 3 and thus require more subjectivity and judgment of TRH's management. 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 or strained 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. (See MD&A for a further discussion of the risks and uncertainties relating to critical accounting estimates.)
The determination of the amount of other-than-temporary impairment ("OTTI") taken on TRH's investments is subjective and could materially impact TRH's results of operations or financial condition.
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. (See Note 4(g) of Notes to Consolidated Financial Statements for the methodology TRH uses to determine OTTI.)
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 considerable judgment and the consideration of various factors and circumstances. The significant factors include:
If TRH's determination of OTTI is materially incorrect, it could have a material adverse effect on TRH's financial condition, results of operations and cash flows.
TRH's liquidity could be materially impaired by future events within or outside of TRH's control, including conditions in the financial and credit markets.
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 TRH's affiliates. These laws and regulations may hinder TRH's ability to access funds that it 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 other invested assets (including alternative investments and direct equity investments). Disruptions in the credit and financial markets may materially affect the liquidity of TRH's 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 from time to time it may be difficult for TRH to obtain a credit facility. In addition, conditions in the credit and financial markets, changes in the Company's stock price and other factors could make it difficult for TRH to raise cash in the capital markets.
The impact on TRH of governmental actions made in response to the recent economic crisis is difficult to determine at this time.
In response to the recent financial crises affecting the credit and financial markets and concern about certain 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 U.S. Government equity investments. 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 TRH's competitors may participate in some of these programs. 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.
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:
It is difficult to predict when and how long these conditions will exist and how TRH's markets, business and investments will 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 the investment, changes in the fair value of TRH's securities are reflected in its consolidated balance sheet, statement of operations and/or statement of comprehensive income. 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 pay principal and/or interest if an issuer is unable to repay its debt. Moreover, issuers may face liquidity pressures as a result of economic conditions and, in turn, may be subject to downgrades by the credit rating agencies. These risks could materially adversely affect TRH's results of operations and 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.
TRH'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.
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 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 material 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. Additionally, any proposed or future legislation or insurance regulatory initiatives may be more restrictive than current regulatory requirements or may result in higher costs. (See Regulation in Item 1. Business for a discussion of regulatory developments and related risks.
TRH's offices that operate in jurisdictions outside the U.S. 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 investments 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 technical reserves and remittance balances in some countries may hinder remittance of profits and repatriation of assets.
The loss of key personnel or the inability to access TRH's facilities could adversely affect TRH's results of operations, financial condition and cash flows.
TRH relies upon the knowledge and talent of its employees to successfully conduct business. A loss of key personnel could have a material effect on TRH's results of operations, financial condition and cash flows in future periods. TRH also relies upon access to its facilities by employees to conduct such business. The inability by employees to access TRH's facilities, if over a prolonged time period, could have a material effect on TRH's results of operations, financial condition and cash flows in future periods.
The Company is a holding company and depends on the ability of its subsidiaries to distribute funds to it in order to meet its financial and other obligations.
The payment of dividends, interest and other obligations by the Company is dependent on the ability of its subsidiaries to pay dividends. The payment of dividends by the Company's subsidiaries is restricted by
insurance regulations. For example, under New York insurance law, TRC and Putnam may pay dividends only out of their statutory earned surplus. The inability of the Company's subsidiaries to pay dividends in an amount sufficient for the Company to meet its obligations could have a material adverse effect on TRH.
TRH's counterparties may acquire certain rights upon a change in control of TRH, which could negatively affect TRH.
TRH is a party to numerous contracts, agreements, licenses, permits, authorizations and other arrangements that contain provisions giving counterparties certain rights (including, in some cases, termination rights) in the event of a change in control of the Company or its subsidiaries. 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 may be required to cancel and commute the contract, subject to an agreement between the parties that may be settled in arbitration. If a contract is cancelled on a cut-off basis, TRH may be required to return unearned premiums, net of commissions. 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.
Whether a ceding company would have cancellation rights in connection with a change in control of TRH depends upon the language of its agreement with TRH. Whether a ceding company exercises any cancellation rights it has would depend on, among other factors, such ceding company's views with respect to the prevailing market conditions, the pricing and availability of replacement reinsurance coverage and TRH's ratings.
In addition, contracts may provide a ceding company with multiple options, such as collateralization or commutation, that would be triggered by a change in control. Collateral requirements may take the form of trust agreements or be funded by securities held or letters of credit. Upon commutation, the amount to be paid to settle the liability for gross loss reserves 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. TRH cannot presently predict the effects, if any, a change in control will have, including the extent to which cancellation rights would be exercised, if at all, nor the effect of a change in control on TRH's financial condition, results of operations, or cash flows, but such effect could be material.
Provisions in the Company's certificate of incorporation and by-laws and the insurance laws of the jurisdictions in which TRH operates could discourage another company from acquiring TRH and may prevent attempts by the Company's stockholders to replace or remove TRH's current management.
Some provisions of the Company's certificate of incorporation and by-laws may have the effect of delaying, discouraging or preventing a merger, acquisition or other change in control that the Company's stockholders may consider favorable, including transactions in which stockholders may receive a premium for their shares. In addition, these provisions may frustrate or prevent any attempts by the Company's stockholders to replace or remove TRH's current management by making it more difficult for stockholders to replace or remove the Company's board of directors. These provisions include:
In addition, at any time and without stockholder approval, the Company's board of directors may amend the Company's by-laws in a manner that has the effect of delaying, discouraging or preventing a merger, acquisition or other change in control that the Company's stockholders may consider favorable, including transactions in which stockholders may receive a premium for their shares.
TRH is also subject to the laws governing insurance holding companies of various states and countries where TRH's reinsurance subsidiaries are domiciled. Under these laws, a person generally must obtain the applicable insurance regulator's approval to acquire, directly or indirectly, ten percent (or sometimes five percent) or more of the outstanding voting securities of TRH's reinsurance subsidiaries. These laws may prevent, delay or defer a change in control of the Company or TRH's reinsurance company subsidiaries.
Volatility in the market price of the Company's common stock may make it difficult or impossible for stockholders to obtain a favorable selling price for their shares.
Volatility in the market price of the Company's common stock may prevent stockholders from being able to sell their shares at or above the price they paid for their shares. The Company's common stock price may be volatile due to factors such as:
The stock market in general has experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of companies like TRH. These broad market and industry factors may materially reduce the market price of the Company's common stock, regardless of TRH's operating performance.
TRH utilizes office space in New York, where TRH's headquarters is located, and in various locations around the world, all of which are leased.
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.
In the ordinary course of business, TRH is involved in lawsuits, arbitrations and other formal and informal dispute resolution procedures, the outcomes of which will determine TRH's rights and obligations under reinsurance agreements and other more general contracts. In some disputes, TRH seeks to enforce its rights under an agreement or to collect funds owing to it. In other matters, TRH is resisting
attempts by others to enforce alleged rights. Such disputes are resolved through formal and informal means, including litigation, arbitration and mediation.
In all such matters, TRH believes that its positions are legally and commercially reasonable. TRH also regularly evaluates those positions, and where appropriate, establishes or adjusts loss reserves to reflect its evaluation. TRH's aggregate loss reserves take into account the possibility that TRH may not ultimately prevail in each and every disputed matter. TRH takes into consideration changes in judicial interpretation of legal liability and policy coverages, changes in claims handling practices and inflation. TRH considers not only monetary increases in the cost of what it reinsures, but also changes in societal factors that influence jury verdicts and case law, TRH's approach to claim resolution, and, in turn, claim costs. TRH believes its aggregate loss reserves reduce the potential that an adverse resolution of one or more of these matters, at any point in time, would have a material impact on TRH's financial condition or results of operations. However, there can be no assurance that adverse resolutions of such matters in any one period or in the aggregate will not result in a material adverse effect on TRH's results of operations or financial condition.
On May 21, 2010, the Company and its subsidiaries, TRC and TRZ (collectively, the "TRH Parties"), filed a demand for arbitration, with the American Arbitration Association, against AIG, AIG Securities Lending Corp. and AIG Securities Lending (Ireland) Ltd. (collectively, "AIG Securities Lending") for losses in excess of $350 million suffered by TRH arising from its participation in a securities lending program administered and managed by AIG Securities Lending during the period that TRH was controlled by AIG. The TRH Parties' participations in such securities lending program ended in the fourth quarter of 2008. While the final outcome cannot be predicted with certainty, TRH believes this arbitration, when resolved, will not have a material adverse effect on TRH's results of operations, financial position or cash flows.
On September 30, 2009, TRC initiated arbitration proceedings, with the AIDA Reinsurance and Insurance Arbitration Society, against United Guaranty Residential Insurance Company, United Guaranty Mortgage Indemnity Company, United Guaranty Credit Insurance Company and United Guaranty Residential Insurance Company of North Carolina (collectively, "UGC"), each a subsidiary of the AIG Group. The arbitration proceedings involve certain contracts related to subprime mortgages and credit default insurance pursuant to which UGC purchased reinsurance from TRC (the "Disputed Contracts"). TRC seeks in the proceedings, among other things, to rescind the Disputed Contracts. While the final outcome cannot be predicted with certainty, TRH believes these arbitration proceedings, when resolved, will not have a material adverse effect on TRH's consolidated results of operations, financial position or cash flows.
In addition, from time to time, regulators commence investigations into insurance and reinsurance-industry 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.
The table below sets forth the names, positions and ages of the persons who are the executive officers of the Company as of February 22, 2011.
The following table sets forth the high and low 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 2010 and 2009:
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 (the "Board") 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, 2011, the approximate number of holders of TRH shares, including those whose TRH shares are held in nominee name, was 30,000.
In December 2009, the Board authorized the purchase of up to $200 million of TRH shares from time to time in the open market or via negotiated transactions through December 31, 2011 (the "December 2009 Authorization"). In October 2010, the Board approved a new share repurchase program, which authorizes the Company to repurchase up to $200 million of the Company's outstanding common shares from time to time in the open market or via negotiated transactions through December 31, 2012 (the "October 2010 Authorization"). The October 2010 Authorization superceded the December 2009 Authorization. In the fourth quarter of 2010, the Company repurchased 1,055,000 shares of its common stock as detailed below:
The following Performance Graph compares the cumulative total return to stockholders on TRH shares for a five-year period (December 31, 2005 to December 31, 2010) with the cumulative total return of the S&P 500 stock index (the "S&P 500 Index"), a new peer group of companies (the "New Peer Group") and the new peer group of companies used in the 2009 Annual Report on Form 10-K (the "Old Peer Group"). Dividend reinvestment has been assumed and returns have been weighted to reflect relative stock market capitalization.
The Old Peer Group consists of sixteen reinsurance companies to which TRH compared its business and operations: Arch Capital Group Ltd., Axis Capital Holdings Ltd., Endurance Specialty Holdings Ltd., Everest Re Group Ltd., IPC Holdings, Ltd. (through September 4, 2009, when it was acquired by Validus Holdings, Ltd.), Max Capital Group Ltd. (through May 12, 2010, when it merged with Harbor Point Ltd. to form Alterra Capital Holdings Ltd.), Montpelier Re Holdings Ltd., Odyssey Re Holdings Corp. (through October 28, 2009, when it was acquired by Fairfax Financial Holdings Limited), 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 S.E., SCOR Holding (Switzerland) (formerly known as Converium Holding AG, through June 27, 2008 when it was delisted) and Swiss Reinsurance Company Ltd. and Validus Holdings Ltd. (starting on September 8, 2009). The performance of IPC Holdings, Ltd., Max Capital Group Ltd., Odyssey Re Holdings Corp., 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. The New Peer Group consists of the Old Peer Group with the addition of Alterra Capital Holdings Ltd. starting on May 13, 2010, the first trading day following its formation.
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.
This Annual Report on Form 10-K and other publicly available documents may include, and Transatlantic Holdings, Inc. and its subsidiaries (collectively, "TRH"), through their 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:
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, failures of pricing models to accurately assess risks, the reserving process, the competitive environment in which TRH operates, interest rate and foreign currency exchange rate fluctuations and the uncertainties inherent in international operations.
These factors are further discussed throughout Management's Discussion and Analysis of Financial Condition and Results of Operations and in Part I, Item 1A. Risk Factors of this Form 10-K. TRH is not under any obligation to (and expressly disclaims any such obligation 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.
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. In certain instances, TRH's unpaid losses and loss adjustment expenses ("LAE") are presented net of related reinsurance recoverable ("net loss reserves") in accordance with principles prescribed or permitted by insurance regulatory authorities, as these are standard measures in the insurance and reinsurance industries.
The following discussion refers to the consolidated financial statements of TRH as of December 31, 2010 and 2009 and for each of the three years in the period ended December 31, 2010, which are presented elsewhere herein. Financial data discussed below have been affected by certain transactions between TRH and related parties. (See Notes 12, 14 and 16 of Notes to Consolidated Financial Statements.)
The operations of the Company are conducted principally by its three major operating subsidiariesTransatlantic Reinsurance Company® ("TRC"), Trans Re Zurich Reinsurance Company Ltd. ("TRZ") and Putnam Reinsurance Company ("Putnam")and are managed based on its geographic segments. Through its operations on six continents, TRH offers reinsurance capacity on both a treaty and facultative basisstructuring 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 represents the aggregation of segments that are generally not material.
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 serving 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 2010, casualty lines comprised 71% of TRH's net premiums written, while property lines totaled 29%. In addition, treaty reinsurance totaled 97% of net premiums written, with the balance representing facultative accounts. Business written by international operations represented 50% of net premiums written in 2010. (See Operational Review for year to year comparisons of such measures.)
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 held to maturity and available for sale fixed maturities. In general, premiums are received significantly in advance of related claims payments.
Secondary Public Offering of the Company's Common Stock by American International Group, Inc. ("AIG", and collectively with its subsidiaries, the "AIG Group")
Prior to June 10, 2009 and as of December 31, 2008, AIG beneficially owned approximately 59% of the Company's outstanding shares. On June 10, 2009, AIG and American Home Assurance Company ("AHAC"), a wholly owned subsidiary of AIG, consummated a secondary public offering (the "June 2009 Offering") of 29.9 million issued and outstanding shares of the common stock of the Company owned by AIG and AHAC. On March 15, 2010, AHAC consummated another secondary public offering (the "March 2010 Offering", and collectively with the June 2009 Offering, the "Secondary Offerings") of 8.5 million issued and outstanding shares of the Company's common stock owned by AHAC. The Company repurchased two million shares of its common stock from AHAC in the March 2010 Offering pursuant to a stock offering agreement for an aggregate purchase price of approximately $105 million. TRH did not receive any proceeds from the Secondary Offerings. Immediately following the March 2010 Offering, the AIG Group, including AHAC, beneficially owned 0.7 million shares of the Company's common stock (excluding shares held by certain mutual funds that are advised or managed by subsidiaries of AIG), representing approximately 1.1% of the Company's then outstanding shares. As a result of its reduced ownership percentage, the AIG Group was no longer considered a related party after March 15, 2010.
The following table summarizes TRH's revenues, income before income taxes and net income for the periods indicated:
Revenues decreased in 2010 compared to 2009 due primarily to a decrease in net premiums earned, partially offset by realized net capital gains in 2010 compared to realized net capital losses in 2009. The decrease in net premiums earned occurred principally in the Domestic and International-Europe segments. The lines with the most significant decreases in net premiums earned were the auto liability, property, medical malpractice and ocean marine lines, partially offset by a significant increase in the other liability line. The increase in realized net capital gains (losses) in 2010 is due to a decrease in
other-than-temporary impairments ("OTTI") and an increase in realized net capital gains on sales and redemptions of securities, partially offset by an increase in net foreign currency transaction losses. (See Note 4(e) of Notes to Consolidated Financial Statements ("Note 4(e)") for a breakdown of realized net capital gains (losses).)
Revenues increased in 2009 compared to 2008 due primarily to a decrease in realized net capital losses. The decrease in realized net capital losses was due principally to a decrease in OTTI and an increase in realized net capital gains (losses) on sales and redemptions of securities in 2009 as financial and credit markets stabilized and partially recovered from the turmoil at the end of 2008.
Results for 2010 included pre-tax net catastrophe costs of $202 million principally relating to the earthquake in Chile, the earthquake in New Zealand, storms and floods in Australia and the Deepwater Horizon explosion. While there were no significant catastrophe losses for events occurring in 2009, the year 2009 included a reduction of pre-tax net catastrophe costs incurred of ($6) million relating to events occurring in prior years. Results for 2008 included pre-tax net catastrophe costs of $170 million principally arising from Hurricane Ike. 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 premium 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 (decrease) net premiums written and earned.
Income before income taxes and net income decreased in 2010 compared to 2009 primarily as a result of a decrease in underwriting profit and an increase in interest expense, offset in part by realized net capital gains in 2010 compared to realized net capital losses in 2009. The decrease in underwriting profit was primarily due to an increase in catastrophe costs in 2010, partially offset by an increase in favorable net loss reserve development. The net impact of increased catastrophe costs and increased favorable net loss reserve development was to decrease pre-tax underwriting profit in 2010 by $185.5 million compared to 2009. The increase in interest expense is due to the issuance of $350 million principal amount of TRH's 8.00% senior notes due in 2039 (the "2039 Notes") in November 2009. The decrease in net income between periods was mitigated by reduced tax expense in 2010 primarily related to the lower pre-tax income in 2010.
Income before income taxes and net income increased in 2009 compared to 2008 primarily as a result of a decrease in realized net capital losses and increased underwriting profit. The increase in underwriting profit was primarily due to decreased catastrophe costs and an increase in favorable net loss reserve development in 2009. The increase in net income between periods was reduced by the significant tax expense in 2009 caused by the improved results in 2009. The net impact of decreased catastrophe costs and increased favorable net loss reserve development was to increase pre-tax underwriting profit in 2009 by $216.2 million compared to 2008.
Underwriting profit (loss) is defined as net premiums earned less net losses and LAE incurred, net of commissions and other underwriting expenses, plus (minus) any increase (decrease) in deferred policy acquisition costs. (See Operational Review for further discussion.)
The market conditions in which TRH operates have historically been cyclical, experiencing periods of price erosion followed by rate strengthening as a result of catastrophes or other significant losses or events
that affect the overall capacity of the industry to provide coverage. For the years under discussion, the reinsurance market has been characterized by significant competition worldwide in most lines of business. Additionally, TRH is exposed to the operating cycles of primary insurers as the rates charged by, and the policy terms associated with, primary insurance agreements may affect the rates charged by, and the policy terms associated with, reinsurance agreements, particularly for pro rata reinsurance business.
Following improvements in the U.S. property marketplace after significant catastrophe losses in 2004 and 2005, additional capacity entered the reinsurance market in the form of new companies in Bermuda as well as the entrance of 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 through 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 insurance company balance sheets meant historical risk levels in many cases 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 could not raise capital by issuing debt, did not want to issue equity at depressed stock prices and lost the ability to access the capital markets for alternative reinsurance solutions. In addition, many reinsurers, affected by similar issues, could not maintain the levels of capacity that they had in recent years to take on risk.
Trends in reinsurance rates at the beginning of 2009 were inconsistent, with rates increasing, staying level or deteriorating depending on the line of business or region. However, as 2009 progressed, improvements in general economic conditions, the strengthening of insurers' and reinsurers' balance sheets and the low level of catastrophe losses in 2009 put downward pressure on reinsurance rates. Insurers had greater capacity to retain risk and increased access to capital market alternatives to reinsurance compared to late 2008, while the strengthening of reinsurer balance sheets increased the amount of capacity available in the reinsurance market. Despite weakness in primary rates in several casualty lines and an increase in capacity, reinsurers generally remained disciplined during the January 1, 2010 renewal period. The January 1, 2010 renewals generally saw higher net retentions by cedants and reinsurance rates remaining within acceptable levels while exhibiting greater stability than primary rates.
In the casualty lines, rates were uneven in 2009. Certain lines, like directors' and officers' liability ("D&O") of financial institutions have shown rate increases, while others have been flat or shown decreases. Results in many casualty lines had benefited from favorable accident year loss severity and frequency trends in 2009. During the January 1, 2010 renewal period, casualty insurance rates generally remained under pressure, with some modest improvements in certain lines.
In the property lines, some catastrophe-exposed regions, particularly peak zones, saw significant rate increases in the first half of 2009, which leveled off in the second half of 2009. Overall this business remained at acceptable rate levels through the January 1, 2010 renewal period, with rates in the U.S. down slightly and rates outside of the U.S. generally flat. The strengthening of insurers' balance sheets also led to higher net retentions by cedants during the January 1, 2010 renewal period.
Market conditions were generally challenging in 2010 as a result of several trends: there was downward pressure on reinsurance rates in many lines; ceding companies increased their retentions; there was excess capital in the reinsurance marketplace; and primary insurance brokers pushed for higher ceding commissions.
While the catastrophe events occurring in 2010, which principally affected property lines, resulted in significant losses for the industry, they did not meaningfully impact overall catastrophe reinsurance pricing trends. In addition, some rate softening was evident, with U.S. catastrophe-exposed lines coming under greater pressure than international lines. In the casualty lines, opportunities remained in certain specialty casualty lines such as D&O, which continues to show favorable loss frequency trends, medical malpractice and accident and health ("A&H"), although these lines faced increased pressure as the year progressed. Market conditions for marine and offshore energy lines showed sustained improvement following the Deepwater Horizon explosion, while rate increases leveled off in the aviation line. Primary rates for other casualty lines generally remained under pressure, although internationally they are showing some signs of improvement.
The competitive market conditions generally continued into the January 1, 2011 renewal period. However, certain lines that TRH focuses on did exhibit favorable loss frequency and severity trends and maintained stable terms and conditions. In the property lines, rates decreased slightly but generally remained at acceptable levels. In the casualty lines, certain lines were acceptable while others were more competitive. Marine and offshore energy, domestic medical malpractice, certain errors and omissions liability ("E&O") niches, international A&H and U.K. motor were among the lines that were acceptable. D&O and most general casualty business were among the lines that were more competitive. With the continued competitive market conditions, TRH continued its practice of not renewing certain business that did not meet TRH's underwriting standards.
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.
Starting in mid-2007, the U.S. residential mortgage market and the global credit and financial markets experienced serious disruptions, although some improvement was evident in the latter part of 2009 and in 2010. 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.) However, the current global credit and financial markets may present attractive opportunities for strategic acquisitions and investments, particularly given TRH's strong capital position, financial resources and reputation, which TRH may, from time to time, evaluate and pursue.
Further information relating to items discussed in this Executive Overview may be found throughout MD&A.
Critical Accounting Estimates
This discussion and analysis of financial condition and results of operations is based on TRH's consolidated financial statements which have been prepared in accordance with generally accepted accounting principles in the United States ("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, OTTI of investments and premium revenues, 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 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:
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 changing legal and economic environments 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 can be 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 is 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:
that of general inflation) and trends in court interpretations of coverage are among the factors which must be considered.
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 those 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 employs to assess the reasonableness of loss reserve estimates include the 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:
the volatile nature of experience in older years. 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.
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 underwriting year and by line of business, a point estimate of the loss reserve need is determined. Differences between the indications arising from the various methods are analyzed to understand the drivers of these differences, so that TRH can make a selection based on the methods that are believed to be most appropriate for that line of business. Frequently, the selection is based on an average of the various indications, giving the most weight to the indications deemed most appropriate. Generally speaking, TRH is often able to give more weight to loss development indications for more mature years where credible reported losses exist, as opposed to the more current years, where the B-F method is often highly relied upon due to the lack of credible and mature reported experience. When the actuarial point estimate is compared to the carried reserve, it is recognized that there is an implicit range around the indicated point estimate whereby a carried reserve within that range may be considered reasonable. TRH reviews the appropriateness of the held reserves relative to the indicated point estimate considering many factors. These factors may include, but are not limited to, the amount and direction of any difference between the point estimate and the held reserve, any operational issues which may be difficult to actuarially quantify, various actuarial assumptions on which management may want additional input or any observations regarding optimism or conservatism which management may believe need to be considered. Thus, the carried reserves, as determined by management, may be more or less than the actuarially determined point estimate. As of December 31, 2010 and 2009, TRH's carried loss and LAE reserves, net of related reinsurance recoverable, were $8.21 billion and $7.87 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 2010 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 the IBNR portion of loss reserves from these longer-tailed lines, which represent approximately 85% of the total IBNR portion of loss reserves at December 31, 2010, 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 15 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 at December 31, 2010. For example, changing the ELRs by 5 percentage points has an impact of about $230 million (either positively or negatively) on the loss reserve estimate. While less likely for many classes of business, TRH notes that changing the ELRs by 10 percentage points has an effect of about $470 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 $380 million. Similarly, a 10% deviation would impact the reserve estimate by about $745 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 $625 million. Increasing these assumptions by 10% simultaneously adds approximately $1.29 billion to the reserve estimates, although management considers this scenario to be significantly less likely than the 5% scenario previously discussed. TRH also notes that the classes of business for which these assumptions are most critical are medical malpractice, D&O, E&O and excess casualty.
Net loss reserves include amounts for risks relating to environmental impairment and asbestos-related illnesses. The majority of TRH's environmental and asbestos-related net loss reserves arose from contracts
entered into after 1985 that were underwritten specifically as environmental or asbestos-related coverages rather than as standard general liability coverages, where the environmental or asbestos-related liabilities were neither clearly defined nor specifically excluded. The reserves carried for these claims, including the IBNR portion, 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.
TRH measures at fair value on a recurring basis financial instruments included principally in its available for sale securities portfolios and certain short-term investments. 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. (See Note 3 of Notes to Consolidated Financial Statements ("Note 3") for the valuation techniques and inputs TRH uses to determine the fair value.)
As of December 31, 2010, of TRH's $11.5 billion of fixed maturities available for sale, equities available for sale and other invested assets measured at fair value on a recurring basis, $11.3 billion was based on prices received from independent pricing services and $0.2 billion was based on non-binding broker quotes or internal valuation sources. Management reviewed fair values from external sources and did not make any material adjustments to fair values.
Through June 30, 2009, the AIG Group managed the investments and performed investment recordkeeping and the valuation services discussed in Note 3 for TRH. Effective July 1, 2009, TRH employs third parties not affiliated with AIG to provide these services.
See Note 3 for discussion of how TRH determines the fair value of its fixed maturities available for sale, equities available for sale and certain short-term investments.
Fair Value Hierarchy and Level 3 Assets
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 for additional information about fair value measurements.)
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, 2010, TRH classified $230.0 million of assets measured at fair value on a recurring basis as Level 3. This represented 2.0% 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 the most significant types of assets classified as Level 3.
(c) OTTI of Investments
See Note 4(g) of Notes to Consolidated Financial Statements ("Note 4(g)") for the criteria TRH uses to evaluate if an investment is a candidate for OTTI.
The determination that a security has incurred OTTI in value requires the judgment of management and consideration of the fundamental condition of the issuer, its near-term prospects and all the relevant facts and circumstances.
There can, however, be no assurance that TRH has accurately assessed the level of OTTI reflected in its financial statements. Furthermore, additional OTTI may need to be taken in the future. Historical trends may not be indicative of future OTTI.
At December 31, 2010, TRH had gross unrealized losses on all fixed maturities (including fixed maturities classified as held to maturity) and equities totaling $150 million which did not meet the criteria for OTTI charged to earnings. If TRH's determination of OTTI is materially incorrect, it could have a material adverse effect on TRH's results of operations.
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 generally 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 IBNR portion of loss reserves. 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 become 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, 2010 and 2009, as follows:
TRH has provided no allowance for bad debts relating to the premium estimates based on its historical experience, the 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.
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 gains (losses), (loss) gain on early extinguishment of debt and total revenue of TRH for the periods indicated:
Net premiums written decreased in 2010 compared to 2009 due principally to a decrease in the Domestic segment. The decrease in net premiums written reflects increased ceding company retentions and competitive market conditions which led TRH not to renew certain business that did not meet TRH's underwriting standards.
Net premiums written decreased in 2009 compared to 2008 due in large part to changes in foreign currency exchange rates, but also reflected competitive market conditions which led TRH not to renew certain business that did not meet TRH's underwriting standards.
In 2010 and 2009, each as compared to the respective immediately prior year, the changes in net premiums written were primarily from treaty business. In general, premium fluctuations reflect prevailing market conditions and strategic decisions by TRH's management in recent periods as discussed earlier in MD&A.
A breakdown of total net premiums written in 2010, 2009 and 2008 is as follows:
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 2010 and 2009 compared to the respective immediately prior year.
Domestic net premiums written decreased in 2010 by $101.5 million, or 5.0%, from 2009 to $1.95 billion. Significant decreases in Domestic net premiums written were recorded in the A&H ($28.5 million), auto liability ($25.7 million), medical malpractice ($24.3 million) and other liability ($20.2 million) lines.
International net premiums written in 2010 totaled $1.93 billion and remained level with 2009. Significant decreases in net premiums written occurred in the Miami ($36.5 million) and Paris ($35.7 million) branches, largely offset by significant increases in TRZ ($24.5 million) and the Hong Kong ($17.3 million) and Tokyo ($13.3 million) branches. Significant decreases in International net premiums written were recorded in the ocean marine ($26.9 million) and credit ($24.9 million) lines. These decreases
were largely offset by significant increases in the A&H ($35.1 million) and auto liability ($22.2 million) lines. Changes in foreign currency exchange rates decreased 2010 International net premiums written by $4.6 million compared to 2009. Excluding the impact of changes in foreign currency exchange rates, International net premiums written would have increased 0.1% in 2010 compared to 2009.
Domestic net premiums written increased in 2009 by $15.4 million, or 0.8%, from 2008 to $2.05 billion. Significant increases in Domestic net premiums written were recorded in the A&H ($38.1 million) and other liability ($21.5 million) lines. These increases were largely offset by significant decreases in the medical malpractice ($31.9 million) and auto liability ($17.5 million) lines.
International net premiums written decreased in 2009 by $137.4 million, or 6.6%, from 2008 to $1.94 billion. The significant decreases in net premiums written occurred in the London ($103.1 million), Paris ($100.0 million) and Hong Kong ($27.3 million) branches, partially offset by significant increases in TRZ ($46.2 million) and the Toronto branch ($26.9 million). Significant decreases in International net premiums written were recorded in the property ($101.2 million), auto liability ($59.0 million), boiler and machinery ($22.0 million) and ocean marine ($20.7 million) lines. These decreases were partially offset by significant increases in the A&H ($63.9 million) and other liability ($18.8 million) lines. Of the $137.4 million decrease in international net premiums written, $98.5 million was due to changes in foreign currency exchange rates. Excluding the impact of changes in foreign currency exchange rates, International net premiums written would have decreased 1.9% in 2009 compared to 2008.
Generally, reasons for changes in gross premiums written between years are similar to those for net premiums written, except for changes in ceded premiums, including premiums assumed from a subsidiary of AIG that, by prearrangement, were ceded in an equal amount to other subsidiaries of AIG. See Note 16 of Notes to Consolidated Financial Statements ("Note 16"). The majority of the increase in premiums ceded in 2010 compared to 2009 is due to an increase in premiums assumed from a subsidiary of AIG that, by prearrangement with TRH, were then ceded in an equal amount to other subsidiaries of AIG. The majority of the decrease in premiums ceded in 2009 compared to 2008 is due to a decrease in premiums assumed from a subsidiary of AIG that, by prearrangement with TRH, were then ceded in an equal amount to other subsidiaries of AIG. As further discussed in Note 14 of Notes to Consolidated Financial Statements, certain business assumed by TRH from the AIG Group were related party transactions as a result of the AIG Group's ownership interest during those periods. TRH either accepted or rejected business with such companies based on its assessment of risk selection, pricing, terms and conditions, among other factors.
As premiums written are primarily earned ratably over the terms of the related coverage, 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 2010 increased compared to 2009 due largely to an increase in investment income from fixed maturities of $25.1 million, offset by decreases in investment income from equities of $3.8 million and other investment income of $12.1 million. Excluding the impact of foreign currency exchange rate changes, net investment income in 2010 would have increased by 1.5% compared to 2009. The increase in investment income from fixed maturities is due in part to the investment of net operating cash inflows in recent periods. Net investment income in 2009 increased compared to 2008 due to an increase in investment results from other invested assets of $40 million, principally related to alternative investments. Excluding the changes in foreign currency exchange rates, net investment income in 2009 would have increased 8.1% compared to 2008. Net investment income from other invested assets can display greater volatility than other classes of investments. (See Note 4(d) 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 2010, 2009 and 2008, the pre-tax effective yields on investments were 3.7%, 4.1% and 3.8%, respectively. The pre-tax effective yield on investments represents net investment income divided by the average balance sheet carrying value of investments and interest-bearing cash. The decrease in the pre-tax effective yield on investments for 2010 compared to 2009 is due primarily to a lower pre-tax effective yield on the fixed maturity portfolio. The increase in the pre-tax effective yield on investments for 2009 compared to 2008 is due largely to increased investment income from other invested assets and the impact of securities lending invested collateral on the yield in 2008, partially offset by the decrease in pre-tax effective yield on fixed maturities for 2009 compared to 2008. Investment returns from securities lending invested collateral served to negatively impact the yield in 2008 by 0.3%, 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. (See Investment Results in Item 1. Business.)
Realized net capital gains (losses) totaled $30.1 million, ($70.6) million and ($435.5) million in 2010, 2009 and 2008, respectively. Realized net capital gains (losses) generally result from (a) investment dispositions, which reflect TRH's investment and tax planning strategies to optimize after-tax income; (b) OTTI of investments; and (c) foreign currency transaction gains (losses). See Note 4(e) for a breakdown of realized net capital gains (losses).
Realized net capital losses in 2010 included ($8.0) million of OTTI write-downs charged to earnings, largely related to issuer-specific credit losses on fixed maturities. OTTI decreased in 2010 compared to 2009 due in large part to improvements in the financial and credit markets. Realized net capital losses in 2009 included ($83.1) million of OTTI write-downs charged to earnings, due in large part to the depressed fair values of certain securities and issuer specific credit events in 2009. OTTI decreased in 2009 compared to 2008 as financial and credit markets stabilized and partially recovered from the turmoil at the end of 2008. Realized net capital losses in 2008 included ($99.9) million of net losses on sales and redemptions of securities and ($317.8) million of OTTI write-downs. The significant realized net capital losses from sales and redemptions of securities and OTTI write-downs in 2008 generally resulted from declines in the fair values of securities and issuer-specific credit events due to the downturn in the U.S. economy, turmoil in the financial markets and financial market illiquidity 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 Note 4(g) for the criteria used in the determination of such write-downs.)
OTTI 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: