10-K 1 group10k2007.htm GROUP 10K 2007

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C 20549

FORM 10-K

 

Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the fiscal year ended December 31, 2007

 

Commission file number 1-15731

EVEREST RE GROUP, LTD.

(Exact name of registrant as specified in its charter)

 

Bermuda

(State or other jurisdiction

of incorporation or organization)

 

98-0365432

(I.R.S Employer

Identification No.)

 

Wessex House – 2nd Floor

45 Reid Street

PO Box HM 845

Hamilton HM DX, Bermuda

441-295-0006

(Address, including zip code, and telephone number, including area code,

of registrant’s principal executive office)

 

 

 

 

 

 

 

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of Each Class

Common Shares, $.01 par value per share

 

Name of Each Exchange

on Which Registered

New York Stock Exchange

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

X

 

No

 

 

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.

 

Yes

 

 

No

X

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

 

 

Yes

X

 

No

 

 

 

 

 

 

 

 

 

 

 

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ]

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or 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):

 

Large accelerated filer

X

Accelerated filer

 

 

 

Non-accelerated filer

 

Smaller reporting company

 

 

(Do not check if smaller reporting company)

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.)

 

 

Yes

 

 

No

X

 

 

The aggregate market value on June 30, 2007, the last business day of the registrant’s most recently completed second quarter, of the voting shares held by non-affiliates of the registrant was $6,865.9 million.

 

At February 1, 2008, the number of shares outstanding of the registrant’s common shares was 62,866,606.

 

 

 

 

 

 

 

DOCUMENTS INCORPORATED BY REFERENCE

 

 

 

 

 

 

 

Certain information required by Items 10, 11, 12, 13 and 14 of Form 10-K is incorporated by reference into Part III hereof from the registrant’s proxy statement for the 2008 Annual General Meeting of Shareholders, which will be filed with the Securities and Exchange Commission within 120 days of the close of the registrant’s fiscal year ended December 31, 2007.

 

TABLE OF CONTENTS

 

Item

Page

 

PART I

 

 

 

1.

Business

1

1A.

Risk Factors

30

1B.

Unresolved Staff Comments

42

2.

Properties

42

3.

Legal Proceedings

42

4.

Submission of Matters to a Vote of Security Holders

43

 

 

 

 

 

 

PART II

 

 

 

5.

Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities

43

6.

Selected Financial Data

46

7.

Management’s Discussion and Analysis of Financial Condition and Results of Operation

47

7A.

Quantitative and Qualitative Disclosures About Market Risk

90

8.

Financial Statements and Supplementary Data

90

9.

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

90

9A.

Controls and Procedures

90

9B.

Other Information

91

 

 

 

 

 

 

PART III

 

 

 

10.

Directors and Executive Officers of the Registrant

91

11.

Executive Compensation

91

12.

Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters

91

13.

Certain Relationships and Related Transactions

91

14.

Principal Accountant Fees and Services

92

 

 

 

 

 

 

PART IV

 

 

 

15.

Exhibits and Financial Statement Schedules

92

 

PART I

 

Unless otherwise indicated, all financial data in this document have been prepared using accounting principles generally accepted in the United States of America (“GAAP”). As used in this document, “Group” means Everest Re Group, Ltd. (formerly Everest Reinsurance Group, Ltd.); “Holdings” means Everest Reinsurance Holdings, Inc.; “Everest Re” means Everest Reinsurance Company and its subsidiaries (unless the context otherwise requires); and the “Company” means Everest Re Group, Ltd. and its subsidiaries, except when referring to periods prior to February 24, 2000, when it means Holdings and its subsidiaries.

 

ITEM 1. BUSINESS

 

The Company.

Group, a Bermuda company, was established in 1999 as a wholly-owned subsidiary of Holdings. On February 24, 2000, a corporate restructuring was completed and Group became the new parent holding company of Holdings. Holdings continues to be the holding company for the Company’s U.S. based operations. Holders of shares of common stock of Holdings automatically became holders of the same number of common shares of Group. Prior to the restructuring, Group had no significant assets or capitalization and had not engaged in any business or prior activities other than in connection with the restructuring.

 

In connection with the restructuring, Group established a Bermuda-based reinsurance subsidiary, Everest Reinsurance (Bermuda), Ltd. (“Bermuda Re”), which commenced business in the second half of 2000. Group also formed Everest Global Services, Inc., a Delaware subsidiary, to perform administrative and back-office functions for Group and its U.S. based and non-U.S. based subsidiaries.

 

Holdings, a Delaware corporation, was established in 1993 to serve as the parent holding company of Everest Re, a Delaware property and casualty reinsurer formed in 1973. Until October 6, 1995, Holdings was an indirect wholly-owned subsidiary of The Prudential Insurance Company of America (“The Prudential”). On October 6, 1995, The Prudential sold its entire interest in the shares of common stock of Holdings in an initial public offering (the “IPO”).

 

The Company’s principal business, conducted through its operating segments, is the underwriting of reinsurance and insurance in the U.S., Bermuda and international markets. The Company had gross written premiums in 2007 of $4.1 billion with approximately 78.3% representing reinsurance and 21.7% representing U.S. insurance. Shareholders’ equity at December 31, 2007 was $5.7 billion. The Company underwrites reinsurance both through brokers and directly with ceding companies, giving us the flexibility to pursue business based on the ceding company’s preferred reinsurance purchasing method. The Company underwrites insurance principally through general agent relationships and surplus lines brokers. Group’s active operating subsidiaries, excluding Mt. McKinley Insurance Company (“Mt. McKinley”), which is in run-off, are each rated A+ (“Superior”) by A.M. Best Company (“A.M. Best”), a leading provider of insurer ratings that assigns financial strength ratings to insurance companies based on their ability to meet their obligations to policyholders.

 

Following is a summary of the Company’s principal operating subsidiaries:

 

Bermuda Re, a Bermuda insurance company and a direct subsidiary of Group, is registered in Bermuda as a Class 4 insurer and long-term insurer and is authorized to write property and casualty business and life and annuity business. Bermuda Re commenced business in the second half of 2000. On January 1, 2004 Bermuda Re purchased the UK branch of Everest Re. Bermuda Re’s UK branch provides property and casualty reinsurance to the United Kingdom and European markets. At December 31, 2007, Bermuda Re had shareholders’ equity of $2.5 billion.

 

1


Everest International Reinsurance, Ltd. (“Everest International”), a Bermuda insurance company and a direct subsidiary of Group, is registered in Bermuda as a Class 4 insurer and is authorized to write property and casualty business. Through 2007, all of Everest International’s business has been inter-affiliate quota share reinsurance assumed from Everest Re and the UK branch of Bermuda Re. At December 31, 2007, Everest International had shareholders’ equity of $412.8 million.

 

Everest Re, a Delaware insurance company and a direct subsidiary of Holdings, is a licensed property and casualty insurer and/or reinsurer in all states (except Nevada and Wyoming), the District of Columbia and Puerto Rico and is authorized to conduct reinsurance business in Canada and Singapore. Everest Re underwrites property and casualty reinsurance for insurance and reinsurance companies in the U.S. and international markets. At December 31, 2007, Everest Re had statutory surplus of $2.9 billion.

 

Everest National Insurance Company (“Everest National”), a Delaware insurance company and a direct subsidiary of Everest Re, is licensed in 47 states and the District of Columbia and is authorized to write property and casualty insurance on an admitted basis in the jurisdictions in which it is licensed. The majority of Everest National’s business is reinsured by its parent, Everest Re.

 

Everest Indemnity Insurance Company (“Everest Indemnity”), a Delaware insurance company and a direct subsidiary of Everest Re, writes excess and surplus lines insurance business in the U.S. on a non-admitted basis. Excess and surplus lines insurance is specialty property and liability coverage that an insurer not licensed to write insurance in a particular jurisdiction is permitted to provide to insureds when the specific specialty coverage is unavailable from admitted insurers. Everest Indemnity is licensed in Delaware and is eligible to write business on a non-admitted basis in 49 states, the District of Columbia and Puerto Rico. The majority of Everest Indemnity’s business is reinsured by its parent, Everest Re.

 

Everest Security Insurance Company (“Everest Security”), a Georgia insurance company and a direct subsidiary of Everest Re, writes property and casualty insurance on an admitted basis in Georgia and Alabama. The majority of Everest Security’s business is reinsured by its parent, Everest Re.

 

Mt. McKinley, a Delaware insurance company and a direct subsidiary of Holdings, was acquired by Holdings in September 2000 from The Prudential. In 1985, Mt. McKinley ceased writing new and renewal insurance and commenced a run-off operation to service claims arising from its previously written business. Effective September 19, 2000, Mt. McKinley and Bermuda Re entered into a loss portfolio transfer reinsurance agreement, whereby Mt. McKinley transferred, for arm’s-length consideration, all of its net insurance exposures and reserves to Bermuda Re.

 

Reinsurance Industry Overview.

Reinsurance is an arrangement in which an insurance company, the reinsurer, agrees to indemnify another insurance company, the ceding company, against all or a portion of the insurance risks underwritten by the ceding company under one or more insurance contracts. Reinsurance can provide a ceding company with several benefits, including a reduction in net liability on individual risks or classes of risks, catastrophe protection from large or multiple losses and assistance in maintaining acceptable financial ratios. Reinsurance also provides a ceding company with additional underwriting capacity by permitting it to accept larger risks and write more business than would be possible without a concomitant increase in capital and surplus. Reinsurance, however, does not discharge the ceding company from its liability to policyholders.

 

There are two basic types of reinsurance arrangements: treaty and facultative reinsurance. In treaty reinsurance, the ceding company is obligated to cede and the reinsurer is obligated to assume a specified portion of a type or category of risks insured by the ceding company. Treaty reinsurers do not separately evaluate each of the individual risks assumed under their treaties: instead, the reinsurer relies upon the pricing and underwriting decisions made by the ceding company. In facultative reinsurance, the ceding company cedes and the reinsurer

 

2


assumes all or part of the risk under a single insurance contract. Facultative reinsurance is negotiated separately for each insurance contract that is reinsured. Facultative reinsurance, when purchased by ceding companies, usually is intended to cover individual risks not covered by their reinsurance treaties because of the dollar limits involved or because the risk is unusual.

 

Both treaty and facultative reinsurance can be written on either a pro rata basis or an excess of loss basis. Under pro rata reinsurance, the ceding company and the reinsurer share the premiums as well as the losses and expenses in an agreed proportion. Under excess of loss reinsurance, the reinsurer indemnifies the ceding company against all or a specified portion of losses and expenses in excess of a specified dollar amount, known as the ceding company's retention or reinsurer's attachment point, generally subject to a negotiated reinsurance contract limit.

 

In pro rata reinsurance, the reinsurer generally pays the ceding company a ceding commission. The ceding commission generally is based on the ceding company’s cost of acquiring the business being reinsured (commissions, premium taxes, assessments and miscellaneous administrative expense). Premiums paid by the ceding company to a reinsurer for excess of loss reinsurance are not directly proportional to the premiums that the ceding company receives because the reinsurer does not assume a proportionate risk. There is usually no ceding commission on excess of loss reinsurance.

 

Reinsurers may purchase reinsurance to cover their own risk exposure. Reinsurance of a reinsurer's business is called a retrocession. Reinsurance companies cede risks under retrocessional agreements to other reinsurers, known as retrocessionaires, for reasons similar to those that cause insurers to purchase reinsurance: to reduce net liability on individual or classes of risks, protect against catastrophic losses, stabilize financial ratios and obtain additional underwriting capacity.

 

Reinsurance can be written through intermediaries, generally professional reinsurance brokers, or directly with ceding companies. From a ceding company's perspective, both the broker and the direct distribution channels have advantages and disadvantages. A ceding company's decision to select one distribution channel over the other will be influenced by its perception of such advantages and disadvantages relative to the reinsurance coverage being placed.

 

Business Strategy.

The Company’s business strategy is to sustain its leadership position within its target reinsurance and insurance markets, provide effective management throughout the property and casualty underwriting cycle and achieve an attractive return for its shareholders. The Company’s underwriting strategies seek to capitalize on its i) financial strength and capacity, ii) global franchise, iii) stable and experienced management team, iv) diversified product and distribution offering, v) underwriting expertise and disciplined approach, vi) efficient and low-cost operating structure and vii) prudent enterprise risk management practices.

 

The Company offers treaty and facultative reinsurance and admitted and non-admitted insurance. The Company’s products include the full range of property and casualty reinsurance and insurance coverages, including marine, aviation, surety, errors and omissions liability (“E&O”), directors’ and officers’ liability (“D&O”), medical malpractice, other specialty lines, accident and health (“A&H”) and workers’ compensation. The Company distributes its products through direct and broker reinsurance channels in U.S., Bermuda and international markets.

 

The Company’s underwriting strategy emphasizes underwriting profitability over premium volume. Key elements of this strategy include careful risk selection, appropriate pricing through strict underwriting discipline and adjustment of the Company’s business mix to respond to changing market conditions. The Company focuses on reinsuring companies that effectively manage the underwriting cycle through proper analysis and

 

3


pricing of underlying risks and whose underwriting guidelines and performance are compatible with its objectives.

 

The Company’s underwriting strategy emphasizes flexibility and responsiveness to changing market conditions, such as increased demand or favorable pricing trends. The Company believes that its existing strengths, including its broad underwriting expertise, global presence, strong financial ratings and substantial capital, facilitate adjustments to its mix of business geographically, by line of business and by type of coverage, allowing it to participate in those market opportunities that provide the greatest potential for underwriting profitability. The Company’s insurance operations complement these strategies by providing access to business that is not available on a reinsurance basis. The Company carefully monitors its mix of business across all operations to avoid unacceptable geographic or other risk concentrations.

 

Marketing.

The Company writes business on a worldwide basis for many different customers and lines of business, thereby obtaining a broad spread of risk. The Company is not substantially dependent on any single customer, small group of customers, line of business or geographic area. For the 2007 calendar year, no single customer (ceding company or insured) generated more than 8.2% of the Company’s gross written premiums. The Company does not believe that a reduction of business from any one customer would have a material adverse effect on its future financial condition or results of operations.

 

Approximately 67%, 10% and 23% of the Company’s 2007 gross written premiums were written in the broker reinsurance, direct reinsurance and insurance markets, respectively. The Company’s ability to write reinsurance both through brokers and directly with ceding companies gives it the flexibility to write business based on the ceding company’s preferred reinsurance purchasing method.

 

The broker reinsurance market consists of several substantial national and international brokers and a number of smaller specialized brokers. Brokers do not have the authority to bind the Company with respect to reinsurance agreements, nor does the Company commit in advance to accept any portion of a broker’s submitted business. Reinsurance business from any ceding company, whether new or renewal, is subject to acceptance by the Company. Brokerage fees are generally paid by reinsurers. The Company’s ten largest brokers accounted for an aggregate of approximately 58% of gross written premiums in 2007, with the two largest brokers accounting for approximately 15% (Marsh & McLennan Companies, Inc.) and 14% (Willis Group, Ltd.) of gross written premiums. The Company does not believe that a reduction of business assumed from any one broker would have a materially adverse effect on the Company.

 

The direct reinsurance market remains an important distribution channel for reinsurance business written by the Company. Direct placement of reinsurance enables the Company to access clients who prefer to place their reinsurance directly with reinsurers based upon the reinsurer’s in-depth understanding of the ceding company’s needs.

 

The Company’s insurance business is written principally through general agents and surplus lines brokers. In 2007, C.V. Starr accounted for approximately 6% of the Company’s gross written premium. No other single general agent generated more than 5% of the Company’s gross written premiums.

 

The Company continually evaluates each business relationship, including the underwriting expertise and experience brought to bear through the involved distribution channel, performs analyses to evaluate financial security, monitors performance and adjusts underwriting decisions accordingly.

 

4


Segment Results.

The Company, through its subsidiaries, operates in five segments: U.S. Reinsurance, U.S. Insurance, Specialty Underwriting, International and Bermuda. The U.S. Reinsurance operation writes property and casualty reinsurance, on both a treaty and facultative basis, through reinsurance brokers, as well as directly with ceding companies within the U.S. The U.S. Insurance operation writes property and casualty insurance primarily through general agents and surplus lines brokers within the U.S. The Specialty Underwriting operation writes A&H, marine, aviation and surety business within the U.S. and worldwide through brokers and directly with ceding companies. The International operation writes non-U.S. property and casualty reinsurance through Everest Re’s branches in Canada and Singapore and offices in Miami and New Jersey. The Bermuda operation provides insurance and reinsurance to worldwide property and casualty markets and reinsurance to the United Kingdom and European markets through its UK branch.

 

These segments are managed in a coordinated fashion with respect to pricing, risk management, control of aggregate catastrophe exposures, capital, investments and support operations. Management generally monitors and evaluates the financial performance of these operating segments based upon their underwriting results.

 

Underwriting results include earned premium less losses and loss adjustment expenses (“LAE”) incurred, commission and brokerage expenses and other underwriting expenses. Underwriting results are measured using ratios, in particular loss, commission and brokerage and other underwriting expense ratios, which respectively, divide incurred losses, commissions and brokerage and other underwriting expenses by earned premium. The Company utilizes inter-affiliate reinsurance, although such reinsurance does not materially impact segment results, as business is generally reported within the segment in which the business was first produced. For selected financial information regarding these segments, see Note 20 of Notes to Consolidated Financial Statements and Segment Results in ITEM 7.

 

5


Underwriting Operations.

The following five year table presents the distribution of the Company’s gross written premiums by its segments: U.S. Reinsurance, U.S. Insurance, Specialty Underwriting, International and Bermuda. The premiums for each segment are further split between property and casualty business and, for reinsurance business, between pro rata or excess of loss business:

 

 

Gross Written Premiums by Segment

 

Years Ended December 31,

(Dollars in millions)

2007

 

2006

 

2005

 

2004

 

2003

U.S. Reinsurance

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  Property

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    Pro Rata (1)

$        455.9

11.2%

 

$     379.7

9.5%

 

$     414.0

10.1%

 

$     339.7

7.2%

 

$     357.8

7.8%

    Excess

332.2

8.1%

 

303.2

7.6%

 

236.9

5.8%

 

208.8

4.4%

 

241.0

5.3%

  Casualty

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    Pro Rata (1)

216.5

5.3%

 

446.7

11.2%

 

529.4

12.9%

 

702.8

14.9%

 

625.7

13.7%

    Excess

189.0

4.6%

 

207.1

5.2%

 

205.9

5.0%

 

226.8

4.8%

 

527.8

11.5%

  Total (2)

1,193.5

29.3%

 

1,336.7

33.4%

 

1,386.2

33.8%

 

1,478.1

31.4%

 

1,752.3

38.3%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Insurance

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  Property

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    Pro Rata (1)

85.6

2.1%

 

40.6

1.0%

 

196.9

4.8%

 

159.0

3.4%

 

42.9

0.9%

    Excess

-

0.0%

 

-

0.0%

 

-

0.0%

 

-

0.0%

 

-

0.0%

  Casualty

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    Pro Rata (1)

800.0

19.6%

 

825.7

20.6%

 

735.6

17.9%

 

1,008.8

21.4%

 

1,026.6

22.5%

    Excess

-

0.0%

 

-

0.0%

 

-

0.0%

 

-

0.0%

 

-

0.0%

  Total (2)

885.6

21.7%

 

866.3

21.7%

 

932.5

22.7%

 

1,167.8

24.8%

 

1,069.5

23.4%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Specialty Underwriting

 

 

 

 

 

 

 

 

 

 

 

 

 

  Property

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    Pro Rata (1)

190.2

4.7%

 

179.3

4.5%

 

206.1

5.0%

 

374.8

8.0%

 

396.7

8.7%

    Excess

51.1

1.3%

 

37.5

0.9%

 

65.2

1.6%

 

65.4

1.4%

 

64.3

1.4%

  Casualty

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    Pro Rata (1)

23.6

0.6%

 

28.5

0.7%

 

30.7

0.7%

 

34.1

0.7%

 

28.1

0.6%

    Excess

5.1

0.1%

 

5.9

0.1%

 

12.6

0.3%

 

12.8

0.3%

 

13.8

0.3%

  Total (2)

270.1

6.6%

 

251.2

6.3%

 

314.6

7.6%

 

487.1

10.4%

 

502.9

11.0%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total U.S.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  Property

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    Pro Rata (1)

731.7

17.9%

 

599.6

15.0%

 

817.0

19.9%

 

873.5

18.6%

 

797.4

17.4%

    Excess

383.3

9.4%

 

340.7

8.5%

 

302.1

7.4%

 

274.2

5.8%

 

305.3

6.7%

  Casualty

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    Pro Rata (1)

1,040.1

25.5%

 

1,300.9

32.5%

 

1,295.7

31.5%

 

1,745.7

37.1%

 

1,680.4

36.8%

    Excess

194.1

4.8%

 

213.0

5.3%

 

218.5

5.3%

 

239.6

5.1%

 

541.6

11.8%

  Total (2)

2,349.2

57.6%

 

2,454.2

61.3%

 

2,633.3

64.1%

 

3,133.0

66.6%

 

3,324.7

72.7%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

International

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  Property

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    Pro Rata (1)

451.6

11.1%

 

415.4

10.4%

 

421.4

10.3%

 

426.0

9.1%

 

328.5

7.2%

    Excess

212.9

5.2%

 

195.6

4.9%

 

160.4

3.9%

 

159.7

3.4%

 

118.6

2.6%

  Casualty

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    Pro Rata (1)

68.3

1.7%

 

53.9

1.3%

 

66.4

1.6%

 

51.2

1.1%

 

31.3

0.7%

    Excess

73.1

1.8%

 

66.8

1.7%

 

58.4

1.4%

 

50.8

1.1%

 

42.4

0.9%

  Total (2)

805.9

19.8%

 

731.7

18.3%

 

706.6

17.2%

 

687.7

14.6%

 

520.8

11.4%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Bermuda

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  Property

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    Pro Rata (1)

282.2

6.9%

 

312.3

7.8%

 

322.9

7.8%

 

309.7

6.6%

 

230.0

5.0%

    Excess

201.6

4.9%

 

174.3

4.4%

 

151.8

3.7%

 

232.5

4.9%

 

239.5

5.2%

  Casualty

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    Pro Rata (1)

326.1

8.0%

 

230.7

5.8%

 

208.8

5.1%

 

227.0

4.8%

 

175.4

3.8%

    Excess

112.5

2.8%

 

97.7

2.4%

 

85.2

2.1%

 

114.2

2.4%

 

83.3

1.8%

  Total (2)

922.5

22.7%

 

815.0

20.4%

 

768.7

18.7%

 

883.4

18.8%

 

728.2

15.9%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Company

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  Property

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    Pro Rata (1)

1,465.6

35.9%

 

1,327.3

33.2%

 

1,561.3

38.0%

 

1,609.2

34.2%

 

1,355.9

29.6%

    Excess

797.8

19.6%

 

710.6

17.8%

 

614.3

15.0%

 

666.4

14.2%

 

663.4

14.5%

  Casualty

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    Pro Rata (1)

1,434.5

35.2%

 

1,585.5

39.6%

 

1,570.9

38.2%

 

2,023.9

43.0%

 

1,887.2

41.3%

    Excess

379.7

9.3%

 

377.5

9.4%

 

362.1

8.8%

 

404.6

8.6%

 

667.3

14.6%

  Total (2)

$     4,077.6

100.0%

 

$  4,000.9

100.0%

 

$  4,108.6

100.0%

 

$  4,704.1

100.0%

 

$  4,573.8

100.0%

___________

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(1) For purposes of the presentation above, pro rata includes all insurance and reinsurance attaching to the first dollar of loss incurred by the ceding company.

 

(2) Certain totals and subtotals may not reconcile due to rounding.

 

 

 

 

 

 

 

 

 

 

6




U.S. Reinsurance Segment. The Company’s U.S. Reinsurance segment writes property and casualty reinsurance, both treaty and facultative, through reinsurance brokers as well as directly with ceding companies within the U.S. The Company targets certain brokers and, through the broker market, specialty companies and small to medium sized standard lines companies. The Company also targets companies that place their business predominantly in the direct market, including small to medium sized regional ceding companies, and seeks to develop long-term relationships with those companies. In addition, the U.S. Reinsurance segment writes portions of reinsurance programs for large, national insurance companies.

 

In 2007, $714.2 million of gross written premiums were attributable to U.S. treaty property business, of which 63.8% was written on a pro rata basis and 36.2% was written on an excess of loss basis. The Company’s property underwriters utilize sophisticated underwriting methods to analyze and price property business. The Company manages its exposures to catastrophe and other large losses by limiting exposures on individual contracts and limiting aggregate exposures to catastrophes in any particular zone and across contiguous zones.

 

U.S. treaty casualty business accounted for $334.0 million of gross written premiums in 2007, of which 64.8% was written on a pro rata basis and 35.2% was written on an excess of loss basis. The treaty casualty business consists of professional liability, D&O liability, workers’ compensation, excess and surplus lines and other liability coverages. As a result of the complex technical nature of most of these risks, the Company’s casualty underwriters tend to specialize by line of business and work closely with the Company’s pricing actuaries.

 

The Company’s facultative unit conducts business both through brokers and directly with ceding companies, and consists of four underwriting units representing property, casualty, specialty and national brokerage lines of business. Business is written from a facultative headquarters office in New York and satellite offices in Chicago and Oakland. In 2007, $55.7 million, $65.2 million, $6.2 million and $18.2 million of gross written premiums were attributable to the property, casualty, specialty and national brokerage lines of business, respectively.

 

In 2007, 89.4%, 7.4% and 3.2% of the U.S. Reinsurance segment’s gross written premiums were written in the broker reinsurance, direct reinsurance and insurance markets, respectively.

 

U.S. Insurance Segment.In 2007, the Company’s U.S. Insurance segment wrote $885.6 million of gross written premiums, of which 90.3% was casualty and 9.7% was property. Of the total business written, Everest National wrote $571.1 million and Everest Re wrote $98.6 million, principally targeting commercial property and casualty business written through general agents with program administrators. Workers’ compensation business accounted for $224.9 million, or 25.4% of the total business written, including $133.1 million, or 59.2%, of workers’ compensation business written in California. Non-workers’ compensation business represented $660.7 million, or 74.6% of the total business written. Everest Indemnity wrote $192.4 million, principally excess and surplus lines insurance business written through surplus lines brokers. Everest Security wrote $23.5 million, principally non-standard auto insurance written through retail agents. With respect to insurance written through general agents and surplus lines brokers, the Company supplements the initial underwriting process with periodic claims, underwriting and operational reviews and ongoing monitoring.

 

Specialty Underwriting Segment. The Company’s Specialty Underwriting segment writes A&H, marine, aviation and surety reinsurance. The A&H unit primarily focuses on health reinsurance of traditional indemnity plans, self-insured health plans, accident coverages and specialty medical plans. The marine and aviation unit focuses on ceding companies with a particular expertise in marine and aviation business. The marine and aviation business is written primarily through brokers and contains a significant international component written primarily through the London market. Surety business underwritten by the Company consists mainly of reinsurance of contract surety bonds.

 

In 2007, gross written premiums of the A&H unit totaled $95.5 million, primarily written through brokers.

 

7


The marine and aviation unit’s 2007 gross written premiums totaled $128.6 million, substantially all of which was written on a treaty basis and sourced through reinsurance brokers. Marine treaties represented 77.7% of marine and aviation gross written premiums in 2007 and consisted mainly of hull and energy coverage. Approximately 57.6% of the marine unit’s premiums in 2007 were written on a pro rata basis and 42.4% on an excess of loss basis. Aviation premiums accounted for 22.3% of marine and aviation gross written premiums in 2007 and included reinsurance for airlines and general aviation. Approximately 82.2% of the aviation unit's premiums in 2007 was written on a pro rata basis and 17.8% on an excess of loss basis.

 

In 2007, gross written premiums of the surety unit totaled $45.9 million, 94.4% of which was written on a pro rata basis. Most of the portfolio is reinsurance of contract surety bonds written directly with ceding companies, with the remainder being trade credit reinsurance, mostly in international markets.

 

International Segment. The Company’s International segment focuses on opportunities in the international reinsurance markets. The Company targets several international markets, including: Canada, with a branch in Toronto; Asia, with a branch in Singapore; and Latin America, Africa and the Middle East, which business is serviced from Everest Re’s Miami and New Jersey offices. The Company also writes from New Jersey “home-foreign” business, which provides reinsurance on the international portfolios of U.S. insurers. Approximately 82.5% of the Company’s 2007 international gross written premiums represented property business, while 17.5% represented casualty business. As with its U.S. operations, the Company’s International segment focuses on financially sound companies that have strong management and underwriting discipline and expertise. Approximately 73.8% of the Company’s international business was written through brokers, with 26.2% written directly with ceding companies.

 

Gross written premiums of the Company’s Canadian branch totaled $169.9 million in 2007 and consisted of 29.7% of pro rata property business, 24.8% of excess property business, 13.9% of pro rata casualty business and 31.6% of excess casualty business. Approximately 76.6% of the Canadian premiums consisted of treaty reinsurance, while 23.4% was facultative reinsurance.

 

The Company’s Singapore branch covers the Asian markets and accounted for $165.3 million of gross written premiums in 2007 and consisted of 60.7% of pro rata property business, 33.5% of excess property business, 3.5% of pro rata casualty business and 2.3% of excess casualty business.

 

International business written out of Everest Re’s Miami and New Jersey offices accounted for $470.7 million of gross written premiums in 2007 and consisted of 63.9% of pro rata treaty property business, 8.3% of pro rata treaty casualty business, 18.0% of excess treaty property business, 3.1% of excess treaty casualty business and 6.7% of facultative property and casualty business. Of this international business, 59.1% was sourced from Latin America, 23.8% was sourced from the Middle East, 8.2% was “home-foreign” business, 7.7% was sourced from Africa, 1.1% was sourced from Asia and 0.1% was sourced from Europe.

 

Bermuda Segment. The Company’s Bermuda segment writes property and casualty insurance and reinsurance through Bermuda Re and property and casualty reinsurance through its UK branch. In 2007, Bermuda Re had gross property and casualty written premiums of $327.8 million accounting for virtually all of its business, of which $305.9 million, or 93.4%, was treaty reinsurance; $21.3 million, or 6.5%, was facultative reinsurance or individual risk insurance and $0.6 million was sourced from Belgium.

 

In 2007, the UK branch of Bermuda Re wrote $594.7 million of gross treaty reinsurance premium consisting of 37.8% of pro rata property business, 20.7% of excess property business, 25.4% of pro rata casualty business and 16.1% of excess casualty business.

 

Geographic Areas. The Company conducts its business in Bermuda, the U.S. and a number of foreign countries. For select financial information about geographic areas, see Note 20 of Notes to the Consolidated Financial

 

8


Statements. Risks attendant to the foreign operations of the Company parallel those attendant to the U.S. operations of the Company, with the primary exception of foreign exchange risks. For more information about the risks, see ITEM 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Safe Harbor Disclosure”.

 

Underwriting.

The Company’s ability to write both property and casualty risks allows it to underwrite entire contracts or major portions thereof that might otherwise need to be syndicated among several reinsurers. The Company’s strategy is to "lead" in as many of the reinsurance treaties it underwrites as possible. The lead reinsurer on a treaty generally accepts one of the largest percentage shares of the treaty and is in the strongest position to negotiate price, terms and conditions. Management believes this strategy enables it to obtain more favorable terms and conditions on the treaties on which it participates. When the Company does not lead the treaty, it may still suggest changes to any aspect of the treaty. The Company may decline to participate on a treaty based upon its assessment of all relevant factors.

 

The Company’s treaty underwriting process emphasizes a team approach among the Company’s underwriters, actuaries and claim staff. Treaties are reviewed for compliance with the Company’s general underwriting standards and certain larger treaties are evaluated, in part, based upon actuarial analyses by the Company. The actuarial models used in such analyses are tailored in each case to the subject exposures and loss experience. The Company does not separately evaluate each of the individual risks assumed under its treaties. The Company does, however, evaluate the underwriting guidelines of its ceding companies to determine their adequacy prior to entering into a treaty. The Company, when appropriate, also conducts underwriting, operational and claim audits at the offices of ceding companies to monitor adherence to underwriting guidelines. Underwriting audits focus on the quality of the underwriting staff, pricing and risk selection and rate monitoring over time. Claim audits, when appropriate, are performed in order to evaluate the client’s claims handling abilities and practices.

 

The Company’s facultative underwriters operate within guidelines specifying acceptable types of risks, limits and maximum risk exposures. Specified classes of large premium U.S. risks are referred to Everest Re’s New York facultative headquarters for specific review before premium quotations are given to clients. In addition, the Company’s guidelines require certain types of risks to be submitted for review because of their aggregate limits, complexity or volatility, regardless of premium amount on the underlying contract. Non-U.S. risks exhibiting similar characteristics are reviewed by senior managers within the involved operations.

 

The Company’s insurance operations principally write casualty coverages for homogeneous risks through select program managers. These programs are evaluated based upon actuarial analysis and the program manager’s capabilities. The Company’s rates, forms and underwriting guidelines are tailored to specific risk types. The Company’s underwriting, actuarial, claim and financial functions work closely with its program managers to establish appropriate underwriting and processing guidelines as well as appropriate performance monitoring mechanisms.

 

Risk Management of Underwriting and Retrocession Arrangements

 

Underwriting Risk and Accumulation Controls.Each segment and business unit manages its underwriting risk in accordance with established guidelines. These guidelines place dollar limits on the amount of business that can be written based on a variety of factors, including ceding company profile, line of business, geographic location and risk hazards. In each case, the guidelines permit limited exceptions, which must be authorized by the Company’s senior management. Management regularly reviews and revises these guidelines in response to changes in business unit market conditions, risk versus reward analyses and the Company’s underwriting risk management processes.

 

9


The operating results and financial condition of the Company can be adversely affected by catastrophe and other large losses. The Company manages its exposure to catastrophes and other large losses by:

 

selective underwriting practices;

 

diversifying its risk portfolio by geographic area and by types and classes of business;

 

limiting its aggregate catastrophe loss exposure in any particular geographic zone and contiguous zones;

 

purchasing retrocessional protection to the extent that such coverage can be secured cost-effectively. See “Retrocession Arrangements”.

 

Like other insurance and reinsurance companies, the Company is exposed to multiple insured losses arising out of a single occurrence, whether a natural event, such as a hurricane or an earthquake, or other catastrophe, such as an explosion at a major factory. A large catastrophic event can be expected to generate insured losses to multiple reinsurance treaties, facultative certificates and across lines of business.

 

The Company focuses on potential losses that could result from any single event or series of events as part of its evaluation and monitoring of its aggregate exposures to catastrophic events. Accordingly, the Company employs various techniques to estimate the amount of loss it could sustain from any single catastrophic event in various geographic areas. These techniques range from non-modeled deterministic approaches, such as tracking aggregate limits exposed in catastrophe-prone zones and applying historic damage factors, to modeled approaches that scientifically measure catastrophe risks using sophisticated Monte Carlo simulation techniques that forecast frequency and severity of expected losses on a probabilistic basis.

 

No single universal model is currently capable of projecting the amount and probability of loss in all global geographic regions in which the Company conducts business. In addition, the form, quality and granularity of underwriting exposure data furnished by ceding companies is not uniformly compatible with the data requirements for the Company’s licensed models, which adds to the inherent imprecision in the potential loss projections. Further, the results from multiple models and analytical methods must be combined and interpolated to estimate potential losses by and across business units. The combination of techniques potentially adds to the imprecision of the Company’s estimates. Also, while most models have been updated to better incorporate factors that contributed to unprecedented industry storm losses in 2004 and 2005, such as flood, storm surge and demand surge, catastrophe model projections are inherently imprecise. In addition, uncertainties with respect to future climatic patterns and cycles add to the already significant uncertainty of loss projections from models using historic long term frequency and severity data.

 

Nevertheless, when combined with traditional risk management techniques and sound underwriting judgment, catastrophe models are a useful tool for underwriters to price catastrophe exposed risks and for providing management with quantitative analyses with which to monitor and manage catastrophic risk exposures by zone and across zones for individual and multiple events.

 

Projected catastrophe losses are generally summarized in terms of the probable maximum loss (“PML”). The Company defines PML as its anticipated loss, taking into account contract terms and limits, caused by a single catastrophe affecting a broad contiguous geographic area, such as that caused by a hurricane or earthquake. The PML will vary depending upon the severity of modeled simulated losses and the make-up of the in force book of business. The projected severity levels are described in terms of “return periods”, such as “100-year events” and “250-year events”. For example, a 100-year PML corresponds to the estimated loss from a single event which has a 1% probability of being exceeded in a twelve month period. Conversely, it corresponds to a 99% probability that the loss from a single event will fall below the indicated PML. It is important to note that PMLs are estimates. Modeled events are hypothetical events produced by a stochastic model. As a result, there can be

 

10


no assurance that any actual event will align with the modeled event or that actual losses from events similar to the modeled events will not vary materially from the modeled event PML.

 

From an enterprise risk management perspective, management sets limits on the levels of catastrophe loss exposure the Company may underwrite. The limits are revised periodically based on a variety of factors, including but not limited to the Company’s financial resources and expected earnings and risk/reward analyses of the business being underwritten.

 

As of January 1, 2008, management estimated that the projected economic loss from its largest 100-year event does not exceed $600 million or about 10% of shareholders’ equity. Economic loss is the gross PML reduced by estimated reinstatement premiums to renew coverage and income taxes. The impact of income taxes on the PML depends on the distribution of the losses by corporate entity, which is also affected by inter-affiliate reinsurance. Management also monitors and controls its largest PMLs at multiple points along the loss distribution curve, such as loss amounts at the 20, 50, 100, 250, 500 and 1,000 year return periods. This process enables management to identify and control exposure accumulations and to integrate such exposures into enterprise risk, underwriting and capital management decisions.

 

The Company’s catastrophe loss projections, segmented by risk zones, are updated quarterly and reviewed as part of a formal risk management review process. The table below reflects the Company’s pre-tax PMLs at various return times for its top three zones/perils (as ranked by the largest 1 in 100 year events) based on loss projection data as of January 1, 2008:

 

Return Periods (in years)

 

1 in 20

1 in 50

1 in 100

1 in 250

1 in 500

1 in 1,000

Exceeding Probability

 

5.0%

2.0%

1.0%

0.4%

0.2%

0.1%

 

 

 

 

 

 

 

 

(Dollars in millions)

 

 

 

 

 

 

 

Zone/Area, Peril

 

 

 

 

 

 

 

Southeast U.S., Wind

 

$            379

$             660

$             888

$        1,197

$        1,346

$        1,445

Europe, Wind

 

233

499

635

737

828

873

Northeast U.S., Wind

 

25

205

500

765

996

1,185

 

The Company purchases limited amounts of retrocessional coverage. While the Company considers purchasing corporate level retrocessional protection by evaluating the underlying exposures in comparison to the availability of cost-effective protection, there was no such retrocessional coverage in place at January 1, 2008. The Company continues to evaluate the availability and cost of various retrocessional products and loss mitigation approaches in the marketplace.

 

The projected economic losses for the three highest 1 in 100 PML losses in the above table are as follows: for the Southeast U.S. wind storm, $564 million; for the European wind storm, $399 million and for the Northeast U.S. wind storm, $318 million. The projection for the Southeast wind storm does not consider potential impacts from the Florida insurance reform that increases insurers’ access to the Florida Hurricane Catastrophe Fund, thus potentially reducing the amount of reinsurance purchased from the private reinsurance markets. The Company is unable to predict if this will reduce future reinsurance coverage in Florida and correspondingly reduce the PML for a Southeast wind storm.

 

The Company believes that its methods of monitoring, analyzing and managing catastrophe exposures provide a credible risk management framework, which can be integrated with its underwriting business and capital management activities. However, there is much uncertainty and imprecision inherent in the catastrophe models and the catastrophe loss estimation process generally. As a result, there can be no assurance that the Company will not experience losses from individual events that exceed the PML or other return period projections, perhaps by a material amount. Nor can there be assurance that the Company will not experience events

 

11


impacting multiple zones, or multiple severe events that could, in the aggregate, exceed the Company’s PML expectations by a significant amount.

 

Terrorism Risk.The Company does not have significant exposure to losses from terrorism risk. While the Company writes some reinsurance contracts covering events of terrorism, the Company’s risk management philosophy is to limit the amount of coverage provided and specifically not provide terrorism coverage for properties or in areas that may be considered a target for terrorists. Although providing terrorism coverage on reinsurance contracts is negotiable, most insurance policies mandate inclusion of terrorism coverage. As a result, the Company is exposed to losses from terrorism on its U.S. insurance book of business, particularly its workers’ compensation policies; however, the Company generally does not insure large corporations or corporate locations that represent large concentrations of risk.

 

As a result of its limited exposure, the Company does not believe the U.S. Terrorism Risk Insurance Act of 2002 that was signed into law November 2002 and amended in December 2005 and December 2007 has had or will have a significant impact on its operations.

 

Retrocession Arrangements. The Company considers retrocessional agreements to reduce its exposure on specific business written and potential accumulations of exposures across some or all of the Company’s operations. Where reinsurance is purchased, the agreements provide for recovery of a portion of losses and LAE from retrocessionaires. The level of retrocessional coverage varies over time, reflecting the underwriter’s and/or Company’s view of the changing dynamics of both the underlying exposure and the reinsurance markets. All retrocessional purchasing decisions consider both the potential coverage and market conditions with respect to the pricing, terms, conditions and availability of such coverage, with the aim of securing cost-effective protection. No assurance can be given that the Company will seek or be able to obtain retrocessional coverage in the future similar to that in place currently or in the past.

 

The Company does not typically purchase significant retrocessional coverage for specific reinsurance business written, but it will do so when management deems it to be prudent and/or cost-effective to reinsure a portion of the specific risks being assumed. The Company also participates in “common account” retrocessional arrangements for certain reinsurance treaties whereby a ceding company purchases reinsurance for the benefit of itself and its reinsurers under one or more of its reinsurance treaties. Common account retrocessional arrangements reduce the effect of individual or aggregate losses to all participating companies, including the ceding company, with respect to the involved treaties.

 

The Company typically considers the purchase of reinsurance to cover insurance program exposures written by the U.S. Insurance segment. The type of reinsurance coverage considered is dependent upon individual risk exposures, individual program exposures, aggregate exposures by line of business, overall segment exposures and the cost effectiveness of available reinsurance. Facultative reinsurance will typically be considered for large individual exposures and quota share reinsurance will generally be considered for entire programs of business.

 

The Company also considers purchasing corporate level retrocessional protection covering the potential accumulation of exposures. Such consideration includes balancing the underlying exposures against the availability of cost-effective retrocessional protection. For years ended December 31, 1999, 2000 and 2001, the Company purchased accident year aggregate excess of loss retrocession coverage that provided up to $175 million of coverage for each year. These excess of loss policies provided coverage if Everest Re’s consolidated statutory basis accident year loss ratio exceeded a specified attachment point for each year of coverage. The attachment point was net of inuring reinsurance and included adjustable premium provisions that effectively caused the Company to offset, on a pre-tax income basis, up to approximately 57% of such ceded losses. The maximum recovery for each year was $175 million before giving effect to the adjustable premium and the Company had ceded the maximum limits under all three contracts. The Company has not purchased similar corporate level coverage subsequent to December 31, 2001.

 

12


All of the Company’s retrocessional agreements transfer significant reinsurance risk and therefore, are accounted for as reinsurance under Statement of Financial Accounting Standards (“FAS”) No. 113, “Accounting and Reporting for Reinsurance of Short Duration and Long Duration Contracts”.

 

In connection with the Company’s acquisition of Mt. McKinley in September 2000, the Company obtained coverage under an aggregate excess of loss reinsurance agreement provided by Prudential Property and Casualty Insurance Company of Indiana (“Prupac”), a wholly-owned subsidiary of The Prudential. On October 31, 2003, LM Property & Casualty Insurance Company (“LM”) completed its purchase of Prupac and its obligations from The Prudential. The Prudential continues to guarantee LM’s obligation under this agreement. This agreement covers 80%, or $160 million, of the first $200 million of any adverse loss reserve development on the carried reserves of Mt. McKinley at the date of acquisition and reimburses the Company as such losses are paid by the Company. Cessions under this reinsurance agreement had exhausted the limit available under the contract as of December 31, 2003.

 

At December 31, 2007, the Company carried as an asset $666.2 million in reinsurance receivables with respect to losses ceded. Of this amount, $176.1 million, or 26.4%, was receivable from Transatlantic Reinsurance Company (“Transatlantic”); $152.1 million, or 22.8%, was receivable from Founders Insurance Company Limited (“Founders”), for which the Company has established $151.4 million provision for uncollectible reinsurance; $100.0 million, or 15.0%, was receivable from Continental Insurance Company ("Continental"); $54.6 million, or 8.2%, was receivable from Munich Reinsurance Company (“Munich Re”); $45.4 million, or 6.8%, was receivable from LM; $38.5 million, or 5.8%, was receivable from ACE Property and Casualty Insurance Company (“Ace”) and $37.7 million, or 5.7%, was receivable from Berkley Insurance Company (“Berkley”). No other retrocessionaire accounted for more than 5% of the Company’s receivables. Although management carefully selects its reinsurers, the Company is subject to credit risk with respect to its reinsurance because the ceding of risk to reinsurers does not relieve the Company of its liability to insureds or ceding companies. See ITEM 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Financial Condition”.

 

The Company’s arrangements with Continental are managed on a funds held basis, which means that the Company has retained the premiums earned by the retrocessionaire to secure obligations of the retrocessionaire, recorded them as a liability, credited interest on the balances at a stated contractual rate and reduced the liability account as payments become due. As of December 31, 2007 and 2006, such funds had reduced the Company’s net exposure to Continental to $27.1 million and $33.2 million, respectively.

 

Claims.

Reinsurance claims are managed by the Company’s professional claims staff whose responsibilities include reviewing initial loss reports and coverage issues, monitoring claims handling activities of ceding companies, establishing and adjusting proper case reserves and approving payment of claims. In addition to claims assessment, processing and payment, the claims staff selectively conducts comprehensive claim audits of both specific claims and overall claim procedures at the offices of selected ceding companies. Insurance claims, except those relating to Mt. McKinley’s business, are generally handled by third party claims service providers who have limited authority and are subject to oversight by the Company’s professional claims staff.

 

The Company intensively manages its asbestos and environmental (“A&E”) exposures through dedicated, centrally managed claim staffs for Mt. McKinley and Everest Re. Both are staffed with experienced claim and legal professionals who specialize in the handling of such exposures. These units actively manage each individual insured and reinsured account, responding to claim developments with evaluations of the involved exposures and adjustment of reserves as appropriate. Specific or general claim developments that may have material implications for the Company are regularly communicated to senior management, actuarial, legal and financial areas. Senior management and claim management personnel meet at least quarterly to review the Company’s overall reserve positions and make changes, if appropriate. The Company continually reviews its

 

13


internal processing, communications and analytics, seeking to enhance the management of its A&E exposures, in particular in regard to changes in asbestos claims and litigation.

 

Reserves for Unpaid Property and Casualty Losses and Loss Adjustment Expenses.

Significant periods of time may elapse between the occurrence of an insured loss, the reporting of the loss to the insurer and the reinsurer and the payment of that loss by the insurer and subsequent payments to the insurer by the reinsurer. To recognize liabilities for unpaid losses and LAE, insurers and reinsurers establish reserves, which are balance sheet liabilities representing estimates of future amounts needed to pay reported and unreported claims and related expenses for losses that have already occurred. Actual losses and LAE paid may deviate, perhaps substantially, from such reserves. To the extent reserves prove to be insufficient to cover actual losses and LAE after taking into account available reinsurance coverage, the Company would have to recognize such reserve shortfalls and incur a charge to earnings, which could be material in the period such recognition takes place. See ITEM 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Loss and LAE Reserves”.

 

As part of the reserving process, insurers and reinsurers evaluate historical data and trends and make judgments as to the impact of various factors such as legislative and judicial developments that may affect future claim amounts, changes in social and political attitudes that may increase loss exposures and inflationary and general economic trends. While the reserving process is difficult and subjective for insurance companies, the inherent uncertainties of estimating such reserves are even greater for the reinsurer, due primarily to the longer time between the date of an occurrence and the reporting of any attendant claims to the reinsurer, 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. In addition, trends that have affected development of liabilities in the past may not necessarily occur or affect liability development in the same manner or to the same degree in the future. As a result, actual losses and LAE may deviate, perhaps substantially, from estimates of reserves reflected in the Company's consolidated financial statements.

 

Like many other property and casualty insurance and reinsurance companies, the Company has experienced adverse loss development for prior accident years, which has led to increases in losses and LAE reserves and corresponding charges to income in the periods in which the adjustments were made. There can be no assurance that adverse development from prior years will not continue in the future or that such adverse development will not have a material adverse effect on net income.

 

Changes in Historical Reserves.

The following table shows changes in historical loss reserves for the Company for 1997 and subsequent years. The table is presented on a GAAP basis except that the Company’s loss reserves for its Canadian branch operations are presented in Canadian dollars, the impact of which is not material. The top line of the table shows the estimated initial reserves for unpaid losses and LAE recorded at each year end date. The upper (paid) portion of the table presents the related cumulative amounts paid through each subsequent year end. The lower (liability re-estimated) portion shows the re-estimated amount of the previously recorded reserves as of the end of each succeeding year. The reserve estimates are revised as more information becomes known about the actual claims for which the initial reserves were carried. The cumulative deficiency line represents the cumulative change in estimates since the initial reserve was established. It is equal to the initial reserve less the latest estimate of the ultimate liability.

 

Since the Company has international operations, some of its loss reserves are established in foreign currencies and converted to U.S. dollars for financial reporting. Changes in conversion rates from period to period impact the U.S. dollar value of carried reserves and correspondingly, the cumulative deficiency line of the table. However, unlike other reserve development that affects net income, the impact of currency translation is a component of other comprehensive income. To differentiate these two reserve development components, the

 

14


translation impacts for each calendar year are reflected in the table of Effects on Pre-tax Income Resulting from Reserve Re-estimates.

 

Each amount other than the original reserves in the top half of the table below includes the effects of all changes in amounts for prior periods. For example, if a loss settled in 2000 for $100,000, was first reserved in 1997 at $60,000 and remained unchanged until settlement, the $40,000 deficiency (actual loss minus original estimate) would affect the cumulative deficiency for each of the years in the period 1997 through 1999. Conditions and trends that have affected development of the ultimate liability in the past are not indicative of future developments. Accordingly, it is not appropriate to extrapolate future redundancies or deficiencies based on this table.

 

Ten Year GAAP Loss Development Table Presented Net of Reinsurance with Supplemental Gross Data (1) (2) (3)

 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in millions)

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

Net Reserves for unpaid

 

 

 

 

 

 

 

 

 

 

 

  loss and LAE

$   2,810.0

$    2,953.5

$     2,977.4

$     3,364.9

$     3,472.5

$     3,895.8

$     5,158.4

$    6,766.9

$   8,175.4

$   8,078.9

$   8,324.7

Paid (cumulative) as of:

 

 

 

 

 

 

 

 

 

 

 

  One year later

450.8

484.3

673.4

718.1

892.7

902.6

1,141.7

1,553.1

2,116.9

1,915.4

 

  Two years later

747.9

955.3

1,159.1

1,264.2

1,517.9

1,641.7

1,932.6

2,412.3

3,447.8

 

 

  Three years later

1,101.5

1,295.5

1,548.3

1,637.5

2,033.5

2,176.8

2,404.6

3,181.4

 

 

 

  Four years later

1,363.1

1,575.9

1,737.8

2,076.0

2,413.1

2,485.2

2,928.5

 

 

 

 

  Five years later

1,592.5

1,693.3

1,787.2

2,286.4

2,612.3

2,836.6

 

 

 

 

 

  Six years later

1,673.4

1,673.9

1,856.0

2,482.5

2,867.9

 

 

 

 

 

 

  Seven years later

1,665.3

1,711.1

2,017.5

2,705.9

 

 

 

 

 

 

 

  Eight years later

1,669.3

1,799.2

2,141.0

 

 

 

 

 

 

 

 

  Nine years later

1,731.6

1,879.3

 

 

 

 

 

 

 

 

 

  Ten years later

1,788.5

 

 

 

 

 

 

 

 

 

 

Net Liability re-estimated

 

 

 

 

 

 

 

 

 

 

 

  as of:

 

 

 

 

 

 

 

 

 

 

 

  One year later

2,836.2

2,918.1

2,985.2

3,364.9

3,612.6

4,152.7

5,470.4

6,633.7

8,419.8

8,356.7

 

  Two years later

2,802.2

2,921.6

2,977.2

3,484.6

3,901.8

4,635.0

5,407.1

6,740.5

8,609.2

 

 

  Three years later

2,794.7

2,910.3

3,070.5

3,688.6

4,400.0

4,705.3

5,654.5

7,059.9

 

 

 

  Four years later

2,773.5

2,924.5

3,202.6

4,210.3

4,516.7

5,062.5

6,073.1

 

 

 

 

  Five years later

2,765.2

3,002.2

3,430.3

4,216.5

4,814.0

5,507.1

 

 

 

 

 

  Six years later

2,778.9

2,997.8

3,338.1

4,379.3

5,240.2

 

 

 

 

 

 

  Seven years later

2,767.3

2,941.6

3,356.7

4,773.4

 

 

 

 

 

 

 

  Eight years later

2,738.7

2,931.5

3,597.6

 

 

 

 

 

 

 

 

  Nine years later

2,738.4

3,190.9

 

 

 

 

 

 

 

 

 

  Ten years later

3,001.5

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cumulative deficiency

$    (191.5)

$     (237.4)

$      (620.2)

$   (1,408.5)

$   (1,767.7)

$   (1,611.3)

$     (914.7)

$     (293.0)

$    (433.8)

$    (277.8)

 

Gross liability-

 

 

 

 

 

 

 

 

 

 

 

  end of year

$   3,498.7

$    3,869.2

$     3,705.2

$     3,853.7

$     4,356.0

$     4,985.8

$     6,424.7

$    7,886.6

$   9,175.1

$   8,888.0

$   9,032.2

Reinsurance receivable

688.7

915.7

727.8

488.8

883.5

1,090.0

1,266.3

1,119.7

999.7

809.1

707.4

Net liability-end of year

2,810.0

2,953.5

2,977.4

3,364.9

3,472.5

3,895.8

5,158.4

6,766.9

8,175.4

8,078.9

8,324.8

Gross re-estimated

 

 

 

 

 

 

 

 

 

 

 

  liability at

 

 

 

 

 

 

 

 

 

 

 

  at December 31, 2007

4,328.1

4,481.1

4,924.4

5,873.4

6,620.8

6,850.3

7,404.0

8,171.5

9,586.3

9,110.7

 

Re-estimated receivable

 

 

 

 

 

 

 

 

 

 

 

  at December 31, 2007

1,326.6

1,290.2

1,326.7

1,100.1

1,380.7

1,343.2

1,330.9

1,111.6

977.2

754.0

 

Net re-estimated liability

 

 

 

 

 

 

 

 

 

 

 

  at December 31, 2007

3,001.5

3,190.9

3,597.6

4,773.4

5,240.2

5,507.1

6,073.1

7,059.9

8,609.2

8,356.7

 

Gross cumulative

 

 

 

 

 

 

 

 

 

 

 

  deficiency

$    (829.4)

$     (611.9)

$   (1,219.2)

$   (2,019.7)

$   (2,264.9)

$   (1,864.5)

$     (979.3)

$     (284.9)

$    (411.3)

$    (222.7)

 

 

 

 

 

 

 

 

 

 

 

 

 

(1) Includes $480.9 million relating to Mt. McKinley at December 31, 2000, principally reflecting $491.1 million of Mt. McKinley reserves at the acquisition date.

(2) The Canadian Branch reserves are reflected in Canadian dollars.

 

 

 

 

 

 

 

(3) Some totals may not reconcile due to rounding.

 

 

 

 

 

 

 

 

 

 

15


Every year in the above table reflects a cumulative deficiency, also referred to as adverse development, with the largest indicated cumulative deficiency in 2001. Three classes of business were the principal contributors to those deficiencies: 1) the run-off of asbestos claims for both direct and reinsurance business has significantly contributed to the cumulative deficiencies for all years presented; 2) professional liability reinsurance, general casualty reinsurance and workers’ compensation insurance contributed to the deficiencies for years 1999 through 2003; and 3) property catastrophe adverse development contributed to the deficiency for 2005.

 

In response to its recent asbestos experience, and in view of industry asbestos experience, the Company completed a detailed study of its experience and its cedants’ exposures and also considered recent industry trends. The Company’s Claims Department undertook a contract by contract analysis of its direct business and projected those findings to its assumed reinsurance business. The Company’s actuaries utilized nine methodologies to project its potential ultimate liabilities including projections based on internal data and assessments, extrapolations of non-public and publicly available data for the Company’s cedants and benchmarking against industry data and experience. As a result of this study, the Company increased its gross reinsurance asbestos reserves by $250.0 million and increased its gross direct asbestos reserves by $75.0 million in the fourth quarter of 2007. These reserve increases, as well as adverse development on asbestos in prior years, have a significant impact on the cumulative deficiencies. Absent the asbestos development, only years 2000 through 2003 would reflect cumulative deficiencies on net reserves, with the remaining years reflecting cumulative redundancies.

 

In the professional liability reinsurance class, the late 1990s and early 2000s saw a proliferation of claims relating to bankruptcies and other corporate, financial and/or management improprieties. This resulted in an increase in the frequency and severity of claims under the professional liability policies reinsured by the Company. In the general casualty area, the Company has experienced claim frequency and severity greater than expected in the Company’s pricing and reserving assumptions, particularly for accident years 1999 and 2000.

 

In the workers’ compensation insurance class, the majority of which was written in California, the Company has experienced adverse development primarily for accident years 2001 and 2002 due to higher than expected claim frequency and severity. As a result of significant growth in this book of business in a challenging business environment, the Company’s writings in this class were subject to more relative variability than in some of its established and/or stable lines of business. Although cumulative results through 2007 continue to be quite profitable for this book of business, there has been some deterioration in claim frequency and severity related to accident years 2001 and 2002.

 

Management believes that adequate provision has been made for the Company’s loss and LAE reserves. While there can be no assurance that these reserves will not need to be increased in the future, management believes that the Company’s existing reserves and reserving methodologies reduce the likelihood that any such increases would have a material adverse effect on the Company’s financial condition, results of operations or cash flows. These statements regarding the Company’s loss reserves are forward looking statements within the meaning of the U.S. federal securities laws and are intended to be covered by the safe harbor provisions contained therein. See ITEM 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Safe Harbor Disclosure”.

 

16


The following table is derived from the Ten Year GAAP Loss Development Table above and summarizes the effect of reserve re-estimates, net of reinsurance, on calendar year operations by accident year for the same ten year period ended December 31, 2007. Each column represents the amount of net reserve re-estimates made in the indicated calendar year and shows the accident years to which the re-estimates are applicable. The amounts in the total accident year column on the far right represent the cumulative reserve re-estimates for the indicated accident years.

 

Since the Company has operations in many countries, part of the Company’s loss and LAE reserves are in foreign currencies and translated to U.S. dollars for each reporting period. Fluctuations in the exchange rates for the currencies, period over period, affect the U.S. dollar amount of outstanding reserves. The translation adjustment line at the bottom of the table eliminates the impact of the exchange fluctuations from the reserve re-estimates.

 

Effects on Pre-tax Income Resulting from Reserves Re-estimates (1)

 

 

 

 

 

 

 

 

 

 

 

 

Cumulative

 

 

 

 

 

 

 

 

 

 

 

 

Re-estimates

 

 

 

 

 

 

 

 

 

 

 

 

for Each

(Dollars in millions)

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

 

Accident Year

Accident Years

 

 

 

 

 

 

 

 

 

 

 

 

1997 & prior

$     (26.2)

$     34.0

$        7.6

$     21.2

$        8.2

$      (13.7)

$        11.6

$       28.6

$          0.3

$     (263.1)

 

$        (191.5)

1998

 

1.4

(11.0)

(9.8)

(22.5)

(64.0)

(7.2)

27.6

9.8

3.7

 

(72.1)

1999

 

 

(4.3)

(3.3)

(79.1)

(54.4)

(232.1)

36.0

(28.7)

18.4

 

(347.5)

2000

 

 

 

(7.9)

(26.4)

(71.9)

(294.1)

(98.3)

(144.2)

(153.2)

 

(796.0)

2001

 

 

 

 

(20.4)

(85.2)

23.5

(110.6)

(134.4)

(32.1)

 

(359.2)

2002

 

 

 

 

 

32.3

15.9

46.4

(60.0)

(18.4)

 

16.3

2003

 

 

 

 

 

 

170.3

133.7

109.7

26.0

 

439.7

2004

 

 

 

 

 

 

 

69.9

140.7

99.2

 

309.7

2005

 

 

 

 

 

 

 

 

(137.6)

130.1

 

(7.6)

2006

 

 

 

 

 

 

 

 

 

(88.4)

 

(88.4)

Total calendar

 

 

 

 

 

 

 

 

 

 

 

 

year effect

$     (26.2)

$     35.4

$      (7.8)

$         -

$   (140.1)

$     (256.9)

$     (312.0)

$     133.3

$     (244.4)

$     (277.8)

 

 

Canada (2)

8.3

(11.0)

4.9

7.4

(1.4)

(26.6)

(16.3)

(6.6)

(0.5)

(49.6)

 

 

Translation Adjustment

-

(17.0)

(26.9)

(17.7)

38.4

86.7

78.9

(100.3)

109.3

120.9

 

 

Re-estimate of net reserve after translation adjustment

$     (17.9)

$       7.4

$     (29.8)

$   (10.3)

$   (103.1)

$     (196.8)

$     (249.4)

$       26.4

$     (135.6)

$     (206.5)

 

 

_________________

 

 

 

 

 

 

 

 

 

 

 

 

 

(1)

Some totals may not reconcile due to rounding.

(2)

This adjustment converts Canadian dollars to U.S. dollars.

 

The reserve development by accident year reflected in the above table was generally the result of the same factors described above that caused the deficiencies shown in the Ten Year GAAP Loss Development Table. The unfavorable development experienced in the 1997 and prior and 2000 accident years relates principally to the previously discussed asbestos development. Other business areas contributing to adverse development were casualty reinsurance, including professional liability classes and workers’ compensation insurance, where, in retrospect, the Company’s initial estimates of losses were underestimated principally as the result of unanticipated variability in the underlying exposures. The favorable development for accident years 2002 through 2004 relates primarily to favorable experience with respect to property reinsurance business. In addition, casualty reinsurance has reflected favorable development for accident years 2003 to 2006. The unfavorable development experienced in the 2006 accident year was principally due to reserve increases for one credit insurance program.

 

17


The Company’s loss reserving methodologies continuously monitor the emergence of loss and loss development trends, seeking, on a timely basis, to both adjust reserves for the impact of trend shifts and to factor the impact of such shifts into the Company’s underwriting and pricing on a prospective basis.

 

The following table presents a reconciliation of beginning and ending reserve balances for the periods indicated on a GAAP basis:

 

Reconciliation of Reserves for Losses and LAE

 

 

 

 

 

 

 

Years Ended December 31,

(Dollars in millions)

2007

 

2006

 

2005

 

 

 

 

 

 

Gross reserves at beginning of period

$            8,840.1

 

$       9,126.7

 

$       7,836.3

Incurred related to:

 

 

 

 

 

  Current year

2,341.6

 

2,298.8

 

3,750.7

  Prior years

206.5

 

135.6

 

(26.4)

    Total incurred losses

2,548.1

 

2,434.4

 

3,724.3

Paid related to:

 

 

 

 

 

  Current year

452.2

 

522.7

 

664.9

  Prior years

1,915.4

 

2,116.9

 

1,553.1

    Total paid losses

2,367.6

 

2,639.6

 

2,218.0

Foreign exchange/translation adjustment

120.9

 

109.3

 

(100.3)

Change in reinsurance receivables on unpaid losses and LAE

(100.9)

 

(190.7)

 

(115.6)

Gross reserves at end of period

$            9,040.6

 

$       8,840.1

 

$       9,126.7

 

Development of prior year incurred losses was $206.5 million unfavorable in 2007, $135.6 million unfavorable in 2006 and $26.4 million favorable in 2005. Such losses were the result of the reserve development discussed above, as well as inherent uncertainty in establishing loss and LAE reserves.

 

Reserves for Asbestos and Environmental Losses and Loss Adjustment Expenses.

At December 31, 2007, 10.2% of the Company’s gross reserves reflected an estimate of the Company’s ultimate liability for A&E claims for which ultimate value cannot be estimated using traditional reserving techniques. The Company’s A&E liabilities stem from Mt. McKinley’s direct insurance business and Everest Re’s assumed reinsurance business. There are significant uncertainties in estimating the amount of the Company’s potential losses from A&E claims. See ITEM 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Asbestos and Environmental Exposures” and Note 3 of Notes to Consolidated Financial Statements.

 

Mt. McKinley’s book of direct A&E exposed insurance is relatively small and homogenous. It also arises from a limited period, effective 1978 to 1984. The book is based principally on excess liability policies, thereby limiting exposure analysis to a limited number of policies and forms. As a result of this focused structure, the Company believes that it is able to comprehensively analyze its exposures, allowing it to identify, analyze and actively monitor those claims which have unusual exposure, including policies in which it may be exposed to pay expenses in addition to policy limits or non-products asbestos claims.

 

The Company endeavors to be actively engaged with every insured account posing significant potential asbestos exposure to Mt. McKinley. Such engagement can take the form of pursuing a final settlement, negotiation, litigation, or the monitoring of claim activity under Settlement in Place (“SIP”) agreements. SIP agreements generally condition an insurer’s payment upon the actual claim experience of the insured and may have annual payment caps or other measures to control the insurer’s payments. The Company’s Mt. McKinley operation is currently managing eight SIP agreements, three of which were executed prior to the acquisition of Mt.

 

18


McKinley in 2000. The Company’s preference with respect to coverage settlements is to execute settlements that call for a fixed schedule of payments, because such settlements eliminate future uncertainty.

 

The Company has significantly enhanced its classification of insureds by exposure characteristics over time, as well as its analysis by insured for those it considers to be more exposed or active. Those insureds identified as relatively less exposed or active are subject to less rigorous, but still active management, with an emphasis on monitoring those characteristics, which may indicate an increasing exposure or levels of activity. The Company continually focuses on further enhancement of the detailed estimation processes used to evaluate potential exposure of policyholders, including those that may not have reported significant A&E losses.

 

Everest Re’s book of assumed reinsurance is relatively concentrated within a modest number of A&E exposed relationships. It also arises from a limited period, effectively 1977 to 1984. Because the book of business is relatively concentrated and the Company has been managing the A&E exposures for many years, its claim staff is familiar with the ceding companies that have generated most of these liabilities in the past and which are therefore most likely to generate future liabilities. The Company’s claim staff has developed familiarity both with the nature of the business written by its ceding companies and the claims handling and reserving practices of those companies. This level of familiarity enhances the quality of the Company’s analysis of its exposure through those companies. As a result, the Company believes that it can identify those claims on which it has unusual exposure, such as non-products asbestos claims, for concentrated attention. However, in setting reserves for its reinsurance liabilities, the Company relies on claims data supplied, both formally and informally by its ceding companies and brokers. This furnished information is not always timely or accurate and can impact the accuracy and timeliness of the Company’s ultimate loss projections.

 

The following table summarizes the composition of the Company’s total reserves for A&E losses, gross and net of reinsurance, for the periods indicated:

 

 

Years Ended December 31,

(Dollars in millions)

2007

 

2006

 

2005

Case reserves reported by ceding companies

$    144.5

 

$     135.6

 

$     125.2

Additional case reserves established by the Company (assumed reinsurance) (1)

147.1

 

152.1

 

157.6

Case reserves established by the Company (direct insurance)

148.2

 

213.7

 

243.5

Incurred but not reported reserves

483.0

 

148.7

 

123.3

Gross reserves

922.8

 

650.1

 

649.6

Reinsurance receivable

(95.4)

 

(138.7)

 

(199.1)

Net reserves

$    827.4

 

$     511.4

 

$     450.5

______________

 

 

 

 

 

 

(1)

Additional reserves are case specific reserves determined by the Company to be needed over and above those reported by the ceding company.

 

Additional losses, including those relating to latent injuries and other exposures, which are as yet unrecognized, the type or magnitude of which cannot be foreseen by either the Company or the industry, may emerge in the future. Such future emergence could have material adverse effects on the Company’s future financial condition, results of operations and cash flows.

 

19


Future Policy Benefit Reserves.

The Company writes a limited amount of life and annuity reinsurance in its Bermuda segment. Future policy benefit liabilities for annuities are reported at the accumulated fund balance of these contracts. Reserves for those liabilities include both mortality and morbidity provisions with respect to life and annuity claims, both reported and unreported. Actual experience in a particular period may be worse than assumedexperience and, consequently, may adversely affect the Company’s operating results for that period. See Note 1F of Notes to Consolidated Financial Statements.

 

Activity in the reserve for future policy benefits is summarized for the periods indicated:

 

 

At December 31,

(Dollars in millions)

2007

 

2006

 

2005

Balance at beginning of year

$       101.0

 

$       133.2

 

$       152.2

   Liabilities assumed

0.2

 

0.3

 

0.2

   Adjustments to reserves

2.4

 

3.0

 

11.6

   Benefits paid in the current year                                                

(25.2)

 

(35.5)

 

(30.8)

Balance at end of year

$           78.4

 

$       101.0

 

$       133.2

 

 

Investments.

The board of directors of each of the Company’s operating subsidiaries is responsible for establishing investment policy and guidelines and, together with senior management, for overseeing their execution.

 

The Company’s principal investment objectives are to ensure funds are available to meet its insurance and reinsurance obligations and to maximize after-tax investment income while maintaining a high quality diversified investment portfolio. Considering these objectives, the Company views its investment portfolio as having two components; 1) the investments needed to satisfy outstanding liabilities and 2) investments funded by the Company’s shareholders’ equity.

 

For outstanding liabilities, the Company invests in taxable and tax-preferenced fixed income securities with an average credit quality of Aa, as rated by Moody’s Investors Service, Inc. (“Moody’s”). The Company’s mix of taxable and tax-preferenced investments is adjusted continuously, consistent with the Company’s current and projected operating results, market conditions and the Company’s tax position. This fixed maturity portfolio is externally managed by an independent, professional investment manager using portfolio guidelines approved by the Company.

 

Over the past few years, the Company has reallocated its equity investment portfolio to include 1) publicly traded equity securities and 2) private equity limited partnership investments. The objective of this portfolio diversification is to enhance the risk-adjusted total return of the investment portfolio by allocating a prudent portion of the portfolio to higher return asset classes. The Company has limited its allocation to these asset classes because of 1) the potential for volatility in their values and 2) the impact of these investments on regulatory and rating agency capital adequacy models. At December 31, 2007, the market or fair value of investments in equity and limited partnership securities approximated 38% of shareholders’ equity.

 

The Company’s fixed income investment guidelines include a general duration guideline of five to six years. The duration of an investment is based on the maturity of the security but also reflects the payment of interest and the possibility of early prepayments. This investment duration guideline is established and periodically revised by management, which considers economic and business factors, as well as the Company’s average duration of potential liabilities, which, at December 31, 2007, is estimated at approximately 3.8 years based on the estimated payouts of underwriting liabilities using standard duration calculations.

 

20


The duration of the fixed income portfolio at December 31, 2007 was 3.9 years, down from 4.1 years at prior year end. This shortened duration mainly reflects the Company’s elevated short-term investment holdings in response to relatively low interest rates combined with a flat to negative yield curve during 2007.

 

For each currency in which the Company has established substantial reserves, the Company seeks to maintain invested assets denominated in such currency in an amount approximately comparable to the estimated liabilities. Approximately 23% of the Company’s consolidated reserves for losses and LAE and unearned premiums represent estimated amounts payable in foreign currencies.

 

The Company’s overall financial strength and results of operations are, in part, dependent on the quality and performance of its investment portfolio. Net investment income and net realized capital gains (losses) on the Company’s invested assets constituted 16.1%, 14.7% and 13.4% of the Company’s revenues for the years ended December 31, 2007, 2006 and 2005, respectively.

 

The increase in 2007 is primarily attributable to the Company’s adoption of fair value accounting for its actively managed equity security investment portfolio. Basically, fair value accounting reports changes in the value as realized capital gains or losses on the statement of operations rather than other comprehensive income on the balance sheet. The Company had $76.6 million, or 1.6% of the Company’s revenues, of fair value re-measurements included in net realized capital gains in 2007. The Company’s cash and invested assets totaled $14.9 billion at December 31, 2007, which consisted of 85.2% fixed maturities and cash of which 98.3% were investment grade, 10.4% equity securities and 4.4% other invested assets. The average maturity of fixed maturities was 7.2 years at December 31, 2007, and their overall duration was 3.9 years.

 

At December 31, 2007, the Company’s fixed maturity portfolio included $25.9 million in book value of asset backed securities with sub-prime mortgage loan exposure. Sub-prime mortgage loans generally represent loans made to borrowers with limited or blemished credit records. At December 31, 2007 almost 100% of the Company’s asset backed securities with sub-prime exposure were investment grade and the market value of these investments was $25.4 million.

 

As of December 31, 2007, the Company did not have any direct investments in commercial real estate or direct commercial mortgages or any material holdings of derivative investments (other than equity index put options as discussed in Note 4 of Notes to Consolidated Financial Statements) or securities of issuers that are experiencing cash flow difficulty to an extent that the Company’s management believes could threaten the issuer’s ability to meet debt service payments, except where other than temporary impairments have been recognized.

 

As of December 31, 2007, the Company’s common stock portfolio, which is primarily comprised of actively managed equity securities, had a market value of $1,560.0 million, comprising 10.4% of total investments and cash. As discussed above, in 2007, the Company adopted fair value accounting for its actively managed equity security portfolio.

 

21


The following table reflects investment results for the Company for the periods indicated:

 

 

 

December 31,

 

 

 

 

 

 

 

 

Pre-tax

 

Pre-tax

 

 

 

 

Pre-tax

 

Pre-tax

 

Realized Net

 

Unrealized Net

 

 

Average

 

Investment

 

Effective

 

Capital Gains

 

Capital (Losses)

(Dollars in millions)

 

Investments (1)

 

Income (2)

 

Yield

 

(Losses) (3)

 

Gains

2007

 

$          14,491.7

 

$           682.4

 

4.71%

 

$                  86.3

 

$                       21.4

2006

 

13,446.5

 

629.4

 

4.68%

 

35.1

 

131.7

2005

 

12,067.8

 

522.8

 

4.33%

 

90.3

 

(77.8)

2004

 

10,042.2

 

495.9

 

4.94%

 

89.6

 

40.1

2003

 

7,779.1

 

402.6

 

5.18%

 

(38.0)

 

68.1

 

 

 

 

 

 

 

 

 

 

 

(1) Average of the beginning and ending carrying values of investments and cash, less net funds held, future policy

 

 

benefit reserve, and non-interest bearing cash. Bonds, common stock and redeemable and non-redeemable

 

 

preferred stocks are carried at market value. Common stock, which are actively managed are carried at fair value.

 

 

(2) After investment expenses, excluding realized net capital gains (losses).

 

 

 

 

 

 

(3) In 2007, includes $76.6 million of fair value re-measurements.

 

 

 

 

 

 

 

 

 

 

The following tables summarize fixed maturities for the periods indicated:

 

 

At December 31, 2007

 

Amortized

 

Unrealized

 

Unrealized

 

Market

(Dollars in millions)

Cost

 

Appreciation

 

Depreciation

 

Value

U.S. Treasury securities and obligations of U.S.

 

 

 

 

 

 

 

    government agencies and corporations

$          224.6

 

$                     7.1

 

$                 (0.1)

 

$       231.6

  Obligations of states and political subdivisions

3,512.7

 

138.4

 

(2.5)

 

3,648.6

  Corporate securities

2,557.8

 

33.4

 

(55.6)

 

2,535.6

  Mortgage-backed securities

1,636.5

 

9.5

 

(18.8)

 

1,627.2

  Foreign government securities

1,123.0

 

25.2

 

(6.6)

 

1,141.6

  Foreign corporate securities

1,061.8

 

14.9

 

(15.7)

 

1,061.0

Total

$    10,116.4

 

$               228.5

 

$              (99.3)

 

$  10,245.6

 

 

 

At December 31, 2006

 

Amortized

 

Unrealized

 

Unrealized

 

Market

(Dollars in millions)

Cost

 

Appreciation

 

Depreciation

 

Value

U.S. Treasury securities and obligations of U.S.

 

 

 

 

 

 

 

    government agencies and corporations

$          229.2

 

$                     1.3

 

$                 (3.8)

 

$        226.7

  Obligations of states and political subdivisions

3,633.2

 

164.4

 

(5.2)

 

3,792.4

  Corporate securities

2,877.1

 

33.9

 

(55.0)

 

2,856.0

  Mortgage-backed securities

1,626.0

 

2.8

 

(34.8)

 

1,594.0

  Foreign government securities

1,019.9

 

18.6

 

(10.1)

 

1,028.4

  Foreign corporate securities

824.8

 

11.4

 

(13.8)

 

822.4

Total

$    10,210.2

 

$               232.4

 

$            (122.7)

 

$   10,319.9

 

 

22


The following table represents the credit quality distribution of the Company’s fixed maturities for the periods indicated:

 

 

At December 31,

 

2007

 

2006

(Dollars in millions)

Market

 

Percent of

 

Market

 

Percent of

Rating Agency Credit Quality Distribution:

Value

 

Total

 

Value

 

Total

 

 

 

 

 

 

 

 

AAA

$         6,422.0

 

62.7%

 

$         6,301.9

 

61.1%

AA

1,250.5

 

12.2%

 

1,213.3

 

11.7%

A

1,510.3

 

14.7%

 

1,628.5

 

15.8%

BBB

847.2

 

8.3%

 

886.6

 

8.6%

BB

152.8

 

1.5%

 

197.0

 

1.9%

B

58.2

 

0.6%

 

80.8

 

0.8%

Other

4.6

 

0.0%

 

11.8

 

0.1%

  Total

$       10,245.6

 

100.0%

 

$       10,319.9

 

100.0%

 

 

The following table summarizes fixed maturities by contractual maturity for the period indicated:

 

 

 

At December 31, 2007

 

 

Market

 

Percent of

(Dollars in millions)

 

Value