10-K 1 c64328_10k.htm 3B2 EDGAR HTML -- c64328_preflight.htm



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

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

For the fiscal year ended December 31, 2010
OR

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

For the transition period from   to  
Commission file number 1-10804

XL GROUP
Public Limited Company

(Exact name of registrant as specified in its charter)

 

 

 

Ireland
(State or other jurisdiction of
incorporation or organization)

 

98-0665416
(I.R.S. Employer Identification No.)

No. 1 Hatch Street Upper, 4th Floor,
Dublin 2, Ireland

(Address of principal executive offices and zip code)

 

+353 (1) 405-2033
(Registrant’s telephone number, including area code)

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

 

 

 

Title of each class

 

Name of each exchange
on which registered

Ordinary Shares, Par Value $0.01 per Share

 

New York Stock Exchange

10.75% Equity Security Units

 

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 S  No £

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes £  No S

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 S  No £

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for shorter period that the registrant was required to submit and post such files). Yes S  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 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. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer  S  Accelerated filer  £  Non-accelerated filer  £  Smaller reporting company  £  

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

The aggregate market value of the voting common equity of the registrant held by non-affiliates of the registrant on June 30, 2010 was approximately $5.5 billion computed upon the basis of the closing sales price of the Ordinary Shares on June 30, 2010. For purposes of this computation, ordinary shares held by directors and officers of the registrant have been excluded. Such exclusion is not intended, nor shall it be deemed, to be an admission that such persons are affiliates of the registrant.

As of February 22, 2011, there were outstanding 311,008,238 Ordinary Shares, $0.01 par value per share, of the registrant.

Documents Incorporated by Reference

Portions of the Registrant’s Definitive Proxy Statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered by this report relating to the annual meeting of ordinary shareholders to be held on May 6, 2011 are incorporated by reference into Part III of this Form 10-K.




XL GROUP PLC
TABLE OF CONTENTS

 

 

 

 

 

 

 

 

 

Page

PART I

Item 1.

 

Business

 

 

 

1

 

Item 1A.

 

Risk Factors

 

 

 

32

 

Item 1B.

 

Unresolved Staff Comments

 

 

 

53

 

Item 2.

 

Properties

 

 

 

53

 

Item 3.

 

Legal Proceedings

 

 

 

53

 

Item 4.

 

Reserved

 

 

 

56

 

PART II

Item 5.

 

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

 

 

 

58

 

Item 6.

 

Selected Financial Data

 

 

 

60

 

Item 7.

 

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

 

 

 

62

 

Item 7A.

 

Quantitative and Qualitative Disclosures About Market Risk

 

 

 

124

 

Item 8.

 

Financial Statements and Supplementary Data

 

 

 

133

 

Item 9.

 

Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

 

 

 

234

 

Item 9A.

 

Controls and Procedures

 

 

 

234

 

Item 9B.

 

Other Information

 

 

 

234

 

PART III

Item 10.

 

Directors, Executive Officers and Corporate Governance

 

 

 

235

 

Item 11.

 

Executive Compensation

 

 

 

235

 

Item 12.

 

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

 

 

 

235

 

Item 13.

 

Certain Relationships and Related Transactions, and Director Independence

 

 

 

235

 

Item 14.

 

Principal Accounting Fees and Services

 

 

 

235

 

PART IV

Item 15.

 

Exhibits, Financial Statement Schedules

 

 

 

236

 

This Annual Report on Form 10-K contains “Forward-Looking Statements” as defined in the Private Securities Litigation Reform Act of 1995. A non-exclusive list of the important factors that could cause actual results to differ materially from those in such Forward-Looking Statements is set forth herein under Item 1A “Risk Factors,” and Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” under the caption “Cautionary Note Regarding Forward-Looking Statements.”


PART I

 

 

 

 

 

 

ITEM 1.

 

BUSINESS

 

 

 

History

XL Group plc, through its subsidiaries is a global insurance and reinsurance company providing property, casualty and specialty products to industrial, commercial and, professional firms, insurance companies and other enterprises on a worldwide basis. The company was incorporated with limited liability under the Cayman Islands Companies Act on March 16, 1998, as EXEL Merger Company. XL Capital Ltd was formed as a result of the merger of EXEL Limited and Mid Ocean Limited on August 7, 1998, and the company was named EXEL Limited on that date. At a special general meeting held on February 1, 1999, the shareholders of EXEL Limited approved a resolution changing the name of the company to XL Capital Ltd.

EXEL Limited and Mid Ocean Limited were incorporated in the Cayman Islands with principal operations in Bermuda in 1986 and 1992, respectively. EXEL Limited and its subsidiaries were formed in response to a shortage of high excess liability underwriting capacity in the insurance industry at that time and included a subsidiary organized in Ireland to serve the European Community. Mid Ocean Limited and its subsidiaries were formed to capitalize on the supply/demand imbalance in the global property catastrophe reinsurance market at that time and included dedicated Lloyd’s syndicate capacity. On June 18, 1999, XL Capital Ltd merged with NAC Re Corp. (“NAC”), a Delaware corporation organized in 1985, in a stock merger. This merger was accounted for as a pooling of interests under U.S. generally accepted accounting principles (“GAAP”). Following the merger, the company changed its fiscal year end from November 30 to December 31 as a conforming pooling adjustment.

On July 25, 2001, the company acquired certain Winterthur International insurance operations (“Winterthur International”) to extend its predominantly North American-based large corporate insurance business globally.

Effective January 1, 2002, the company increased its shareholding in Le Mans Ré from 49% to 67% in order to expand its international reinsurance operations. On September 3, 2003, the company exercised its option to buy the remaining 33% from MMA and changed the name of Le Mans Ré to XL Re Europe S.A. On October 18, 2006, the company received approval to form a new European company, XL Re Europe Ltd, based in Dublin, Ireland, which is licensed to write all classes of reinsurance business. XL Re Europe Ltd is the headquarters of the company’s European reinsurance platform with branch offices in France and the U.K.

On August 4, 2006, the company completed the sale of approximately 37% of its then financial guarantee reinsurance and insurance businesses through an initial public offering of 23.4 million common shares of Syncora Holdings Ltd. (“Syncora”) (formerly Security Capital Assurance Ltd. or “SCA”). On June 6, 2007, the company completed the sale of a portion of Syncora’s common shares still owned by the company through a secondary offering and thereby reduced its ownership of Syncora’s outstanding common shares further from approximately 63% to approximately 46%. On August 5, 2008, the company closed an agreement (the “Master Agreement”) with Syncora and its subsidiaries, as well as certain counterparties to credit default swap agreements, in connection with the termination of certain reinsurance and other agreements. As part of the Master Agreement, the company transferred all of the shares it owned in Syncora to a trust and, as a result, has no further ownership interest in the company. For further details relating to the Master Agreement, see Item 8, Note 4 to the Consolidated Financial Statements, “Syncora Holdings Ltd.”

On July 1, 2010, XL Group plc, a newly formed Irish public limited company (“XL-Ireland”) and XL Capital Ltd (now known as XL Group Ltd.), an exempted company organized under the laws of the Cayman Islands (“XL-Cayman”), completed a redomestication transaction in which all of the ordinary shares of XL- Cayman were exchanged for all of the ordinary shares of XL-Ireland (the “Redomestication”). As a result, XL-Cayman became a wholly owned subsidiary of XL-Ireland. On July 23, 2010, the Irish High Court approved XL-Ireland’s creation of distributable reserves, subject to the completion of certain formalities under Irish Company law. These formalities were completed in early August 2010. For further detailed information on this transaction and its impacts on shareholder rights, shareholders’ equity, debt and

1


notes outstanding and employee stock plan awards, see the company’s Report on Form 8-K filed with the U.S. Securities and Exchange Commission on July 1, 2010. In addition, on July 1, 2010, XL Capital Ltd changed its name to XL Group Ltd.

For periods prior to July 1, 2010, unless the context otherwise indicates, references herein to the “Company” are to, and the Consolidated Financial Statements herein include the accounts of XL-Cayman and its consolidated subsidiaries. For periods, on and subsequent to July 1, 2010, unless the context otherwise indicates, references herein to the “Company” are to, and the Consolidated Financial Statements herein include the accounts of XL-Ireland and its consolidated subsidiaries.

See further information under Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Segments

Following the streamlining of the Company’s operating segments in the first quarter of 2010, the Company is organized into three operating segments: Insurance, Reinsurance and Life Operations. The general investment and financing operations of the Company are reflected in Corporate.

The Company evaluates the performance of both the Insurance and Reinsurance segments based on underwriting profit and the performance of the Life Operations segment based on its contribution to net income. Other items of revenue and expenditure of the Company are not evaluated at the segment level for reporting purposes. In addition, the Company does not allocate investment assets of its property and casualty (“P&C”) operations to the other segments. Investment assets related to the Company’s Life Operations and certain structured products included in the Insurance and Reinsurance segments are held in separately identified portfolios. As such, net investment income from these assets is included in the contribution from each of these operations.

The following table sets forth an analysis of gross premiums written by segment for the years ended December 31, 2010, 2009 and 2008. Additional financial information about the Company’s segments, including financial information about geographic areas, is included in Item 8, Note 6 to the Consolidated Financial Statements, “Segment Information.”

 

 

 

 

 

 

 

 

 

 

 

Year ended December 31
(U.S. dollars in thousands)

 

2010
Gross
Premiums
Written

 

Percentage
Change

 

2009
Gross
Premiums
Written

 

Percentage
Change

 

2008
Gross
Premiums
Written

Insurance

 

 

$

 

4,418,380

 

 

 

 

3.9

%

 

 

 

$

 

4,251,888

 

 

 

 

(19.9

)%

 

 

 

$

 

5,308,914

 

Reinsurance

 

 

 

1,842,951

 

 

 

 

(0.9

)%

 

 

 

 

1,859,423

 

 

 

 

(17.7

)%

 

 

 

 

2,260,477

 

Life Operations

 

 

 

411,938

 

 

 

 

(28.5

)%

 

 

 

 

576,162

 

 

 

 

(16.6

)%

 

 

 

 

690,915

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

 

6,673,269

 

 

 

 

(0.2

)%

 

 

 

$

 

6,687,473

 

 

 

 

(19.0

)%

 

 

 

$

 

8,260,306

 

 

 

 

 

 

 

 

 

 

 

 

Insurance Segment

General

The Company’s Insurance segment provides commercial property, casualty and specialty insurance products on a global basis. Products generally provide tailored coverages for complex corporate risks and include the following lines of business: property, casualty, professional liability, environmental liability, aviation and satellite, marine and offshore energy, equine, fine art and specie, excess and surplus lines, surety and other insurance coverages including program business. The Company focuses on those lines of business within its insurance operations that are believed to provide the best return on capital over time.

Property and casualty products are typically written as global insurance programs for large multinational companies and institutions and include property and liability coverages, umbrella liability, product recall, U.S. workers’ compensation and auto liability as well as property catastrophe. Property and casualty products generally provide large capacity on a primary, quota share or excess of loss basis. Global insurance programs are targeted to large worldwide companies in major industry groups including aerospace, automotive, consumer products, pharmaceutical, pulp and paper, high technology, telecommunications, transportation and basic metals. The primary casualty programs (including workers’

2


compensation and auto liability) generally require customers to take large deductibles or self-insured retentions. For the umbrella and excess business written, the Company’s liability attaches after large deductibles, including self insurance or insurance from other companies. Policies are written on an occurrence, claims-made and occurrence reported basis. The Company’s property business written, which also includes construction projects, is short-tail by nature and written on both a primary and excess of loss basis. Property business includes exposures to man-made and natural disasters, and generally, loss experience is characterized as low frequency and high severity. This may result in volatility in the Company’s results of operations, financial condition and liquidity. In addition to the property and casualty products noted above, in 2008 the Company launched underwriting capabilities for the Upper Middle Markets (“UMM”) in the U.S., U.K. and Continental Europe.

Professional liability insurance includes directors’ and officers’ liability, errors and omissions liability and employment practices liability coverages. Policies are written on both a primary and excess of loss basis. Directors’ and officers’ coverage includes primary and excess directors’ and officers’ liability, employment practices liability and company securities and private company directors’ and officers’ liability. Products are targeted at a variety of different sized companies, with a heavy concentration on small to medium-sized firms when written on a primary basis. Employment practices liability is written primarily for very large corporations on an excess of loss basis and covers those firms for legal liability in regard to the treatment of employees. Errors and omissions coverage is written on a primary and excess basis. Errors and omissions insurance written on a primary basis is targeted to small and medium-sized firms and coverage is provided for various professional exposures, including, but not limited to, insurance brokers, consultants, architects and engineers, lawyers, public entities and real estate agents.

Environmental liability products include pollution and remediation legal liability, general and project-specific pollution and professional liability, and commercial general property redevelopment and contractor’s pollution liability. Business is written for both single and multiple years on a primary or excess of loss, claims- made or, less frequently, occurrence basis. Targeted industries include environmental service firms, contractors, healthcare facilities, manufacturing facilities, real estate redevelopment, transportation and construction.

Aviation and satellite products include comprehensive airline hull and liability, airport liability, aviation manufacturers’ product liability, aviation ground handler liability, large aircraft hull and liability, corporate non-owned aircraft liability, space third party liability and satellite risk including damage or malfunction during ascent to orbit and continual operation, and aviation war. Aviation liability and physical damage coverage is offered for large aviation risks on a proportional basis, while smaller general aviation risks are offered on a primary basis. Satellite risks are generally written on a proportional basis. The target markets for aviation and satellite products include airlines, aviation product manufacturers, aircraft service firms, general aviation operators and telecommunications firms.

Marine and offshore energy, equine and fine art and specie insurance are also provided by the Company. Marine and energy coverage includes marine hull and machinery, marine war, marine excess liability, cargo and offshore energy insurance. Equine products specialize in providing bloodstock and livestock insurance. Fine art and specie coverages include fine art, jewelers block, cash in transit and related coverages for financial institutions.

Excess and surplus lines products include general liability coverages where most Insurance Services Office, Inc. (“ISO”) products are written. The Company ceased offering excess and surplus property coverages in 2009.

The Company’s program business specializes in insurance coverages for distinct market segments in North America, including program administrators and managing general agents who operate in a specialized market niche and have unique industry backgrounds or specialized underwriting capabilities. Products encompass mostly property and casualty coverages. The Company terminated an automobile extended warranty program in 2009.

Certain structured indemnity products, previously structured by XL Financial Solutions (“XLFS”), are included within the results of the Insurance segment covering a range of insurance risks including property and casualty insurance, certain types of residual exposures and other market risk management products. In August 2008, the Company ceased certain operations that included the closure of the XLFS business unit

3


and reassignment of responsibility for existing structured indemnity business to either the Insurance or Reinsurance segment depending on the underlying nature of the transactions.

Also included as part of the Insurance segment is XL Global Asset Protection Services (“XL GAPS”), a fee for service loss prevention consulting service which offers individually tailored risk management solutions to risk managers, insurance brokers and insurance company clients operating on a global basis.

The excess nature of many of the Company’s insurance products, coupled with historically large policy limits, results in a book of business that can have losses characterized as low frequency and high severity. As a result, large losses, though infrequent, can have a significant impact on the Company’s results of operations, financial condition and liquidity. The Company attempts to mitigate this risk by, among other things, using strict underwriting guidelines, effective risk management practices (e.g., monitoring of aggregate exposures) and various reinsurance arrangements, discussed below.

U.S. Terrorism

The U.S. Terrorism Risk Insurance Act of 2002 (“TRIA”), as amended, established the Terrorism Risk Insurance Program (“TRIP”) which became effective on November 26, 2002 and was a three-year federal program effective through 2005. On December 22, 2005, President George W. Bush signed a bill extending TRIA (“TRIAE”) for two more years, continuing TRIP through 2007. On December 26, 2007, President George W. Bush signed the Terrorism Risk Insurance Program Reauthorization Act of 2007 (“TRIPRA”) which further extended TRIP for seven years until December 31, 2014 and also eliminated the distinction between foreign and domestic acts of terrorism.

TRIA voided in force terrorism exclusions as of November 26, 2002 for certified terrorism on all TRIA specified property and casualty business. TRIA required covered insurers to make coverage available for certified acts of terrorism (other than nuclear, biological, radiological and chemical, or “NBRC”) on all new and renewal policies issued after TRIA was enacted. Legislation approved under TRIP, as noted above, allows the Company to assess a premium charge for terrorism coverage and, if the policyholder declines the coverage or fails to pay the buy-back premium, certified acts of terrorism will then be excluded from the policy, subject, however, to state specific requirements. Terrorism coverage cannot be excluded from workers’ compensation policies. Subject to a premium-based deductible and provided that the Company has otherwise complied with all the requirements as specified under TRIPRA, the Company is eligible for reimbursement by the Federal Government for up to 85% of its covered terrorism-related losses arising from a certified terrorist attack. Such payment by the government will, in effect, provide reinsurance protection on a quota share basis. The maximum liability during a program year, including both the Federal Government’s and insurers’ shares, is capped on an aggregated basis at $100 billion.

The Company had, prior to the passage of TRIP and the related legislation, underwritten exposures under certain insurance policies that included coverage for terrorism. The passage of TRIP and the related legislation, has required the Company to make a mandatory offer of “Certified” terrorism coverage with respect to relevant covered insurance policies as specified under the related legislation.

Non-U.S. Terrorism

The Company provides coverage for terrorism outside of the United States under casualty policies on a case-by-case basis. The Company generally does not provide significant limits of coverage for terrorism under first party property policies outside of the U.S. unless required to do so by local law, or as required to comply with any national terrorism risk pool which may be available. Various countries have enacted legislation to provide insurance coverage for terrorism occurring within their borders, to protect registered property, and to protect citizens traveling abroad. The legislation typically requires registered direct insurers to provide terrorism coverage for specified coverage lines and then permits them to cede the risk to a national risk pool. The Company has subsidiaries that participate in terrorism risk pools in various jurisdictions, including Australia, France, Spain, the Netherlands and the United Kingdom.

Underwriting

The Company underwrites and prices most risks individually following a review of the exposure and in accordance with the Company’s underwriting guidelines. Most of the Company’s insurance operations have underwriting guidelines that are industry-specific. The Company seeks to serve its clients while controlling

4


its exposure on individual insurance contracts through terms and conditions, policy limits and sublimits, attachment points, and facultative and treaty reinsurance arrangements on certain types of risks.

The Company’s underwriters generally evaluate each industry category and subgroups within each category. Premiums are set and adjusted for an insured based, in large part, on the industry group in which the insured is placed and the insured’s perceived risk relative to the other risks in that group. Rates may vary significantly according to the industry group of the insured as well as the insured’s risk relative to the group. The Company’s rating methodology for individual insureds seeks to set premiums in accordance with claims potential as measured by past experience and future expectations, the attachment point and amount of underlying insurance, the nature and scope of the insured’s operations, including the industry group in which the insured operates, exposures to loss, natural hazard exposures, risk management quality and other specific risk factors relevant in the judgment of the Company’s underwriters to the type of business being written.

Underwriting and loss experience is reviewed regularly for, among other things, loss trends, emerging exposures, changes in the regulatory or legal environment as well as the efficacy of policy terms and conditions.

As the Company’s insurance products are primarily specialized coverages, underwriting guidelines and policy forms differ by product offering as well as by legal jurisdiction. Liability insurance is written on both a primary and excess of loss basis, on occurrence, occurrence reported and claims-made policy forms. Occurrence reported policies typically cover occurrences causing unexpected and unintended personal injury or property damage to third parties arising from events or conditions that commence at or subsequent to an inception date, or retroactive date, if applicable, and prior to the expiration of the policy provided that proper notice is given during the term of the policy or the discovery period. Claims made policies typically cover only claims made during the policy period or extended reporting period and are generally associated with professional liability and environmental coverages. Traditional occurrence coverage is also available for restricted classes of risk and is generally written on a follow-form basis where the policy adopts the terms, conditions and exclusions of the underlying policy. Property insurance risks are written on a lead or follow-form basis that usually provides coverage for all risks of physical damage and business interruption. Maximum limits are generally subject to sublimits for coverage in critical earthquake and flood zones, where the Company seeks to limit its liability in these areas.

Reinsurance Ceded

In certain cases, the risks assumed by the Company in the Insurance segment are partially reinsured with third party reinsurers. Reinsurance ceded varies by location and line of business based on a number of factors, including market conditions. The benefits of ceding risks to third party reinsurers include reducing exposure on individual risks, protecting against catastrophic risks, maintaining acceptable capital ratios and enabling the writing of additional business. Reinsurance ceded does not legally discharge the Company from its liabilities to the original policyholder in respect of the risk being reinsured.

The Company uses reinsurance to support the underwriting and retention guidelines of each of its subsidiaries as well as to control the aggregate exposure of the Company to a particular risk or class of risks. Reinsurance is purchased at several levels ranging from reinsurance of risks assumed on individual contracts to reinsurance covering the aggregate exposure on a portfolio of policies issued by groups of companies. See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” for further information.

Premiums

Premium rates and underwriting terms and conditions for all lines of business written vary by jurisdiction principally due to local market conditions, competitor product offerings and legal requirements.

The following table is an analysis of the Insurance segment’s gross premiums written, net premiums written and net premiums earned, by line of business for the year ended December 31, 2010:

5


 

 

 

 

 

 

 

(U.S. dollars in thousands)

 

Gross
Premiums
Written

 

Net
Premiums
Written

 

Net
Premiums
Earned

Casualty – professional lines

 

 

$

 

1,412,131

 

 

 

$

 

1,306,441

 

 

 

$

 

1,316,173

 

Casualty – other lines

 

 

 

1,030,877

 

 

 

 

650,717

 

 

 

 

632,737

 

Other property

 

 

 

699,442

 

 

 

 

414,251

 

 

 

 

416,917

 

Marine, energy, aviation and satellite

 

 

 

668,878

 

 

 

 

570,957

 

 

 

 

540,319

 

Other specialty lines (1)

 

 

 

602,787

 

 

 

 

519,557

 

 

 

 

606,682

 

Other (2)

 

 

 

(2,545

)

 

 

 

 

(7,582

)

 

 

 

 

1,554

 

Structured indemnity

 

 

 

6,810

 

 

 

 

6,809

 

 

 

 

14,756

 

 

 

 

 

 

 

 

Total

 

 

$

 

4,418,380

 

 

 

$

 

3,461,150

 

 

 

$

 

3,529,138

 

 

 

 

 

 

 

 


 

 

(1)

 

 

 

Other specialty lines within the Insurance segment includes: environmental, programs, equine, warranty, specie, middle markets and excess and surplus lines.

 

(2)

 

 

 

Other includes credit and surety and other lines.

Competition

The Company competes globally in the property and casualty insurance markets. Its competitors include the following companies and their affiliates: The ACE Group of Companies (“ACE”); Allianz Aktiengesellschaft (“Allianz”); American International Group, Inc., primarily their Chartis subsidiary (“AIG”); Factory Mutual Global (“FMG”) for property only; Hartford Financial Services (“Hartford”); Lloyd’s of London Syndicates (“Lloyd’s”); The Chubb Corporation (“Chubb”); The Travelers Companies (“Travelers”); and Zurich Financial Services Group (“Zurich”).

The Company’s major geographical markets for its property and casualty insurance operations are North America, Europe and Bermuda. The Company’s main competitors in each of these markets include the following:

North America – AIG, ACE, Chubb, FMG, Zurich, Travelers, CNA Financial Corporation, Hartford, Liberty Mutual Group and Lloyd’s.

Europe – Allianz, AIG, FMG, Zurich, AXA Insurance Ltd. (“AXA”), ACE, Lloyd’s, Assicurazioni Generali (“Generali”) and HDI-Gerling Industrie Versicherung AG (“HDI-Gerling”).

Bermuda – ACE, Allied World Assurance Company (“AWAC”), Axis Capital Group (“Axis”), Alterra Capital (“Alterra”), Endurance Specialty Insurance Ltd (“Endurance”) and Arch Capital Group Ltd (“Arch”).

See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Executive Overview,” for further discussion.

Marketing and Distribution

The majority of Insurance segment business originates via a large number of international, national and regional producers, acting as the brokers and representatives of current and prospective policyholders. A portion of Insurance segment business is marketed and underwritten by general agents and a portion by independent agents acting on behalf of the Company. Typically, all such producers, general agents and independent agents receive commission payments from the Company for their services, which payments are calculated as a percentage of the gross premium paid by the policyholder on an account-by-account basis. A certain portion of business originating from producers is submitted on a fee basis under which the producer is compensated by a fee paid to it by its policyholder client. From time to time, the Company also considers requests for commissions from a producer, with disclosure by the producer to the policyholder-client, where the producer receives a fee from the policyholder-client. The Company evaluates such requests on a case-by-case basis.

The Company considers requests for contingent commission arrangements where such additional commissions are based upon the volume of bound business originated from a specific producer during a prior calendar year where legal and appropriate. Such arrangements are distinct from program business where additional commissions are generally based on profitability of business submitted to and bound by the Company.

6


With regard to excess and surplus lines business, the Company receives submissions from licensed wholesale surplus lines brokers.

The Company has no implied or explicit commitments to accept business from any particular broker, and neither producers nor any other third party have the authority to bind the Company, except in the case where underwriting authority may be delegated contractually to selected general agents. Such general agents are subject to a financial and operational due diligence review prior to any such delegation of authority and ongoing reviews and audits are carried out as deemed necessary by the Company with the goal of assuring the continuing integrity of underwriting and related business operations. See Item 8, Note 19(a) to the Consolidated Financial Statements for information on the Company’s major producers, “Commitments and Contingencies – Concentrations of Credit Risk.”

Apart from compensation arrangements established with producers in connection with insurance transactions, the Company also has engaged, and may in the future engage, certain producers or their affiliates in consulting roles pursuant to which such producers provide access to certain systems and information that may assist the Company with its marketing and distribution strategy. In instances where the Company engages producers in such consulting roles, the Company may compensate the relevant producers on a fixed fee basis, a variable fee basis based upon Company usage of the systems and information proffered, or through a combination of fixed and variable fee.

Structure of Insurance Operations

In October 2009, the Company’s insurance operations were reorganized into four business units: Global Professional Lines, Global Specialty Lines, North America Property and Casualty and International Property and Casualty. This new simplified structure has had no impact on the Company’s client facing activities but provides increased authority and accountability to each business unit leader. The Company operated under its product and geography based matrix business structure up to October 2009.

The segment’s most significant operating legal entities in terms of revenues during 2010 were as follows: XL Insurance (Bermuda) Ltd, XL Insurance Company Limited, XL Specialty Insurance Company, Indian Harbor Insurance Company, Greenwich Insurance Company and XL Insurance Switzerland Ltd, as well as certain Lloyd’s syndicates.

Claims Administration

Claims management for the insurance operations includes the review of initial loss reports, administration of claims databases, generation of appropriate responses to claims reports, identification and handling of coverage issues, determination of whether further investigation is required and, where appropriate, retention of claims counsel, establishment of case reserves, payment of claims and notification to reinsurers. With respect to the establishment of case reserves, when the Company is notified of insured losses, claims personnel record a case reserve as appropriate for the estimated amount of the exposure at that time. The estimate reflects the judgment of claims personnel based on general reserving practices, the experience and knowledge of such personnel regarding the nature of the specific claim and, where appropriate, advice of counsel. Reserves are also established to provide for the estimated expense of settling claims, including legal and other fees and the general expenses of administering the claims adjustment process.

Claims in respect of business written by the Company’s Lloyd’s syndicates are primarily notified by various central market bureaus. Where a syndicate is a “leading” syndicate on a Lloyd’s policy, its underwriters and claims adjusters will deal with the broker or insured on behalf of itself and the following market for any particular claim. This may involve appointing attorneys or loss adjusters. The claims bureaus and the leading syndicate advise movement in loss reserves to all syndicates participating on the risk. The Company’s claims department may adjust the case reserves it records from those advised by the bureaus as deemed necessary.

Certain of the Company’s product lines have arrangements with third party administrators to provide claims handling services to the Company in respect of such product lines. These agreements set forth the duties of the third party administrators, limits of authority, protective indemnification language and various

7


procedures that are required to meet statutory compliance. These arrangements are also subject to audit review by the Company’s relevant claim department.

In February 2010, the insurance operations started deploying a new claims IT platform called XL GlobalClaim (“GCS”). The system was successfully deployed throughout the U.S. and Bermuda operations during 2010 and is scheduled to be deployed throughout Europe and Asia during the first half of 2011. GCS converts the claim operation to a paperless environment and connects the legacy systems to allow for operations consistent data aggregation for all global claims operations.

Reinsurance Segment

General

The Company’s Reinsurance segment provides casualty, property risk (including energy and engineering), property catastrophe, marine, aviation, and other specialty reinsurance on a global basis with business being written on both a proportional and non-proportional basis and in certain limited instances on a direct basis. Given challenging market conditions and the changing economic environment that has been experienced throughout 2008 and early 2009, the Company’s lines of business within its reinsurance operations changed to those that provide the best return on capital. For the Company’s Reinsurance segment, this resulted, in certain instances, in a greater emphasis being placed on short-tail lines of business.

Business written on a non-proportional basis generally provides for an indemnification by the Company to the ceding company for a portion of losses, both individually and in the aggregate, on policies with limits in excess of a specified individual or aggregate loss deductible. For business written on a proportional bases including “quota share” or “surplus” basis, the Company receives an agreed percentage of the premium and is liable for the same percentage of each and all incurred loss. For proportional business, the ceding company normally receives a ceding commission for the premiums ceded and may also, under certain circumstances, receive a profit commission based on performance of the contract. Occasionally this commission could be on a sliding scale depending on the loss ratio performance of the contract. The Company’s casualty reinsurance includes general liability, professional liability, automobile and workers’ compensation. Professional liability includes directors’ and officers’, employment practices, medical malpractice and environmental liability. Casualty lines are written as treaties or programs and on both a proportional and a non-proportional basis. The treaty business includes clash programs which cover a number of underlying policies involved in one occurrence or a judgment above an underlying policy’s limit, before suffering a loss.

The Company’s property business, primarily short-tail in nature, is written on both a portfolio/treaty and individual/facultative basis and includes property catastrophe, property risk excess of loss and property proportional. A significant portion of the property business underwritten consists of large aggregate exposures to man-made and natural disasters and, generally, loss experience is characterized as low frequency and high severity. This may result in volatility in the Company’s results of operations, financial condition and liquidity. See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

The Company seeks to manage its reinsurance exposures to catastrophic events by limiting the amount of exposure written in each geographic or peril zone worldwide, underwriting in excess of varying attachment points and requiring that contracts exposed to catastrophe loss include aggregate limits. The Company also seeks to protect its total aggregate exposures by peril and zone through the purchase of reinsurance programs.

The Company’s property catastrophe reinsurance account is generally “all risk” in nature. As a result, the Company is exposed to losses from sources as diverse as hurricanes and other windstorms, earthquakes, freezing, riots, floods, industrial explosions, fires, and many other potential natural or man-made disasters. In accordance with market practice, the Company’s policies generally exclude certain risks such as war, nuclear contamination or radiation. Following the terrorist attacks at the World Trade Center in New York City, Washington, D.C. and Pennsylvania on September 11, 2001 (collectively, “the September 11 event”), terrorism cover, including NBRC, has been restricted or excluded in many territories and classes. Some U.S. states make it mandatory to provide some cover for “Fire Following” terrorism and some countries

8


make terrorism coverage mandatory. The Company’s predominant exposure under such coverage is to property damage.

The Company had, prior to the passing of TRIA, underwritten reinsurance exposures in the U.S. that included terrorism coverage. Since the passage of TRIA in the U.S., together with the TRIAE and TRIPRA extensions noted above, the Company has underwritten a very limited number of stand-alone terrorism coverage policies in addition to coverage included within non-stand-alone policies. In the U.S., in addition to NBRC acts, the Company generally excludes coverage included under TRIA from the main catastrophe exposed policies. In other cases, both within and outside the U.S., the Company generally relies on either a terrorism exclusion clause, which does not include personal lines, excluding NBRC, or a similar clause that excludes terrorism completely. There are a limited number of classes underwritten where no terrorism exclusion exists.

Property catastrophe reinsurance provides coverage on an excess of loss basis when aggregate losses and loss adjustment expenses from a single occurrence of a covered event exceed the attachment point specified in the policy. Some of the Company’s property catastrophe contracts limit coverage to one occurrence in any single policy year, but most contracts generally enable at least one reinstatement to be purchased by the reinsured.

The Company also writes property risk excess of loss reinsurance. Property risk excess of loss reinsurance covers a loss to the reinsured on a single risk of the type reinsured rather than to aggregate losses for all covered risks on a specific peril, as is the case with catastrophe reinsurance. The Company’s property proportional account includes reinsurance of direct property insurance. The Company seeks to limit the catastrophe exposure from its proportional and per risk excess business through extensive use of occurrence and cession limits.

Other specialty reinsurance products include energy, marine, aviation, space, engineering, fidelity, trade credit and political risk. The Company underwrites a small portfolio of contracts covering political risk and trade credit. Exposure is assumed from a limited number of trade credit contracts.

Underwriting

Underwriting risks for the reinsurance property and casualty business are evaluated using a number of factors including, but not limited to, the type and layer of risk to be assumed, the actuarial evaluation of premium adequacy, the cedant’s underwriting and claims experience, the cedant’s financial condition and claims paying rating, the exposure and/or experience with the cedant, and the line of business to be reinsured.

Other factors assessed by the Company include the reputation of the proposed cedant, the geographic area in which the cedant does business and its market share, a detailed evaluation of catastrophe and risk exposures, and historical loss data for the cedant where available and for the industry as a whole in the relevant regions, in order to compare the cedant’s historical loss experience to industry averages. On-site underwriting and claim reviews are performed where it is deemed necessary to determine the quality of a current or prospective cedant’s underwriting operations, with particular emphasis on casualty proportional and working excess of loss placements.

For property catastrophe reinsurance business, the Company’s underwriting guidelines generally limit the amount of exposure it will directly underwrite for any one reinsured and the amount of the aggregate exposure to catastrophic losses in any one geographic zone. The Company believes that it has defined geographic and peril zones such that a single occurrence, for example an earthquake or hurricane, should not affect more than one peril zone. While the exposure to multiple zones is considered remote for events such as a hurricane, the Company does manage its aggregate exposures for such a scenario where the Company considers it appropriate to do so. The definition of the Company’s peril zones is subject to periodic review. The Company also generally seeks an attachment point for its property catastrophe reinsurance at a level that is high enough to produce a low frequency of loss. The Company seeks to limit its aggregate exposure in the proportional business through extensive use of occurrence and cession limits.

9


Reinsurance Retroceded

The Company uses third party reinsurance to support the underwriting and retention guidelines of each reinsurance subsidiary as well as to seek to limit the aggregate exposure of the Company to a particular risk or class of risks. Reinsurance is purchased at several levels ranging from reinsurance of risks assumed on individual contracts to reinsurance covering the aggregate exposures. The benefits of ceding risks to other reinsurers include reducing exposure on individual risks, protecting against catastrophic risks, maintaining acceptable capital ratios and enabling the writing of additional business. Reinsurance ceded does not legally discharge the Company from its liabilities in respect of the risk being reinsured. Reinsurance ceded varies by location and line of business based on factors including, among others, market conditions and the credit worthiness of the counterparty.

Effective January 1, 2008, the Company entered into a quota share reinsurance treaty with a newly-formed Bermuda reinsurance company, Cyrus Re II. Pursuant to the terms of the quota share reinsurance treaty, Cyrus Re II assumed a 10% cession of certain lines of property catastrophe reinsurance and retrocession business underwritten by certain operating subsidiaries of the Company for business that incepted between January 1, 2008 and July 1, 2008. In connection with such cessions, the Company paid Cyrus Re II a reinsurance premium less a ceding commission, which included a reimbursement of direct acquisition expenses incurred by the Company as well as a commission to the Company for generating the business. The quota share reinsurance treaty also provided for a profit commission payable to the Company. The quota share with Cyrus Re II was canceled after its original term and not renewed.

The Company’s traditional catastrophe retrocession program was renewed in June 2010 to cover certain of the Company’s exposures. These protections, in various layers and in excess of varying attachment points according to the territory exposed, assist in managing the Company’s net retention to an acceptable level. The Company has co-reinsurance retentions within this program. The Company renewed additional structures with a restricted territorial scope for 12 months in July 2010. The Company continues to buy additional protection for the Company’s marine and offshore energy exposures. These covers provide protection in various layers and excess of varying attachment points according to the scope of cover provided. The Company has co-reinsurance participations within this program.

The Company continues to buy specific reinsurance on its motor third party liability, property and aviation portfolios to manage its net exposures in these classes.

See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and Item 8, Note 12 to the Consolidated Financial Statements, “Reinsurance,” for further information.

Premiums

The following table is an analysis of the Reinsurance segment’s gross premiums written, net premiums written and net premiums earned, by line of business for the year ended December 31, 2010:

 

 

 

 

 

 

 

(U.S. dollars in thousands)

 

Gross
Premiums
Written

 

Net
Premiums
Written

 

Net
Premiums
Earned

Casualty – professional lines

 

 

$

 

218,301

 

 

 

$

 

222,133

 

 

 

$

 

222,720

 

Casualty – other lines

 

 

 

229,535

 

 

 

 

222,351

 

 

 

 

219,154

 

Property catastrophe

 

 

 

370,266

 

 

 

 

326,758

 

 

 

 

323,588

 

Other property

 

 

 

802,494

 

 

 

 

562,416

 

 

 

 

534,422

 

Marine, energy, aviation and satellite

 

 

 

117,438

 

 

 

 

103,926

 

 

 

 

88,855

 

Other (1)

 

 

 

103,959

 

 

 

 

99,897

 

 

 

 

112,305

 

Structured indemnity

 

 

 

958

 

 

 

 

957

 

 

 

 

955

 

 

 

 

 

 

 

 

Total

 

 

$

 

1,842,951

 

 

 

$

 

1,538,438

 

 

 

$

 

1,501,999

 

 

 

 

 

 

 

 


 

 

(1)

 

 

 

Other includes credit and surety, whole account contracts and other lines.

Additional discussion and financial information about the Reinsurance segment is set forth in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Item 8, Note 6 to the Consolidated Financial Statements, “Segment Information.”

10


Competition

The Company competes globally in the property and casualty markets.

The Company’s major geographical markets for its property and casualty reinsurance operations are North America, Europe, Bermuda and Emerging Markets (covering Asia/Pacific and South America). The main competitors in each of these markets include the following:

North America – Berkshire Hathaway, Munich Re Corporation, Swiss Re America Corporation, Transatlantic Re, Everest Re Group Ltd, Hannover Re and PartnerRe Ltd.

Europe – Munich Re, Swiss Re, Lloyd’s, SCOR Reinsurance Company and PartnerRe Ltd.

Bermuda – ACE Tempest Reinsurance Ltd, AXIS Specialty Limited, Arch Reinsurance Limited, Renaissance Reinsurance Limited, Montpelier Reinsurance Ltd, Platinum Underwriters Bermuda Ltd and PartnerRe Ltd.

See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Executive Overview,” for further discussion.

Marketing and Distribution

See Insurance Segment – “Marketing and Distribution” and Item 8, Note 19(a) to the Consolidated Financial Statements, “Commitments and Contingencies – Concentrations of Credit Risk,” for information in the Company’s marketing and distribution procedures and information on the Company’s major brokers.

Structure of Reinsurance Operations

The Company’s reinsurance operations are structured geographically into Bermuda operations, North American operations, European/Asia Pacific operations and Latin American operations.

The segment’s most significant operating legal entities in terms of revenues during 2010 were as follows: XL Reinsurance America Inc., XL Re Ltd, XL Re Europe Limited and XL Re Latin America Ltd.

Claims Administration

Claims management for the reinsurance operations includes the receipt of loss notifications, review and approval of claims through a claims approval process, establishment of loss reserves and approval of loss payments. Case reserves for reported claims are generally established based on reports received from ceding companies with additional case reserves being established when deemed appropriate. Additionally, claims audits are conducted for specific claims and claims procedures at the offices of selected ceding companies, particularly in the U.S. and the U.K.

Life Operations Segment

During 2009, the Company completed a strategic review of its life reinsurance business. In relation to this initiative, the Company sold the renewal rights to its Continental European short-term life, accident and health business in December 2008. The Company also announced in March 2009 that it would run-off its existing book of U.K. and Irish traditional life and annuity business, and not accept new business. In addition, during July 2009, the Company entered into an agreement to sell its U.S. life reinsurance business. The transaction closed during the fourth quarter of 2009. In December 2009, the Company entered into an agreement to novate and recapture a number of U.K. and Irish term assurance and critical illness treaties. The transaction closed during the fourth quarter of 2009. During the first quarter of 2010, the Company entered into an agreement to recapture U.K. and Irish term assurance treaties and this transaction closed during March 2010. Further recaptures of U.K. term assurance treaties and U.S. mortality retrocession pools took place during the first and fourth quarters of 2010, respectively.

The Life Operations segment provided life reinsurance on business written by life insurance companies, principally to help them manage mortality, morbidity, survivorship, investment and lapse risks.

Prior to the decision to run-off the U.K. and Irish business, products offered included a broad range of underlying lines of life insurance business, including term assurances, group life, critical illness cover, immediate annuities and disability income. In addition, prior to selling the renewal rights, the products

11


offered included short-term life, accident and health business. Notwithstanding these sales, the segment still covers a range of geographic markets, with an emphasis on the U.K., U.S., Ireland and Continental Europe.

The portfolio has three particularly significant components:

1) The portfolio includes a small number of large contracts relating to closed blocks of U.K. and Irish fixed annuities in payment. In relation to certain of these contracts, the Company received cash and investment assets at the inception of the reinsurance contract, relating to the future policy benefit reserves assumed. These contracts are long-term in nature, and the expected claims payout period can span up to 30 or 40 years with average duration of around 10 years. The Company is exposed to investment and survivorship risk over the life of these arrangements.

2) The second component of the portfolio relates to life risks (in the U.S., U.K. and Ireland) and critical illness risks (in the U.K. and Ireland) where the Company is exposed to the mortality, morbidity and lapse experience from the underlying business, over the medium to long-term.

3) The third component relates to the annually renewable business covering life, accident and health risks written in Continental Europe. These contracts are short-term in nature and include both proportional and non-proportional reinsurance structures. While the renewal rights for this business have been sold, the existing business remains with the Company.

Underwriting & Claims Administration

While the Life Operations segment was closed to new business in March 2009, the pricing information below reflects how new business was acquired prior to that date and hence is relevant to the in-force portfolio of business.

Life reinsurance transactions fall into two distinct forms. The first relates to the reinsurance of an existing and closed block of risks (“in-force deal”), where the nature of the underlying exposure is known at the date of execution. The second relates to the reinsurance of liabilities which are yet to be written by the ceding company (“new business treaty”) where, provided the subsequent risks are within the agreed treaty parameters, these risks may be added to the portfolio.

The underwriting of an in-force deal is highly actuarial in nature, requiring detailed analytical appraisal of the key parameters which drive the ultimate profitability of the deal. This includes analysis of historic experience (claims, lapses, etc.) as well as the projection of these assumptions into the future.

When new business was written, in addition to the actuarial analysis required to set the terms, there was also a requirement to establish medical underwriting criteria that will apply to the new risks which may be added to the treaty. Once a treaty is accepted, there is then an ongoing need to monitor the risk selection by the medical underwriters at the ceding company and to ensure that the criteria are being met.

The team includes many members with specialized actuarial knowledge. Claims administration also relies on experienced team members and specific medical expertise, supported where required by third party medical underwriters and claims managers.

The Company maintained comprehensive “terms of trade” guidelines for all core product lines. These guidelines describe the approach to be taken in assessing and underwriting opportunities, including the approach to be taken to the setting of core parameters and to the determination of appropriate pricing levels. The “terms of trade” were overseen by a separate team from the new business underwriters.

In addition, the Company maintained a medical underwriting manual which sets out the approach to be taken to underwriting specific medical impairments when setting terms for a new business treaty.

Reinsurance Retroceded

The Company purchases limited retrocession capacity on a “per-life” basis in the U.S. in order to cap the maximum claim arising from the death of a single individual. Cover is purchased from professional retrocessionaires which meet the Company’s criteria for counterparty exposures. Limited retrocession of fixed annuity business has been arranged to manage aggregate longevity capacity on specific deals. Limited retrocession of life, accident and health business on specific treaties written in Continental Europe has also been arranged to manage mortality and morbidity risks.

12


Premiums

The following table is an analysis of the Life Operations gross premiums written, net premiums written and net premiums earned for the year ended December 31, 2010:

 

 

 

 

 

 

 

(U.S. dollars in thousands)

 

Gross
Premiums
Written

 

Net
Premiums
Written

 

Net
Premiums
Earned

Other Life

 

 

$

 

256,703

 

 

 

$

 

255,056

 

 

 

$

 

255,905

 

Annuity

 

 

 

155,235

 

 

 

 

127,019

 

 

 

 

127,019

 

 

 

 

 

 

 

 

Total

 

 

$

 

411,938

 

 

 

$

 

382,075

 

 

 

$

 

382,924

 

 

 

 

 

 

 

 

Additional discussion and financial information about the Life Operations is set forth in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and Item 8, Note 6 to the Consolidated Financial Statements, “Segment Information.”

Competition

In regards to the Life Operations segment, the core activity is in the U.S., U.K., Ireland and Continental Europe. While the Company no longer competes for new business, it retains an in-force portfolio and hence views companies with similar portfolios as competitors.

For the fixed annuity business, competition has historically come from less traditional reinsurance entities, such as Canada Life and Prudential (U.K.) or recently established entities such as Paternoster, Synesis and Pension Insurance Corporation. However, in recent years, more traditional reinsurance players, including Swiss Re, Partner Re and Pacific Life Re, also have entered or re-entered this market.

Marketing and Distribution

The Company predominantly marketed its long-term products directly to clients, with a smaller element sourced through reinsurance intermediaries. The Company primarily marketed the short-term life, accident and health business through reinsurance intermediaries. Following the closure to new business and the sale of the renewal rights, the Company has ceased to market these product lines.

The Company’s distribution strategy was to avoid any undue concentration on any single client or market. Efforts were made to target ceding companies that were themselves strong and growing in their target segments.

Other Financial Lines Business

Following the streamlining of the Company’s operating segments in the first quarter of 2009, the Other Financial Lines business is now included in Corporate. This business previously included contracts associated with the funding agreement (“FA”) business and the guaranteed investment contract (“GIC”) business. GICs and FAs provide users guaranteed rates of interest on amounts previously invested with the Company. FAs were very similar to GICs in that they have known cash flows. FAs were sold to institutional investors, typically through medium term note programs. During August 2010, the remaining balance of FAs of $450 million was settled and the business is no longer active.

Unpaid Losses and Loss Expenses

Loss reserves are established due to the significant periods of time that may lapse between the occurrence, reporting and payment of a loss. To recognize liabilities for unpaid losses and loss expenses, the Company estimates future amounts needed to pay claims and related expenses with respect to insured events. The Company’s reserving practices and the establishment of any particular reserve reflects management’s judgment concerning sound financial practice and do not represent any admission of liability with respect to any claim. Unpaid losses and loss expense reserves are established for reported claims (“case reserves”) and incurred but not reported (“IBNR”) claims.

The nature of the Company’s high excess of loss liability and catastrophe business can result in loss payments that are both irregular and significant. Similarly, adjustments to reserves for individual years can

13


be irregular and significant. Such adjustments are part of the normal course of business for the Company. Certain aspects of the Company’s business have loss experience characterized as low frequency and high severity. This may result in volatility in the Company’s results of operations, financial condition and liquidity.

The tables below present the development of the Company’s unpaid losses and loss expense reserves on both a net and gross basis. The cumulative redundancy (deficiency) calculated on a net basis differs from that calculated on a gross basis. As different reinsurance programs cover different underwriting years, net and gross loss experience will not develop proportionately. The top lines of the tables show the estimated liability, net of reinsurance recoveries, as at the year end balance sheet date for each of the indicated years. This represents the estimated amounts of losses and loss expenses, including IBNR, arising in the current and all prior years that are unpaid at the year end balance sheet date of the indicated year. The tables show the re-estimated amount of the previously recorded reserve liability based on experience as of the year end balance sheet date of each succeeding year. The estimate changes as more information becomes known about the frequency and severity of claims for individual years. The cumulative redundancy (deficiency) represents the aggregate change with respect to that liability originally estimated. The lower portion of the first table also reflects the cumulative paid losses relating to these reserves. Conditions and trends that have affected development of liabilities in the past may not necessarily occur in the future. Accordingly, it may not be appropriate to extrapolate redundancies or deficiencies into the future, based on the tables below. See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Cautionary Note Regarding Forward-Looking Statements.”

Analysis of Losses and Loss Expense Reserve Development
Net of Reinsurance Recoveries

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(U.S. dollars in millions)

 

2000

 

2001

 

2002

 

2003

 

2004

 

2005

 

2006

 

2007

 

2008

 

2009

 

2010

ESTIMATED LIABILITY FOR UNPAID LOSSES AND LOSS EXPENSES, NET OF REINSURANCE RECOVERABLES

 

 

$

 

4,207

 

 

 

$

 

7,004

 

 

 

$

 

8,313

 

 

 

$

 

10,532

 

 

 

$

 

12,671

 

 

 

$

 

17,200

 

 

 

$

 

17,900

 

 

 

$

 

18,191

 

 

 

$

 

17,686

 

 

 

$

 

17,266

 

 

 

$

 

16,882

 

LIABILITY RE-ESTIMATED AS OF:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

One year later

 

 

 

4,382

 

 

 

 

7,404

 

 

 

 

9,250

 

 

 

 

10,800

 

 

 

 

13,785

 

 

 

 

17,090

 

 

 

 

17,475

 

 

 

 

17,580

 

 

 

 

17,401

 

 

 

 

16,893

 

 

 

Two years later

 

 

 

4,345

 

 

 

 

8,423

 

 

 

 

9,717

 

 

 

 

11,842

 

 

 

 

13,675

 

 

 

 

16,828

 

 

 

 

16,631

 

 

 

 

17,286

 

 

 

 

17,027

 

 

 

 

 

Three years later

 

 

 

5,118

 

 

 

 

8,653

 

 

 

 

10,723

 

 

 

 

11,849

 

 

 

 

13,607

 

 

 

 

16,155

 

 

 

 

16,441

 

 

 

 

16,956

 

 

 

 

 

 

 

Four years later

 

 

 

5,294

 

 

 

 

9,727

 

 

 

 

10,738

 

 

 

 

11,860

 

 

 

 

13,258

 

 

 

 

16,067

 

 

 

 

16,064

 

 

 

 

 

 

 

 

 

Five years later

 

 

 

5,435

 

 

 

 

9,674

 

 

 

 

10,710

 

 

 

 

11,680

 

 

 

 

13,236

 

 

 

 

15,796

 

 

 

 

 

 

 

 

 

 

 

Six years later

 

 

 

5,419

 

 

 

 

9,718

 

 

 

 

10,642

 

 

 

 

11,794

 

 

 

 

13,068

 

 

 

 

 

 

 

 

 

 

 

 

 

Seven years later

 

 

 

5,508

 

 

 

 

9,680

 

 

 

 

10,824

 

 

 

 

11,669

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Eight years later

 

 

 

5,496

 

 

 

 

9,921

 

 

 

 

10,775

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine years later

 

 

 

5,571

 

 

 

 

9,863

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Ten years later

 

 

 

5,541

 

 

 

 

     

 

 

 

 

     

 

 

 

 

     

 

 

 

 

     

 

 

 

 

     

 

 

 

 

     

 

 

 

 

     

 

 

 

 

     

 

 

 

 

     

 

 

 

 

     

 

CUMULATIVE REDUNDANCY (DEFICIENCY) (1)

 

 

 

(1,334

)

 

 

 

 

(2,859

)

 

 

 

 

(2,462

)

 

 

 

 

(1,137

)

 

 

 

 

(397

)

 

 

 

 

1,404

 

 

 

 

1,836

 

 

 

 

1,235

 

 

 

 

659

 

 

 

 

373

 

 

 

CUMULATIVE PAID LOSSES, NET OF REINSURANCE RECOVERIES, AS OF:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

One year later

 

 

$

 

1,184

 

 

 

$

 

2,011

 

 

 

$

 

2,521

 

 

 

$

 

1,985

 

 

 

$

 

2,008

 

 

 

$

 

3,437

 

 

 

$

 

3,188

 

 

 

$

 

3,207

 

 

 

$

 

3,436

 

 

 

 

3,028

 

 

 

Two years later

 

 

 

1,920

 

 

 

 

3,984

 

 

 

 

3,800

 

 

 

 

2,867

 

 

 

 

3,884

 

 

 

 

5,759

 

 

 

 

5,620

 

 

 

 

5,673

 

 

 

 

5,848

 

 

 

 

 

Three years later

 

 

 

2,683

 

 

 

 

4,703

 

 

 

 

4,163

 

 

 

 

4,380

 

 

 

 

5,181

 

 

 

 

7,590

 

 

 

 

7,528

 

 

 

 

7,471

 

 

 

 

 

 

 

Four years later

 

 

 

3,038

 

 

 

 

4,641

 

 

 

 

5,365

 

 

 

 

5,286

 

 

 

 

6,392

 

 

 

 

8,936

 

 

 

 

8,787

 

 

 

 

 

 

 

 

 

Five years later

 

 

 

3,290

 

 

 

 

5,526

 

 

 

 

6,018

 

 

 

 

6,225

 

 

 

 

7,386

 

 

 

 

9,882

 

 

 

 

 

 

 

 

 

 

 

Six years later

 

 

 

3,774

 

 

 

 

5,969

 

 

 

 

6,764

 

 

 

 

7,002

 

 

 

 

8,098

 

 

 

 

 

 

 

 

 

 

 

 

 

Seven years later

 

 

 

3,985

 

 

 

 

6,514

 

 

 

 

7,381

 

 

 

 

7,591

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Eight years later

 

 

 

4,351

 

 

 

 

6,965

 

 

 

 

7,797

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine years later

 

 

 

4,589

 

 

 

 

7,291

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Ten years later

 

 

 

4,751

 

 

 

 

     

 

 

 

 

     

 

 

 

 

     

 

 

 

 

     

 

 

 

 

     

 

 

 

 

     

 

 

 

 

     

 

 

 

 

     

 

 

 

 

     

 

 

 

 

     

 

14


Analysis of Property and Casualty Losses and Loss Expense Reserve Development
Gross of Reinsurance Recoverables

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(U.S. dollars in millions)

 

2000

 

2001

 

2002

 

2003

 

2004

 

2005

 

2006

 

2007

 

2008

 

2009

 

2010

ESTIMATED GROSS LIABILITY FOR UNPAID LOSSES AND LOSS EXPENSES

 

 

$

 

5,668

 

 

 

$

 

11,807

 

 

 

$

 

13,333

 

 

 

$

 

16,553

 

 

 

$

 

19,616

 

 

 

$

 

23,598

 

 

 

$

 

22,895

 

 

 

$

 

22,857

 

 

 

$

 

21,650

 

 

 

$

 

20,824

 

 

 

$

 

20,532

 

LIABILITY RE-ESTIMATED AS OF:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

One year later

 

 

$

 

6,118

 

 

 

$

 

12,352

 

 

 

$

 

15,204

 

 

 

$

 

18,189

 

 

 

$

 

19,987

 

 

 

$

 

23,209

 

 

 

$

 

22,458

 

 

 

$

 

21,803

 

 

 

$

 

21,348

 

 

 

 

20,509

 

 

 

Two years later

 

 

 

6,105

 

 

 

 

14,003

 

 

 

 

16,994

 

 

 

 

18,520

 

 

 

 

19,533

 

 

 

 

22,937

 

 

 

 

21,337

 

 

 

 

21,445

 

 

 

 

21,094

 

 

 

 

 

Three years later

 

 

 

6,909

 

 

 

 

15,377

 

 

 

 

17,210

 

 

 

 

18,324

 

 

 

 

19,525

 

 

 

 

22,139

 

 

 

 

21,057

 

 

 

 

21,305

 

 

 

 

 

 

 

Four years later

 

 

 

7,086

 

 

 

 

15,441

 

 

 

 

17,048

 

 

 

 

18,362

 

 

 

 

19,153

 

 

 

 

21,992

 

 

 

 

20,787

 

 

 

 

 

 

 

 

 

Five years later

 

 

 

7,240

 

 

 

 

15,267

 

 

 

 

17,106

 

 

 

 

18,236

 

 

 

 

19,099

 

 

 

 

21,835

 

 

 

 

 

 

 

 

 

 

 

Six years later

 

 

 

7,223

 

 

 

 

15,401

 

 

 

 

17,051

 

 

 

 

18,328

 

 

 

 

19,050

 

 

 

 

 

 

 

 

 

 

 

 

 

Seven years later

 

 

 

7,317

 

 

 

 

15,381

 

 

 

 

17,189

 

 

 

 

18,321

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Eight years later

 

 

 

7,370

 

 

 

 

15,602

 

 

 

 

17,253

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine years later

 

 

 

7,460

 

 

 

 

15,639

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Ten years later

 

 

 

7,450

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

CUMULATIVE REDUNDANCY (DEFICIENCY)

 

 

 

(1,782

)

 

 

 

 

(3,832

)

 

 

 

 

(3,920

)

 

 

 

 

(1,768

)

 

 

 

 

566

 

 

 

 

1,763

 

 

 

 

2,108

 

 

 

 

1,552

 

 

 

 

556

 

 

 

 

315

 

 

 

The following table presents an analysis of the Company’s paid, unpaid and incurred losses and loss expenses and a reconciliation of beginning and ending unpaid losses and loss expenses for the years indicated:

Reconciliation of Unpaid Losses and Loss Expenses

 

 

 

 

 

 

 

(U.S. dollars in thousands)

 

2010

 

2009

 

2008

Unpaid losses and loss expenses at beginning of year

 

 

$

 

20,823,524

 

 

 

$

 

21,650,315

 

 

 

$

 

23,207,694

 

Unpaid losses and loss expenses recoverable

 

 

 

3,557,391

 

 

 

 

3,964,836

 

 

 

 

4,665,615

 

Financial guarantee reserves related to previous reinsurance agreements with Syncora that were recorded within “Net loss from operating affiliates”

 

 

 

 

 

 

 

 

 

 

 

(350,988

)

 

 

 

 

 

 

 

 

Net unpaid losses and loss expenses at beginning of year

 

 

 

17,266,133

 

 

 

 

17,685,479

 

 

 

 

18,191,091

 

Increase (decrease) in net losses and loss expenses incurred in respect of losses occurring in:

 

 

 

 

 

 

Current year

 

 

 

3,584,662

 

 

 

 

3,453,577

 

 

 

 

4,573,562

 

Prior years

 

 

 

(372,862

)

 

 

 

 

(284,740

)

 

 

 

 

(610,664

)

 

 

 

 

 

 

 

 

Total net incurred losses and loss expenses

 

 

 

3,211,800

 

 

 

 

3,168,837

 

 

 

 

3,962,898

 

Exchange rate effects

 

 

 

(125,107

)

 

 

 

 

287,752

 

 

 

 

(677,664

)

 

Less net losses and loss expenses paid in respect of losses occurring in:

 

 

 

 

 

 

Current year

 

 

 

442,262

 

 

 

 

439,638

 

 

 

 

584,120

 

Prior years

 

 

 

3,028,247

 

 

 

 

3,436,297

 

 

 

 

3,206,726

 

 

 

 

 

 

 

 

Total net paid losses

 

 

 

3,470,509

 

 

 

 

3,875,935

 

 

 

 

3,790,846

 

Net unpaid losses and loss expenses at end of year

 

 

 

16,882,317

 

 

 

 

17,266,133

 

 

 

 

17,685,479

 

Unpaid losses and loss expenses recoverable

 

 

 

3,649,290

 

 

 

 

3,557,391

 

 

 

 

3,964,836

 

 

 

 

 

 

 

 

Unpaid losses and loss expenses at end of year

 

 

$

 

20,531,607

 

 

 

$

 

20,823,524

 

 

 

$

 

21,650,315

 

 

 

 

 

 

 

 

The Company’s net unpaid losses and losses expenses relating to the Company’s operating segments at December 31, 2010 and 2009 were as follows:

 

 

 

 

 

(U.S. dollars in millions)

 

2010

 

2009

Insurance

 

 

$

 

11,240

 

 

 

$

 

11,128

 

Reinsurance

 

 

 

5,642

 

 

 

 

6,138

 

 

 

 

 

 

Net unpaid loss and loss expense reserves

 

 

$

 

16,882

 

 

 

$

 

17,266

 

 

 

 

 

 

15


Current year net losses incurred

Net losses incurred were flat at $3.2 billion in both 2010 and 2009. Net losses incurred decreased by $794.1 million in 2009 as compared to 2008, mainly as a result of the current year loss ratio decreasing by 9.4 loss percentage points during the same period. This decrease is due primarily to lower levels of large property risk and catastrophe losses occurring in 2009 combined with the impact of anticipated sub prime and credit related losses in 2008. The lower level of property losses in 2009 as well as business mix changes more than offset the impacts of a softening rate environment. The decrease in net losses incurred is also due to a reduction in business volume as net premiums earned decreased 14.0% in 2009 relative to 2008.

See the Income Statement Analysis at Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” for further information regarding the current year loss ratios for each of the years indicated within each of the Company’s operating segments.

Prior year net losses incurred

The following tables present the development of the Company’s gross and net losses and loss expense reserves. The tables also show the estimated reserves at the beginning of each fiscal year and the favorable or adverse development (prior year development) of those reserves during such fiscal year.

 

 

 

 

 

 

 

Gross
(U.S. dollars in millions)

 

2010

 

2009

 

2008

Unpaid losses and loss expense reserves at the beginning of the year

 

 

$

 

20,824

 

 

 

$

 

21,650

 

 

 

$

 

22,857

 

Net (favorable) adverse development of those reserves during the year

 

 

 

(315

)

 

 

 

 

(302

)

 

 

 

 

(1,054

)

 

 

 

 

 

 

 

 

Unpaid losses and loss expense reserves re-estimated one year later

 

 

$

 

20,509

 

 

 

$

 

21,348

 

 

 

$

 

21,803

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net
(U.S. dollars in millions)

 

2010

 

2009

 

2008

Unpaid losses and loss expense reserves at the beginning of the year

 

 

$

 

17,266

 

 

 

$

 

17,686

 

 

 

$

 

18,191

 

Net (favorable) adverse development of those reserves during the year

 

 

 

(373

)

 

 

 

 

(285

)

 

 

 

 

(611

)

 

 

 

 

 

 

 

 

Unpaid losses and loss expense reserves re-estimated one year later

 

 

$

 

16,893

 

 

 

$

 

17,401

 

 

 

$

 

17,580

 

 

 

 

 

 

 

 

As different reinsurance programs cover different underwriting years, contracts and lines of business, net and gross loss experience do not develop proportionately. In 2010, net prior year favorable development exceeded gross prior year favorable development due primarily to the Insurance segment from a single large claim in excess casualty that was heavily ceded.

In 2009, gross prior year favorable development was in line with net favorable development in both the Insurance and Reinsurance segments. In 2008, gross prior year favorable development exceeded net prior year favorable development in both the Reinsurance and Insurance segments. Within the Reinsurance segment, the gross impact of favorable loss experience related to a large crop program was mostly offset by the impact of retrocessional protection related to this program. In the Insurance segment, the impact of reductions in gross reported losses on older years in certain casualty lines was mostly offset by the impact of the reinsurance recoverable component on such losses, while the impact of gross reserve releases in professional and specialty lines was mostly offset by the impact of a reduction in estimated ceded IBNR following a reserve review in these lines.

The following table presents the net (favorable) adverse prior year loss development of the Company’s loss and loss expense reserves by operating segment for each of the years indicated:

 

 

 

 

 

 

 

(U.S. dollars in millions)

 

2010

 

2009

 

2008

Insurance segment

 

 

$

 

(127.4

)

 

 

 

$

 

(62.9

)

 

 

 

$

 

(305.5

)

 

Reinsurance segment

 

 

 

(245.5

)

 

 

 

 

(221.8

)

 

 

 

 

(305.2

)

 

 

 

 

 

 

 

 

Total

 

 

$

 

(372.9

)

 

 

 

$

 

(284.7

)

 

 

 

$

 

(610.7

)

 

 

 

 

 

 

 

 

The Company had net favorable prior year reserve development in property and casualty operations of $372.9 million, $284.7 million and $610.7 million for the years ending December 31, 2010, 2009 and 2008, respectively. See the Income Statement Analysis at Item 7, “Management’s Discussion and Analysis of

16


Financial Condition and Results of Operations” and Item 8, Note 11 to the Consolidated Financial Statements, “Losses and Loss Expenses,” for further information regarding the developments in prior year loss reserve estimates for each of the years indicated within each of the Company’s operating segments.

Net loss reserves (disposed) acquired

The Company did not dispose of or acquire net loss reserves in 2010, 2009 or 2008.

Exchange rate effects

Exchange rate effects on net loss reserves in each of the three years ended December 31 related to the global operations of the Company primarily where reporting units have a functional currency that is not the U.S. dollar. In 2010, the U.S. dollar was stronger against the Euro, while weaker against the Swiss franc, Canadian dollar and Brazilian real. In 2009, the U.S. dollar weakened against all of the Company’s major currency exposures, particularly the Canadian dollar and U.K. sterling. In 2008, the U.S. dollar was stronger against the Euro, the Swiss franc, and U.K. sterling. These movements in the U.S. dollar gave rise to translation and revaluation exchange movements related to carried loss reserve balances of ($125.1) million, $287.8 million and ($677.7) million in the years ended December 31, 2010, 2009 and 2008, respectively.

Net paid losses

Total net paid losses were $3.5 billion, $3.9 billion and $3.8 billion in 2010, 2009 and 2008, respectively. See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” for further information.

Other loss related information

The Company’s net incurred losses and loss expenses include actual and estimates of potential non-recoveries from reinsurers. As at December 31, 2010 and 2009, the reserve for potential non-recoveries from reinsurers was $121.9 million and $189.8 million, respectively. For further information, see Note 12 to the Consolidated Financial Statements, “Reinsurance.”

Except for certain financial guarantee and workers’ compensation liabilities, the Company does not discount its unpaid losses and loss expenses.

With respect to financial guarantee exposures, the amount of case basis reserve is based on the net present value of the expected ultimate loss and loss adjustment expense payments that the Company expects to make, net of expected recoveries under salvage and subrogation rights. Case basis reserves are determined using cash flow or similar models to estimate the net present value of the anticipated shortfall between (i) scheduled payments on the insured obligation plus anticipated loss adjustment expenses and (ii) anticipated cash flow from the proceeds to be received on sales of any collateral supporting the obligation and other anticipated recoveries.

The Company utilizes tabular reserving for workers’ compensation (including long-term disability) unpaid losses that are considered fixed and determinable, and discounts such losses using an interest rate of 5% in 2010 and 2009. The interest rate approximates the average yield to maturity on specific fixed income investments that support these liabilities. The tabular reserving methodology results in applying uniform and consistent criteria for establishing expected future indemnity and medical payments (including an explicit factor for inflation) and the use of mortality tables to determine expected payment periods. Tabular unpaid losses and loss expenses, net of reinsurance, at December 31, 2010 and 2009 on an undiscounted basis were $660.3 million and $734.1 million, respectively. The related discounted unpaid losses and loss expenses were $311.9 million and $343.7 million as of December 31, 2010 and 2009, respectively.

17


Investments

Investment structure and strategy

The Company’s investment operations are managed centrally by the Company’s Investment Group. The Risk and Finance Committee of the Board of Directors of the Company approves overall investment policy and guidelines, and reviews the implementation of the investment strategies on a regular basis.

Strategic Asset Allocation

During 2008, management initiated a Strategic Asset Allocation (“SAA”) process that resulted in the development of an asset allocation benchmark for its property insurance, casualty insurance and reinsurance operations (“P&C”). This project was a stochastic dynamic financial analysis (“DFA”) model of investment assets and liabilities by major line of business to changes in underlying economic variables (including interest rates, inflation and GDP). The resulting SAA benchmark selected by management maximizes the Company’s enterprise value, over the strategic planning period, subject to accounting, regulatory, capital, risk tolerance and other business constraints. In 2009 the Company expanded its SAA process to include its run-off Life Operations which was completed in 2010. The Company continues to focus on optimizing the composition of the two investment portfolios (P&C and Life) relative to the SAA benchmarks. See “Investment Portfolio Repositioning – Investment Portfolio Structure” for more details.

Investment Portfolio Repositioning

For a discussion on the portfolio repositioning and risk reduction actions, see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Other Key Focuses of Management.”

Investment Portfolio Structure

The Company’s investment portfolio consists of fixed income securities, equities, alternative investments, private investments, derivatives and other investments and cash. These securities and investments are denominated in both U.S. dollar and foreign currencies. The Company’s direct use of investment derivatives includes futures, forwards, swaps and option contracts that derive their value from underlying assets, indices, reference rates or a combination of these factors. When investment guidelines allow for the use of derivatives, these can generally only be used for the purpose of managing foreign exchange rate risk, interest rate risk, and credit risk, and replicating permitted investments, provided the use of such instruments is incorporated in the overall portfolio evaluation. The direct use of derivatives to economically leverage the portfolio outside of the stated guidelines is generally not permitted. Derivatives may also be used to add value to the investment portfolio where market inefficiencies are perceived to exist, to equitize cash holdings through the purchase of equity-indexed derivatives and to adjust the duration of a portfolio of fixed income securities as part of duration management activities for the P&C investment portfolio.

The Company’s investment portfolio is structured to take into account a number of variables including local regulatory requirements, business needs, collateral management and risk tolerance. At December 31, 2010 and 2009, total investments, cash and cash equivalents, accrued investment income, and net receivable (payable) for investments sold (purchased), were $35.8 billion and $35.9 billion, respectively.

Functionally, the Company’s investment portfolio is divided into two principal components:

1) P&C investment portfolio: The largest component is the P&C investment portfolio and its principal objective is to support the Company’s insurance and reinsurance operations, the liabilities of which have some uncertainty as to the timing and/or amount. In addition, a smaller portion of the P&C investment portfolio supports corporate operations as well as run-off financial lines business, in which the liabilities have a greater level of certainty and much longer durations than typical P&C business.

18


The principal asset classes in the P&C investment portfolio are summarized in the following table:

 

 

 

 

 

 

 

 

 

(U.S. dollars in thousands)

 

Carrying Value
2010 (1)

 

Percent of
Total

 

Carrying
Value
2009 (1)

 

Percent of
Total

Cash and cash equivalents.

 

 

$

 

2,728,696

 

 

 

 

9.2

%

 

 

 

$

 

3,388,806

 

 

 

 

11.5

%

 

Net receivable (payable) for investments sold (purchased).

 

 

 

(7,798

)

 

 

 

 

0.0

%

 

 

 

 

54,167

 

 

 

 

0.2

%

 

Accrued investment income

 

 

 

223,094

 

 

 

 

0.8

%

 

 

 

 

214,023

 

 

 

 

0.7

%

 

Short-term investments

 

 

 

1,957,386

 

 

 

 

6.7

%

 

 

 

 

1,682,277

 

 

 

 

5.7

%

 

Fixed maturities, available for sale:

 

 

 

 

 

 

 

 

U.S. Government and Government-Related/Supported (2)

 

 

 

1,961,005

 

 

 

 

6.7

%

 

 

 

 

2,500,342

 

 

 

 

8.5

%

 

Corporate

 

 

 

8,069,856

 

 

 

 

27.5

%

 

 

 

 

6,337,182

 

 

 

 

21.5

%

 

Residential mortgage-backed securities – Agency

 

 

 

5,152,712

 

 

 

 

17.6

%

 

 

 

 

6,213,192

 

 

 

 

21.1

%

 

Residential mortgage-backed securities – Non-Agency

 

 

 

994,806

 

 

 

 

3.4

%

 

 

 

 

1,291,764

 

 

 

 

4.4

%

 

Commercial mortgage-backed securities

 

 

 

1,108,698

 

 

 

 

3.8

%

 

 

 

 

1,153,821

 

 

 

 

3.9

%

 

Collateralized debt obligations

 

 

 

733,660

 

 

 

 

2.5

%

 

 

 

 

698,561

 

 

 

 

2.4

%

 

Other asset-backed securities

 

 

 

853,315

 

 

 

 

2.9

%

 

 

 

 

756,901

 

 

 

 

2.6

%

 

U.S. states and political subdivisions of the states

 

 

 

1,349,852

 

 

 

 

4.6

%

 

 

 

 

911,672

 

 

 

 

3.1

%

 

Non-U.S. Sovereign Government, Supranational and Government-Related (2)

 

 

 

2,106,946

 

 

 

 

7.2

%

 

 

 

 

2,225,946

 

 

 

 

7.6

%

 

 

 

 

 

 

 

 

 

 

Total fixed maturities

 

 

$

 

22,330,850

 

 

 

 

76.2

%

 

 

 

$

 

22,089,381

 

 

 

 

75.1

%

 

Equity securities

 

 

 

84,767

 

 

 

 

0.3

%

 

 

 

 

17,779

 

 

 

 

0.1

%

 

Investments in affiliates (3)

 

 

 

1,069,028

 

 

 

 

3.6

%

 

 

 

 

1,185,604

 

 

 

 

4.0

%

 

Other investments (4)

 

 

 

951,723

 

 

 

 

3.2

%

 

 

 

 

783,189

 

 

 

 

2.7

%

 

 

 

 

 

 

 

 

 

 

Total investments and cash and cash equivalents

 

 

$

 

29,337,746

 

 

 

 

100.0

%

 

 

 

$

 

29,415,226

 

 

 

 

100.0

%

 

 

 

 

 

 

 

 

 

 


 

 

(1)

 

 

 

Carrying value represents the fair value for available for sale fixed maturities and amortized cost for held to maturity securities.

 

(2)

 

 

 

U.S. Government and Government-Related/Supported and Non-U.S. Sovereign Government, Supranational and Government-Related include government-related securities with an amortized cost of $1,781.2 million and fair value of $1,802.2 million and U.S. Agencies with an amortized cost of $889.3 million and fair value of $932.5 million.

 

(3)

 

 

 

There are two main categories within Investments in affiliates: 1) investment funds and 2) operating affiliates. Investment funds include $0.5 billion of alternative investment funds, and $0.2 billion of private investment funds at December 31, 2010, as compared to $0.5 billion and $0.3 billion respectively at December 31, 2009. Alternative investment funds are classified by the Company into four general style categories : (i) event driven, which includes strategies that pursue merger arbitrage, distressed and special situations opportunities; (ii) directional/tactical, which includes strategies that pursue long/short equity, managed futures and macro opportunities; (iii) arbitrage, which includes strategies that pursue equity market neutral, fixed income arbitrage and convertible arbitrage opportunities; and (iv) multi- strategy, which includes strategies incorporating several aspects of the above.

 

 

 

 

 

Operating affiliates were valued at $0.3 billion at December 31, 2010 and $0.4 billion at December 31, 2009 respectively. Operating affiliates include investment and (re)insurance affiliates. At December 31, 2010, the Company’s allocation to investment and (re)insurance affiliates and investments in investment management companies’ securities was approximately 0.9% of the total investment portfolio (including cash and cash equivalents, accrued investment income and net receivable (payable) for investments sold (purchased)) as compared to approximately 1.1% at December 31, 2009.

 

 

 

 

 

At December 31, 2010, the Company owned minority stakes in seven independent investment management companies. The Company seeks to achieve strong returns on capital while accessing the investment expertise of professionals to help manage portions of the Company’s investment assets. The Company’s active interactions with the managers of these investment firms provides it with an exchange of expertise that the Company believes enhances its overall financial performance. Of the seven current investments held by the Company, four are companies actively managing client capital and seeking growth opportunities. One of the remaining companies successfully sold its core business in an asset sale during the year and is now winding up the legal entity. The other two inactive firms are unwinding their operations as a result of lack of traction with clients and are carried on the Company’s balance sheet as of December 31, 2010 at a value less than $0.5 million.

 

 

 

 

 

Where the Company maintains significant influence over the decisions of an operating affiliate, through board representation or through certain voting and/or consent rights, the Company’s proportionate share of the income or loss from these companies is reported as net income from operating affiliates. The Company’s existing managers manage or sponsor a broad range of investment products, providing institutional and high net worth investor’s access to a wide array of asset classes and investment strategies. See Item 8, Note 8 to the Consolidated Financial Statements, “Investments.”

 

(4)

 

 

 

Other investments includes equity interests in investment funds, limited partnerships and unrated tranches of collateralized debt obligations for which the Company does not have sufficient rights or ownership interests to follow the equity method of accounting. The Company accounts for equity securities that do not have readily determinable market values at estimated fair value as it has no significant influence over these entities. Also included within other investments are structured transactions which are carried at amortized cost.

19


The investment strategy for the P&C investment portfolio is based on the SAA process, which establishes a portfolio asset allocation target (“Benchmark”) that is constructed to maximize enterprise value subject to business constraints and the risk tolerance of management and approved by the Risk and Finance Committee of the Board of Directors. The SAA process involves stochastic DFA models of XL’s P&C Operations that includes financial conditions, reserve volatility and payout patterns, premium expense and loss ratio projections, liability correlations and sensitivities to economic variables.

The primary performance objective is capital preservation through managing the risk profile of the P&C investment portfolio to be within management’s risk tolerance envelope as reflected in the SAA Benchmark. The second performance objective is for the constrained total return of the P&C investment portfolio to meet or exceed the total return of the SAA Benchmark. The third performance objective is achieving the budget for Net Investment Income.

As part of the overall SAA process and framework the Company has developed and implemented a comprehensive authorities framework that establishes decision authorities that have been approved by management and the Risk and Finance Committee of the Board of Directors. The objective of the authorities is to control the range of exposures and the risk profile within which the P&C investment portfolio will be managed to ensure consistency with SAA and to tie the P&C investment portfolio to the SAA Benchmark. The authorities permit active or tactical deviations from the SAA Benchmark therefore allowing the Company to be underweight or overweight certain components of the SAA Benchmark. The authorities framework has been designed such that as the magnitude of these deviations increases or the resulting impact on the risk profile of the P&C investment portfolio reaches certain predetermined thresholds then additional levels of authority and approval are required, up to and including the Risk and Finance Committee. The authorities are monitored by the Risk & Compliance Team on a monthly basis with any new approvals being documented and reviewed in accordance with the authorities set out in the authorities framework. On at least a quarterly basis an authorities report and update, detailing the authorities for which the Risk and Finance Committee of the Board of Directors of the Company is the approval party, is provided to the Risk and Finance Committee of the Board of Directors of the Company for their consideration, review and approval.

2) The second component of the investment portfolio is the Life investment portfolio, which was approximately $6.4 billion at December 31, 2010 and 2009. As at December 31, 2010, the Company’s allocation to securities in the Life investment portfolio was approximately 19% of the total investment portfolio (including cash and cash equivalents, accrued investment income and net receivable (payable) for investments sold (purchased)) as compared to approximately 18% as at December 31, 2009.

The principal objective of the Life investment portfolio is to support the Company’s Life Operations, which are now in run-off. The largest portion of the Life investment portfolio supports the policy benefit reserves associated with asset annuity transactions, with limited uncertainty as to the timing or amount of the liability cash flows. A smaller portion of the Life investment portfolio supports life annuity liabilities that were assumed without portfolio asset transfer.

20


The principal asset classes in the Life investment portfolio are summarized in the following table:

 

 

 

 

 

 

 

 

 

(U.S. dollars in thousands)

 

Carrying Value
2010 (1)

 

Percent of
Total

 

Carrying
Value
2009 (1)

 

Percent of
Total

Cash and cash equivalents.

 

 

$

 

294,172

 

 

 

 

4.5

%

 

 

 

$

 

254,891

 

 

 

 

4.0

%

 

Net receivable (payable) for investments sold (purchased).

 

 

 

(4,801

)

 

 

 

 

0.0

%

 

 

 

 

(6,529

)

 

 

 

 

(0.1

)%

 

Accrued investment income

 

 

 

126,997

 

 

 

 

2.0

%

 

 

 

 

136,032

 

 

 

 

2.1

%

 

Short-term investments

 

 

 

91,221

 

 

 

 

1.4

%

 

 

 

 

95,083

 

 

 

 

1.5

%

 

Fixed maturities, available for sale:

 

 

 

 

 

 

 

 

U.S. Government and Government-Related/Supported (2)

 

 

 

166,486

 

 

 

 

2.6

%

 

 

 

 

164,283

 

 

 

 

2.5

%

 

Corporate

 

 

 

2,291,027

 

 

 

 

35.5

%

 

 

 

 

3,461,818

 

 

 

 

53.7

%

 

Residential mortgage-backed securities – Agency

 

 

 

12,034

 

 

 

 

0.2

%

 

 

 

 

15,309

 

 

 

 

0.2

%

 

Residential mortgage-backed securities – Non-Agency

 

 

 

26,282

 

 

 

 

0.4

%

 

 

 

 

129,551

 

 

 

 

2.0

%

 

Commercial mortgage-backed securities

 

 

 

63,809

 

 

 

 

1.0

%

 

 

 

 

62,978

 

 

 

 

1.0

%

 

Collateralized debt obligations

 

 

 

3

 

 

 

 

0.0

%

 

 

 

 

 

 

 

 

%

 

Other asset-backed securities

 

 

 

95,516

 

 

 

 

1.5

%

 

 

 

 

411,084

 

 

 

 

6.4

%

 

U.S. states and political subdivisions of the states

 

 

 

1,825

 

 

 

 

0.0

%

 

 

 

 

1,801

 

 

 

 

%

 

Non-U.S. Sovereign Government, Supranational and Government-Related (2)

 

 

 

556,347

 

 

 

 

8.6

%

 

 

 

 

1,175,827

 

 

 

 

18.2

%

 

 

 

 

 

 

 

 

 

 

Total fixed maturities, available for sale

 

 

$

 

3,213,329

 

 

 

 

49.8

%

 

 

 

$

 

5,422,651

 

 

 

 

84.0

%

 

Fixed maturities, held to maturity:

 

 

 

 

 

 

 

 

U.S. Government and Government-Related/Supported (2)

 

 

 

10,541

 

 

 

 

0.2

%

 

 

 

 

 

 

 

 

%

 

Corporate

 

 

 

1,337,797

 

 

 

 

20.6

%

 

 

 

 

 

 

 

 

%

 

Residential mortgage-backed securities – Non-Agency

 

 

 

82,763

 

 

 

 

1.3

%

 

 

 

 

 

 

 

 

%

 

Other asset-backed securities

 

 

 

287,109

 

 

 

 

4.5

%

 

 

 

 

 

 

 

 

%

 

Non-U.S. Sovereign Government, Supranational and Government-Related (2)

 

 

 

1,010,125

 

 

 

 

15.7

%

 

 

 

 

546,067

 

 

 

 

8.5

%

 

 

 

 

 

 

 

 

 

 

Total fixed maturities, held to maturity

 

 

 

2,728,335

 

 

 

 

42.3

%

 

 

 

 

546,067

 

 

 

 

8.5

%

 

 

 

 

 

 

 

 

 

 

Total investments and cash and cash equivalents

 

 

$

 

6,449,253

 

 

 

 

100.0

%

 

 

 

$

 

6,448,195

 

 

 

 

100.0

%

 

 

 

 

 

 

 

 

 

 


 

 

(1)

 

 

 

Carrying value represents the fair value for available for sale fixed maturities and amortized cost for held to maturity securities.

 

(2)

 

 

 

U.S. Government and Government-Related/Supported and Non U.S. Sovereign Government, Supranational and Government-Related include government-related securities with an amortized cost of $319.8 million and fair value of $329.0 million and U.S. Agencies with an amortized cost of $130.2 million and fair value of $140.1 million.

The investment strategy for the Life investment portfolio is based on a SAA process similar to that which was described for the P&C investment portfolio. The SAA process for the Life portfolio incorporates a more extensive focus on Asset-Liability Management (“ALM”), which is possible owing to the lower volatility of life liabilities relative to P&C liabilities. In addition, there are multiple SAA benchmarks within the Life portfolio that represent the liability characteristics of the individual asset annuity transactions.

The primary performance objective for the asset annuity transactions is to achieve a steady credit-adjusted book yield of the Life investment portfolio in order to maximize Life embedded value and minimize statutory capital needs (owing to unique technical requirements of the statutory capital model). For the investments supporting the other portions of the Life investment portfolio, which do not have this unique capital model, the performance objective is the constrained total return relative to the Benchmark. A comprehensive authorities framework has also been developed for the Life portfolio, which is similar to that described for the P&C investment portfolio.

Implementation of investment strategy

Although the Company’s management within the Investment Group is responsible for implementation of the investment strategy, the day-to-day management of the Company’s investment portfolio is outsourced

21


to investment management service providers in accordance with detailed investment guidelines provided and monitored by the Company. This allows the Company an active management of its investment portfolio with flexible access to top talents specializing in various investment products and markets. Investment management service providers are selected directly by the Company on the basis of various criteria including investment style, track record, performance, risk management capabilities, internal controls, operational risk, and diversification implications. Well-established, large institutional investment management service providers manage the vast majority of the Company’s investment portfolio. Each investment management service provider may manage one or more portfolios, each of which is generally governed by a detailed set of investment guidelines, including overall objectives, risk limits (where appropriate), and diversification requirements that fall within the Company’s overall investment policies and guidelines, including but not limited to exposures to eligible securities, prohibited investments/transactions, credit quality and general concentrations limits.

Investment performance

See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” for discussion of the Company’s investment performance.

Investment portfolio credit ratings, duration and maturity profile

It is the Company’s policy to operate the combined P&C and Life (“aggregate”) fixed income portfolio with a minimum weighted average credit rating of Aa3/AA–. The aggregate credit rating is determined based on the weighted average rating of securities, where the average credit rating, where available, from Standard & Poor’s (“S&P”), Moody’s Investors Service (“Moody’s”) and Fitch Ratings (“Fitch”) is allocated to each security. The weighted average credit rating of the aggregate fixed income portfolio was AA at December 31, 2010 and 2009.

The Company did not have an aggregate direct investment in a single corporate issuer in excess of 5% of shareholders’ equity at December 31, 2010 or December 31, 2009, excluding government-backed and government-sponsored enterprises, government-guaranteed paper, cash and cash equivalents, and asset and mortgage backed securities that were issued, sponsored or serviced by the parent.

The overall duration and currency denomination of the aggregate fixed income portfolio is managed relative to the respective SAA Benchmarks for P&C and Life operations, both of which incorporate matching currency and duration within a range relative to liabilities. Duration measures bond price volatility and is an indicator of the sensitivity of the price of a bond (or a portfolio of bonds) to changes in interest rates, assuming a parallel change in all global yield curves reflecting the percentage change in price for a 100 basis point change in yield. Management believes that the duration of the aggregate fixed income portfolio is the best single measure of interest rate risk for the aggregate fixed income portfolio.

The table below summarizes the weighted average duration in years and currency of the main components of the aggregate fixed income portfolio at December 31, 2010 and 2009:

 

 

 

 

 

Aggregate Fixed Income Portfolio Weighted Average Duration in Years

 

December 31,
2010

 

December 31,
2009

Fixed income portfolio by Liability Type:

 

 

 

 

Total Property and Casualty and Structured Products

 

 

 

2.9

 

 

 

 

2.9

 

Life Operations

 

 

 

8.3

 

 

 

 

8.7

 

Total fixed income portfolio

 

 

 

4.0

 

 

 

 

4.0

 

 

 

 

 

 

Aggregate fixed income portfolio by Liability Currency:

 

 

 

 

U.S. Dollar

 

 

 

3.2

 

 

 

 

3.0

 

U.K. Sterling

 

 

 

7.3

 

 

 

 

7.6

 

Euro

 

 

 

5.3

 

 

 

 

5.6

 

Other

 

 

 

2.2

 

 

 

 

2.1

 

Aggregate fixed income portfolio

 

 

 

4.0

 

 

 

 

4.0

 

 

 

 

 

 

The maturity profile of the aggregate fixed income portfolio is a function of the maturity profile of liabilities, the expected operating cash flows of the Company and, to a lesser extent, the maturity profile of

22


common fixed income benchmarks. For further information on the maturity profile of the fixed income portfolio see Item 8, Note 8 to the Consolidated Financial Statements, “Investments.”

Enterprise Risk Management (“ERM”)

Risk Management Framework

The Company faces strategic and operational risks related to, among others: underwriting activities, financial reporting, changing macro economic conditions, investment risks, reserving estimates, changes in laws or regulations, information systems, business interruption and fraud. The Company’s global P&C business, its Life Operations (which is in run-off) and its investment portfolios each have their own set of risks (see Item 1A, “Risk Factors,” for a discussion of such risks). From time to time, these risks may exhibit greater levels of correlation than might be expected over the longer term due to the presence of, to a greater or lesser degree, some common risk drivers (internal or external to the Company) embedded in the Company’s businesses that may manifest themselves simultaneously. An enterprise view of risk is required to identify and manage the consequences of these common risks and risk drivers on the Company’s profitability, capital strength and liquidity.

The Company’s ERM initiatives are led by the Chief Enterprise Risk Officer (“CERO”), who is a member of the Company’s senior management team, and who reports to the Company’s Chief Executive Officer. The CERO also acts as a liaison between the Company’s Enterprise Risk Committee (see below) and the Board (or other of its committees) with respect to risk matters. All of the Company’s employees are expected to assist in the appropriate and timely identification and management of risks and to enhance the quality and effectiveness of ERM.

The Company’s ERM framework is designed to allow management to identify and understand material risk concentrations, including concentrations that have unattractive risk/reward dynamics so that prompt, appropriate, corrective or mitigating actions can be taken. To do this, the Company has risk management committees and processes to serve as points of managerial dialogue and convergence across its businesses and functional areas, creates risk aggregation methodologies and develops specific risk appetites to coordinate the identification, vetting and discussion of risk topics and metrics. As part of its ERM activities, the Company applies a suite of stress tests, tools, risk indicators, metrics and reporting processes that examine the consequences of low probability/high severity events (including those related to emerging risks) in order to drive mitigating actions where required.

Risk Governance

Risk Governance relates to the processes by which oversight and decision-making authorities with respect to risks are granted to individuals within the enterprise. The Company’s governance framework establishes accountabilities for tasks and outcomes as well as escalation criteria. Governance processes are designed to ensure that transactions and activities, individually and in the aggregate, are carried out in accordance with the Company’s risk policies, philosophies, appetites, limits and risk concentrations, and in a manner consistent with expectations of excellence of integrity, accountability and client service.

In order to enhance governance over its ERM activities, the Company established in 2009 the Special Committee on Enterprise Risk Management (the “Special Committee”) as a new Board Committee to oversee the Board’s responsibilities relating to enterprise-wide management of the Company’s key risks. The Special Committee reviewed, among other things, the methodology for establishing the Company’s risk capacity, the overall risk appetite for the Company, and policies for the establishment of risk limit frameworks and adherence to such limits and recommended risk limits to the full Board, based on management’s recommendations and in consultation with the Finance Committee. The Special Committee also assessed the integrity and adequacy of the risk management function of the Company and evaluated the risk impact of any strategies under consideration to determine whether they are consistent with the Company’s risk profile.

In July 2010, after completing a comprehensive review of the Company’s ERM processes and controls, the Board determined that there was no longer a need for a Special Committee. As a result, the Finance Committee of the Board now oversees enterprise risk management matters, changed its name to the Risk

23


and Finance Committee (“RFC”) and revised its charter to reflect these responsibilities. With respect to the responsibilities relating to enterprise risk management, the RFC:

 

 

 

 

Oversees enterprise risk management activities, including the risk management framework employed by management. In light of the overall risk management framework, the RFC (i) reviews the methodology for establishing the Company’s overall risk capacity; (ii) reviews the policies for the establishment of risk limit frameworks, and adherence to such limits; and (iii) reviews and approves enterprise risk limits.

 

 

 

 

Oversees the Company’s compliance with any significant enterprise risk limits, authorities and policies. The RFC evaluates what actions to take with respect to such enterprise limits, authorities and policies, and approves any exceptions thereto from time to time as necessary.

 

 

 

 

Reviews the Company’s overall risk profile and monitor key risks across the Company’s organization as a whole, which may involve coordination with other committees of the Board from time to time as appropriate.

 

 

 

 

Reviews the Company’s process controls over model use and development with respect to model effectiveness, accuracy, propriety and model risk.

 

 

 

 

Monitors the Company’s risk management performance and obtains reasonable assurance from management that the Company’s risk management policies are effective and are being adhered to.

The review of the Company’s overall risk appetites and the evaluation of the risk impact of any material strategic decision being contemplated, including consideration of whether such strategic decision is within the risk profile established by the Company, is conducted by the full Board. “Risk appetites,” as referred to above, are broad statements used to guide the Company’s risk and reward preferences over time, all consistent with, among other factors, business prudence, market opportunities, the underwriting pricing cycle and investment climate. Risk appetites are regularly monitored and can change over time in light of the above. See “–Risk Appetite Management” below.

Management oversight of ERM is performed, in part, via a centralized Enterprise Risk Committee (“ERC”) which is chaired by the CERO. The ERC is comprised of the Company’s most senior management from its businesses and functions and is charged with developing and monitoring enterprise risk policies, risk appetites, risk limits and compliance with such limits, and risk aggregations, and identifying key emerging risks and ways to mitigate such risks.

In addition to the ERC, the Company has established a framework of separate yet complementary ERM subcommittees, each focusing on particular aspects of ERM. These subcommittees include:

 

 

 

 

Economic Capital Model Subcommittee: This subcommittee oversees the development of economic capital models that support ERM activities, and helps set priorities and manage resources related to such models. It reviews assumptions and related methodologies used within the Company’s economic capital model, including assessments of model validation, model control and model risk.

 

 

 

 

Liability Subcommittee: This subcommittee supports and assists the ERC’s identification, measurement, management, monitoring and reporting of key underwriting liability and emerging risks.

 

 

 

 

Asset Subcommittee: This subcommittee assists the ERC in its responsibilities in relation to governance and oversight of asset-related risks across the Company, including its Investment Portfolio. Among the activities under the responsibility of this subcommittee are (a) involvement in policy decisions on modeling and quantification of risk measurements; and (b) providing an interpretation and assessment of asset-related risks, with a particular focus on market-related risks. Further, the subcommittee is responsible for coordinating on a regular basis with the Credit Subcommittee of the ERC on asset-related credit risks.

 

 

 

 

Credit Subcommittee: This subcommittee develops and implements the metrics and supporting framework for allocation of credit risk capacity across major business units, including the amount and types of credit exposure.

 

 

 

 

Operational Risk Subcommittee: This subcommittee supports the ERC’s identification, measurement, management and oversight of key operational risks through its oversight over key operational risk

24


 

 

 

 

management processes and through its review of related operational risk indicators, trends and metrics.

In addition to the above, risk management subcommittees within each of the Company’s businesses function to ensure that risk is managed in accordance with the risk limits, guidelines and tolerances that have been allocated to them by the Company.

Risk Appetite Management

The Company believes that the management of risk appetite is fundamental to strong governance and necessary in order to produce, among other things, a high-quality earnings process. The Company’s risk appetite framework establishes the risk preferences and risk agenda of the organization, which helps set a context for where risk/capital should be deployed in pursuit of value, and hence, from which returns should arise. The Company’s risk appetite standards are integrated into its overall business and strategic planning process.

The Company’s risk appetites, tolerances and related limits are designed to take account of and balance the expectations of the Company’s stakeholders by helping to reinforce the Company’s risk and return culture and by helping to set a context in which its risk preferences can be associated with decision-making across the organization.

The Company’s risk appetite framework guides its strategies relating to, among other things, capital preservation, earnings volatility, net worth at risk, operational loss, liquidity standards, capital rating and capital structure. This framework also addresses the Company’s tolerance to risks from material individual events (e.g., natural or man-made catastrophes such as terrorism), the Company’s investment portfolio, realistic disaster scenarios that cross multiple lines of business and risks related to some or all of the above that may actualize concurrently, with the objective of preserving the Company’s capital base.

In relation to event risk management, the Company establishes net underwriting limits for individual large events as follows:

 

1.

 

 

 

The Company imposes limits for each peril region/event type at a 1% exceedance probability. If the Company was to deploy the full limit, for any given peril region/event type, there would be a 1% probability that an event would occur during the next year that would result in a net underwriting loss in excess of the limit.

 

2.

 

 

 

The Company also imposes limits for each natural catastrophe peril region at a 1% tail value at risk (“TVaR”) probability. This statistic indicates the average amount of net loss expected to be incurred given that a loss above the 1% exceedance probability level has occurred.

 

3.

 

 

 

The Company also imposes limits for certain other event types at a 0.4% exceedance probability as described in further detail below. If the Company were to deploy the full limit, for any given event type, there would be a 0.4% probability that an event that would occur during the next year would result in a net underwriting loss in excess of the limit.

For planning purposes and to calibrate risk tolerances for business to be written from September 30, 2010 through September 30, 2011, the Company set its underwriting limits as a percent of September 30, 2010 Tangible Shareholders’ Equity (hereafter, “Tangible Shareholders’ Equity”). Tangible Shareholders’ Equity is defined as Total Shareholders’ Equity less Goodwill and Other Intangible Assets. These limits may be recalibrated, from time to time, to reflect material changes in Total Shareholders’ Equity that may occur after September 30, 2010, at the discretion of management and as overseen by the Board.

Per event 1% exceedance probability underwriting limits for “Tier 1 event types,” which include natural catastrophes, terrorism and other realistic disaster scenarios, are set at a level not to exceed approximately 15% of Tangible Shareholders’ Equity.

Per event 1% TVaR underwriting limits for certain peak natural catastrophe peril regions approximate 20% of Tangible Shareholders’ Equity. 1% TVaR underwriting limits for non-peak natural catastrophe peril regions are set below the per event 1% TVaR limits described above.

Per event 1% exceedance probability underwriting limits for “Tier 2 event types,” which include country risk, longevity risk and pandemic risk, are set at a level not to exceed 7.5% of Tangible Shareholders’ Equity.

25


Per event 0.4% exceedance probability underwriting limits for “Tier 2 event types” are set at a level not to exceed 15% of Tangible Shareholders’ Equity. The 0.4% exceedance probability limit is used for Tier 2 event types rather than a TVaR measure due to the difficulty in estimating the full distribution of outcomes in the extreme tail of the distribution for these risk types as required for the TVaR measure.

In all instances, the above-referenced underwriting limits reflect pre-tax losses net of reinsurance and net of inwards and outwards reinstatement premiums related to the specific events being measured. The limits are not net of underwriting profits expected to be generated in the absence of catastrophic loss activity.

In setting underwriting limits, the Company also considers such factors as:

 

 

 

 

Correlation of underwriting risk with other risks (e.g., asset/investment risk, operational risk, etc.);

 

 

 

 

Model risk and robustness of data;

 

 

 

 

Geographical concentrations;

 

 

 

 

Exposures at lower return periods;

 

 

 

 

Expected payback period associated with losses;

 

 

 

 

Projected share of industry loss; and

 

 

 

 

Annual aggregate losses at a 1% exceedance probability and at a 1% TVaR level on both a peril region/risk type basis as well as at the portfolio level.

Loss exposure estimates for all event risks are derived from a combination of commercially available and internally developed models together with the judgment of management, as overseen by the Board. Actual incurred losses may vary materially from the Company’s estimates. Factors that can cause a deviation between estimated and actualized loss potential include:

 

 

 

 

Inaccurate assumption of event frequency and severity;

 

 

 

 

Inaccurate or incomplete data;

 

 

 

 

Changing climate conditions, which may add to the unpredictability of frequency and severity of natural catastrophes in certain parts of the world and create additional uncertainty as to future trends and exposures;

 

 

 

 

Future possible increases in property values and the effects of inflation, which may increase the severity of catastrophic events to levels above the modeled levels;

 

 

 

 

Natural catastrophe models, which incorporate and are critically dependent on meteorological, seismological and other earth science assumptions and related statistical relationships that may not be representative of prevailing conditions and risks, and may, therefore, misstate how particular events actually materialize, causing a material deviation between forecasted and actual damages associated with such events; and

 

 

 

 

A change in the judicial climate.

For the above and other reasons, the incidence and severity of catastrophes and other event types are inherently unpredictable and it is difficult to predict the timing of such events with statistical certainty or estimate the amount of loss any given occurrence will generate. As a consequence, there is material uncertainty around the Company’s ability to measure exposures associated with individual events and combinations of events. This uncertainty could cause actual exposures and losses to deviate from those amounts estimated below, which in turn can create a material adverse effect on the Company’s financial condition and results of operations and may result in substantial liquidation of investments, possibly at a loss, and outflows of cash as losses are paid.

For a further discussion on risk appetite management see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Other Key Focuses of Management.”

Impact of ERM Processes

The Company believes that its ERM processes improve the quality and timeliness of strategic decisions, enhance the integration of strategic initiatives with the risks related to such initiatives and act as

26


catalysts to improve risk awareness and informed action by and across the Company. The Company believes that the integration of ERM with existing business processes and controls improves the quality of strategic decisions, optimizes the risk/reward characteristics of business strategies, and enhances the Company’s overall risk management culture.

In addition, the Company’s ERM processes complement the Company’s overall internal control framework by helping to manage the complexity that is inherent within an organization of the Company’s size, the variety of its businesses and investment activities and geographical reach. However, internal controls and ERM can provide only reasonable, not absolute, assurance that control objectives will be met. As a result, the possibility of material financial loss remains in spite of the Company’s ERM activities. An investor should carefully consider the risks and all information set forth in this report including the discussion included in Item 1A “Risk Factors,” Item 7A – “Quantitative and Qualitative Disclosure About Market Risk,” and Item 8, “Financial Statements and Supplementary Data.”

Ratings

The Company’s ability to underwrite business is dependent upon the quality of its claims paying and financial strength ratings as evaluated by independent rating agencies. As a result, in the event that the Company is downgraded, its ability to write business as well as its financial condition and/or results of operations, could be materially adversely effected.

The Company believes that the primary users of ratings include commercial and investment banks, policyholders, brokers, ceding companies and investors.

Tax Matters

See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and Item 8, Note 24 to the Consolidated Financial Statements, “Taxation.”

Regulation

The Company’s operations are subject to regulation and supervision in each of the jurisdictions where they are domiciled and licensed to conduct business. Generally, regulatory authorities can have broad supervisory and administrative powers over such matters as licenses, fitness of management, standards of solvency, material transactions between affiliates, premium rates, policy forms, investments, security deposits, methods of accounting, form and content of financial statements, reserves for unpaid losses and loss adjustment expenses, reinsurance, minimum capital and surplus requirements and/or risk based capital standards, dividends and other distributions to shareholders, periodic examinations and annual and other report filings. In general, such regulation is for the protection of policyholders rather than shareholders.

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Bermuda Operations

The Insurance Act 1978 of Bermuda and related regulations, as amended (the “Act”), regulates the Company’s (re)insurance operating subsidiaries in Bermuda, and it provides that no person may carry on any insurance business in or from within Bermuda unless registered as an insurer by the Bermuda Monetary Authority (the “BMA”) under the Act. Insurance as well as reinsurance is regulated under the Act.

The Act imposes on Bermuda insurance companies, solvency and liquidity standards, certain restrictions on the declaration and payment of dividends and distributions, certain restrictions on the reduction of statutory capital, auditing and reporting requirements, and grants the BMA powers to supervise, investigate and intervene in the affairs of insurance companies. Significant requirements include the appointment of an independent auditor, the appointment of a loss reserve specialist and the filing of the Annual Statutory Financial Return with the BMA. The Supervisor of Insurance is the chief administrative officer under the Act.

In early July 2008, the Insurance Amendment Act of 2008 was passed, which introduced a number of changes to the Act, such as allowing the BMA to prescribe standards for an enhanced capital requirement and a capital and solvency return with which insurers and reinsurers must comply. The Bermuda Solvency Capital Requirement (“BSCR”) employs a standard mathematical model that can relate more accurately the risks taken on by (re)insurers to the capital that is dedicated to their business. (Re)insurers may adopt the BSCR model or, where an insurer or reinsurer believes that its own internal model better reflects the inherent risk of its business, an in-house model approved by the BMA. Class 4 (re)insurers, such as the Company, were required to implement the new capital requirements under the BSCR model beginning with fiscal years ending on or after December 31, 2008.

Under the Bermuda Companies Act 1981, as amended, a Bermuda company may not declare or pay a dividend or make a distribution out of contributed surplus if there are reasonable grounds for believing that: (a) the company is, or would after the payment be, unable to pay its liabilities as they become due; or (b) the realizable value of the company’s assets would thereby be less than the aggregate of its liabilities and its issued share capital and share premium accounts. For further information see Item 8, Note 25 to the Consolidated Financial Statements, “Statutory Financial Data.”

United States

Within the United States, the Company’s insurance and reinsurance subsidiaries are subject to regulation and supervision by their respective states of incorporation and by other jurisdictions in which they do business. The methods of regulation vary, but in general have their source in statutes that delegate regulatory and supervisory powers to an insurance official. The regulation and supervision relate primarily to approval of policy forms and rates, the standards of solvency that must be met and maintained, including risk-based capital standards, material transactions between an insurer and its affiliates, the licensing of insurers, agents and brokers, restrictions on insurance policy terminations, the nature of and limitations on the amount of certain investments, limitations on the net amount of insurance of a single risk compared to the insurer’s surplus, deposits of securities for the benefit of policyholders, methods of accounting, periodic examinations of the financial condition and market conduct of insurance companies, the form and content of reports of financial condition required to be filed, and reserves for unearned premiums, losses, expenses and other obligations. All transactions between or among the insurance and reinsurance company subsidiaries must be fair and equitable. In general, such regulation is for the protection of policyholders rather than shareholders.

Regulations generally require insurance and reinsurance companies to furnish information to their domestic state insurance department concerning activities that may materially affect the operations, management or financial condition and solvency of the company. Regulations vary from state to state but generally require that each primary insurance company obtain a license from the department of insurance of a state to conduct business in that state. A reinsurance company is not generally required to have an insurance license to reinsure a U.S. ceding company from outside the U.S. However, for a U.S. ceding company to obtain financial statement credit for reinsurance ceded, the reinsurer must obtain an insurance license or accredited status from the cedant’s state of domicile or another U.S. state with equivalent insurance regulation or must post collateral to support the liabilities ceded. In addition, regulations for

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reinsurers vary somewhat from primary insurers in that the form and rate of reinsurance contracts and the market conduct of reinsurers are not subject to regulator approval.

The Company’s U.S. insurance and reinsurance subsidiaries are required to file detailed annual and, in most states, quarterly reports with state insurance regulators in each of the states in which they are licensed. Such annual and quarterly reports are required to be prepared on a calendar year basis. In addition, the U.S. insurance subsidiaries’ operations and accounts are subject to financial condition and market conduct examination at regular intervals by state regulators. Effective January 1, 2010, the Company’s U.S. insurance subsidiaries are required to comply with expanded state model audit laws which require the filing of a Management’s Report of Internal Control Over Financial Reporting. The report will provide management’s assertion that it has responsibility for establishing and maintaining a system of adequate internal controls over statutory financial reporting, and will provide management’s assessment that the system is effective. In addition, these new laws also expanded the governance requirements of the insurance subsidiaries.

Statutory surplus is an important measure utilized by the regulators and rating agencies to assess the Company’s U.S. insurance subsidiaries’ ability to support business operations and provide dividend capacity. The Company’s U.S. insurance subsidiaries are subject to various state statutory and regulatory restrictions that limit the amount of dividends that may be paid, within any twelve-month period, from earned surplus without prior approval from regulatory authorities. These restrictions differ by state, but are generally based on a calculation of the lesser of 10% of statutory surplus or 100% of ‘adjusted net investment income’ to the extent that it has not previously been distributed.

The National Association of Insurance Commissioners (the “NAIC”) promulgated, and all states have adopted, Risk-Based Capital (“RBC”) standards for property and casualty companies and life insurance companies as a means of monitoring certain aspects affecting the overall financial condition of insurance companies. RBC is designed to measure the adequacy of an insurer’s statutory surplus in relation to the risks inherent in its business. The NAIC’s RBC Model Law provides for four incremental levels of regulatory attention for insurers whose surplus is below the calculated RBC target. These levels of attention range in severity from requiring the insurer to submit a plan for corrective action to actually placing the insurer under regulatory control. The Company’s current RBC ratios for its U.S. subsidiaries are satisfactory and such ratios are not expected to result in any adverse regulatory action. The Company is not aware of any such actions relative to it.

While the federal government currently does not directly regulate the insurance business in the U.S. (other than for flood, nuclear and reinsurance of losses from terrorism), federal legislation and administrative policies can affect the insurance industry.

In July 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) was passed into law. Dodd-Frank requires the creation of a Federal Insurance Office within the Treasury Department that will be focused on national coordination of the insurance sector, systemic risk mitigation and international regulatory cooperation. Although the Federal Insurance Office currently does not directly regulate the insurance industry, under Dodd-Frank it has the power to preempt state insurance regulations that are inconsistent with international agreements regarding insurance regulation, subject to certain exceptions. In addition, Dodd-Frank provides that, within 18 months of its enactment, the Federal Insurance Office must submit a report to Congress on improving U.S. insurance regulation, which must cover the feasibility of future federal regulation of the U.S. insurance industry.

The federal government has also undertaken initiatives in several areas that may impact the insurance industry including tort reform, corporate governance and the taxation of insurance companies. In addition, legislation has been introduced from time to time in recent years that, if enacted, could result in the federal government assuming a more direct role in the regulation of the insurance industry, primarily as respects federal licensing in lieu of state licensing.

Other International Operations

A substantial portion of the Company’s property and casualty insurance business and a majority of its life reinsurance business are carried on in countries other than Bermuda and the U.S. The degree of regulation in foreign jurisdictions can vary. Generally, the Company’s subsidiaries must satisfy local

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regulatory requirements. Licenses issued by foreign authorities to subsidiaries of the Company are subject to modification or revocation for cause by such authorities. The Company’s subsidiaries could be prevented, for cause, from conducting business in certain of the jurisdictions where they currently operate. While each country imposes licensing, solvency, auditing and financial reporting requirements, the type and extent of the requirements differ substantially. Key areas where country regulations may differ include: (i) the type of financial reports to be filed; (ii) a requirement to use local intermediaries; (iii) the amount of reinsurance permissible; (iv) the scope of any regulation of policy forms and rates; and (v) the type and frequency of regulatory examinations.

In addition to these requirements, the Company’s foreign operations are also regulated in various jurisdictions with respect to currency, amount and type of security deposits, amount and type of reserves, amount and type of local investment and limitations on the share of profits to be returned to policyholders on participating policies. For further information see Item 8, Note 25 to the Consolidated Financial Statements, “Statutory Financial Data.”

European Union

Financial services including insurance, reinsurance and trading in the United Kingdom are regulated by the Financial Services Authority (“FSA”). The FSA’s Handbook of Rules and Guidance (the “FSA Rules”) covers all aspects of regulation including capital adequacy, financial and non-financial reporting and certain activities of U.K.-regulated firms. The Company’s subsidiaries carrying out regulated activities in the U.K. comply with the FSA Rules. The Company’s Lloyd’s managing agency, its managed syndicates and its associated corporate capital vehicles are subject to additional Lloyd’s requirements.

FSA regulations also impact the Company as “controller” (an FSA defined term) of its U.K.-regulated subsidiaries. Through the FSA’s Approved Persons regime, certain employees and Directors are subject to regulation by the FSA of their fitness and certain employees are individually registered at Lloyd’s.

The Company’s network of offices in the European Union consists mainly of branches of U.K. as well as Irish (regulated by the Central Bank of Ireland) companies that are principally regulated under European Directives from their home states, the U.K. and Ireland, rather than by each individual jurisdiction. Company law in the U.K. and Ireland prohibits XL UK and Irish entities from declaring a dividend to their respective shareholders unless the applicable entity has “profits available for distribution.” The determination of whether a company has profits available for distribution is based on its accumulated realized profits less its accumulated realized losses. While the U.K. and Irish insurance regulatory laws impose no statutory restrictions on a general insurer’s ability to declare a dividend, the regulatory rules require maintenance of each insurance company’s solvency margin within its jurisdiction and, in addition, regulatory approval must be sought in advance of paying a distribution by an Irish or U.K. regulated company. In addition, as an Irish public limited company, XL Group plc is also subject to additional reporting requirements under Irish company law.

An E.U. directive covering the capital adequacy and risk management of, and regulatory reporting for, insurers, known as Solvency II was adopted by the European Parliament in April 2009. Insurers and reinsurers within the European Economic Area (“EEA”) will need to be compliant with Solvency II by January 1, 2013. Solvency II presents a number of risks to XL’s European operations. Insurers across Europe are liaising closely with the regulators and undertaking a significant amount of work to develop their internal capital models and to ensure that they will meet the new requirements. This may divert resources from other business- related tasks. Final Solvency II guidance has yet to be published; consequently the Company’s implementation plans are based on its current understanding of the Solvency II requirements and Solvency II equivalence for the BMA’s regime, which may change. Increases in capital requirements as a result of Solvency II may be required and may impact the Company’s results of operations.

Swiss Operations

In Switzerland, the Company’s operations are regulated under the Insurance Supervision Act of December 17, 2004. Both Insurance and Reinsurance operations are supervised under this Act. Reinsurance branches of foreign legal entities are not regulated. Insurance branches of foreign entities are subject to

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limited regulations, (Insurance branches have to comply with the “tied assets” requirements but do not need to fulfill the Swiss Solvency Test). Supervision in Switzerland is exercised by the Federal Financial Market Supervisory Authority (“FINMA”). The supervisory regime currently comprises both Solvency I requirements and Solvency II type requirements (“Swiss Solvency Test”), the latter of which impose higher capital requirements, with which the entities operating in Switzerland comply.

FINMA may call for supervision of an “Insurance group,” based on certain qualitative and quantitative standards. XL’s operations in Switzerland are currently not subject to this “Group supervision.” XL Company Switzerland GmbH, the intermediary holding, is consequently not subject to FINMA regulations.

In its opinion dated July 2010, the European Insurance and Occupational Pensions Authority (“EIOPA”) made a proposal to the European Commission that the Swiss supervisory regime (together with the regime in Bermuda) should be considered in the first wave of the third country equivalence assessment with regard to all three articles on equivalence (Art. 172 Equivalence for reinsurance supervision, Art. 227 Calculating group solvability, Art. 260 Equivalence for third country group supervision).

Employees

At December 31, 2010, the Company had 3,576 employees. At that date, 240 of the Company’s employees were represented by workers’ councils and 403 of the Company’s employees were subject to industry-wide collective bargaining agreements in several countries outside the United States.

Available Information

The public can read and copy any materials the Company files with the U.S. Securities and Exchange Commission (“SEC”) at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. The public can obtain information on the operation of the Public Reference Room by calling the SEC at 1-800- SEC-0330. The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers, including the Company, that file electronically with the SEC. The address of the SEC’s website is http://www.sec.gov.

The Company’s Internet website address is http://www.xlgroup.com. The information contained on the Company’s website is not incorporated by reference into this Annual Report on Form 10-K or any other of the Company’s documents filed with or furnished to the SEC.

The Company makes available free of charge, including through the Company’s Internet website, the Company’s Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after such material is electronically filed with, or furnished to, the SEC.

The Company adopted Corporate Governance Guidelines, as well as written charters for each of the Audit Committee, the Management Development and Compensation Committee, the Nominating, Governance and External Affairs Committee and the Risk and Finance Committee, as well as a Code of Conduct and a related Compliance Program. Each of these documents is posted on the Company’s web-site at http://www.xlgroup.com, and each is available in print to any shareholder who requests it by writing to the Company at Investor Relations Department, XL Group plc, XL House, One Bermudiana Road, Hamilton HM 08, Bermuda.

The Company intends to post on its website at http://www.xlgroup.com any amendment to, or waiver of, a provision of its Code of Conduct that applies to its Chief Executive Officer, Chief Financial Officer and Corporate Controller or persons performing similar functions and that relates to any element of the code of ethics definition set forth in Item 406 of Regulation S-K of the Securities Act of 1933, as amended.

The Company intends to use its website as a means of disclosing material non-public information and for complying with its disclosure obligations under Regulation FD. Such disclosures will be included on the website in the “Investor Relations” section. Accordingly, investors should monitor such portions of the Company’s website, in addition to following its press releases, SEC filings and public conference calls and webcasts.

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ITEM 1A.

 

RISK FACTORS

 

 

 

Any of the following risk factors could have a significant or material adverse effect on our business, financial condition, results of operations and/or liquidity, in addition to the other information contained in this report. Additional risks not presently known to us or that we currently deem immaterial may also impair our business, financial condition and results of operations.

The occurrence of disasters could adversely affect our financial condition.

We have substantial exposure to losses resulting from natural and man-made disasters and other catastrophic events. Catastrophes can be caused by various events, including hurricanes, earthquakes, floods, hailstorms, explosions, severe weather, fires, war and acts of terrorism. Changing climate conditions may add to the unpredictability and frequency of natural disasters in certain parts of the world and create additional uncertainty as to future trends and exposures. The incidence and severity of catastrophes are inherently unpredictable, and it is difficult to predict the timing of such events with statistical certainty or estimate the amount of loss any given occurrence will generate.

The occurrence of claims from catastrophic events is likely to result in substantial volatility in our financial condition, results of operations and cash flows for the fiscal quarter or year in which a catastrophic event occurs, as well as subsequent fiscal periods, and could have a material adverse effect on our financial condition and results of operations and our ability to write new business. This risk is exacerbated due to accounting principles and rules that do not permit (re)insurers to reserve for such catastrophic events until they occur. We expect that future possible increases in the values and concentrations of insured property, the effects of inflation and changes in cyclical weather patterns may increase the severity of catastrophic events in the future. Although we attempt to manage our exposure to catastrophic events, a single catastrophic event could affect multiple geographic zones and lines of business and the frequency or severity of catastrophic events could exceed our estimates, in each case potentially having a material adverse effect on our financial condition, results of operations and cash flows. In addition, while we may, depending on market conditions, purchase catastrophe reinsurance and retrocessional protection, the occurrence of one or more major catastrophes in any given period could result in losses that exceed such reinsurance and retrocessional protection. This could have a material adverse effect on our financial condition and results of operations and may result in substantial liquidation of investments, possibly at a loss, and outflows of cash as losses are paid.

The failure of any of the underwriting risk management strategies that we employ could have a material adverse effect on our financial condition, results of operations and/or liquidity.

We seek to limit our loss exposure by, among other things, writing a number of our reinsurance or retrocession contracts on an excess of loss basis, adhering to maximum limitations on reinsurance written in defined geographical zones, limiting program size for each client and prudently underwriting each program written. In addition, in the case of proportional treaties, we generally seek to use per occurrence limitations or loss ratio caps to limit the impact of losses from any one event. We cannot be sure that all of these loss limitation methods will have the precise risk management impact intended. For instance, although we also seek to limit our loss exposure by geographic diversification, geographic zone limitations involve significant underwriting judgments, including the determination of the area of the zones and the inclusion of a particular policy within a particular zone’s limits. Underwriting involves the exercise of considerable judgment and the making of important assumptions about matters that are inherently unpredictable and beyond our control, and for which historical experience and probability analysis may not provide sufficient guidance. The failure of any of the underwriting risk management strategies that we employ could have a material adverse effect on our financial condition, results of operations and cash flows. Also, we cannot provide assurance that various provisions of our policies, such as limitations or exclusions from coverage or choice of forum, will be enforceable in the manner that we intend and disputes relating to coverage and choice of legal forum may arise, which could materially adversely affect our financial condition and results of operations.

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The insurance and reinsurance industries are historically cyclical and we may experience periods with excess underwriting capacity and unfavorable premium rates.

The insurance and reinsurance industries have historically been cyclical, characterized by periods of intense price competition due to excess underwriting capacity as well as periods when shortages of capacity permitted favorable premium levels. An increase in premium levels is often followed by an increasing supply of insurance and reinsurance capacity, either by capital provided by new entrants or by the commitment of additional capital by existing insurers or reinsurers, which may cause prices to decrease. Either of these factors could lead to a significant reduction in premium rates, less favorable policy terms and conditions and fewer submissions for our underwriting services. In addition to these considerations, changes in the frequency and severity of losses suffered by insureds and insurers may affect the cycles of the insurance and reinsurance industries significantly.

A downgrade or potential downgrade in our financial strength and credit ratings by one or more rating agencies could materially and negatively impact our business, financial condition, results of operations and/or cash flows.

As our ability to underwrite business is dependent upon the quality of our claims paying and financial strength ratings as evaluated by independent rating agencies, a downgrade by any of these institutions could cause our competitive position in the insurance and reinsurance industry to suffer and make it more difficult for us to market our products.

A downgrade below “A–” of our principal insurance and reinsurance subsidiaries by either Standard & Poor’s (“S&P”) or A.M. Best Company (“A.M. Best”), which is two notches below the current S&P and A.M. Best financial strength ratings of “A” (Stable) for our principal insurance and reinsurance subsidiaries, may trigger termination provisions in a significant amount of our assumed reinsurance agreements and may potentially require us to return unearned premium to cedants. Whether a client would exercise its termination rights after such a downgrade would likely depend on, among other things, the reasons for the downgrade, the extent of the downgrade, prevailing market conditions, the degree of unexpired coverage, and the pricing and availability of replacement reinsurance coverage. Based on premium value, approximately 67% of our reinsurance contracts that incepted at January 1, 2011 contained provisions allowing clients to terminate those contracts upon a decline in our ratings to below “A–.” In the event of such a downgrade, we cannot predict whether or how many of our clients would actually exercise such termination rights or the extent to which any such terminations would have a material adverse effect on our financial condition, results of operations, cash flows or future prospects or the market price for our securities. A downgrade could also result in a substantial loss of business for us as ceding companies and brokers that place such business may move to other insurers and reinsurers with higher ratings and the loss of key employees. In addition, due to collateral posting requirements under our letter of credit and revolving credit facility agreements, such a downgrade may require the posting of cash collateral in support of certain “in use” portions of these facilities (see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources” under Part II, Item 7 of this report). Specifically, a downgrade below “A–” by A.M. Best would trigger such collateral requirements for the Company’s largest credit facility. In certain limited instances, such downgrades may require us to return cash or assets to counterparties or to settle derivative and/or other transactions with the respective counterparties.

In addition to the financial strength ratings of our principal insurance and reinsurance subsidiaries, various rating agencies also publish credit ratings for XL-Cayman. Credit ratings are indicators of a debt issuer’s ability to meet the terms of debt obligations in a timely manner are part of our overall funding profile and affect our ability to access certain types of liquidity. Downgrades in our credit ratings could have a material adverse effect on our financial condition and results of operations and cash flows in a number of ways, including adversely limiting our access to capital markets, potentially increasing the cost of debt or requiring us to post collateral.

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Our efforts to develop new products or expand in targeted markets may not be successful and may create enhanced risks.

A number of our recent and planned business initiatives involve developing new products or expanding existing products in targeted markets. This includes the following efforts, from time to time, to protect or grow market share:

 

 

 

 

We may develop products that insure risks we have not previously insured or contain new coverage or coverage terms.

 

 

 

 

We may refine our underwriting processes.

 

 

 

 

We may seek to expand distribution channels.

 

 

 

 

We may focus on geographic markets within or outside of the United States where we have had relatively little or no market share.

We may not be successful in introducing new products or expanding in targeted markets and, even if we are successful, these efforts may create enhanced risks. Among other risks:

 

 

 

 

Demand for new products or in new markets may not meet our expectations.

 

 

 

 

To the extent we are able to market new products or expand in new markets, our risk exposures may change, and the data and models we use to manage such exposures may not be as sophisticated as those we use in existing markets or with existing products. This, in turn, could lead to losses in excess of our expectations.

 

 

 

 

Efforts to develop new products or markets have the potential to create or increase distribution channel conflict.

 

 

 

 

In connection with the conversion of existing policyholders to a new product, some policyholders’ pricing may increase, while the pricing for other policyholders may decrease, the net impact of which could negatively impact retention and margins.

 

 

 

 

To develop new products or markets, we may need to make substantial capital and operating expenditures, which may also negatively impact results in the near term.

If our efforts to develop new products or expand in targeted markets are not successful, our results could be materially and adversely affected.

We are exposed to significant capital markets risk related to changes in interest rates, credit spreads, equity prices and foreign exchange rates as well as other investment risks, which may adversely affect our results of operations, financial condition or cash flows.

Our operating results are affected by the performance of our investment portfolio. Our assets are invested by a number of investment management service providers under the direction of the Company’s management within the Investment Group in accordance, in general, with detailed investment guidelines set by us under the oversight of our Risk and Finance Committee of the Board of Directors, and established in accordance with Strategic Asset Allocation (“SAA”) framework for our P&C operations and Life operations. Although our investment policies stress diversification of risks and conservation of principal and liquidity, our investments are subject to market-wide risks, as noted below, and fluctuations, as well as to risks inherent in particular securities. We are exposed to significant capital markets risks related to changes in interest rates, credit spreads and defaults, market liquidity, equity prices and foreign currency exchange rates. If significant continued market volatility, changes in interest rates, changes in credit spreads and defaults, a lack of pricing transparency, a reduction in market liquidity, declines in equity prices, and the strengthening or weakening of foreign currencies against the U.S. dollar occur, individually or in tandem, this could have a material adverse effect on our consolidated results of operations, financial condition or cash flows through realized losses, impairments, and changes in unrealized positions. Levels of write-down or impairment are impacted by our assessment of the intent to sell securities which have declined in value as well as actual losses as a result of defaults or deterioration in estimates of cash flows. We periodically review our investment portfolio structure and strategy. If, as a result of such review, we determine to reposition or realign portions of the investment portfolio and sell securities in an unrealized loss position, we will incur an other than temporary impairment charge. Any such charge may have a material adverse effect on our results of operations and business.

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For the year ended December 31, 2010, as a result of the prolonged and continued volatility and disruptions in the public debt and equity markets, we incurred realized and unrealized investment losses, as described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” under Part II, Item 7 of this report. We continue to closely monitor current market conditions and evaluate the long term impact of this recent market volatility on all of our investment holdings. Depending on market conditions, we could incur additional realized and unrealized losses in future periods, which could have a material adverse effect on the Company’s results of operations, financial condition and business.

Our exposure to interest rate risk relates primarily to the market price and cash flow variability associated with changes in interest rates. Our investment portfolio contains interest rate sensitive instruments, such as fixed income securities, which have been and may continue to be adversely affected by changes in interest rates from central bank monetary policies, domestic and international economic and political conditions and other factors beyond our control. A rise in interest rates would increase the net unrealized loss position of our investment portfolio, offset by our ability to earn higher rates of return on funds reinvested. Conversely, a decline in interest rates would decrease the net unrealized loss position of our investment portfolio, offset by lower rates of return on funds reinvested. We maintain a P&C investment portfolio with diversified maturities that has a weighted average duration that is determined in accordance with its SAA Benchmark based on a dynamic financial analysis of investment assets and liabilities, and that is intended to maximize the Company’s enterprise value subject to accounting, regulatory, capital and risk tolerances. The SAA Benchmarks and portfolios supporting our Life operations are rebalanced regularly to reflect an explicit asset-liability management process. However, for both the P&C and Life investment portfolios our estimates of the time and size of the liability cash flow profile may be inaccurate and we may be forced to liquidate investments prior to maturity at a loss in order to cover liabilities. We are exposed to interest rate risk relative to our liabilities.

Our exposure to credit spread risk relates primarily to the market price associated with changes in prevailing market credit spreads and the impact on our holdings of spread products such as corporate and structured credit. A portion of our aggregate fixed income portfolio consists of below investment-grade high yield fixed income securities. These securities have a higher degree of credit or default risk. Certain sectors within the investment and below investment grade fixed income market, such as structured and corporate credit, may be less liquid in times of economic weakness or market disruptions. While we have put in place procedures to monitor the credit risk and liquidity of our invested assets in general and those impacted by recent credit market issues specifically, it is possible that, in periods of economic weakness or periods of turmoil in capital markets, we may experience default losses in both our investment grade and below investment grade corporate and structured credit holdings. This may result in a material reduction of net income, capital and cash flows.

We invest a portion of our investment portfolio in common stock or equity-related securities, including alternative funds and private equity funds. The value of these assets fluctuates, along with other factors, due to changes in the equity and credit markets. In times of economic weakness, the market value and liquidity of these assets may decline, and may impact net income, capital and cash flows. In addition, certain of the products offered by our Life Operations segment offer fixed guaranteed returns while debt and equity yields may continue to decline. In addition, the amount of earnings from alternative funds and private investment funds are not earned evenly across the year, or even from year to year. As a result, the amount of earnings that we record from these investments may vary substantially from quarter to quarter. The timing of distributions from such private investment funds depends on particular events relating to the underlying investments. The ability of an alternative fund to satisfy any redemption request from its investors depends on the underlying liquidity of the alternative fund’s investments. As a result, earnings, distributions and redemptions from these two asset classes may be more difficult to predict.

The functional currencies of our principal insurance and reinsurance subsidiaries include the U.S. dollar, U.K. sterling, the Euro, the Swiss Franc and the Canadian dollar. Exchange rate fluctuations relative to the functional currencies may materially impact our financial position, results of operations and cash flows. Many of our non-U.S. subsidiaries maintain both assets and liabilities in currencies different than their functional currency, which exposes us to changes in currency exchange rates.

In addition, locally-required capital levels are invested in local currencies in order to satisfy regulatory requirements and to support local insurance operations regardless of currency fluctuations. Foreign exchange

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rate risk is reviewed as part of our risk management process. While we utilize derivative instruments such as futures, options and foreign currency forward contracts to, among other things, manage our foreign currency exposure, it is possible that these instruments will not effectively mitigate all or a substantial portion of our foreign exchange rate risk.

Certain of our investments may be illiquid and are in asset classes that have been experiencing significant market valuation fluctuations.

We hold certain investments that may lack liquidity or for which the observability of prices or inputs may be reduced in periods of market dislocation, such as non-agency residential mortgage-backed and collateralized debt obligations securities. Even some of our high quality assets have been more illiquid as a result of the recent challenging market conditions. Generally, securities classified as Level 3 pursuant to the fair value hierarchy set forth in authoritative accounting guidance over fair value measurements may be less liquid, may be more difficult to value, requiring significant judgment, and may be more likely to result in sales at materially different amounts than the fair values determined by management.

If we require significant amounts of cash on short notice in excess of normal cash requirements or are required to post or return collateral in connection with certain of our reinsurance contracts, credit agreements, derivative transactions or our invested portfolio, we may have difficulty selling these investments in a timely manner, be forced to sell them for less than we otherwise would have been able to realize, or both.

The reported value of our relatively illiquid types of investments and, in certain circumstances, our high quality, generally liquid asset classes, does not necessarily reflect the lowest current market bid price for the asset. If we were forced to sell certain of our assets in the current market, there can be no assurance that we will be able to sell them for the prices at which we have recorded them and we may be forced to sell them at significantly lower prices, particularly at times of extreme market illiquidity.

If actual claims exceed our loss reserves, or if changes in the estimated levels of loss reserves are necessary, our financial results and cash flows could be adversely affected.

Our results of operations and financial condition depend upon our ability to assess accurately the potential losses associated with the risks that we insure and reinsure. We establish reserves for unpaid losses and loss adjustment expense (“LAE”) liabilities, which are estimates of future payments of reported and unreported claims for losses and related expenses with respect to insured events that have occurred. The process of establishing reserves for property and casualty claims can be complex and is subject to considerable variability as it requires the use of informed estimates and judgments. Actuarial estimates of unpaid loss and LAE liabilities are subject to potential errors of estimation, which could be significant, due to the fact that the ultimate disposition of claims incurred prior to the date of such estimation, whether reported or not, is subject to the outcome of events that have not yet occurred. Examples of these events include the accuracy of the factual information on which the estimates were based, especially as this develops, jury decisions, court interpretations, legislative changes, changes in the medical condition of claimants, public attitudes, and economic conditions such as inflation.

Recent deficit spending by governments in the Company’s major markets exposes the Company to heightened risk of inflation. Inflation in relation to medical costs, construction costs and tort issues in particular impact the property and casualty industry; however, broader market inflation also poses a risk of increasing overall loss costs. The impact of inflation on loss costs could be more pronounced for those lines of business that are considered “long tail” such as general liability, as they require a relatively long period of time to finalize and settle claims for a given accident year. Changes in the level of inflation also result in an increased level of uncertainty in our estimation of loss reserves, particularly for long tail lines of business. The estimation of loss reserves may also be more difficult during times of adverse economic conditions due to unexpected changes in behavior of claimants and policyholders, including an increase in fraudulent reporting of exposures and/or losses, reduced maintenance of insured properties or increased frequency of small claims.

Similarly, the actual emergence of claims for life business may vary from the assumptions underlying the policy benefit reserves, in particular, the future assumed mortality improvements on the blocks of in-payment annuities.

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In relation to previously written financial guarantee business and related exposures, we establish reserves for losses and LAE on such business based on management’s best estimate of the ultimate expected incurred losses. Establishment of such reserves requires the use and exercise of significant judgment by management, including with respect to estimates regarding the occurrence and amount of a loss on an insured or reinsured obligation. Estimates of losses may differ from actual results and such difference may be material, due to the fact that the ultimate dispositions of claims are subject to the outcome of events that have not yet occurred. Examples of these events include changes in the level of interest rates, credit deterioration of insured and reinsured obligations, and changes in the value of specific assets supporting insured and reinsured obligations. In general, guarantees on previously written credit default swaps are exposed to the same risks as noted above, except in events of default by the guarantor. Credit default swaps, however, do not qualify for the financial guarantee scope exception under authoritative accounting guidance over derivative instruments and hedging activities, and, therefore are reported at fair value with changes in the fair value included in earnings. Fair values for such swaps are determined based on methodologies further described in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies and Estimates.” Any estimate of future costs is subject to the inherent limitation on our ability to predict the aggregate course of future events. It should therefore be expected that the actual emergence of losses and LAE will vary, perhaps materially, from any estimate.

We have an actuarial staff in each of our operating segments and a Chief Actuary who regularly evaluates the levels of loss reserves, taking into consideration factors that may impact the ultimate losses incurred. Any such evaluation could result in future changes in estimates of losses or reinsurance recoverable and would be reflected in our results of operations in the period in which the estimates are changed. Losses and LAE, to the extent that they exceed the applicable reserves, are charged to income as incurred. The reserve for unpaid losses and LAE represents the estimated ultimate losses and LAE less paid losses and LAE, and comprises case reserves and incurred but not reported loss reserves (“IBNR”). During the loss settlement period, which can span many years in duration for casualty business, additional facts regarding individual claims and trends often will become known and case reserves may be adjusted by allocation from IBNR without any change in the overall reserve. In addition, application of statistical and actuarial methods may require the adjustment of the overall reserves upward or downward from time to time. Accordingly, the ultimate settlement of losses may be significantly greater than or less than reported loss and loss expense reserves.

The effects of emerging claim and coverage issues on our business are uncertain.

As industry practices and legal, judicial, social and other environmental conditions change, unexpected issues related to claims and coverage may emerge. These issues may adversely affect our business by either extending coverage beyond our underwriting intent or by increasing the number or size of claims, such as the effects that recent disruptions in the credit markets could have on the number and size of reported claims under directors and officers liability insurance (“D&O”) and professional liability insurance lines of business. In some instances, these changes may not become apparent until some time after we have issued the insurance or reinsurance contracts that are affected by the changes. Historically such claims and coverage issues have occurred at heightened levels during periods of very soft market conditions which often reflect an inflection point in the typical cycle of insurance industry market conditions. In addition, our actual losses may vary materially from our current estimate of the loss based on a number of factors, including receipt of additional information from insureds or brokers, the attribution of losses to coverages that had not previously been considered as exposed and inflation in repair costs due to additional demand for labor and materials. As a result, the full extent of liability under an insurance or reinsurance contract may not be known for many years after such contract is issued and a loss occurs.

There can be no assurance as to the effect that governmental and regulatory actions will have on financial markets generally or on us in particular.

In response to the financial crises affecting the banking system and financial markets and going concern threats to financial institutions, there have been numerous regulatory and governmental actions in the United States, the United Kingdom and the Euro-zone among other countries. The purpose of these legislative and regulatory actions is to stabilize the U.S. and international banking systems, improve the flow of credit and foster an economic recovery. However, there can be no assurance as to the success of

37


such actions or the effect that any such governmental actions or future regulatory initiatives may have on certain investment instruments in our investment portfolio, or on our competitive position, business and financial position. If global economic and market conditions remain uncertain, persist, or deteriorate further, we may experience material adverse impacts on our business operations results and financial condition.

For example, we own a number of Tier 1 and Upper Tier 2 hybrid securities issued by financial institutions including those based in the U.S., Europe and U.K. There is a risk that if the capital positions of financial institutions deteriorate further government intervention, particularly nationalization of such institutions, could occur. There is also a risk of regulatory imposed deferral of coupons or decisions by bank management not to call the capital or defer the coupon payments. This may result in losses on the hybrid securities we hold. There is also the risk of further downgrades of these securities as rating agencies re-evaluate their rating methodologies, which would negatively impact the regulatory capital of the Life operations.

In particular, the current sovereign debt crisis concerning European countries, including Ireland, Greece, Italy, Portugal and Spain, and related European financial restructuring efforts, may cause the value of the European currencies, including the Euro, to further deteriorate, which in turn could adversely impact Euro- denominated assets held in our investment portfolio or our European book of business. In addition, the European crisis is contributing to instability in global credit markets, as well as the widening of bond yield spreads. Recent rating agency downgrades on European sovereign debt and growing concern of the potential default of government issuers or of a possible break-up of the European Union has further contributed to this uncertainty. Should governments default on their obligations, there will be a negative impact on both our direct holdings, as well as on non-government issues and financials held within the country of default.

We may be unable to purchase reinsurance and, even if we are able to successfully purchase reinsurance, we are subject to the possibility of uncollectability. The impairment of other financial institutions also could adversely affect us.

We purchase reinsurance for our own account in order to mitigate the volatility that losses impose on our financial condition. Our clients purchase reinsurance from us to cover part of the risk originally written by them. Retrocessional reinsurance involves a reinsurer ceding to another reinsurer, the retrocessionaire, all or part of the reinsurance that the first reinsurer has assumed. Reinsurance, including retrocessional reinsurance, does not legally discharge the ceding company from its liability with respect to its obligations to its insureds or reinsureds. A reinsurer’s or retrocessionaire’s insolvency, inability or refusal to make timely payments under the terms of its agreements with us, therefore, could have a material adverse effect on us because we remain liable to our insureds and reinsureds. At December 31, 2010, we had approximately $3.8 billion of reinsurance recoverables and reinsurance balances receivable, net of reserves for uncollectible recoverables. For further information regarding our reinsurance exposure, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations” under Part II, Item 7 of this report.

From time to time, market conditions may limit or prevent us from obtaining the types and amounts of reinsurance that we consider adequate for our business needs such that we may not be able to obtain reinsurance or retrocessional reinsurance from entities with satisfactory creditworthiness in amounts that we deem desirable or on terms that we deem appropriate or acceptable.

We also have exposure to counterparties in various industries, including banks, hedge funds and other investment vehicles, and in transactions in addition to reinsurance agreements, including derivative transactions. Many of these transactions expose us to credit risk in the event our counterparty fails to perform its obligations. Even if we are entitled to collateral when a counterparty defaults, such collateral may be illiquid or proceeds from such collateral when liquidated may not be sufficient to recover the full amount of the obligation. We also have exposure to financial institutions in the form of secured and unsecured debt instruments and equity securities.

Since we depend on a few brokers for a large portion of our revenues, loss of business provided by any one of them could adversely affect us.

We market our insurance and reinsurance products worldwide primarily through insurance and reinsurance brokers. Marsh & McLennan Companies, AON Corporation and the Willis Group and their respective subsidiaries each provided approximately 21%, 21% and 11% respectively, of our gross written

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premiums for property and casualty operations for the year ended December 31, 2010. Loss of all or a substantial portion of the business provided by one or more of these brokers could have a material adverse effect on our business.

Our reliance on brokers subjects us to credit risk.

In certain jurisdictions, when an insured or ceding insurer pays premiums for policies of insurance or contracts of reinsurance to brokers for further payment to us, such premiums might be considered to have been paid and the insured or ceding insurer will no longer be liable to us for such amounts, whether or not we have actually received the premiums from the broker. In addition, in accordance with industry practice, we generally pay amounts owed on claims under our reinsurance contracts to brokers, and these brokers, in turn, pay these amounts over to the clients that have purchased reinsurance from us. Although the law is unsettled and depends upon the facts and circumstances of the particular case, in some jurisdictions, if a broker fails to make such a claims payment to the insured or ceding insurer, we might remain liable to the insured or ceding insurer for that non-payment. Consequently, we assume a degree of credit risk associated with the brokers with whom we transact business. Due to the unsettled and fact-specific nature of the law governing these types of scenarios and our lack of historical experience with such risks, we are unable to quantify our exposure to this risk.

We are subject to a number of risks associated with our business outside the United States.

We conduct business outside the United States primarily in the United Kingdom, Bermuda, continental Europe and Ireland. We have also started to pursue opportunities in other countries, including in emerging markets such as Asia and Brazil. While our business in emerging and other markets currently constitutes a relatively small portion of our revenues, in conducting such business we are subject to a number of significant risks. These risks include restrictions such as price controls, capital controls, exchange controls, ownership limits and other restrictive governmental actions, which could have an adverse effect on our business and our reputation. In addition, some countries, particularly emerging economies, have laws and regulations that lack clarity and, even with local expertise and effective controls, it can be difficult to determine the exact requirements of the local laws. Failure to comply with local laws in a particular market could have a significant and negative effect not only on our business in that market but also on our reputation generally.

Our holding company structure and certain regulatory and other constraints affect our ability to pay dividends, make payments on our debt securities and make other payments.

As a holding company with no direct operations or significant assets other than the capital stock of our subsidiaries, we rely on investment income, cash dividends, loans and other permitted payments from our subsidiaries to make principal and interest payments on our debt, to pay operating expenses and common and preferred shareholder dividends, to make capital investments in our subsidiaries and to pay certain of our other obligations that may arise from time to time. We expect future investment income, dividends and other permitted payments from these subsidiaries to be our principal source of funds to pay such expenses, preferred and common stock dividends and obligations. The payment of dividends to us by our insurance and reinsurance subsidiaries is regulated under the laws of various jurisdictions including Bermuda, the U.K., Ireland and Switzerland and certain insurance statutes of various states in the United States in which our insurance and reinsurance subsidiaries are licensed to transact business and the other jurisdictions where we have regulated subsidiaries. For further information regarding regulatory restrictions governing the payment of dividends by the Company’s significant property and casualty subsidiaries in Ireland, Bermuda and the U.S., see Note 25 to the Consolidated Financial Statements, “Statutory Financial Data.”

XL-Ireland is subject to certain legal constraints that affect its ability to pay dividends on or redeem or buyback our ordinary shares. While XL-Ireland’s articles of association authorize its board of directors to declare and pay dividends as justified from the profits, under Irish law, XL-Ireland may only pay dividends or buyback or redeem shares using distributable reserves. As of December 31, 2010 XL-Ireland had $4.8 billion in distributable reserves. In addition, no dividend or distribution may be made unless the net assets of XL-Ireland are not less than the aggregate of its share capital plus undistributable reserves and the distribution does not reduce XL-Ireland’s net assets below such aggregate.

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In addition, XL-Cayman is subject to certain constraints that affect its ability to pay dividends on its preferred shares. Under Cayman Islands law, XL-Cayman may not declare or pay a dividend if there are reasonable grounds for believing that XL-Cayman is, or would after the payment be, unable to pay its liabilities as they become due in the ordinary course of business. Also, the terms of XL-Cayman’s preferred shares prohibit declaring or paying dividends on the ordinary shares unless full dividends have been declared and paid on the outstanding preferred shares. In addition, the ability to declare and pay dividends may be restricted by covenants in our letters of credit and revolving credit facilities.

We may require additional capital in the future, which may not be available to us on satisfactory terms, on a timely basis or at all.

Our future capital requirements depend on many factors, including our ability to write new business successfully and to establish premium rates and reserves at levels sufficient to cover our losses. To the extent that the funds generated by our ongoing operations are insufficient to fund future operating requirements and cover claim payments, or that our capital position is adversely impacted by mark-to-market changes on the investment portfolio, catastrophe events or otherwise, we may need to raise additional funds through financings or curtail our growth and reduce our assets. As a result of the current severe economic conditions that persist in the capital markets, any future financing may not be available on terms that are favorable to us, if at all. In addition, any future equity financings could be dilutive to our existing shareholders or could result in the issuance of securities that have rights, preferences and privileges that are senior to those of our other securities. Our inability to obtain adequate capital could have a material adverse effect on our business, financial condition and results of operations.

Competition in the insurance and reinsurance industries could reduce our operating margins.

The insurance and reinsurance industries are highly competitive. We compete on an international and regional basis with major U.S., Bermudian, European and other international insurers and reinsurers and with underwriting syndicates, some of which have greater financial and management resources and higher ratings than we do. We also compete with new companies that continue to be formed to enter the insurance and reinsurance markets. In addition, capital market participants have created alternative products that are intended to compete with reinsurance products. Increased competition could result in fewer submissions, lower premium rates and less favorable policy terms and conditions, which could reduce our margins.

Operational risks, including human or systems failures, are inherent in our business.

Operational risk and losses can result from, among other things, fraud, errors, failure to document transactions properly or to obtain proper internal authorization, failure to comply with regulatory requirements, information technology failures, or external events. Areas of operational risk can be heightened in discontinued or exited business as a result of reduced overall resource allocation and the loss of relevant knowledge and expertise by departing management. The Company has exited a number of businesses in recent years, potentially increasing operational risk in such businesses.

We believe that our modeling, underwriting and information technology and application systems are critical to our business. Moreover, our information technology and application systems have been an important part of our underwriting process and our ability to compete successfully. We have also licensed certain systems and data from third parties. We cannot be certain that we will have access to these, or comparable, service providers, or that our information technology or application systems will continue to operate as intended. A major defect or failure in our internal controls or information technology and application systems could result in management distraction, harm to our reputation or increased expense.

In particular, we have outsourced the day-to-day management, custody and record-keeping of our investment portfolio to third-party managers and custodians that we believe to be reputable. A major defect in those investment managers’ investment management strategy, information and technology systems, internal controls or decision-making could result in management distraction and/or significant financial loss. A major defect in custodian internal controls or information and technology systems could result in management distraction or significant financial loss.

We believe appropriate controls and mitigation procedures are in place to prevent significant risk of defect in our internal controls, information technology, application systems, investment management and custody and record-keeping, but internal controls provide only reasonable, not absolute, assurance as to the

40


absence of errors or irregularities and any ineffectiveness of such controls and procedures could have a material adverse effect on our business.

Unanticipated losses from terrorism and uncertainty surrounding the future of the TRIPRA could have a material adverse effect on our financial condition, results of operations and cash flows.

In response to the tightening of supply in certain insurance and reinsurance markets resulting from, among other things, the September 11 event, the TRIP was created upon the enactment of the TRIA of 2002 to ensure the availability of commercial insurance coverage for certain terrorist acts in the U.S. This law established a federal assistance program through the end of 2005 to help the commercial property and casualty insurance industry cover claims related to future terrorism-related losses and required that coverage for terrorist acts be offered by insurers. TRIA was originally scheduled to expire at the end of 2005, but was extended in December 2005 for an additional two years. On December 26, 2007, President George W. Bush approved the TRIPRA, extending TRIP through December 31, 2014 and also eliminating the distinction between foreign and domestic acts of terrorism.

TRIA voided in force terrorism exclusions as of November 26, 2002 for certified terrorism on all TRIA specified property and casualty business. TRIA required covered insurers to make coverage available for certified acts of terrorism on all new and renewal policies issued after TRIA was enacted. TRIA along with further extensions to TRIP, as noted above, allows us to assess a premium charge for terrorism coverage and, if the policyholder declines the coverage or fails to pay the buy-back premium, certified acts of terrorism may then be excluded from the policy, subject, however, to state specific requirements. Terrorism coverage cannot be excluded from workers’ compensation policies. Subject to a premium-based deductible and provided that we have otherwise complied with all the requirements as specified under TRIPRA, we are eligible for reimbursement by the Federal Government for up to 85% of our covered terrorism-related losses arising from a certified terrorist attack. Such payment by the government will, in effect, provide reinsurance protection on a quota share basis. The maximum liability during a program year, including both the Federal Government’s and insurers’ shares, is capped on an aggregated basis at $100 billion. While regulations have been promulgated by the Department of the Treasury (“Treasury”) requiring that Treasury advise participating insurers, such as the Company, in advance of reaching the $100 billion aggregate limit that such aggregate limit could be reached during the program year, there is a risk that the Company will not be given adequate notice of the potential exhaustion of that aggregate limit. Accordingly, the Company could overpay with regard to such losses, and it is unlikely Treasury would reimburse the Company for such losses; moreover, it is unclear whether the Company, in the event of an overpayment, would be able to recover the amount of any such overpayment.

We believe that TRIP and the related legislation have been an effective mechanism to assist policyholders and industry participants with the extreme contingent losses that might be caused by acts of terrorism. Nevertheless, we cannot assure you that TRIPRA will be extended beyond 2014, and its expiration or a significant change in terms could have an adverse effect on us, our clients or the insurance industry.

The regulatory regimes under which we operate, and potential changes thereto, could have a material adverse effect on our business.

Our insurance and reinsurance subsidiaries operate in 24 countries around the world as well as in all 50 U.S. states. Our operations in each of these jurisdictions are subject to varying degrees of regulation and supervision. The laws and regulations of the jurisdictions in which our insurance and reinsurance subsidiaries are domiciled require, among other things, that these subsidiaries maintain minimum levels of statutory capital, surplus and liquidity, meet solvency standards, submit to periodic examinations of their financial condition and restrict payments of dividends and reductions of capital. Statutes, regulations and policies that our insurance and reinsurance subsidiaries are subject to may also restrict the ability of these subsidiaries to write insurance and reinsurance policies, make certain investments and distribute funds.

In recent years, the U.S. insurance regulatory framework has come under increased federal scrutiny. In July 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) was signed into law. The Dodd-Frank Act requires many federal agencies to adopt new rules and regulations that will apply to the financial services industry and also calls for many studies regarding various industry practices. In particular, the Dodd-Frank Act created a Federal Insurance Office within the Treasury

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Department that will be focused on national coordination of the insurance sector, systemic risk mitigation and international regulatory cooperation. Although the Federal Insurance Office currently does not directly regulate the insurance industry, under the Dodd-Frank Act it has the power to preempt state insurance regulations that are inconsistent with international agreements regarding insurance regulation, subject to certain exceptions. In addition, the Dodd-Frank Act provides that, within 18 months of its enactment, the Federal Insurance Office must submit a report to Congress on improving U.S. insurance regulation, which must cover the feasibility of future federal regulation of the U.S. insurance industry. This study or another among the various studies required by the legislation could result in additional rulemaking or legislative action, which could negatively impact our business and financial results. While we have not yet been required to make material changes to our business or operations as a result of the Dodd-Frank Act, due to the complexity and broad scope of the Dodd-Frank Act and the time required for regulatory implementation, it is not certain what the scope of future rulemaking or interpretive guidance from the SEC, CFTC or other regulatory agencies may be, and what impact this will have on our compliance costs, business, operations and profitability.

In addition, some state legislatures have considered or enacted laws that may alter or increase state regulation of insurance and reinsurance companies and holding companies. Moreover, the National Association of Insurance Commissioners, which is the organization of insurance regulators from the 50 U.S. states, the District of Columbia and the four U.S. territories, as well as state insurance regulators regularly reexamine existing laws and regulations.

In addition to these proposals and initiatives in the United States, regulators and law makers around the world are actively reviewing the causes of the financial crisis and exploring steps to avoid similar problems in the future. New capital adequacy and risk management regulations called Solvency II are in the process of being implemented throughout the EU introducing changes to the prudential regulation of European insurers effective January 1, 2013. Similar legislation is also in the process of being developed or implemented in other jurisdictions, including Canada and Switzerland. In addition, regulations in countries in which we have operations are working with the International Association of Insurance Supervisors (and in the U.S., with the NAIC) to consider changes to insurance company supervision, including solvency requirements and group supervision. There remains significant uncertainty as to the impact of these efforts, however, such impacts could constrain our ability to move capital between subsidiaries or require that additional capital or security to be provided in certain jurisdictions, which may impact profitability.

We may not be able to comply fully with, or obtain desired exemptions from, revised statutes, regulations and policies that govern the conduct of our business. Failure to comply with, or to obtain desired authorizations and/or exemptions under, any applicable laws could result in restrictions on our ability to do business or undertake activities that are regulated in one or more of the jurisdictions in which we operate and could subject us to fines and other sanctions. In addition, changes in the laws or regulations to which we are subject, or in the interpretations thereof by enforcement or regulatory agencies, could have a material adverse effect on our business.

Potential government intervention in our industry as a result of recent events and instability in the marketplace for insurance products could hinder our flexibility and negatively affect the business opportunities that may be available to us in the market.

Government intervention and the possibility of future government intervention have created uncertainty in the insurance and reinsurance markets. Government regulators are generally concerned with the protection of policyholders to the exclusion of other constituencies, including shareholders of insurers and reinsurers. While we cannot predict the exact nature, timing or scope of possible governmental initiatives, such proposals could adversely affect our business by, among other things:

 

 

 

 

providing insurance and reinsurance capacity in markets and to consumers that we target, e.g., the creation or expansion of a state or federal catastrophe funds such as those in Florida;

 

 

 

 

requiring our participation in industry pools and guarantee associations

 

 

 

 

expanding the scope of coverage under existing policies;

 

 

 

 

regulating the terms of insurance and reinsurance policies; or

 

 

 

 

disproportionately benefiting the companies of one country over those of another.

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Government intervention has recently taken the form of financial support of certain companies in our industry. Governmental support of individual competitors can lead to increased pricing pressure, a distortion of market dynamics, and ultimately prolong the current period of soft market conditions. The insurance industry is also affected by political, judicial and legal developments that may create new and expanded theories of liability, which may result in unexpected claims frequency and severity and delays or cancellations of products and services by insureds, insurers and reinsurers which could adversely affect our business.

For further information regarding government regulation and/or intervention in response to the financial and credit crises, see risk factor entitled “There can be no assurance as to the effect that governmental actions will have on such markets generally or on us in particular” above.

Consolidation in the insurance industry could adversely impact us.

Insurance industry participants may seek to consolidate through mergers and acquisitions. Continued consolidation within the insurance industry will further enhance the already competitive underwriting environment as we would likely experience more robust competition from larger, better capitalized competitors. These consolidated entities may use their enhanced market power and broader capital base to negotiate price reductions for our products and services, and reduce their use of reinsurance, and as such, we may experience rate declines and possibly write less business.

If our Bermuda operating subsidiaries become subject to insurance statutes and regulations in jurisdictions other than Bermuda or if there is a change in Bermuda law or regulations or the application of Bermuda law or regulations, there could be a significant and negative impact on our business.

XL Insurance (Bermuda) Ltd and XL Re Ltd, two of our wholly-owned operating subsidiaries, are registered as Bermuda Class 4 insurers. In addition, XL Re Ltd is registered as a long-term (life) reinsurer. As such, they are subject to regulation and supervision in Bermuda. Bermuda insurance statutes and the regulation, policies and procedures of the Bermuda Monetary Authority require XL Insurance (Bermuda) Ltd and XL Re Ltd to, among other things:

 

 

 

 

maintain a minimum level of capital and surplus;

 

 

 

 

maintain solvency margins and liquidity ratios;

 

 

 

 

restrict dividends and distributions in certain circumstances;

 

 

 

 

obtain prior approval regarding the ownership and transfer of shares;

 

 

 

 

maintain a principal office and appoint and maintain a principal representative in Bermuda;

 

 

 

 

file an annual statutory financial return;

 

 

 

 

file annual audited financial statements in accordance with applicable GAAP or International Financial Reporting Standards and quarterly unaudited management accounts;

 

 

 

 

file annual Bermuda Solvency Capital Requirement (“BSCR”), a risk-based capital adequacy model, and capital and solvency return;

 

 

 

 

File a qualitative description of its underwriting strategy and description of policies surrounding the use of derivatives and certain market value and exposure information relating to derivative; and

 

 

 

 

allow for the performance of certain periodic examinations of XL Insurance (Bermuda) Ltd and XL Re Ltd.

These statutes and regulations may restrict our ability to write insurance and reinsurance policies, distribute funds and pursue our investment strategy.

In 2008, the BMA introduced new risk-based capital standards for insurance companies as a tool to assist the BMA both in measuring risk and in determining appropriate levels of capitalization. The required statutory capital and surplus of our Bermuda-based operating subsidiaries increased under the BSCR. While our Bermuda-based operating subsidiaries currently have excess capital and surplus under these new requirements, there can be no assurance that such requirement or similar regulations, in their current form or as may be amended in the future, will not have a material adverse effect on our business, financial condition or results of operations.

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The process of obtaining licenses is very time consuming and costly and XL Insurance (Bermuda) Ltd and XL Re Ltd may not be able to become licensed in jurisdictions other than Bermuda should we choose to do so. The modification of the conduct of our business that would result if we were required or chose to become licensed in certain jurisdictions could significantly and negatively affect our financial condition and results of operations. In addition, our inability to comply with insurance statutes and regulations could significantly and adversely affect our financial condition and results of operations by limiting our ability to conduct business as well as subjecting us to penalties and fines.

Because XL Insurance (Bermuda) Ltd and XL Re Ltd are Bermuda companies, they are subject to changes in Bermuda law and regulation that may have an adverse impact on our operations, including through the imposition of tax liability or increased regulatory supervision. In addition, XL Insurance (Bermuda) Ltd and XL Re Ltd will be exposed to any changes in the political environment in Bermuda, including, without limitation, changes as a result of the independence issues which have been discussed in Bermuda in recent years. While we cannot predict the future impact on our operations of changes in the laws and regulation to which we are or may become subject, any such changes could have a material adverse effect on our business, financial condition and results of operations.

The loss of one or more key executives or the inability to attract, motivate and retain qualified personnel could adversely affect our ability to conduct business.

Our success depends on our ability to attract new, highly skilled individuals and to motivate and retain our existing key executives and qualified personnel. The loss of the services of any of our key executives or the inability to attract, motivate and retain other highly skilled individuals in the future could adversely affect our ability to conduct our business. In addition, we do not maintain key man life insurance policies with respect to our employees.

Although the market price of our ordinary shares gained 19% during fiscal 2010 as compared to the market price as at December 31, 2009, it has not fully recovered from the very significant decline in market price during fiscal 2008. A substantial portion of our annual compensation paid to our senior employees has, in recent years, been paid in the form of equity-based awards. In addition, we reduced the number of employees across nearly all of our locations in August 2008 as well as in the period between February and July 2009. The combination of these events could adversely affect our ability to hire, motivate and retain qualified employees.

In addition, certain of our senior executives who work in our Bermuda operations are not Bermudian and our success in such operations may depend in part on the continued services of key employees working in Bermuda. Under Bermuda law, non-Bermudians (other than spouses of Bermudians and holders of permanent resident certificates) may not engage in any gainful occupation in Bermuda without an appropriate governmental work permit. A work permit may be granted or renewed by the Bermuda government for a specific period of time, upon showing that, after proper public advertisement, no Bermudian (or spouse of a Bermudian or holder of a permanent resident certificate) is available who meets the minimum standards reasonably required by an employer with respect to a certain position. The government of Bermuda places term limits on individuals with work permits, subject to certain exemptions for key employees. No assurances can be given that any work permit will be issued or, if issued, renewed upon the expiration of the relevant term or that key employee status will be granted or revoked.

A decrease in the fair values of our reporting units may result in future goodwill impairments.

Our consolidated financial statements include goodwill at December 31, 2010 in the amount of $822.2 million. When we acquire an entity, the excess of the purchase price over the net identifiable assets acquired is allocated to goodwill. We conduct impairment tests on our reported goodwill at least annually or more frequently if impairment indicators exist. In performing a goodwill impairment test, we use various methods and make various assumptions to determine the fair value of our reporting units, including the determination of expected future cash flows and/or profitability of such reporting units, and we take into account market value multiples and/or cash flows of entities that we deem to be comparable in nature, scope or size to our reporting units. However, expected future cash flows and/or profitability may be materially and negatively impacted as a result of, among other things, a decrease in renewal activity and new business opportunities, a decrease in retention or our underwriting teams, lower-than-expected yields and/or cash flows from our investment portfolio, higher-than-expected claims activity and magnitude of

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incurred losses and general economic factors that impact the reporting unit. In addition, previously determined market value multiples and/or cash flows may no longer be relevant as a result of these potential factors. As a result of these potential changes, the estimated fair value of one or more of our reporting units may decrease, causing the carrying value of the net assets assigned to the reporting unit to exceed the fair value of such net assets. If we determine an impairment exists, we adjust the carrying value of goodwill to its implied fair value. The impairment charge is recorded in our income statement in the period in which the impairment is determined. If we are required in the future to write down additional goodwill, our financial condition and results of operations would be negatively affected. In connection with fair value measurements and the accounting for goodwill, the use of generally accepted accounting principles requires management to make certain estimates and assumptions. Significant judgment is required in making these estimates and assumptions, and actual results may ultimately be materially different from such estimates and assumptions.

Provisions in our Articles of Association may reduce the voting rights of our ordinary shares.

Our Articles of Association generally provide that shareholders have one vote for each ordinary share held by them and are entitled to vote, on a non-cumulative basis, at all meetings of shareholders. However, the voting power that may be exercised by certain persons or groups may not equal or exceed 10% or more of the voting power conferred by our shares.

In particular, our Articles of Association provide that if, and for so long as, the votes conferred by the Controlled Shares (as defined below) of any person constitute 10% or more of the votes conferred by all our issued shares, the voting rights with respect to the Controlled Shares of such person shall be limited, in the aggregate, to a voting power equal to approximately (but slightly less than) 10%, pursuant to a formula set forth in the our Articles of Association. “Controlled Shares” of a person (as defined in our Articles of Association) include (1) all of our shares owned directly, indirectly or constructively by that person (within the meaning of Section 958 of the Code, and (2) all of our shares owned directly, indirectly or constructively by that person or any “group” of which that person is a part, within the meaning of Section 13(d)(3) of the U.S. Securities Exchange Act of 1934, as amended (the “Exchange Act”).

Provisions in our Articles of Association may restrict the ownership and transfer of our ordinary shares.

Our Articles of Association provide that our Board of Directors shall decline to register a transfer of shares if it appears to our Board of Directors, whether before or after such transfer, that the effect of such transfer would be to increase the number of Controlled Shares of any person to 10% or more of any class of our voting shares, of our total issued shares, or of the total voting power of our total issued shares.

Certain provisions in our charter documents could, among other things, impede an attempt to replace our directors or to effect a change of control, which could diminish the value of our ordinary shares.

Our Articles of Association contain provisions that may make it more difficult for shareholders to replace directors and could delay or prevent a change of control that a shareholder may consider favorable. These provisions include a staggered board of directors, limitations on the ability of shareholders to remove directors, limitations on voting rights and certain transfer restrictions on our ordinary shares. See “Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities,” under Part II, Item 5 of this report.

As an Irish company, we are subject to the Irish Takeover Rules, under which our Board of Directors is not permitted to take any action which might “frustrate” an offer for our shares once the Board of Directors has received an offer or has reason to believe an offer is or may be imminent without the approval of more than 50% of shareholders entitled to vote at a general meeting of shareholders and/or the consent of the Irish Takeover Panel. This could limit the ability of the Board of Directors to take defensive actions even if the Board of Directors believes that such defensive actions would be in the best interests of the Company and its shareholders.

The Irish Takeover Rules also could discourage an investor from acquiring 30% or more of our outstanding ordinary shares unless such investor was prepared to make a bid to acquire all outstanding ordinary shares. Further, it could be more difficult for us to obtain shareholder approval for a merger or negotiated transaction because of heightened shareholder approval requirements for certain types of transactions under Irish law.

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In addition, insurance regulations in certain jurisdictions may also delay or prevent a change of control or limit the ability of a shareholder to acquire in excess of specified amounts of our ordinary shares.

Irish shareholder voting requirements may limit flexibility with respect to certain aspects of capital management.

Irish law allows shareholders to authorize a board of directors to subsequently issue shares without shareholder approval, but this authorization must be renewed after five years. Additionally, subject to specified exceptions, Irish law grants statutory pre-emption rights to existing ordinary shareholders to subscribe for new issuances of shares for cash, but allows such shareholders to authorize the waiver of such statutory pre-emption rights for five years. Our Articles of Association currently provide authority to the Board of Directors to issue shares without further shareholder approval and to waive ordinary shareholders’ statutory pre-emption rights. However, these authorizations expire after five years, unless renewed by XL-Ireland’s shareholders, and we can provide no assurance that these authorizations and waivers will always be renewed, which could limit our ability to issue equity in the future.

It may be difficult to enforce judgments against XL-Ireland, XL-Cayman or their directors and executive officers.

XL-Ireland is incorporated pursuant to the laws of Ireland and our principal executive offices are in Bermuda. In addition, certain of our directors and officers reside outside the United States and a substantial portion of our assets and the assets of such directors and officers are located outside the United States. As such, it may be difficult or impossible to effect service of process within the United States upon those persons or to recover on judgments of U.S. courts against us or our directors and officers, including judgments predicated upon civil liability provisions of U.S. federal securities laws. We have been advised that there is no treaty between Ireland and the United States providing for the reciprocal enforcement of foreign judgments. The following requirements must be met before the foreign judgment will be deemed to be enforceable in Ireland:

 

 

 

 

The judgment must be for a definite sum;

 

 

 

 

The judgment must be final and conclusive; and

 

 

 

 

The judgment must be provided by a court of competent jurisdiction.

An Irish court will also exercise its right to refuse judgment if the foreign judgment was obtained by fraud, if the judgment violated Irish public policy, if the judgment is in breach of natural justice or if it is irreconcilable with an earlier foreign judgment.

In addition, XL-Cayman is incorporated pursuant to the laws of the Cayman Islands and its principal executive offices are in Bermuda. We have been advised that there is doubt as to whether the courts of the Cayman Islands would enforce:

 

 

 

 

judgments of U.S. courts based upon the civil liability provisions of U.S. federal securities laws obtained in actions against XL-Cayman or its directors and officers who reside outside the United States; or

 

 

 

 

original actions brought in the Cayman Islands against these persons or XL-Cayman predicated solely upon U.S. federal securities laws.

We have also been advised that there is no treaty in effect between the United States and the Cayman Islands providing for such enforcement and there are grounds upon which Cayman Islands courts may not enforce judgments of United States courts. Some remedies available under the laws of U.S. jurisdictions, including some remedies available under U.S. federal securities laws, may not be allowed in Cayman Islands courts as contrary to public policy.

The ultimate outcome of lawsuits, including putative class action lawsuits, that have been filed against us by policyholders and security holders could have a material adverse effect on our consolidated financial condition, future operating results and/or liquidity.

We are subject to lawsuits and arbitrations in the regular course of our business. See Item 3, “Legal Proceedings.” In addition, lawsuits have been filed against us as detailed in Item 8, Note 19(g) to the Consolidated Financial Statements, “Commitments and Contingencies – Claims and Other Litigation.” We

46


believe that we have substantial defenses to all outstanding litigation and intend to pursue our defenses vigorously, although an adverse resolution of one or more of these items could have a material adverse effect on our results of operations in a particular fiscal quarter or year.

Changes in current accounting practices and future pronouncements may materially impact our reported financial results.

Unanticipated developments in accounting practices may require us to incur considerable additional expenses to comply with such developments, particularly if we are required to prepare information relating to prior periods for comparative purposes or to apply the new requirements retroactively. The impact of changes in current accounting practices and future pronouncements cannot be predicted but may affect the calculation of net income, net equity and other relevant financial statement line items and the timing of when impairments and other charges are tested or taken. In particular, recent guidance and ongoing projects put in place by standard setters globally have indicated a possible move away from the current insurance accounting models toward more “fair value” based models which could introduce significant volatility in the earnings of insurance industry participants.

There is a possibility that the Master Agreement entered into at the time of the sale of Syncora and the related commutations and releases could be challenged or that we could be subject to litigation as a result of the Master Agreement. Any such challenge could have a material adverse effect on our financial condition, results of operations, liquidity or the market price of our securities.

We provided certain reinsurance protections (the “Reinsurance Agreements”) with respect to adverse development on certain transactions as well as indemnification under specific facultative and excess of loss coverages for subsidiaries of Syncora: Syncora Guarantee Re and Syncora Guarantee. At June 30, 2008, our total net exposure under facultative agreements with Syncora subsidiaries was approximately $6.4 billion of net par value outstanding. Pursuant to the closing of the Master Agreement, all of these Reinsurance Agreements were commuted.

In addition, through one or more of our subsidiaries, we entered into certain agreements with subsidiaries of Syncora pursuant to which we guaranteed certain obligations of Syncora Guarantee Re and Syncora Guarantee under specific agreements (the “Guarantee Agreements”). At June 30, 2008, the total net par value outstanding of business written by subsidiaries of Syncora which fell under the Guarantee Agreements was approximately $60 billion. Pursuant to the terms of, and required conditions under, the Master Agreement, Syncora Guarantee Re’s facultative quota share reinsurance agreement with Syncora Guarantee, and all individual risk cessions thereunder, and the Financial Security Master Facultative Agreement, and all individual risk cessions thereunder, were commuted, thereby rendering the Syncora Guarantee Re guarantee and Financial Security guarantee of no further force and effect.

Following the closing of the Master Agreement, Syncora and its applicable subsidiaries were required to use commercially reasonable efforts to commute the underlying financial guarantees that are the subject of the EIB Guarantees, which was completed in June 2010.

As further described in Note 4 to the Consolidated Financial Statements, “Syncora Holdings Ltd. (“Syncora”),” while the New York Insurance Department (“NYID”) and the BMA approved the Master Agreement and related agreements and transactions, including the commutation of the agreements described above, and the Delaware Insurance Department (“DID”) approved the Master Agreement and the commutation of the Syncora Guarantee Re/Syncora Guarantee Quota Share, and although we believe the effect of the Master Agreement and subsequent commutation of the EIB Guarantee relieved us of all of our obligations under the Reinsurance Agreements and the Guarantee Agreements no assurance can be given that the enforceability of the Master Agreement, the agreements relating thereto and the transactions contemplated thereunder will not be challenged, including under applicable fraudulent transfer laws (described in the following paragraph) and/or by asserting any number of other theories for recovery, including third-party beneficiary rights, or that other litigation will not be commenced against us as a result of the Master Agreement and such related agreements and transactions. We believe that we would have significant defenses to any such challenges and would vigorously defend against any such claims. However, we cannot assure you that any such claims would not be made or, that any such claims would not ultimately be successful.

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Under federal bankruptcy law and comparable provisions of state fraudulent transfer laws (including those applicable in any state insurance insolvency proceeding) Syncora’s commutation and release of our obligations pursuant to the Master Agreement and related agreements would constitute a voidable fraudulent transfer if it was determined that Syncora or any applicable subsidiary thereto, at the time it entered into the Master Agreement or such related agreement:

 

 

 

 

intended to hinder, delay or defraud its creditors; or

 

 

 

 

received less than “reasonably equivalent value” or “fair value consideration” for such release; and either:

 

 

 

 

was insolvent or rendered insolvent by reason of such occurrence; or

 

 

 

 

was engaged in a business or transaction for which its remaining assets constituted unreasonably small capital; or

 

 

 

 

intended to incur, or believed that it would incur, debts beyond its ability to pay such debts as they mature.

Among other regulatory approvals obtained in connection with the Master Agreement, the NYID issued an approval letter to Syncora Guarantee under Section 1505 of the New York Insurance Law and the DID issued an approval letter to Syncora Guarantee Re under Section 5005(a) of the Delaware Insurance Code (effective upon Syncora Guarantee Re’s redomestication to Delaware) (both of which require that the terms of a transaction between an issuer and one or more of its affiliates be fair and equitable) stating, in the case of NYID, that the terms of the Master Agreement and each of the commutations are fair and equitable to Syncora Guarantee and do not adversely affect policyholders of Syncora Guarantee and, in the case of the DID, stating that the terms of the Master Agreement and the commutation of the Syncora Guarantee Re/Syncora Guarantee Quota Share were fair and equitable to Syncora Guarantee. The BMA (the domiciliary regulator of Syncora Guarantee Re) also issued an approval letter approving the Master Agreement and each commutation to which Syncora Guarantee Re is a party, including the Syncora Guarantee Re/Syncora Guarantee Quota Share. There can be no assurance that a court would agree with our, the NYID’s, the DID’s, the BMA’s or Syncora’s conclusions, or as to what law or standard a court would ultimately apply in making any such determination or as to how such court would ultimately rule. Additionally, in the event of any liquidation or rehabilitation or similar proceeding of any insurance subsidiary of Syncora, there can be no assurance that any insurance regulator or regulators responsible for such proceedings, in their capacity as liquidator or rehabilitator, would respect the insurance regulatory approvals obtained in connection with the Master Agreement.

If any such challenge were successful, we could be required to honor our original obligations under the Reinsurance Agreements and Guarantee Agreements or be subject to other remedies. Any challenge could have a material adverse effect on the market price for our securities and on our business and, if successful, could also have a material adverse effect on our financial condition, results of operations and liquidity.

We and our non-U.S. insurance subsidiaries may become subject to U.S. tax, which may have a material adverse effect on our results of operations and your investment.

We take the position that neither we nor any of our non-U.S. insurance subsidiaries are engaged in a U.S. trade or business through a U.S. permanent establishment. Accordingly, we take the position that none of our non-U.S. insurance subsidiaries should be subject to U.S. tax (other than U.S. excise tax on insurance and reinsurance premium income attributable to insuring or reinsuring U.S. risks and U.S. withholding tax on some types of U.S. source investment income). However, because there is considerable uncertainty as to the activities that constitute being engaged in a trade or business within the United States, we cannot be certain that the U.S. Internal Revenue Service (the “IRS”) will not contend successfully that we or any of our non-U.S. insurance subsidiaries are engaged in a trade or business in the United States. If we or any of our non- U.S. insurance subsidiaries were considered to be engaged in a trade or business in the United States, any such entity could be subject to U.S. corporate income and additional branch profits taxes on the portion of its earnings effectively connected to such U.S. business, in which case our financial condition and results of operations could be materially adversely affected.

48


Changes in U.S. tax law might adversely affect an investment in our shares.

The tax treatment of non-U.S. companies and their U.S. and non-U.S. insurance subsidiaries has been the subject of Congressional discussion and legislative proposals. For example, one legislative proposal would impose additional limits on the deductibility of interest by foreign-owned U.S. corporations. Another legislative proposal would modify the standards which indicate when a non-U.S. corporation might be treated as a U.S. corporation for U.S. federal income tax purposes if it were considered to be primarily managed and controlled in the U.S. In addition, in 2010, legislation was proposed in the U.S. that would severely restrict the ability of a company to utilize affiliate reinsurance to manage its U.S. risks and capital position. In general, the proposed legislation would permanently disallow the deduction for premiums ceded to affiliates, to the extent the reinsurance exceeded industry aggregate levels of unrelated party reinsurance, calculated on a statutory line of business basis. The U.S. 2012 Fiscal Year Budget, issued on February 14, 2011, includes a similar provision that would disallow tax deductions for all affiliate reinsurance premiums paid to companies not taxed in the U.S., but would not tax ceding commissions or recoveries of paid losses received by the U.S. companies. If any of these proposals, or a similar proposal using the same underlying principles, is enacted, the resulting impact to the Company could have an adverse impact on us or our shareholders. It is possible that other legislative proposals could emerge in the future that could also have an adverse impact on us or our shareholders. We cannot assure you that future legislative action will not increase the amount of U.S. tax payable by us. If this happens, our financial condition and results of operations could be materially adversely affected.

Additionally, the U.S. federal income tax laws and interpretations, including those regarding whether a company is engaged in a trade or business (or has a permanent establishment) within the United States or is a Passive Foreign Investment Company (“PFIC”), or whether U.S. holders would be required to include in their gross income “subpart F income” or the related person insurance income, which we refer to as “RPII” of a Controlled Foreign Corporation (“CFC”), are subject to change, possibly on a retroactive basis. There are currently no regulations regarding the application of the PFIC rules to insurance companies and the regulations regarding RPII are still in proposed form. New regulations or pronouncements interpreting or clarifying such rules may be forthcoming. We cannot be certain if, when or in what form such regulations or pronouncements may be provided and whether such guidance will have a retroactive effect.

There is U.S. income tax risk associated with reinsurance between U.S. insurance companies and their Bermuda affiliates.

As discussed above, Congress has periodically considered legislation intended to eliminate certain perceived tax advantages of non-U.S. insurance companies and U.S. insurance companies with non-U.S. affiliates, including perceived tax benefits resulting principally from reinsurance between or among U.S. insurance companies and their non-U.S. affiliates. In this regard, section 845 of the Code was amended in 2004 to permit the IRS to reallocate, recharacterize or adjust items of income, deduction or certain other items related to a reinsurance agreement between related parties to reflect the proper “amount, source or character” for each item (in contrast to prior law, which only covered “source and character”). If the IRS were to successfully challenge our reinsurance arrangements under section 845, our financial condition and results of operations could be materially adversely affected and the price of our ordinary shares could be adversely affected.

The Organisation for Economic Co-operation and Development is considering measures that might change the manner in which we are taxed.

On July 17, 2008, the Organisation for Economic Co-operation and Development (the “OECD”) issued the final version of its “Report on the Attribution of Profits to Permanent Establishments” (the “Report”). The Report is the final report on the OECD’s project to establish a broad consensus regarding the interpretation and practical application of Article 7 of the OECD Model Tax Convention on Income and on Capital (“Article 7”). Article 7 sets forth international tax principles for attributing profits to a permanent establishment and forms the basis of an extensive network of bilateral income tax treaties between OECD member countries and between many OECD member and non-member countries. Part IV of the Report addresses the attribution of profits to a permanent establishment of an enterprise that conducts insurance activities.

49


The OECD implemented the conclusions of the Report in two phases. First, to provide improved certainty for the interpretation of existing treaties based on the current text of Article 7, the OECD revised the commentary to the current version of Article 7 to take into account the conclusions of the Report that did not conflict with the existing interpretation of Article 7 reflected in the previous commentary. Second, to reflect the full conclusions of the Report, the OECD issued, on July 22, 2010, a new version of Article 7 and related commentary to be used in the negotiation of new treaties and amendments to existing treaties. The provisions of the final version of new Article 7 and related commentary are not expected to change materially the manner in which we are taxed.

If an investor acquires 10% or more of our ordinary shares, it may be subject to taxation under the “controlled foreign corporation” rules.

Under certain circumstances, a U.S. person who owns 10% or more of the voting power of a foreign corporation that is a CFC (a foreign corporation in which 10% U.S. shareholders own more than 50% of the voting power of the foreign corporation or more than 25% of a foreign insurance company) for an uninterrupted period of 30 days or more during a taxable year must include in gross income for U.S. federal income tax purposes such “10% U.S. Shareholder’s” pro rata share of the CFC’s “subpart F income,” even if the subpart F income is not distributed to such 10% U.S. Shareholder, if such 10% U.S. Shareholder owns (directly or indirectly through foreign entities) any shares of the foreign corporation on the last day of the corporation’s taxable year. “Subpart F income” of a foreign insurance corporation typically includes foreign personal holding company income (such as interest, dividends and other types of passive income), as well as insurance and reinsurance income (including underwriting and investment income) attributable to the insurance of risks situated outside the CFC’s country of incorporation. Ownership of our equity security units by a U.S. person may cause such person to be treated for U.S. federal income tax purposes as the owner of our ordinary shares prior to the purchase contract settlement date. For purposes of interpreting the voting restrictions in our Articles of Association, we intend to treat the ordinary shares issuable upon settlement of a purchase contract underlying a unit as currently owned by the holder of that unit.

We believe that because of the dispersion of our share ownership, provisions in our organizational documents that limit voting power and other factors, no U.S. person or U.S. partnership that acquires our shares directly or indirectly through one or more foreign entities should be required to include its “subpart F income” in income under the CFC rules of the Internal Revenue Code of 1986, as amended (the “Code”). It is possible, however, that the IRS could challenge the effectiveness of these provisions and that a court could sustain such a challenge, in which case an investor’s investment could be materially adversely affected, if the investor is considered to own 10% or more of our shares.

U.S. Persons who hold shares will be subject to adverse tax consequences if we are considered to be a PFIC for U.S. federal income tax purposes.

If we are considered a PFIC for U.S. federal income tax purposes, a U.S. person who owns any of our shares will be subject to adverse tax consequences, including a greater tax liability than might otherwise apply and tax on amounts in advance of when tax would otherwise be imposed, in which case an investor’s investment could be materially adversely affected. In addition, if we were considered a PFIC, upon the death of any U.S. individual owning shares, such individual’s heirs or estate would not be entitled to a “step-up” in the basis of the shares which might otherwise be available under U.S. federal income tax laws. We believe that we are not, have not been, and currently do not expect to become, a PFIC for U.S. federal income tax purposes. We cannot provide absolute assurance, however, that we will not be deemed a PFIC by the IRS. If we were considered a PFIC, it could have material adverse tax consequences for an investor that is subject to U.S. federal income taxation. There are currently no regulations regarding the application of the PFIC provisions to an insurance company. New regulations or pronouncements interpreting or clarifying these rules may be forthcoming. We cannot predict what impact, if any, such guidance would have on an investor that is subject to U.S. federal income taxation.

There are U.S. income tax risks associated with the related person insurance income of our non-U.S. insurance subsidiaries.

If (i) the related person insurance income, which we refer to as “RPII,” of any one of our non-U.S. insurance subsidiaries were to equal or exceed 20% of that subsidiary’s gross insurance income in any

50


taxable year and (ii) U.S. persons were treated as owning 25% or more of the subsidiary’s stock (by vote or value), a U.S. person who owns any ordinary shares, directly or indirectly, on the last day of such taxable year on which the 25% threshold is met would be required to include in its income for U.S. federal income tax purposes that person’s ratable share of that subsidiary’s RPII for the taxable year, determined as if that RPII were distributed proportionately only to U.S. holders at that date, regardless of whether that income is distributed. The amount of RPII earned by a subsidiary (generally premium and related investment income from the direct or indirect insurance or reinsurance of any direct or indirect U.S. holder of shares of that subsidiary or any person related to that holder) would depend on a number of factors, including the identity of persons directly or indirectly insured or reinsured by that subsidiary. Although we do not believe that the 20% threshold will be met in respect of any of our non-U.S. insurance subsidiaries, some of the factors that may affect the result in any period may be beyond our control. Consequently, we cannot provide absolute assurance that we will not exceed the RPII threshold in any taxable year.

The RPII rules provide that if a holder who is a U.S. person disposes of shares in a non-U.S. insurance corporation that had RPII (even if the 20% gross income threshold was not met) and met the 25% ownership threshold at any time during the five-year period ending on the date of disposition, and the holder owned any stock at such time, any gain from the disposition will generally be treated as a dividend to the extent of the holder’s share (taking into account certain rules for determining a U.S. holder’s share of RPII) of the corporation’s undistributed earnings and profits that were accumulated during the period that the holder owned the shares (possibly whether or not those earnings and profits are attributable to RPII). In addition, such a shareholder will be required to comply with specified reporting requirements, regardless of the amount of shares owned. We believe that these rules should not apply to dispositions of our ordinary shares because XL- Ireland is not itself directly engaged in the insurance business. We cannot provide absolute assurance, however, that the IRS will not successfully assert that these rules apply to dispositions of our ordinary shares.

We and our Bermuda insurance subsidiaries may become subject to taxes in Bermuda in the future, which may have a material adverse effect on our financial condition, results of operations and your investment.

Our Bermuda insurance subsidiaries previously received from the Ministry of Finance in Bermuda exemptions from any Bermuda taxes that might be imposed on profits, income or any capital asset, gain or appreciation until March 28, 2016. In his November 2010 Speech from the Throne, His Excellency Sir Richard Gozney KCMG, CVO, Governor of Bermuda announced the intention of the Bermuda Government to extend to 2035 the tax exemption given by the Ministry of Finance to international businesses, including the Company. This proposed extension would provide long term certainty of the tax exemption currently enjoyed by us and our Bermuda subsidiaries. As the proposed extension has not yet been enacted, such tax certainty cannot be assured. Thus, we continue to have an exposure to Bermuda taxation that could have a material adverse effect on our financial condition, results of operations and the price of our ordinary shares.

The exemptions are subject to the proviso that they are not construed so as to prevent the application of any tax or duty to such persons as are ordinarily resident in Bermuda (the Company and our Bermuda insurance subsidiaries are not so currently designated) and to prevent the application of any tax payable in accordance with the provisions of The Land Tax Act 1967 or otherwise payable in relation to the land leased to us and our Bermuda insurance subsidiaries. XL Group plc and other Bermuda-based subsidiaries not incorporated in Bermuda, as permit companies under The Companies Act 1981 of Bermuda, have also received similar exemptions, which are also expected to be extended to 2035. Our Bermuda insurance subsidiaries are required to pay certain annual Bermuda government fees and certain business fees as an insurer under The Insurance Act 1978 of Bermuda. Currently there is no Bermuda withholding tax on dividends paid by our Bermuda insurance subsidiaries to us.

XL-Cayman may become subject to taxes in the Cayman Islands after June 2, 2018, which may have a material adverse effect on our results of operations and your investment.

Under current Cayman Islands law, we are not obligated to pay any taxes in the Cayman Islands on our income or gains. We have received an undertaking from the Governor-in-Council of the Cayman Islands pursuant to the provisions of the Tax Concessions Law, as amended, that until June 2, 2018, (i) no subsequently enacted law imposing any tax on profits, income, gains or appreciation shall apply to us and

51


(ii) no such tax and no tax in the nature of an estate duty or an inheritance tax shall be payable on any of our ordinary shares, debentures or other obligations. Under current law, no tax will be payable on the transfer or other disposition of our ordinary shares. The Cayman Islands currently impose stamp duties on certain categories of documents; however, our current operations do not involve the payment of stamp duties in any material amount. The Cayman Islands also currently impose an annual corporate fee upon all exempted companies incorporated in the Cayman Islands. Given the limited duration of the undertaking from the Governor- in-Council of the Cayman Islands, we cannot be certain that we will not be subject to any Cayman Islands tax after June 2, 2018. Such taxation could have a material adverse effect on our financial condition, results of operations and your investment.

Our tax position could be adversely impacted by changes in tax laws, tax treaties or tax regulations or the interpretation or enforcement thereof.

Our tax position could be adversely impacted by changes in tax laws, tax treaties or tax regulations or the interpretation or enforcement thereof by the tax authorities in Ireland, the United States and other jurisdictions, and such changes may be more likely or become more likely in view of recent economic trends in such jurisdictions, particularly if such trends continue. For example, Ireland has suffered from the consequences of worldwide adverse economic conditions and the credit ratings on its debt have been downgraded. Such changes could cause a material and adverse change in our worldwide effective tax rate and we may have to take further action, at potentially significant expense, to seek to mitigate the effect of such changes. Any future amendments to the current income tax treaties between Ireland and other jurisdictions, including the United States, could subject us to increased taxation and/or potentially significant expense.

Dividends you receive may be subject to Irish dividend withholding tax and Irish income tax.

Dividend withholding tax (currently at a rate of 20%) may arise in respect of dividends paid on the Company’s ordinary shares. However, a number of exemptions from dividend withholding tax exist such that ordinary shareholders resident in the United States and ordinary shareholders resident in other specified countries (listed in Annex F attached to the Redomestication Proxy Statement filed with the SEC on March 10, 2010) may be entitled to exemptions from dividend withholding tax if they complete and file certain dividend withholding tax forms. Ordinary shareholders resident in the U.S. that hold their ordinary shares through DTC will not be subject to dividend withholding tax provided the addresses of the beneficial owners of such ordinary shares in the records of the brokers holding such ordinary shares are in the United States (so that such brokers can further transmit the relevant information to a qualifying intermediary appointed by the Company). Similarly, ordinary shareholders resident in the U.S. that hold their ordinary shares outside of DTC are not subject to dividend withholding tax if such ordinary shareholders held ordinary shares in the Company on January 12, 2010 and they provided a valid Form W-9 showing a U.S. address to the Company’s transfer agent. However, other ordinary shareholders may be subject to dividend withholding tax, which could adversely affect the price of our ordinary shares.

In addition, ordinary shareholders entitled to an exemption from Irish dividend withholding tax on dividends received from the Company should not be subject to Irish income tax in respect of those dividends, unless they have some connection with Ireland other than their ordinary shareholdings in the Company. Ordinary shareholders who receive dividends subject to Irish dividend withholding tax will generally have no further liability to Irish income tax on those dividends unless they have some connection with Ireland other than their ordinary shareholding in the Company.

A future transfer of your ordinary shares, other than one effected by means of the transfer of book entry interests in DTC, may be subject to Irish stamp duty.

Transfers of our ordinary shares effected by means of the transfer of book entry interests in DTC will not be subject to Irish stamp duty. The majority of our ordinary shares will be traded through DTC, either directly or through brokers who hold such ordinary shares on behalf of customers through DTC. However, if you hold your ordinary shares directly rather than beneficially through DTC (or through a broker that holds your ordinary shares through DTC), any transfer of your ordinary shares could be subject to Irish stamp duty (currently at the rate of 1% of the higher of the price paid or the market value of the ordinary shares acquired). Payment of Irish stamp duty is generally a legal obligation of the transferee. The potential for stamp duty could adversely affect the price of our ordinary shares.

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ITEM 1B.

 

UNRESOLVED STAFF COMMENTS

 

 

 

None.

 

 

 

 

 

 

ITEM 2.

 

PROPERTIES

 

 

 

The Company operates in Bermuda, the United States, Europe and various other locations around the world. In 1997, the Company acquired commercial real estate in Hamilton, Bermuda for the purpose of securing long-term office space for its worldwide headquarters. The development was completed in April 2001. The total cost of this development, including land, was approximately $126.6 million. The Company has subsequently sub-leased portions of this property as a part of its broader expense reduction initiatives.

In July 2003, the Company acquired new offices at 70 Gracechurch Street, London, which have become the Company’s new London headquarters. The acquisition was made through a purchase, sale and leaseback transaction. The move to the new offices was completed in 2004 and consolidated the Company’s London businesses in one location. The capital lease asset and liability associated with this transaction totaled $107.4 million at December 31, 2010.

The majority of all other office facilities throughout the world that are occupied by the Company and its subsidiaries are leased.

Total rent expense for the years ended December 31, 2010, 2009 and 2008 was $31.8 million, $34.4 million and $35.4 million, respectively. See Item 8, Note 19(d) to the Consolidated Financial Statements, “Commitments and Contingencies – Properties,” for discussion of the Company’s lease commitments for real property.

 

 

 

 

 

 

ITEM 3.

 

LEGAL PROCEEDINGS

 

 

 

In November 2006, a subsidiary of XL-Cayman received a grand jury subpoena from the Antitrust Division of the U.S. Department of Justice (“DOJ”) and a subpoena from the SEC, both of which sought documents in connection with an investigation into the municipal Guaranteed Investment Contracts (“GIC”) market and related products. In June 2008, subsidiaries of XL-Cayman also received a subpoena from the Connecticut Attorney General and an Antitrust Civil Investigative Demand from the Office of the Florida Attorney General in connection with a coordinated multi-state Attorneys General investigation into the matters referenced in the DOJ and SEC subpoenas. At various times during the period from late 2006 through 2008, the subsidiaries produced documents and other information in response to the aforementioned subpoenas and demands. XL Group plc plans to cooperate fully with any further information requests that it may receive in connection with these investigations.

Commencing in March 2008, XL-Cayman and two of its subsidiaries were named, along with approximately 20 other providers and insurers of municipal GICs and similar derivative products in the U.S. (collectively “Municipal Derivatives”) as well as fourteen brokers of such products, in several purported federal antitrust class actions. The Judicial Panel on Multidistrict Litigation ordered that these be consolidated for pretrial purposes and assigned them to the Southern District of New York. The consolidated amended complaint filed in August 2008 alleges that there was a conspiracy among the defendants during the period from January 1, 1992 to the present to rig bids and otherwise unlawfully decrease the yield for Municipal Derivative products. The purported class of plaintiffs consists of purchasers of Municipal Derivatives. On October 21, 2008 most of the defendants filed motions to dismiss the consolidated amended complaint. The District Judge granted the motions by order dated April 29, 2009, but allowed plaintiffs leave to file a second amended complaint. Plaintiffs filed a Second Consolidated Amended Class Action Complaint on June 18, 2009, but did not include XL-Cayman or any of its subsidiaries as a defendant. The remaining defendants in that action again moved to dismiss, which motion was denied by the Court on March 25, 2010.

In addition, XL-Cayman and three of its subsidiaries (along with numerous other parties) were named as defendants in eleven individual (i.e., non-class) actions filed by various municipalities or other local government bodies in California state and federal courts. The allegations are similar to the allegations in the Second Consolidated Amended Class Action Complaint described above. The defendants removed the state court cases to federal court, and all eleven cases were then transferred to the Southern District of New York by the Judicial Panel on Multidistrict Litigation. On April 26, 2010, the District Judge dismissed all

53


eleven cases against XL-Cayman and its subsidiaries without prejudice, but denied motions to dismiss as respects most of the other defendants. Since then several additional similar actions have been filed, but none of these includes XL-Cayman or any of its subsidiaries as a defendant.

In August 2005, plaintiffs in a proposed class action (the “Class Action”) that was consolidated into a multidistrict litigation in the United States District Court for the District of New Jersey, captioned In re Brokerage Antitrust Litigation, MDL No. 1663, Civil Action No. 04-5184 (the “MDL”), filed a consolidated amended complaint (the “Amended Complaint”), which named as new defendants approximately 30 entities, including Greenwich Insurance Company, Indian Harbor Insurance Company and XL-Cayman. In the MDL, the Class Action plaintiffs asserted various claims purportedly on behalf of a class of commercial insureds against approximately 113 insurance companies and insurance brokers through which the named plaintiffs allegedly purchased insurance. The Amended Complaint alleged that the defendant insurance companies and insurance brokers conspired to manipulate bidding practices for insurance policies in certain insurance lines and failed to disclose certain commission arrangements and asserted statutory claims under the Sherman Act, various state antitrust laws and the Racketeer Influenced and Corrupt Organizations Act (“RICO”), as well as common law claims alleging breach of fiduciary duty, aiding and abetting a breach of fiduciary duty and unjust enrichment. By Opinion and Order dated August 31, 2007, the Court dismissed the Sherman Act claims with prejudice and, by Opinion and Order dated September 28, 2007, the Court dismissed the RICO claims with prejudice. The plaintiffs then appealed both Orders to the U.S. Court of Appeals for the Third Circuit. On August 16, 2010, the Third Circuit affirmed in large part the District Court’s dismissal. The Third Circuit reversed the dismissal of certain Sherman Act and RICO claims alleged against several defendants including XL-Cayman and two of its subsidiaries but remanded those claims to the District Court for further consideration of their adequacy. In light of its reversal and remand of certain of the federal claims, the Third Circuit also reversed the District Court’s dismissal (based on the District Court’s declining to exercise supplemental jurisdiction) of the state-law claims against all defendants. On October 1, 2010 the remaining defendants including XL-Cayman and two of its subsidiaries filed motions to dismiss the remanded federal claims and the state-law claims. The motions have been fully briefed and await the District Court’s decision.

Various XL entities have been named as defendants in three of the many tag-along actions that have been consolidated into the MDL for pretrial purposes. The complaints in these tag-along actions make allegations similar to those made in the Amended Complaint but do not purport to be class actions. On April 4, 2006, a tag-along complaint was filed in the U.S. District Court for the Northern District of Georgia on behalf of New Cingular Wireless Headquarters LLC and several other corporations against approximately 100 defendants, including Greenwich Insurance Company, XL Specialty Insurance Company, XL Insurance America, Inc., XL Insurance Company Limited, Lloyd’s syndicates 861, 588 and 1209 and XL-Cayman. On or about May 21, 2007, a tag-along complaint was filed in the U.S. District Court for the District of New Jersey on behalf of Henley Management Company, Big Bear Properties, Inc., Northbrook Properties, Inc., RCK Properties, Inc., Kitchens, Inc., Aberfeldy LP and Payroll and Insurance Group, Inc. against multiple defendants, including “XL Winterthur International.” On October 12, 2007, a complaint in a third tag-along action was filed in the U.S. District Court for the Northern District of Georgia by Sears, Roebuck & Co., Sears Holdings Corporation, Kmart Corporation and Lands’ End Inc. against many named defendants including X.L. America, Inc., XL Insurance America, Inc., XL Specialty Insurance Company and XL Insurance (Bermuda) Ltd. By order entered on or about October 5, 2010, the District Court ruled that the tag-along actions, including the three in which the XL entities are named defendants, will remain stayed pending the District Court’s decision on defendants’ October 1, 2010 motions to dismiss the remaining claims in the Class Action.

XL-Cayman and one of its subsidiaries (collectively, “the XL Entities”), Syncora, four Syncora officers, and various underwriters of Syncora securities were named in a Consolidated Amended Complaint (“CAC”) filed in August 2008 on behalf of shareholders of Syncora in the Southern District of New York. By Order dated March 31, 2010, Judge Deborah Batts granted motions to dismiss all claims asserted in the CAC as against all defendants principally on the basis of absence of loss causation and, granted the Plaintiffs leave to amend the CAC. The Plaintiffs filed a further amended complaint in June 2010. This complaint alleges violations of the Securities Act of 1933 arising out of the secondary public offering of Syncora common shares held by the XL Entities on June 6, 2007 as well as under the Securities Exchange Act of 1934 arising out of trading in Syncora securities during the asserted class period of July 24, 2007 to

54


December 20, 2007. The principal allegations are that Syncora failed to appropriately and timely disclose its processes with respect to underwriting certain derivative contracts and insurance of tranches of structured securities. A subsidiary of XL-Cayman is named as a party that sold stock in the secondary public offering and XL-Cayman is named as a party that “controlled” Syncora during the relevant time period. On September 10, 2010, all of the defendants including the XL Entities filed motions to dismiss the June 2010 amended complaint. The principal bases for the XL Entities’ motion are (a) plaintiffs have not adequately alleged falsity of any of the challenged disclosures, and (b) plaintiffs have not adequately alleged “loss causation” arising out of corrections of the assertedly misrepresented or omitted facts in the relevant offering materials. The motions have been fully briefed and await the District Court’s decision.

In connection with the secondary offering of Syncora shares, a subsidiary of XL-Cayman and Syncora each agreed to indemnify the several underwriters of that offering against certain liabilities, including liabilities under the Securities Act of 1933 for payment of legal fees and expenses, settlements and judgments incurred with respect to litigation such as this. The XL-Cayman subsidiary and Syncora have agreed to each bear 50% of this indemnity obligation.

The Company and its subsidiaries are subject to litigation and arbitration in the normal course of its business. These lawsuits and arbitrations principally involve claims on policies of insurance and contracts of reinsurance and are typical for the company and for the property and casualty insurance and reinsurance industry in general. Such legal proceedings are considered in connection with the company’s loss and loss expense reserves. Reserves in varying amounts may or may not be established in respect of particular claims proceedings based on many factors, including the legal merits thereof. In addition to litigation relating to insurance and reinsurance claims, the Company and its subsidiaries are subject to lawsuits and regulatory actions in the normal course of business that do not arise from or directly relate to claims on insurance or reinsurance policies. This category of business litigation typically involves, amongst other things, allegations of underwriting errors or misconduct, employment claims, regulatory activity, shareholder disputes or disputes arising from business ventures. The status of these legal actions is actively monitored by management.

Legal actions are subject to inherent uncertainties, and future events could change management’s assessment of the probability or estimated amount of potential losses from pending or threatened legal actions. For further information in relation to legal proceedings, see Item 8, Note 19(g) to the Consolidated Financial Statements, “Commitments and Contingencies – Claims and Other Litigation.”

55


 

 

 

 

 

 

ITEM 4.

 

RESERVED

 

 

 

Executive Officers of the Company

The table below sets forth the names, ages and titles of the persons who were the executive officers of the Company at February 25, 2011:

 

 

 

 

 

Name

 

Age

 

Position

Michael S. McGavick

 

 

 

53

   

Chief Executive Officer and Director

Susan L. Cross

 

 

 

50

   

Executive Vice President and Global Chief Actuary

David B. Duclos

 

 

 

53

   

Executive Vice President and Chief Executive of Insurance Operations

Irene M. Esteves

 

 

 

52

   

Executive Vice President and Chief Financial Officer

Kirstin Romann Gould

 

 

 

44

   

Executive Vice President, General Counsel and Secretary

Gregory S. Hendrick

 

 

 

45

   

Executive Vice President, Strategic Growth

W. Myron Hendry

 

 

 

62

   

Executive Vice President and Chief Platform Officer

Elizabeth L. Reeves

 

 

 

57

   

Executive Vice President, Chief Human Resources Officer

Jacob D. Rosengarten

 

 

 

55

   

Executive Vice President and Chief Enterprise Risk Officer

Sarah E. Street

 

 

 

48

   

Executive Vice President and Chief Investment Officer

James H. Veghte

 

 

 

54

   

Executive Vice President and Chief Executive of Reinsurance Operations

Michael S. McGavick, was appointed as Director of the Company in April 2008 and shortly prior to his commencement as the Company’s Chief Executive Officer on May 1, 2008. Previously, Mr. McGavick was President & CEO of the Seattle-based Safeco Corporation from January 2001 to December 2005. Prior to joining Safeco, Mr. McGavick spent six years with the Chicago-based CNA Financial Corporation, where he held various senior executive positions before becoming President and Chief Operating Officer of the company’s largest commercial insurance operating unit. Mr. McGavick’s insurance industry experience also includes two years as Director of the American Insurance Association’s Superfund Improvement Project in Washington D.C. where he became the Association’s lead strategist in working to transform U.S. Superfund environmental laws.

Susan L. Cross was appointed to the Company’s senior leadership team in August 2008, serving as Executive Vice President and Global Chief Actuary. Ms. Cross has served as Global Chief Actuary since 2006 and previously was Chief Actuary of the Company’s reinsurance operations from 2004 to 2006 and Chief Actuary of XL Re Bermuda from 2002 to 2004. She also held various actuarial positions in the insurance and reinsurance operations of the Company from 1999 to 2002. Prior to joining the Company, Ms. Cross was Principal and Consulting Actuary at Tillinghast Towers Perrin.

David B. Duclos was appointed Executive Vice President, Chief Executive of Insurance Operations in April 2008. From 2006 to his appointment in April 2008, Mr. Duclos was the Chief Operating Officer of the Company’s Insurance Operations and was responsible for product line underwriting, regional management and sales, ceded reinsurance and risk management. From 2004 to 2006, Mr. Duclos served as Executive Vice President of global specialty lines within the Company’s Insurance Operations and in 2003, upon joining the Company, he served as Senior Vice President responsible for U.S. program operations. Prior to joining the Company, Mr. Duclos worked for more than three years at Kemper Insurance Company in various senior level positions. Mr. Duclos began his career with CIGNA Corporation where he spent 21 years in various regional and national management roles in the field and home office.

Irene M. Esteves was appointed Executive Vice President, Chief Financial Officer in May 2010. From 2008 to 2010 Ms. Esteves was the Senior Executive Vice President and Chief Financial Officer of Regions Financial Corporation. Prior to joining Regions, from 2004 to 2008 Ms. Esteves served as Senior Vice President and Chief Financial Officer of Wachovia Corporation’s Capital Management Group. From 1997 to 2004, Ms. Esteves served as Senior Managing Director and Chief Financial Officer of Putnam Investments.

Kirstin Romann Gould was appointed to the position of Executive Vice President, General Counsel in September 2007, which position includes her prior responsibilities as General Counsel, Corporate Affairs and Corporate Secretary. Ms. Gould was previously Executive Vice President, General Counsel, Corporate Affairs from July 2006 to September 2007 and has also served as Chief Corporate Legal Officer from November 2004 to July 2006, and Associate General Counsel from July 2001 to November 2004. Prior to

56


joining the Company in 2000, Ms. Gould was associated with the law firms of Clifford Chance and Dewey Ballantine in New York and London.

Gregory S. Hendrick was appointed Executive Vice President, Strategic Growth in October 2010. From 2004 to October 2010, Mr. Hendrick served as President and Chief Underwriting Officer of XL Re Ltd. Previously, he served as Lead for U.S. Property Treaty underwriting at XL Re Ltd and Vice President responsible for U.S. Property Underwriting for XL Mid Ocean Reinsurance Ltd. Prior to joining XL, Mr. Hendrick, was Assistant Vice President of Treaty Underwriting for the Winterthur Reinsurance Corporation of America.

W. Myron Hendry joined the Company’s senior leadership team upon his appointment as Executive Vice President, Chief Platform Officer in December 2009. Prior to joining the Company, from 2006 to December 2009 Mr. Hendry served as Business Operations Executive of Bank of America’s Insurance Group, joining there from a merger with Countrywide Insurance Services Group. Prior to the merger, Mr. Hendry served as Managing Director and Chief Operating Officer for Countrywide and prior to this, from 2004 to 2006, Mr. Hendry served as Senior Vice President, Property and Casualty Services at Safeco. From 1971 to 2004, Mr. Hendry held various leadership roles with CNA Insurance, with his last assignment being the Senior Vice President of Worldwide Operations.

Elizabeth L. Reeves was appointed to the Company’s senior leadership team in June 2009, serving as Executive Vice President, Chief Human Resources Officer, where she is responsible for global compensation, employee benefits, employee relations, recruiting, learning, organizational development, performance management, talent development, succession planning, HR information systems and Payroll. Prior to joining the Company, from August 2008 to May 2009, Ms. Reeves served as Senior Vice President and Chief Human Resources Officer at Liz Claiborne, Incorporated. Prior to that, from January 2005 to May 2008, Ms. Reeves served as Senior Vice President of Human Resources at Lincoln Financial Group.

Jacob D. Rosengarten joined the Company’s senior leadership team and was appointed Executive Vice President, Chief Enterprise Risk Officer in September 2008. Prior to joining the Company, Mr. Rosengarten served as Managing Director of Risk Management and Analytics for Goldman Sachs Asset Management from 1998 to 2008. From 1993 to 1997, Mr. Rosengarten served as Director of Risk and Quantitative Analysis at Commodities Corporation and prior to this, from 1983 to 1992 held progressively senior finance positions at Commodities Corporation.

Sarah E. Street was appointed to the position of Executive Vice President and Chief Investment Officer in October 2006. Ms. Street has also served as the Chief Executive Officer of XL Capital Investment Partners Inc. since April 2001. Prior to joining XL in 2001, Ms. Street held numerous leadership positions at JPMorganChase and its predecessor organizations, working in a number of corporate finance units as well as in the capital markets business of the bank.

James H. Veghte was appointed Executive Vice President, Chief Executive of Reinsurance Operations in January 2006. Mr. Veghte had served as the Chief Executive Officer of XL Reinsurance America Inc. (XLRA) since 2004, having previously served as Chief Operating Officer of the Company’s reinsurance operations and President, Chief Operating Officer & Chief Underwriting Officer of XL Re Ltd. Additional previously held roles with the Company include President of XL Re Latin America Ltd., Chief Operating Officer of Le Mans Re (now the French branch of XL Re Europe Ltd.), General Manager of XL Re Ltd’s London branch and Executive Vice President and Underwriter of XL Mid Ocean Reinsurance Ltd in Bermuda. Prior to joining XL, Mr. Veghte was Senior Vice President and Chief Underwriting Officer of Winterthur Reinsurance Corporation of America.

57


PART II

 

 

 

 

 

 

ITEM 5.

 

MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

 

 

 

The Company’s ordinary shares, $0.01 par value per share, are listed on the NYSE under the symbol “XL.”

The following table sets forth the high, low and closing sales prices per share of the Company’s ordinary shares per fiscal quarter, as reported on the New York Stock Exchange Composite Tape:

 

 

 

 

 

 

 

 

 

High

 

Low

 

Close

2010:

 

 

 

 

 

 

1st Quarter

 

 

$

 

19.54

 

 

 

 

15.91

 

 

 

 

18.90

 

2nd Quarter

 

 

 

20.39

 

 

 

 

15.63

 

 

 

 

16.01

 

3rd Quarter

 

 

 

22.14

 

 

 

 

15.59

 

 

 

 

21.66

 

4th Quarter

 

 

 

22.52

 

 

 

 

19.36

 

 

 

 

21.82

 

2009:

 

 

 

 

 

 

1st Quarter

 

 

$

 

6.44

 

 

 

 

2.56

 

 

 

 

5.46

 

2nd Quarter

 

 

 

12.45

 

 

 

 

5.20

 

 

 

 

11.46

 

3rd Quarter

 

 

 

18.19

 

 

 

 

10.83

 

 

 

 

17.46

 

4th Quarter

 

 

 

19.03

 

 

 

 

15.78

 

 

 

 

18.33

 

Each ordinary share has one vote, except if, and so long as, the Controlled Shares (defined below) of any person constitute ten percent (10%) or more of the issued ordinary shares, the voting rights with respect to the Controlled Shares owned by such person are limited, in the aggregate, to a voting power of approximately 10%, pursuant to a formula specified in the Company’s Articles of Association. “Controlled Shares” includes, among other things, all ordinary shares which such person is deemed to beneficially own directly, indirectly or constructively (within the meaning of Section 13(d)(3) of the Securities Exchange Act of 1934, as amended, or Section 958 of the Internal Revenue Code of 1986, as amended).

The number of record holders of ordinary shares as of December 31, 2010 was 175. This figure does not represent the actual number of beneficial owners of the Company’s ordinary shares because such shares are frequently held in “street name” by securities dealers and others for the benefit of individual owners who may vote the shares.

In 2010, four quarterly dividends were paid at $0.10 per share to all ordinary shareholders of record as of March 15, June 15, September 15 and December 15. In 2009, four quarterly dividends were paid at $0.10 per share to all ordinary shareholders of record as of March 13, June 15, September 15 and December 15.

The declaration and payment of future dividends by the Company will be at the discretion of the Board of Directors and will depend upon many factors, including the Company’s earnings, financial condition, business needs, capital and surplus requirements of the Company’s operating subsidiaries and regulatory and contractual restrictions.

As a holding company, the Company’s principal source of income is dividends or other statutorily permissible payments from its subsidiaries. The ability to pay such dividends is limited by the applicable laws and regulations of the various countries in which the Company’s subsidiaries operate, including Bermuda, the U.S. and the U.K., applicable requirements of the Society of Lloyd’s, and certain contractual provisions. See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and Item 8, Note 25 to the Consolidated Financial Statements, “Statutory Financial Data,” for further discussion.

Information concerning securities authorized for issuance under equity compensation plans appears in Part III, Item 12, “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.”

58


Purchases of Equity Securities by the Issuer and Affiliate Purchases

The following table provides information about purchases by the Company during the quarter ended December 31, 2010 of equity securities that are registered by the Company pursuant to Section 12 of the Exchange Act:

 

 

 

 

 

 

 

 

 

Period

 

Total Number
of Shares
Purchased

 

Average Price
Paid
per share

 

Total Number
of Shares
Purchased as
Part of
Publicly
Announced Plans
or Programs

 

Approximate Dollar
Value of Shares
that May Yet Be
Purchased Under
the Plans
or Programs (1) (2)

October

 

 

 

4,925,535

 

 

 

$

 

21.69

 

 

 

 

4,925,535

 

 

 

$

 

 

November (1)

 

 

 

2,313

 

 

 

$

 

20.92

 

 

 

 

 

 

 

$

 

1,000 million

 

December

 

 

 

6,858,761

 

 

 

$

 

21.01

 

 

 

 

6,857,280

 

 

 

$

 

856.0 million

 

 

 

 

 

 

 

 

 

 

Total

 

 

 

11,786,609

 

 

 

$

 

21.29

 

 

 

 

11,782,815

 

 

 

$

 

856.0 million

 

 

 

 

 

 

 

 

 

 


 

 

(1)

 

 

 

All shares were purchased in connection with the vesting of restricted shares granted under the Company’s restricted stock plan. All of these purchases were made in connection with satisfying tax withholding obligations of those employees. These shares were not purchased as part of the Company’s share buyback program noted below.

 

(2)

 

 

 

During the third quarter of 2007, the Company’s Board of Directors approved a share buyback program, authorizing the Company to purchase up to $500.0 million of its ordinary shares. As of January 1, 2010, $375.4 million ordinary shares remained available for purchase under this program. During the third quarter of 2010, the Company purchased and cancelled 13.9 million ordinary shares under this program for $268.6 million. During October 2010, the Company purchased and cancelled 4.9 million ordinary shares for $106.8 million. In combination, these purchases totaled $375.4 million, the full amount remaining under this buyback program.

 

 

 

 

 

On November 2, 2010, the Company announced that its Board of Directors approved a new share buyback program, authorizing the Company to purchase up to $1.0 billion of its ordinary shares. During the fourth quarter of 2010, the Company purchased and cancelled 6.9 million ordinary shares for $144.0 million under the 2010 buyback program. Between January 1 and February 22, 2011, the Company purchased and cancelled an additional 5.3 million shares for $121.3 million under the 2010 buyback program. As of February 22, 2011, $734.7 million remains available for purchase under this buyback program.

Ordinary Share Performance Graph

Set forth below is a line graph comparing the yearly dollar change in the cumulative total shareholder return, with all dividends reinvested, over a five-year period on the Company’s ordinary shares from December 31, 2005 through December 31, 2010 as compared to the cumulative total return of the Standard & Poor’s 500 Stock Index and the cumulative total return of the Standard & Poor’s Property & Casualty Insurance Index.

59


 

 

 

 

 

 

ITEM 6.

 

SELECTED FINANCIAL DATA

 

 

 

The selected consolidated financial data below is based upon the Company’s fiscal year end of December 31. The selected consolidated financial data should be read in conjunction with the Consolidated Financial Statements and the Notes thereto presented under Item 8.

 

 

 

 

 

 

 

 

 

 

 

 

 

2010

 

2009

 

2008

 

2007

 

2006

 

 

(U.S. dollars in thousands, except per share amounts)

Income Statement Data:

 

 

 

 

 

 

 

 

 

 

Net premiums earned

 

 

$

 

5,414,061

 

 

 

$

 

5,706,840

 

 

 

$

 

6,640,102

 

 

 

$

 

7,205,356

 

 

 

$

 

7,569,518

 

Net investment income

 

 

 

1,198,038

 

 

 

 

1,319,823

 

 

 

 

1,768,977

 

 

 

 

2,248,807

 

 

 

 

1,978,184

 

Net realized (losses) gains on investments

 

 

 

(270,803

)

 

 

 

 

(921,437

)

 

 

 

 

(962,054

)

 

 

 

 

(603,268

)

 

 

 

 

(116,458

)

 

Net realized and unrealized (losses) gains on derivative instruments

 

 

 

(33,843

)

 

 

 

 

(33,647

)

 

 

 

 

(73,368

)

 

 

 

 

(55,451

)

 

 

 

 

101,183

 

Net income (loss) income from investment fund affiliates (1)

 

 

 

51,102

 

 

 

 

78,867

 

 

 

 

(277,696

)

 

 

 

 

326,007

 

 

 

 

269,036

 

Fee income and other

 

 

 

40,027

 

 

 

 

43,201

 

 

 

 

52,158

 

 

 

 

14,271

 

 

 

 

31,732

 

Net losses and loss expenses
incurred (2)

 

 

 

3,211,800

 

 

 

 

3,168,837

 

 

 

 

3,962,898

 

 

 

 

3,841,003

 

 

 

 

4,201,194

 

Claims and policy benefits – life operations

 

 

 

513,833

 

 

 

 

677,562

 

 

 

 

769,004

 

 

 

 

888,658

 

 

 

 

807,255

 

Acquisition costs, operating expenses and foreign exchange gains and losses

 

 

 

1,749,202

 

 

 

 

1,994,194

 

 

 

 

1,921,940

 

 

 

 

2,188,889

 

 

 

 

2,374,358

 

Interest expense

 

 

 

213,643

 

 

 

 

216,504

 

 

 

 

351,800

 

 

 

 

621,905

 

 

 

 

552,275

 

Loss on settlement of guarantee

 

 

 

23,500

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Extinguishment of debt

 

 

 

 

 

 

 

 

 

 

 

22,527

 

 

 

 

 

 

 

 

 

Impairment of goodwill

 

 

 

 

 

 

 

 

 

 

 

989,971

 

 

 

 

 

 

 

 

 

Amortization of intangible assets

 

 

 

1,858

 

 

 

 

1,836

 

 

 

 

2,968

 

 

 

 

1,680

 

 

 

 

2,355

 

Income (loss) before non-controlling interests, net income from operating affiliates and income tax expense

 

 

 

684,746

 

 

 

 

134,714

 

 

 

 

(872,989

)

 

 

 

 

1,593,587

 

 

 

 

1,895,758

 

Income (loss) from operating
affiliates (1)(2)

 

 

 

121,372

 

 

 

 

60,480

 

 

 

 

(1,458,246

)

 

 

 

 

(1,059,848

)

 

 

 

 

111,670

 

Preference share dividends

 

 

 

74,521

 

 

 

 

80,200

 

 

 

 

78,645

 

 

 

 

69,514

 

 

 

 

40,322

 

Net income (loss) attributable to ordinary shareholders

 

 

 

585,472

 

 

 

 

206,607

 

 

 

 

(2,632,458

)

 

 

 

 

206,375

 

 

 

 

1,722,445

 

60


 

 

 

 

 

 

 

 

 

 

 

 

 

2010

 

2009

 

2008

 

2007

 

2006

 

 

(U.S. dollars in thousands, except per share amounts)

Per Share Data:

 

 

 

 

 

 

 

 

 

 

Net income (loss) per ordinary share – basic (3)(7)

 

 

$

 

1.74

 

 

 

$

 

0.61

 

 

 

$

 

(10.94

)

 

 

 

$

 

1.14

 

 

 

$

 

9.55

 

Net income (loss) per ordinary share – diluted (3)(7)

 

 

$

 

1.73

 

 

 

$

 

0.61

 

 

 

$

 

(10.94

)

 

 

 

$

 

1.14

 

 

 

$

 

9.53

 

Weighted average ordinary shares outstanding – diluted (3)

 

 

 

337,709

 

 

 

 

340,966

 

 

 

 

240,657

 

 

 

 

181,209

 

 

 

 

180,799

 

Cash dividends per ordinary share

 

 

$

 

0.40

 

 

 

$

 

0.40

 

 

 

$

 

1.14

 

 

 

$

 

1.52

 

 

 

$

 

1.52

 

Balance Sheet Data:

 

 

 

 

 

 

 

 

 

 

Total investments available for sale

 

 

$

 

27,677,553

 

 

 

$

 

29,307,171

 

 

 

$

 

27,464,510

 

 

 

$

 

36,265,803

 

 

 

$

 

39,350,983

 

Total investments held to maturity

 

 

 

2,728,335

 

 

 

 

546,067

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

 

 

3,022,868

 

 

 

 

3,643,697

 

 

 

 

4,353,826

 

 

 

 

3,880,030

 

 

 

 

2,223,748

 

Investments in affiliates.

 

 

 

1,069,028

 

 

 

 

1,185,604

 

 

 

 

1,552,789

 

 

 

 

2,611,149

 

 

 

 

2,308,781

 

Unpaid losses and loss expenses recoverable

 

 

 

3,671,887

 

 

 

 

3,584,028

 

 

 

 

3,997,722

 

 

 

 

4,697,471

 

 

 

 

5,027,772

 

Premiums receivable.

 

 

 

2,414,912

 

 

 

 

2,597,602

 

 

 

 

3,135,985

 

 

 

 

3,637,452

 

 

 

 

3,591,238

 

Total assets

 

 

 

45,023,351

 

 

 

 

45,663,894

 

 

 

 

45,702,786

 

 

 

 

57,794,000

 

 

 

 

59,338,818

 

Unpaid losses and loss expenses

 

 

 

20,531,607

 

 

 

 

20,823,524

 

 

 

 

21,650,315

 

 

 

 

23,207,694

 

 

 

 

22,895,021

 

Future policy benefit reserves

 

 

 

5,075,127

 

 

 

 

5,490,119

 

 

 

 

5,452,865

 

 

 

 

6,772,042

 

 

 

 

6,476,057

 

Unearned premiums

 

 

 

3,484,830

 

 

 

 

3,651,310

 

 

 

 

4,217,931

 

 

 

 

4,681,989

 

 

 

 

5,652,897

 

Notes payable and debt

 

 

 

2,464,410

 

 

 

 

2,451,417

 

 

 

 

3,189,734

 

 

 

 

2,868,731

 

 

 

 

3,368,376

 

Shareholders’ equity

 

 

 

10,613,049

 

 

 

 

9,432,417

 

 

 

 

6,116,831

 

 

 

 

9,950,561

 

 

 

 

10,693,287

 

Fully diluted book value per ordinary share

 

 

$

 

29.78

 

 

 

$

 

24.60

 

 

 

$

 

15.46

 

 

 

$

 

50.29

 

 

 

$

 

53.01

 

Operating Ratios:

 

 

 

 

 

 

 

 

 

 

Loss and loss expense ratio (4)

 

 

 

63.8

%

 

 

 

 

61.5

%

 

 

 

 

66.2

%

 

 

 

 

59.8

%

 

 

 

 

62.2

%

 

Underwriting expense ratio (5)

 

 

 

31.0

%

 

 

 

 

32.1

%

 

 

 

 

28.7

%

 

 

 

 

29.0

%

 

 

 

 

27.3

%

 

Combined ratio (6)

 

 

 

94.8

%

 

 

 

 

93.6

%

 

 

 

 

94.9

%

 

 

 

 

88.8

%

 

 

 

 

89.5

%

 


 

 

(1)

 

 

 

The Company records the income related to alternative fund affiliates on a one month lag and the private investment fund affiliates on a three month lag in order for the Company to meet the accelerated filing deadlines as this is the most current information available at the date of filing. The Company records the income related to operating affiliates on a three month lag.

 

(2)

 

 

 

In 2008, net loss from operating affiliates includes losses totaling approximately $1.4 billion related to the closing of the Master Agreement as well as losses recorded throughout 2008 and up until the closing of the Master Agreement that were associated with previous reinsurance and guarantee agreements with Syncora. In 2007, $351.0 million of financial guarantee reserves related to reinsurance agreements with Syncora were recorded within net loss from operating affiliates. In 2010, net income from operating affiliates included $50.2 million relating to sale of a majority of the Company’s shareholding in Primus Guaranty Ltd.

 

(3)

 

 

 

Effective for the fiscal year beginning January 1, 2009 and for all interim periods within 2009, the Company adopted final authoritative guidance that addresses whether instruments granted in share-based payment transactions are participating securities prior to vesting and, therefore, need to be included in the earnings allocation in computing basic earnings per share (“EPS”) pursuant to the two-class method described in EPS guidance. A share-based payment award that contains a non-forfeitable right to receive cash when dividends are paid to ordinary shareholders irrespective of whether that award ultimately vests is considered a participating security as these rights to dividends provide a non-contingent transfer of value to the holder of the share-based payment award. Accordingly, these awards are included in the computation of basic EPS pursuant to the two-class method. Under the terms of the Company’s restricted stock awards, grantees are entitled to receive dividends on the unvested portions of their awards. There is no requirement to return these dividends in the event the unvested awards are forfeited in the future. Accordingly, this guidance had an impact on the Company’s EPS calculations. All prior period EPS data presented has been adjusted retrospectively to conform to the provisions of this guidance. The adoption of this guidance reduced basic loss per ordinary share for fiscal 2008 and fiscal 2005 by $0.08 and $0.08, respectively, and reduced basic earnings per ordinary share by $0.02, and $0.08 for fiscal 2007 and fiscal 2006, respectively, and reduced diluted loss per ordinary share for fiscal 2008 $0.08 and fiscal 2005 by $0.08, respectively, and reduced diluted earnings per ordinary share by $0.01 and $0.07, for fiscal 2007 and fiscal 2006, respectively.

 

(4)

 

 

 

The loss and loss expense ratio related to the property and casualty operations is calculated by dividing the losses and loss expenses incurred by the net premiums earned for the Insurance and Reinsurance segments.

 

(5)

 

 

 

The underwriting expense ratio related to the property and casualty operations is the sum of acquisition expenses and operating expenses for the Insurance and Reinsurance segments divided by net premiums earned for the Insurance and Reinsurance segments. See Item 8, Note 6 to the Consolidated Financial Statements, “Segment Information,” for further information.

 

(6)

 

 

 

The combined ratio related to the property and casualty operations is the sum of the loss and loss expense ratio and the underwriting expense ratio. A combined ratio under 100% represents an underwriting profit and over 100% represents an underwriting loss.

 

(7)

 

 

 

Effective April 1, 2009 the Company adopted final authoritative guidance that addressed the treatment of credit losses on investments. This guidance was not applied retroactively. For additional information see Item 8, Note 2(r) to the Consolidated Financial Statements, “Recent Accounting Pronouncements.”

61


 

 

 

 

 

 

ITEM 7.

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

 

 

This “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contains forward-looking statements which involve inherent risks and uncertainties. Statements that are not historical facts, including statements about the Company’s beliefs and expectations, are forward-looking statements. These statements are based upon current plans, estimates and expectations. Actual results may differ materially from those projected in such forward-looking statements, and therefore undue reliance should not be placed on them. See “Cautionary Note Regarding Forward-Looking Statements,” for a list of additional factors that could cause actual results to differ materially from those contained in any forward-looking statement.

This discussion and analysis should be read in conjunction with the audited Consolidated Financial Statements and Notes thereto presented under Item 8.

Certain aspects of the Company’s business have loss experience characterized as low frequency and high severity. This may result in volatility in both the Company’s results of operations and financial condition.

Index

 

 

 

Executive Overview

 

 

 

63

 

Results of Operations and Key Financial Measures

 

 

 

66

 

Significant Items Affecting the Results of Operations

 

 

 

69

 

Other Key Focuses of Management

 

 

 

71

 

Critical Accounting Policies and Estimates

 

 

 

74

 

Segments

 

 

 

88

 

Income Statement Analysis

 

 

 

88

 

Insurance

 

 

 

88

 

Reinsurance

 

 

 

91

 

Life Operations

 

 

 

93

 

Syncora

 

 

 

95

 

Investment Activities

 

 

 

96

 

Investment Performance

 

 

 

97

 

Net realized gains and losses on investments and other than temporary declines in the value of investments

 

 

 

97

 

Net realized and unrealized gains and losses on derivative instruments

 

 

 

98

 

Other Revenues and Expenses

 

 

 

98

 

Balances Sheet Analysis

 

 

 

100

 

Investments

 

 

 

100

 

Gross and net unrealized gains and losses on investments

 

 

 

102

 

Fair Value Measurements of Assets and Liabilities

 

 

 

108

 

Unpaid Losses and Loss Expenses

 

 

 

110

 

Unpaid Losses and Loss Expenses Recoverable and Reinsurance Balances Receivable

 

 

 

110

 

Liquidity and Capital Resources

 

 

 

111

 

Cross-Default and Other Provisions in Debt Instruments

 

 

 

120

 

Long-Term Contractual Obligations

 

 

 

121

 

Variable Interest Entities and Other Off-Balance Sheet Arrangements

 

 

 

121

 

Recent Accounting Pronouncements

 

 

 

122

 

Cautionary Note Regarding Forward-Looking Statements

 

 

 

122

 

62


Executive Overview

Background

The Company, through its subsidiaries, is a global insurance and reinsurance company providing property, casualty and specialty products to industrial, commercial and professional firms, insurance companies and other enterprises on a worldwide basis. The Company operates in markets where it believes its underwriting expertise and financial strength represent a relative advantage.

The Company has grown through acquisitions and development of new business opportunities. Acquisitions included Global Capital Re in 1997, Mid Ocean Limited in 1998, ECS, Inc. and NAC Re Corp. in 1999, Winterthur International in 2001 and Le Mans Re in 2002. All acquisitions were entered into in order to further support the Company’s strategic plan to develop a global platform in insurance and reinsurance. The Company competes as an integrated global business and at December 31, 2010 employed 3,576 employees in 25 countries. For further information in relation to the Company’s Operations, see Item 1, “Business.”

Underwriting Environment

The Company earns its revenue primarily from net premiums written and earned. The property and casualty insurance and reinsurance markets have historically been cyclical, meaning that based on market conditions, there have been periods where premium rates are high and policy terms and conditions are more favorable to the Company (a “hard market”) and there have been periods where premium rates decline and policy terms and conditions are less favorable to the Company (a “soft market”). Market conditions are driven primarily by competition in the marketplace, the supply of capital in the industry, investment yields and the frequency and severity of loss events. Management’s goal is to build long-term shareholder value by capitalizing on current opportunities and managing through any cyclical downturns by reducing its property and casualty book of business and exposures if and when rates deteriorate during soft market periods.

Insurance

The trading environment for the core lines of insurance business written by the Company remains difficult as competitive pressures continue. The Company continues its disciplined underwriting approach to grow on a very selective basis and exit lines where margins are unacceptable. Overall, retention ratios have continued to improve and premium rates were broadly flat for the year, with rate declines in the Insurance segment’s U.S.-based professional lines and global property books offset by some increases in its international excess casualty book as well as an international professional solicitors program. The Company continues to develop new business opportunities in several areas, including its North American construction and surety businesses as recently announced. For further information on recent rate and renewal activity, see “2011 Underwriting Outlook” below.

The following table provides an analysis of gross premiums written, net premiums written and net premiums earned for the Insurance segment for the last three years ended December 31:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(U.S. dollars in thousands)

 

2010

 

2009 (1)

 

2008 (1)

 

Gross
Premiums
Written

 

Net
Premiums
Written

 

Net
Premiums
Earned

 

Gross
Premiums
Written

 

Net
Premiums
Written

 

Net
Premiums
Earned

 

Gross
Premiums
Written

 

Net
Premiums
Written

 

Net
Premiums
Earned

Casualty – professional lines

 

 

$

 

1,412,131

 

 

 

$

 

1,306,441

 

 

 

$

 

1,316,173

 

 

 

$

 

1,423,756

 

 

 

$

 

1,336,541

 

 

 

$

 

1,276,005

 

 

 

$

 

1,472,874

 

 

 

$

 

1,351,237

 

 

 

$

 

1,369,668

 

Casualty – other lines

 

 

 

1,030,877

 

 

 

 

650,717

 

 

 

 

632,737

 

 

 

 

947,121

 

 

 

 

570,887

 

 

 

 

655,126

 

 

 

 

1,273,016

 

 

 

 

793,512

 

 

 

 

822,252

 

Other property

 

 

 

699,442

 

 

 

 

414,251

 

 

 

 

416,917

 

 

 

 

649,592

 

 

 

 

361,841

 

 

 

 

426,441

 

 

 

 

886,418

 

 

 

 

503,387

 

 

 

 

471,283

 

Marine, energy, aviation, and satellite

 

 

 

668,878

 

 

 

 

570,957

 

 

 

 

540,319

 

 

 

 

644,898

 

 

 

 

516,408

 

 

 

 

546,806

 

 

 

 

747,311

 

 

 

 

604,786

 

 

 

 

621,774

 

Other specialty lines (2)

 

 

 

602,787

 

 

 

 

519,557

 

 

 

 

606,682

 

 

 

 

577,804

 

 

 

 

483,166

 

 

 

 

634,436

 

 

 

 

850,404

 

 

 

 

712,307

 

 

 

 

660,322

 

Other (3)

 

 

 

(2,545

)

 

 

 

 

(7,582

)

 

 

 

 

1,554

 

 

 

 

5,257

 

 

 

 

1,077

 

 

 

 

12,217

 

 

 

 

22,736

 

 

 

 

(22,908

)

 

 

 

 

(11,055

)

 

Structured indemnity

 

 

 

6,810

 

 

 

 

6,809

 

 

 

 

14,756

 

 

 

 

3,460

 

 

 

 

3,460

 

 

 

 

8,762

 

 

 

 

56,155

 

 

 

 

42,505

 

 

 

 

62,801

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

 

$

 

4,418,380

 

 

 

$

 

3,461,150

 

 

 

$

 

3,529,138

 

 

 

$

 

4,251,888

 

 

 

$

 

3,273,380

 

 

 

$

 

3,559,793

 

 

 

$

 

5,308,914

 

 

 

$

 

3,984,826

 

 

 

$

 

3,997,045

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 


 

 

(1)

 

 

 

Certain reclassifications have been made to conform to current year presentation.

 

(2)

 

 

 

Other specialty lines within the Insurance segment includes: environmental, programs, equine, warranty, specie, middle markets and excess and surplus lines.

 

(3)

 

 

 

Other includes credit and surety and other lines.

63


Reinsurance

Challenging market conditions persist for the Reinsurance segment but, in general, January 1, 2011 renewals were competitive, but orderly. In long tail lines, January 1, 2011 renewals saw terms and conditions remain firm. However, this market is heavily dependent on the pricing conditions of the primary market which continues to be weak. For short tail lines, there was deterioration in U.S. catastrophe rates on a risk adjusted basis between 7-10% and international rates decreased by 5%. For the year ended December 31, 2010, gross premiums written marginally decreased by 0.9% while net premiums written increased by 4.6%, compared with the same period of 2009. The gross premiums written decrease was primarily from reduced new and renewal business in the U.S. and Bermuda, some timing differences of inceptions in Bermuda along with reduced premium estimates on proportional treaties and lower premiums from a U.S. agricultural program. The net premium increase resulted from the reduced reinsurance cessions on the U.S. agricultural program.

The following table provides an analysis of gross premiums written, net premiums written and net premiums earned for the Reinsurance segment for the last three years ended December 31:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(U.S. dollars in thousands)

 

2010

 

2009 (2)

 

2008 (2)

 

Gross
Premiums
Written

 

Net
Premiums
Written

 

Net
Premiums
Earned

 

Gross
Premiums
Written

 

Net
Premiums
Written

 

Net
Premiums
Earned

 

Gross
Premiums
Written

 

Net
Premiums
Written

 

Net
Premiums
Earned

Casualty – professional lines

 

 

$

 

218,301

 

 

 

$

 

222,133

 

 

 

$

 

222,720

 

 

 

$

 

170,928

 

 

 

$

 

166,903

 

 

 

$

 

196,624

 

 

 

$

 

213,519

 

 

 

$

 

213,498

 

 

 

$

 

247,979

 

Casualty – other lines

 

 

 

229,535

 

 

 

 

222,351

 

 

 

 

219,154

 

 

 

 

218,778

 

 

 

 

217,889

 

 

 

 

257,610

 

 

 

 

356,723

 

 

 

 

347,849

 

 

 

 

425,541

 

Property catastrophe

 

 

 

370,266

 

 

 

 

326,758

 

 

 

 

323,588

 

 

 

 

357,267

 

 

 

 

312,321

 

 

 

 

312,780

 

 

 

 

401,740

 

 

 

 

290,443

 

 

 

 

305,690

 

Other property

 

 

 

802,494

 

 

 

 

562,416

 

 

 

 

534,422

 

 

 

 

862,310

 

 

 

 

553,556

 

 

 

 

560,379

 

 

 

 

947,899

 

 

 

 

602,423

 

 

 

 

678,504

 

Marine, energy, aviation, and satellite

 

 

 

117,438

 

 

 

 

103,926

 

 

 

 

88,855

 

 

 

 

89,100

 

 

 

 

82,393

 

 

 

 

83,532

 

 

 

 

119,593

 

 

 

 

104,346

 

 

 

 

126,761

 

Other (1)

 

 

 

103,959

 

 

 

 

99,897

 

 

 

 

112,305

 

 

 

 

156,092

 

 

 

 

132,322

 

 

 

 

172,588

 

 

 

 

220,332

 

 

 

 

194,237

 

 

 

 

205,433

 

Structured indemnity

 

 

 

958

 

 

 

 

957

 

 

 

 

955

 

 

 

 

4,948

 

 

 

 

4,948

 

 

 

 

8,433

 

 

 

 

671

 

 

 

 

671

 

 

 

 

3,298

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

 

$

 

1,842,951

 

 

 

$

 

1,538,438

 

 

 

$

 

1,501,999

 

 

 

$

 

1,859,423

 

 

 

$

 

1,470,332

 

 

 

$

 

1,591,946

 

 

 

$

 

2,260,477

 

 

 

$

 

1,753,467

 

 

 

$

 

1,993,206

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 


 

 

(1)

 

 

 

Other includes credit and surety, whole account contracts and other lines.

 

(2)

 

 

 

Certain reclassifications have been made to conform to current year presentation.

The following sets forth potential trends relevant to the Company’s property and casualty operations:

2011 Underwriting Outlook

Throughout 2009 and 2010 the Company was focused on selective growth initiatives, emphasizing short-tail lines, where applicable, in the Company’s reinsurance operations, exiting other businesses, such as Casualty facultative business and non-renewing certain insurance programs, as well as continuing to reduce long- term agreements within the insurance operations in order to take advantage of improvements in market conditions when and where they occur.

In 2011, these initiatives will continue. In addition, in recent quarters the Company’s focus shifted to concentrate on strategic growth and investment in areas where the Company believes it can achieve appropriate returns. Recent strategic growth initiatives include the expansion of the U.S. construction and surety lines, new innovative products, including a product recall policy for the food and beverage industry and a creative multi-year product warranty technology program, and the further move into emerging markets. In December 2010 the Company announced that it had been granted a license to operate as a P&C company in Shanghai, China. This represents a significant step in the implementation of the Company’s strategy to strengthen its presence in emerging markets. There will also be significant investment in 2011 to install systems to both achieve greater efficiency and to create a platform from which the Company can grow as markets allow.

Despite some early positive signs in 2009, credit spreads narrowed sharply throughout 2009 and this continued into 2010. The credit markets brought capital back into the market, strengthening balance sheets and putting increased pressure on market pricing which continues today. However, in the U.S. there have been some recent indications of economic improvement which is reflected in some of the Company’s larger, more complex institutional clients’ exposure growth predictions. The market outlook for Europe is mixed, with Germany continuing to perform strongly and further improve while the U.K. and other markets

64


remain weak. As already mentioned, the Company is seeing growth opportunities in the emerging markets books through the granting of the Chinese license and further opportunities in Latin America.

The following is a summary of the January 2011 rate indications and recent renewal activity for each of the Insurance and Reinsurance segments of the Company:

Insurance

With regard to market conditions, within the Insurance segment’s core lines of business, fourth quarter 2010 renewals reflected broadly flat premium rates in aggregate. While this reflects an improvement over the previous three quarters, the improvement is the result of some stronger pricing in excess casualty and a specific international professional program, offset by what continues to be a very competitive marketplace for most lines of business. This is particularly the case in both property and U.S. based professional lines where, rate decreases are in the low to mid single digits.

The Company continues to focus on those lines of business that it believes provide the best return on capital, including the writing of selective new business and remaining committed to the underwriting actions initially taken in 2009. Looking forward in 2011, initial indications are consistent with current market conditions described above. In the International P&C business unit, where nearly 40% of the book renews on January 1st, the Company experienced strong retentions across all product lines, including 86% based on accounts and 90% based on premium, and initial pricing indications are broadly stable.

Reinsurance

As mentioned above, January 1, 2011 renewals saw rate deterioration across most lines of business and the market expectation is that these competitive trading conditions will continue for some time to come in most sectors. Despite this, the segment continues to develop new business opportunities in several areas, including the U.K. motor and marine markets, Bermuda catastrophe business and some select opportunities in the U.S. Looking ahead for the remainder of 2011, the segment will continue its philosophy of disciplined underwriting while seeking opportunities for strategic growth.

Investment Environment

The Company seeks to generate income and book value growth from investment activities through returns on its investment portfolio. The Company’s current investment strategy seeks to support the liabilities arising from the operations of the Company, generate investment income and build book value over the longer term. During the year ended December 31, 2010, interest rates declined in the Company’s major markets and corporate credit spreads tightened. The Company’s results of operations and investment portfolio during the year ended December 31, 2010 were impacted by these trends. Net investment income yields were negatively impacted as a result of lower short-term interest rates, particularly U.S. LIBOR, on floating rate assets, higher allocations to lower yielding government, agency and cash securities, and reduced prevailing yields on reinvestment income. Net realized losses resulted from sales transactions in relation to the Company’s portfolio optimization efforts, and other-than-temporary impairment charges relating to the deterioration of future cash flow estimates, particularly in below investment grade non-agency RMBS. The impact of decreasing government rates during the twelve months ended December 31, 2010 was the primary reason for the improvement in the net unrealized position on fixed maturities and short-term investments combined with tightening credit spreads and net realized losses over the course of the year. For further information, see Item 7, “Investment Activities” below.

Claims Environment

The Company’s profitability in any given period is based upon its premium and investment revenues as noted above, less net losses incurred and expenses. Net losses incurred are based upon claims paid and changes to unpaid loss reserves. Unpaid loss reserves are estimated by the Company and include both reported loss reserves and reserves for losses incurred but not reported, or IBNR. The Company’s lower underwriting results for 2010 as compared to 2009 were due to higher net losses incurred from natural catastrophes, which were $294.3 million in 2010 as compared to $52.3 million in 2009. In addition, other large loss events, as well as property losses relating to the Deepwater Horizon oil rig, contributed to the

65


higher losses in 2010 than during 2009. In contrast, the Company’s improved underwriting results for 2009 as compared to 2008 were largely due to minimal large loss activity in 2009 compared to the catastrophe and property risk losses experienced in 2008. For further analysis, see “Results of Operations” below.

Results of Operations and Key Financial Measures

Results of Operations

The following table presents an analysis of the Company’s net income (loss) attributable to ordinary shareholders and other financial measures (described below) for the years ended December 31, 2010, 2009 and 2008:

 

 

 

 

 

 

 

(U.S. dollars in thousands, except share and per share amounts)

 

2010

 

2009

 

2008

Net income (loss) attributable to ordinary shareholders

 

 

$

 

585,472

 

 

 

$

 

206,607

 

 

 

$

 

(2,632,458

)

 

Earnings (loss) per ordinary share – basic

 

 

$

 

1.74

 

 

 

$

 

0.61

 

 

 

$

 

(10.94

)

 

Earnings (loss) per ordinary share – diluted

 

 

$

 

1.73

 

 

 

$

 

0.61

 

 

 

$

 

(10.94

)

 

Weighted average number of ordinary shares and ordinary share equivalents – basic

 

 

 

336,283

 

 

 

 

340,612

 

 

 

 

240,657

 

Weighted average number of ordinary shares and ordinary share equivalents – diluted

 

 

 

337,709

 

 

 

 

340,966

 

 

 

 

240,657

 

Key Financial Measures

The following are some of the financial measures management considers important in evaluating the Company’s operating performance in the Company’s P&C operations:

 

 

 

 

 

 

 

(U.S. dollars in thousands, except ratios and per share amounts)

 

2010

 

2009

 

2008

Underwriting profit – P&C operations

 

 

$

 

262,494

 

 

 

$

 

327,306

 

 

 

$

 

303,017

 

Combined ratio – P&C operations

 

 

 

94.8

%

 

 

 

 

93.6

%

 

 

 

 

94.9

%

 

Net investment income – P&C operations (1)

 

 

$

 

884,866

 

 

 

$

 

987,398

 

 

 

$

 

1,385,982

 

Book value per ordinary share (2)

 

 

$

 

30.37

 

 

 

$

 

24.64

 

 

 

$

 

15.46

 

Fully diluted book value per ordinary share (3)

 

 

$

 

29.78

 

 

 

$

 

24.60

 

 

 

$

 

15.46

 

Return on average ordinary shareholders’ equity

 

 

 

6.5

%

 

 

 

 

3.1

%

 

 

 

 

NM*

 


 

 

(1)

 

 

 

Net investment income relating to P&C operations includes the net investment income related to the net results from structured products.

 

(2)

 

 

 

Book value per share is a non-GAAP financial measure and is calculated by dividing ordinary shareholders’ equity by the number of outstanding ordinary shares at any period end. Book value per ordinary share is affected primarily by the Company’s net income (loss), by any changes in the net unrealized gains and losses on its investment portfolio, currency translation adjustments and also the impact of any share buyback or issuance activity.

 

(3)

 

 

 

Fully diluted book value per ordinary share, a non-GAAP measure, represents book value per ordinary share combined with the impact from dilution of share based compensation including in-the-money stock options at any period end. The Company believes that fully diluted book value per ordinary share is a financial measure important to investors and other interested parties who benefit from having a consistent basis for comparison with other companies within the industry. However, this measure may not be comparable to similarly titled measures used by companies either outside or inside of the insurance industry.

 

*

 

 

 

NM – Not Meaningful

Underwriting profit – property and casualty operations

One way that the Company evaluates the performance of its insurance and reinsurance operations is the underwriting profit or loss. The Company does not measure performance based on the amount of gross premiums written. Underwriting profit or loss is calculated from premiums earned less net losses incurred and expenses related to underwriting activities. The Company’s underwriting profit in the year ended December 31, 2010 was primarily reflective of the combined ratio discussed below.

Combined ratio – property and casualty operations

The combined ratio for P&C operations is used by the Company and many other insurance and reinsurance companies as another measure of underwriting profitability. The combined ratio is calculated from the net losses incurred and underwriting expenses as a ratio of the net premiums earned for the Company’s insurance and reinsurance operations. A combined ratio of less than 100% indicates an

66


underwriting profit and greater than 100% reflects an underwriting loss. The Company’s combined ratio for the year ended December 31, 2010 is higher than for the same period in the previous year, primarily as a result of an increase in the loss and loss expense ratio, partially offset by a decrease in the underwriting expense ratio. The loss and loss expense ratio has increased as a result of higher levels of catastrophe losses and other large loss events in both the insurance and reinsurance segments. The decreased underwriting expense ratio reflects the Company’s restructuring activities over the last several years.

The Company’s combined ratio for the year ended December 31, 2009, is slightly lower than the same period in the previous year, primarily as a result of a decrease in the loss and loss expense ratio, partially offset by an increase in the underwriting expense ratio. The loss and loss expense ratio has declined as a result of lower levels of catastrophe losses in both the insurance and reinsurance segments and lower current year professional lines losses in the insurance segment partially offset by larger prior year reserve releases reported in 2008. The increased underwriting expense ratio has been driven largely by increases in operating expenses against lower net premiums earned. Operating expenses increased mainly as a result of the Company’s two restructuring activities already mentioned.

Net investment income – property and casualty (“P&C”) operations

Net investment income related to P&C operations is an important measure that affects the Company’s overall profitability. The largest liability of the Company relates to its unpaid loss reserves, and the Company’s investment portfolio provides liquidity for claims settlements of these reserves as they become due. As a result, a significant part of the investment portfolio is invested in fixed income securities. Net investment income is influenced by a number of factors, including the amounts and timing of inward and outward cash flows, the level of interest rates and credit spreads and changes in overall asset allocation. Net investment income related to P&C investment portfolio decreased by $102.5 million during 2010 as compared to the same period in the prior year. Overall, portfolio yields have decreased as a result of the impact of declines in U.S. interest rates, and particularly the impact of decreased U.S. LIBOR on the Company’s floating rate securities. Should investments yields remain low, overall profitability and cash flow will continue to be negatively impacted.

Net investment income related to property and casualty and corporate operations decreased by $398.6 million during 2009 as compared to same period in the prior year. Overall, portfolio yields have decreased as a result of the impact of declines in U.S. interest rates, and particularly the impact of decreased U.S. LIBOR on the Company’s floating rate securities previously supporting the GIC and funding agreement business. In addition, the Company increased its holdings in lower-yielding cash, government and agency RMBS securities in connection with its investment portfolio de-risking efforts as the Company re-aligns its portfolio to one more typical of a P&C investment portfolio and to increase liquidity.

Book value per ordinary share

Management also views the change in the Company’s book value per ordinary share as an additional measure of the Company’s performance. Book value per share is a non-GAAP financial measure and is calculated by dividing ordinary shareholders’ equity by the number of outstanding ordinary shares at any period end. Book value per ordinary share is affected primarily by the Company’s net income (loss), by any changes in the net unrealized gains and losses on its investment portfolio, currency translation adjustments and also the impact of any share buyback or issuance activity.

Book value per ordinary share increased by $5.73 in the year to December 31, 2010 as compared to an increase of $9.18 during 2009. The increase in 2010 was a result of improved investment portfolio fair values, higher net income and the impact of share buyback activity. During 2010, there was a decrease in net unrealized losses on available for sale investments of $1.1 billion, net of tax, as compared to December 31, 2009. The improved investment portfolio fair values were due in large part to declining interest rates during 2010 but also tightening spreads.

Net income attributable to ordinary shareholders increased by $378.9 million during 2010 compared to the same period in the previous year. This increase was comprised of an increase in net income attributable to XL-Ireland of $568.4 million offset by a decrease of $195.2 million in the gains associated with the two

67


separate purchases of portions of the Company’s Redeemable Series C Preference Ordinary Shares that were completed during the first nine months of each of 2010 and 2009.

During the third quarter of 2007, the Company’s Board of Directors approved a share buyback program, authorizing the Company to purchase up to $500.0 million of its ordinary shares. As of January 1, 2010, $375.4 million ordinary shares remained available for purchase under this program. During the third quarter of 2010, the Company purchased and cancelled 13.9 million ordinary shares under this program for $268.6 million. During October 2010, the Company purchased and cancelled 4.9 million ordinary shares for $106.8 million. In combination, these purchases totaled $375.4 million, the full amount remaining under this buyback program.

On November 2, 2010, the Company announced that its Board of Directors approved a new share buyback program, authorizing the Company to purchase up to $1.0 billion of its ordinary shares. During the fourth quarter of 2010, the Company purchased and cancelled 6.9 million ordinary shares for $144.0 million under the 2010 buyback program. Between January 1 and February 22, 2011, the Company purchased and cancelled an additional 5.3 million shares for $121.3 million under the 2010 buyback program. As of February 22, 2011, $734.7 million remains available for purchase under this buyback program.

Book value per ordinary share increased by $9.18 in the year ended December 31, 2009. During 2009, there was a decrease in net unrealized losses of $2.2 billion, net of tax. Although there was significant quarter-to-quarter volatility, in aggregate the impact of tightening credit spreads combined with the benefit from declining interest rates resulted in overall increased book value. Book value was further increased by the issuance of 11,461,080 shares issued at $65.00 per share upon the maturity of the purchase contracts associated with the 7.0% Equity Security Units, as such issuance was accretive to book value. In addition, book value per ordinary share increased as a result of net income attributable to ordinary shareholders of $206.6 million which included a $211.8 million gain associated with the purchase of a portion of the Company’s Redeemable Series C Preference Ordinary Shares.

Fully diluted book value per ordinary share is a non-GAAP financial measure and represents book value per ordinary share combined with the impact from dilution of share based compensation including in-the-money stock options at any period end. Fully diluted book value per ordinary share increased by $5.18 and increased by $9.14 during the years ended December 31, 2010 and 2009, respectively, as a result of the factors noted above.

Return on average ordinary shareholders’ equity

Return on average ordinary shareholder’s equity (“ROE”) is another non-GAAP financial measure that management considers important in evaluating the Company’s operating performance. ROE is calculated by dividing the net income for any period by the average of the opening and closing ordinary shareholders’ equity. The opening and closing ordinary shareholders’ equity amounts were determined by subtracting from opening and closing shareholders’ equity attributable to XL-Ireland, the non-controlling interest in equity of consolidated subsidiaries and the preference ordinary shareholders’ equity balances. The Company establishes minimum target ROEs for its total operations, segments and lines of business. If the Company’s minimum ROE targets over the longer term are not met with respect to any line of business, the Company seeks to modify and/or exit these lines. In addition, among other factors, the Company’s compensation of its senior officers is dependent on the achievement of the Company’s performance goals to enhance shareholder value as measured by ROE (adjusted for certain items considered to be “non-operating” in nature).

In 2010, ROE was 6.5%, 3.4 percentage points higher than for the same period in the prior year when it was 3.1%. This was the result of increased net income which was largely offset by significantly higher equity levels during 2010 following the increase in the fair value of the Company’s investment portfolio.

In 2009, ROE was 3.1%, significantly higher than for the same period in the prior year when it was negative, mainly as a result of the closing of the Master Agreement in August 2008, see Item 8, Note 4 to the Consolidated Financial Statements, “Syncora Holdings Ltd.” Shareholders’ equity increased over the past twelve months mainly as a result of the decreases in unrealized losses on investments and favorable foreign exchange translation adjustments during this period.

68


Significant Items Affecting the Results of Operations

The Company’s net income and other financial measures as shown above for the year ended December 31, 2010 have been affected by the following significant items, among other things:

 

1)

 

 

 

impact of different levels of catastrophe and large loss events;

 

2)

 

 

 

continuing competitive factors impacting the underwriting environment;

 

3)

 

 

 

net favorable prior year loss development; and

 

4)

 

 

 

impact of credit market movements in 2010, 2009 and 2008 on the Company’s investment portfolio and investment fund affiliates;

1. Impact of different levels of catastrophe and large loss events

Net losses incurred from natural catastrophes were higher in 2010 at $294.3 million as compared to $52.3 million in 2009. Notable natural catastrophes during 2010 included the Chilean Earthquake, European Windstorm Xynthia, U.S. tornadoes and hailstorm activity, the New Zealand Earthquake and floods in Central Europe, China, Poland and Queensland, Australia. In addition, other large loss events as well as property losses relating to the Deepwater Horizon oil rig contributed to the higher risk losses in 2010 than during 2009.

Management’s preliminary loss estimate of the total loss exposure in 2010 to the Queensland floods, net of reinsurance and reinstatement premium, was approximately $23.3 million, of which $18.3 million is attributable to the Insurance segment and $5.0 million to the Reinsurance segment. Loss estimates are based on industry loss data and reports from policy holders. The Australian flooding events continued in 2011 so additional losses in the range of $75-95 million are expected in the first quarter of 2011.

Management’s preliminary loss estimate of the total property loss exposure to the Deepwater Horizon oil rig, net of reinsurance and reinstatement premium, was approximately $27.4 million, of which $12.5 million is attributable to the Insurance segment and $14.9 million to the Reinsurance segment.

The Company is a major writer of large, complex energy-related (re)insurance coverages and manages its exposure through, among other items, the purchase of reinsurance. The Company continues to assess its potential third party liability exposures arising out of the Deepwater Horizon oil rig explosion in the Gulf. However, given that the facts are still developing, as well as the complexities of the nature of the event, including indemnities from BP p.l.c., other defenses to liability based on contract and common law and coverage issues, it is too early to estimate losses at this time.

Net losses in 2009 decreased by $794.1 million over 2008, primarily due to lower levels of large property risk and catastrophe losses occurring in 2009 as compared to 2008. On September 1, 2008, Hurricane Gustav hit the Louisiana coast of the U.S. as a Category 2 hurricane, causing considerable damage to insured property and loss of life. On September 13, 2008, Hurricane Ike made landfall near Galveston, Texas as a strong Category 2 hurricane, causing significantly more damage and loss of life than Hurricane Gustav. Hurricane Ike was the third costliest hurricane to ever make landfall in the U.S. In 2008, the Company incurred losses, net of reinsurance recoveries and reinstatement premiums, of $22.5 million and $210.0 million related to Hurricanes Gustav and Ike, respectively. In addition to natural peril catastrophes, there was also an increase in large property risk losses globally during 2008 that contributed to higher loss ratios in both the Insurance and Reinsurance segments.

Overall, 2009 experienced a lower number of natural catastrophes as compared to 2008. In 2009, natural catastrophes included Hailstorm Wolfgang, Japanese earthquake, Windstorm Klaus, Typhoon Ketsana, Asian earthquake and tsunami and Australian wildfires.

For further details see the segment results in the “Income Statement Analysis” below.

2. Continuing competitive factors impacting the underwriting environment

Soft market conditions were experienced across most lines of business throughout 2008, 2009 and 2010, resulting in an overall decrease in gross and net premiums written. For further information in relation to the underwriting environment, including details relating to rates and retention, see “Executive Overview – Underwriting Environment,” above.

69


3. Net favorable prior year loss development

Net favorable prior year loss development occurs when there is a decrease to loss reserves recorded at the beginning of the year, resulting from actual or reported loss development for prior years that is less than expected loss development. Net prior year adverse loss development occurs when there is an increase to loss reserves recorded at the beginning of the year, resulting from actual or reported loss development for prior years exceeding expected loss development.

The following table presents the net (favorable) adverse prior year loss development of the Company’s loss and loss expense reserves for its property and casualty operations which include the Insurance and Reinsurance segments for each of the years indicated:

 

 

 

 

 

 

 

(U.S. dollars in millions)

 

2010

 

2009

 

2008

Insurance segment

 

 

$

 

(127.4

)

 

 

 

$

 

(62.9

)

 

 

 

$

 

(305.5

)

 

Reinsurance segment

 

 

 

(245.5

)

 

 

 

 

(221.8

)

 

 

 

 

(305.2

)

 

 

 

 

 

 

 

 

Total

 

 

$

 

(372.9

)

 

 

 

$

 

(284.7

)

 

 

 

$

 

(610.7

)

 

 

 

 

 

 

 

 

During 2010, net favorable prior year development totaled $372.9 million in the Company’s property and casualty operations and included net favorable development in the Insurance and Reinsurance segments of $127.4 million and $245.5 million, respectively. See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and Item 8, Note 11 to the Consolidated Financial Statements, “Losses and Loss Expenses,” for further information regarding the developments in prior year loss reserve estimates for each of the years indicated within each of the Company’s operating segments.

4. Impact of credit market movements in 2010, 2009 and 2008 on the Company’s investment portfolio and investment fund affiliates

During the year ended December 31, 2010, interest rates declined in the Company’s major markets combined with tightening of corporate and structured credit spreads. The net impact of the market conditions on the Company’s investment portfolio for the year resulted in an improvement of $1.1 billion in the net unrealized loss position on available for sale investments as compared to December 31, 2009. This represents approximately a 2.5% appreciation on average assets for the year ended December 31, 2010.

The following table provides further detail regarding the movements in the global credit markets, as well as in government interest rates using some sample market indices:

 

 

 

 

 

 

 

Interest Rate Movement for the year
ended December 31, 2010 (1)
(‘+’/‘-’ represents increases / decreases
in interest rates)

 

Credit Spread Movement for the year ended December 31, 2010 (2)
(‘-’ represents tightening of credit spreads)

United States

 

-67 basis points (5 year Treasury)

 

-28 basis points (US Corporate A rated)

 

 

+5 basis points (3 month LIBOR)

 

+24 basis points (US Agency RMBS, AAA rated)

 

 

 

 

-137 basis points (US CMBS, AAA rated)

United Kingdom

 

-62 basis points (10 year Gilt)

 

-5 basis points (UK Corporate, AA rated)

Euro-zone

 

-59 basis points (5 year Bund)

 

+23 basis points (Europe Corporate, A rated)


 

 

(1)

 

 

 

Source: Bloomberg Finance L.P.

 

(2)

 

 

 

Source: Merrill Lynch Global Indices.

Net realized losses on investments in the year ended December 31, 2010 totaled $270.8 million, including net realized losses of approximately $205.1 million related to the impairment of certain of the Company’s fixed income, equity and other investments, where the Company determined that there was an other-than- temporary decline in the value of those investments. For further analysis of this, see “Results of Operations” below.

Other Key Focuses of Management

Throughout 2010 and into 2011, the Company remains focused on, among other things, tailoring the Company’s business model to focus on core P&C business, optimizing the P&C investment portfolio, and enhancing its enterprise risk management capabilities. The Company continues to focus on those lines of business within its Insurance and Reinsurance segments that provide the best return on capital. The

70


Company’s derisking efforts within the P&C investment portfolio are substantially complete and, as a result of this progress, the Company is focused on optimizing the P&C investment portfolio. Details relating to the enterprise risk management and other initiatives are outlined below.

Capital Management

Fundamental to supporting the Company’s business model is its ability to underwrite business, which is largely dependent upon the quality of its claims paying and financial strength ratings as evaluated by independent rating agencies. As a result, in the event that the Company is downgraded, its ability to write business, as well as its financial condition and/or results of operations, could be adversely affected.

During the third quarter of 2007, the Company’s Board of Directors approved a share buyback program, authorizing the Company to purchase up to $500.0 million of its ordinary shares. As of January 1, 2010, $375.4 million ordinary shares remained available for purchase under this program. During the third quarter of 2010, the Company purchased and cancelled 13.9 million ordinary shares under this program for $268.6 million. During October 2010, the Company purchased and cancelled 4.9 million ordinary shares for $106.8 million. In combination, these purchases totaled $375.4 million, the full amount remaining under this buyback program.

On November 2, 2010, the Company announced that its Board of Directors approved a new share buyback program, authorizing the Company to purchase up to $1.0 billion of its ordinary shares. During the fourth quarter of 2010, the Company purchased and cancelled 6.9 million ordinary shares for $144.0 million under the 2010 buyback program. Between January 1 and February 22, 2011, the Company purchased and cancelled an additional 5.3 million shares for $121.3 million under the 2010 buyback program. As of February 22, 2011, $734.7 million remains available for purchase under this buyback program.

In addition, on February 12, 2010, the Company redeemed approximately 4.4 million Series C Preference Ordinary Shares with a liquidation value of $110.8 million for approximately $94.2 million. As a result, a book value gain to ordinary shareholders of approximately $16.6 million was recorded in the first quarter of 2010.

Risk Management

The Company’s risk appetite framework guides its strategies relating to, among other things, capital preservation, earnings volatility, net worth at risk, operational loss, liquidity standards, capital rating and capital structure, with the objective of preserving the Company’s capital base. This framework also addresses the Company’s tolerance to risks from material individual events (e.g., natural or man-made catastrophes such as terrorism), the Company’s investment portfolio, realistic disaster scenarios that cross multiple lines of business and risks related to some or all of the above that may actualize concurrently.

In relation to event risk management, the Company establishes net underwriting limits for individual large events as follows:

 

1.

 

 

 

The Company imposes limits for each peril region/event type at a 1% exceedance probability. If the Company was to deploy the full limit, for any given peril region/event type, there would be a 1% probability that an event would occur during the next year which would result in a net underwriting loss in excess of the limit.

 

2.

 

 

 

The Company also imposes limits for each natural catastrophe peril region at a 1% tail value at risk (“TVaR”) probability. This statistic indicates the average amount of net loss expected to be incurred given that a loss above the 1% exceedance probability level has occurred.

 

3.

 

 

 

The Company also imposes limits for certain other event types at a 0.4% exceedance probability as described in further detail below. If the Company were to deploy the full limit, for any given event type, there would be a 0.4% probability that an event would occur during the next year which would result in a net underwriting loss in excess of the limit.

For planning purposes and to calibrate risk tolerances for business to be written from September 30, 2010 through September 30, 2011, the Company set its underwriting limits as a percent of September 30, 2010 Tangible Shareholders’ Equity (hereafter, “Tangible Shareholders’ Equity”). Tangible Shareholders’ Equity is defined as Total Shareholders’ Equity less Goodwill and Other Intangible Assets. These limits

71


may be recalibrated, from time to time, to reflect material changes in Total Shareholders’ Equity that may occur after September 30, 2010, at the discretion of management and as overseen by the Board.

Per event 1% exceedance probability underwriting limits for “Tier 1 event types,” which include natural catastrophes, terrorism and other realistic disaster scenarios, are set at a level not to exceed approximately 15% of Tangible Shareholders’ Equity.

Per event 1% TVaR underwriting limits for certain peak natural catastrophe peril regions approximate 20% of Tangible Shareholders’ Equity. 1% TVaR underwriting limits for non-peak natural catastrophe peril regions are set below the per event 1% TVaR limits described above.

Per event 1% exceedance probability underwriting limits for “Tier 2 event types,” which include country risk, longevity risk and pandemic risk, are set at a level not to exceed 7.5% of Tangible Shareholders’ Equity.

Per event 0.4% exceedance probability underwriting limits for “Tier 2 event types” are set at a level not to exceed 15% of Tangible Shareholders’ Equity. The 0.4% exceedance probability limit is used for Tier 2 event types rather than a TVaR measure due to the difficulty in estimating the full distribution of outcomes in the extreme tail of the distribution for these risk types as required for the TVaR measure.

In all instances, the above referenced underwriting limits reflect pre-tax losses net of reinsurance and net of inwards and outwards reinstatement premiums related to the specific events being measured. The limits are not net of underwriting profits expected to be generated in the absence of catastrophic loss activity.

In setting underwriting limits, the Company also considers such factors as:

 

 

 

 

Correlation of underwriting risk with other risks (e.g. asset/investment risk, operational risk, etc.);

 

 

 

 

Model risk and robustness of data;

 

 

 

 

Geographical concentrations;

 

 

 

 

Exposures at lower return periods;

 

 

 

 

Expected payback period associated with losses;

 

 

 

 

Projected share of industry loss; and

 

 

 

 

Annual aggregate losses at a 1% exceedance probability and at a 1% TVaR level on both a peril region/risk type basis as well as at the portfolio level.

Loss exposure estimates for all event risks are derived from a combination of commercially available and internally developed models together with the judgment of management, as overseen by the Board. Actual incurred losses may vary materially from the Company’s estimates. Factors that can cause a deviation between estimated and actualized loss potential include:

 

 

 

 

Inaccurate assumption of event frequency and severity;

 

 

 

 

Inaccurate or incomplete data;

 

 

 

 

Changing climate conditions may add to the unpredictability of frequency and severity of natural catastrophes in certain parts of the world and create additional uncertainty as to future trends and exposures;

 

 

 

 

Future possible increases in property values and the effects of inflation may increase the severity of catastrophic events to levels above the modeled levels;

 

 

 

 

Natural catastrophe models incorporate and are critically dependent on meteorological, seismological and other earth science assumptions and related statistical relationships that may not be representative of prevailing conditions and risks, and may therefore misstate how particular events actually materialize, causing a material deviation between forecasted and actual damages associated with such events; and

 

 

 

 

A change in the judicial climate.

For the above and other reasons, the incidence and severity of catastrophes and other event types are inherently unpredictable and it is difficult to predict the timing of such events with statistical certainty or estimate the amount of loss any given occurrence will generate. As a consequence, there is material

72


uncertainty around the Company’s ability to measure exposures associated with individual events and combinations of events. This uncertainty could cause actual exposures and losses to deviate from those amounts estimated below, which in turn can create a material adverse effect on the Company’s financial condition and results of operations and may result in substantial liquidation of investments, possibly at a loss, and outflows of cash as losses are paid.

The table below shows the Company’s estimated per event net 1% and 0.4% exceedance probability exposures for certain peak natural catastrophe perils regions. These estimates assume that amounts due from reinsurance and retrocession purchases are 100% collectible. There may be credit or other disputes associated with these potential receivables.

 

 

 

 

 

 

 

 

 

 

 

 

 

Geographical Zone
(U.S. dollars in millions)

 

Peril

 

Measurement
Date
of In-Force
Exposures (1)

 

1-in-100 Event

 

1-in-250 Event

 

Probable
Maximum
Loss (1)

 

Percentage
of Tangible
Shareholders’
Equity at
December 31,
2010

 

Probable
Maximum
Loss (2)

 

Percentage
of Tangible
Shareholders’
Equity at
December 31,
2010

California

 

 

 

Earthquake

 

 

 

 

July 1, 2010

 

 

 

$

 

549

 

 

 

 

5.6

%

 

 

 

$

 

853

 

 

 

 

8.7

%

 

U.S.

 

 

 

Windstorm

 

 

 

 

July 1, 2010

 

 

 

 

890

 

 

 

 

9.1

%

 

 

 

 

1,210

 

 

 

 

12.4

%

 

Europe

 

 

 

Windstorm

 

 

 

 

July 1, 2010

 

 

 

 

390

 

 

 

 

4.0

%

 

 

 

 

552

 

 

 

 

5.6

%

 

Japan

 

 

 

Earthquake

 

 

 

 

July 1, 2010

 

 

 

 

219

 

 

 

 

2.2

%

 

 

 

 

309

 

 

 

 

3.2

%

 

Japan

 

 

 

Windstorm

 

 

 

 

July 1, 2010

 

 

 

 

134

 

 

 

 

1.4

%

 

 

 

 

226

 

 

 

 

2.3

%

 


 

 

(1)

 

 

 

Detailed analyses of aggregated In-force exposures and maximum loss levels are done periodically. The measurement dates represent the date of the last completed detailed analysis by geographical zone.

 

(2)

 

 

 

Probable maximum losses include secondary uncertainty which incorporates variability around the expected probable maximum loss for each event, does not represent the Company’s maximum potential exposures and are pre-tax.

Regulatory Change

Management continues to actively monitor the various regulatory bodies and initiatives that impact the Company globally and assess the potential for significant impact on results or operations. The European Commission is in the process of implementing changes to the prudential regulation of European insurers, known as Solvency II, with a timeline to achieve full compliance by 2013. Solvency II is designed to impose economic risk-based solvency requirements across all EU Member States. Advice and implementation consists of three pillars: (1) Pillar I – quantitative capital requirements, based on a valuation of the entire balance sheet; (2) Pillar II – qualitative regulatory review, which includes governance, internal controls, enterprise risk management and supervisory review process, and (3) Pillar III – market discipline, which is accomplished through reporting of the insurer’s financial condition to regulators and the public. Other jurisdictions such as Bermuda and Canada are in the process of implementing consistent changes to strengthen their capital and risk management requirements in order to be considered equivalent for purposes of group regulatory considerations. The Company has significant resources supporting the regulatory process, such as the Solvency II Quantitative Impact Studies and Bermuda Monetary Authority regulatory data calls, and these resources are also actively engaged in the implementation of Solvency II related measures across the Company.

Strategy Implementation

As a continuing part of the Company’s focus on strategy, management has created an Office of Strategic Growth, headed by Greg Hendrick, Executive Vice President, Strategic Growth, that oversees the implementation of the strategic plan, coordinates the implementation work plans and creates planning milestones and metrics for success. Specifically, along with the Leadership Team, this office is focusing on, among other matters, the acquisition of talent and teams as well as areas in which XL can innovate and capitalize on its underwriting expertise.

Critical Accounting Policies and Estimates

The following are considered to be the Company’s critical accounting policies and estimates due to the judgments and uncertainties affecting the application of these policies and/or the likelihood that materially

73


different amounts would be reported under different conditions or using different assumptions. If actual events differ significantly from the underlying assumptions or estimates applied for any or all of the accounting policies (either individually or in the aggregate), there could be a material adverse effect on the Company’s results of operations, financial condition and liquidity. These critical accounting policies have been discussed by management with the Audit Committee of the Company’s Board of Directors.

Other significant accounting policies are nevertheless important to an understanding of the Company’s Consolidated Financial Statements. Policies such as those related to revenue recognition, financial instruments and consolidation require difficult judgments on complex matters that are often subject to multiple sources of authoritative guidance. See Item 8, Note 2 to the Consolidated Financial Statements, “Significant Accounting Policies.”

1) Unpaid Loss and Loss Expenses and Unpaid Loss and Loss Expenses Recoverable

As the Company earns premiums for the underwriting risks it assumes, it also establishes an estimate of the expected ultimate losses related to the premium. Loss reserves for unpaid loss and loss expenses are established due to the significant periods of time that may elapse between the occurrence, reporting and settlement of a loss. The process of establishing reserves for unpaid property and casualty claims can be complex and is subject to considerable variability, as it requires the use of informed estimates and judgments. These estimates and judgments are based on numerous factors, and may be revised as additional experience and other data become available and are reviewed, as new or improved methodologies are developed or as current laws change. Loss reserves include:

 

a)

 

 

 

Case reserves – reserves for reported losses and loss expenses that have not yet been settled; and

 

b)

 

 

 

IBNR losses – reserves for incurred but not reported losses or for reported losses over and above the amount of case reserves.

Case reserves for the Company’s property and casualty operations are established by management based on amounts reported from insureds or ceding companies and consultation with legal counsel, and represent the estimated ultimate cost of events or conditions that have been reported to or specifically identified by the Company. The method of establishing case reserves for reported claims differs among the Company’s operations.

With respect to the Company’s insurance operations, the Company is notified of insured losses and records a case reserve for the estimated amount of the settlement, if any. The estimate reflects the judgment of claims personnel based on general reserving practices, the experience and knowledge of such personnel regarding the nature of the specific claim and, where appropriate, advice of legal counsel. Reserves are also established to provide for the estimated expense of settling claims, including legal and other fees and the general expenses of administering the claims adjustment process. With respect to the Company’s reinsurance operations, case reserves for reported claims are generally established based on reports received from ceding companies. Additional case reserves may be established by the Company to reflect the estimated ultimate cost of a loss. The uncertainty in the reserving process for reinsurers is due, in part, to the time lags inherent in reporting from the original claimant to the primary insurer to the reinsurer. As a predominantly broker market reinsurer for both excess-of-loss and proportional contracts, the Company is subject to a potential additional time lag in the receipt of information as the primary insurer reports to the broker who in turn reports to the Company. As of December 31, 2010, the Company did not have any significant backlog related to its processing of assumed reinsurance information.

Since the Company relies on information regarding paid losses, case reserves and IBNR provided by ceding companies in order to assist it in estimating its liability for unpaid losses and LAE, the Company maintains certain procedures in order to help determine the completeness and accuracy of such information. Periodically, management assesses the reporting activities of its ceding companies on the basis of qualitative and quantitative criteria. In addition to conferring with ceding companies or brokers on claims matters, the Company’s claims personnel conduct periodic audits of specific claims and the overall claims procedures of its ceding companies at their offices. The Company relies on its ability to effectively monitor the claims handling and claims reserving practices of ceding companies in order to help establish the proper reinsurance premium for reinsurance agreements and to establish proper loss reserves. Disputes with ceding companies have been rare and generally have been resolved through negotiation.

74


As noted above, case reserves for the Company’s reinsurance operations are generally established based on reports received from ceding companies. Additional case reserves may be established by the Company to reflect the Company’s estimated ultimate cost of a loss. In addition to information received from ceding companies on reported claims, the Company also utilizes information on the pattern of ceding company loss reporting and loss settlements from previous catastrophic events in order to estimate the Company’s ultimate liability related to catastrophic events such as hurricanes. Commercial catastrophe model analyses and zonal aggregate exposures are utilized to assess potential client loss before and after an event. Initial cedant loss reports are generally obtained shortly after a catastrophic event, with subsequent updates received as new information becomes available. The Company actively requests loss updates from cedants periodically for the first year following an event. The Company’s claim settlement processes also incorporate an update to the total loss reserve at the time a claim payment is made to a ceding company.

While the reliance on loss reports from ceding companies may increase the level of uncertainty associated with the estimation of total loss reserves for property reinsurance relative to direct property insurance, there are several factors which serve to reduce the uncertainty in loss reserve estimates for property reinsurance. First, for large natural catastrophe events, aggregate limits in property catastrophe reinsurance contracts are generally fully exhausted by the loss reserve estimates. Second, as a reinsurer, the Company has access to information from a broad cross section of the insurance industry. The Company utilizes such information in order to perform consistency checks on the data provided by ceding companies and is able to identify trends in loss reporting and settlement activity and incorporate such information in its estimate of IBNR reserves. Finally, the Company also supplements the loss information received from cedants with loss estimates developed by market share techniques and/or from third party catastrophe models applied to exposure data supplied by cedants.

IBNR reserves represent management’s best estimate, at a given point in time, of the amount in excess of case reserves that is needed for the future settlement and loss adjustment costs associated with claims incurred. It is possible that the ultimate liability may differ materially from these estimates. Because the ultimate amount of unpaid losses and LAE is uncertain, the Company believes that quantitative techniques to estimate these amounts are enhanced by professional and managerial judgment. Management reviews the IBNR estimates produced by the Company’s actuaries who determine the best estimate of the liabilities to record in the Company’s financial statements. The Company considers this single point estimate to be the mean expected outcome.

IBNR reserves are estimated by the Company’s actuaries using several standard actuarial methodologies including the loss ratio method, the loss development or chain ladder method, the Bornhuetter-Ferguson (“BF”) method and frequency and severity approaches. IBNR related to a specific event may be based on the Company’s estimated exposure to an industry loss and may include the use of catastrophe modeling software. On a quarterly basis, IBNR reserves are reviewed by the Company’s actuaries, and are adjusted as new information becomes available. Any such adjustments are accounted for as changes in estimates and are reflected in the results of operations in the period in which they are made.

The Company’s actuaries utilize one set of assumptions in determining the single point estimate, which includes actual loss data, loss development factors, loss ratios, reported claim frequency and severity. The actuarial reviews and documentation are completed in accordance with professional actuarial standards with reserves established on a basis consistent with U.S. GAAP. The selected assumptions reflect the actuary’s judgment based on historical data and experience combined with information concerning current underwriting, economic, judicial, regulatory and other influences on ultimate claim settlements.

When estimating IBNR reserves, each of the Company’s insurance and reinsurance business units segregate business into exposure classes (over 150 classes are reviewed in total). Within each class, the business is further segregated by either the year in which the contract incepted (“underwriting year”), the year in which the claim occurred (“accident year”), or the year in which the claim is reported (“report year”). The majority of the Insurance segment is reviewed on an accident year basis. Professional lines insurance business is reviewed on a report year basis due to the claims made nature of the underlying policies. The majority of the Reinsurance segment is reviewed on an underwriting year basis.

Generally, initial actuarial estimates of IBNR reserves not related to a specific event are based on the loss ratio method applied to each class of business. Actual paid losses and case reserves (“reported losses”) are subtracted from expected ultimate losses to determine IBNR reserves. The initial expected ultimate

75


losses involve management judgment and are based on historical information for that class of business; which includes loss ratios, market conditions, changes in pricing and conditions, underwriting changes, changes in claims emergence, and other factors that may influence expected ultimate losses.

Over time, as a greater number of claims are reported, actuarial estimates of IBNR are based on the BF and loss development techniques. The BF method utilizes actual loss data and the expected patterns of loss emergence, combined with an initial expectation of ultimate losses to determine an estimate of ultimate losses. This method may be appropriate when there is limited actual loss data and a relatively less stable pattern of loss emergence. The chain ladder method utilizes actual loss and expected patterns of loss emergence to determine an estimate of ultimate losses that is independent of the initial expectation of ultimate losses. This method may be appropriate when there is a relatively stable pattern of loss emergence and a relatively larger number of reported claims. Multiple estimates of ultimate losses using a variety of actuarial methods are calculated for each of the Company’s (150+) classes of business for each year of loss experience. The Company’s actuaries look at each class and determine the most appropriate point estimate based on the characteristics of the particular class and other relevant factors, such as historical ultimate loss ratios, the presence of individual large losses, and known occurrences that have not yet resulted in reported losses. Once the Company’s actuaries make their determination of the most appropriate point estimate for each class, this information is aggregated and presented to management for review and approval.

The pattern of loss emergence is determined using actuarial analysis, including judgment, and is based on the historical patterns of the recording of paid and reported losses by the Company, as well as industry information. Information that may cause historical patterns to differ from future patterns is considered and reflected in expected patterns as appropriate. For property, marine and aviation insurance, losses are generally reported within 2 to 3 years from the beginning of the accident year. For casualty insurance, loss emergence patterns can vary from 3 years to over 20 years depending on the type of business. For other insurance, loss emergence patterns fall between the property and casualty insurance. For reinsurance business, loss reporting lags the corresponding insurance classes by at least one quarter due to the need for loss information to flow from the ceding companies to the Company generally via reinsurance intermediaries. Such lags in loss reporting are reflected in the actuary’s selections of loss reporting patterns used in establishing the Company’s reserves.

Such estimates are not precise because, among other things, they are based on predictions of future developments and estimates of future trends in claim severity, claim frequency, and other issues. In the process of estimating IBNR reserves, provisions for economic inflation and changes in the social and legal environment are considered, but involve considerable judgment. When estimating IBNR reserves, more judgment is typically required for lines of business with longer loss emergence patterns.

Due to the low frequency and high severity nature of some of the business underwritten by the Company, the Company’s reserve estimates are highly dependent on actuarial and management judgment and are therefore uncertain. In property classes, there can be additional uncertainty in loss estimation related to large catastrophe events. With wind events, such as hurricanes, the damage assessment process may take more than a year. The cost of claims is subject to volatility due to supply shortages for construction materials and labor. In the case of earthquakes, the damage assessment process may take several years as buildings are discovered to have structural weaknesses not initially detected. The uncertainty inherent in IBNR reserve estimates is particularly pronounced for casualty coverages, such as excess liability, professional liability coverages, and workers’ compensation, where information emerges relatively slowly over time.

The Company’s three types of property and casualty reserve exposure with the longest tails are:

 

(1)

 

 

 

high layer excess casualty insurance;

 

(2)